AAI Paper Discusses Pros, Cons of Optional Federal Chartering; Finds State Regulation—With Changes—Best

August 21, 2002

While desperately in need of a tune up, state regulation of insurance continues to make economic sense and should not be junked for an untested federal system that will bring with it a new set of problems, according to the conclusion of a new study and white paper commissioned by the Alliance of American Insurers.

The study is “Optional Federal Chartering of Property/Casualty Insurance Companies,” prepared by Scott Harrington, Ph.D., of the University of South Carolina’s Moore School of Business. It examines the latest issues surrounding the debate over state versus federal regulation of the insurance industry using both historical evidence and economic principles.

“The results clearly show that optional federal chartering of property/casualty insurers is not in the best interest of policyholders and taxpayers,” Alliance President Rodger Lawson commented. “That being said, the state system is sorely in need of reform. Reforming the state system is a much more sensible approach to solving the efficiency problem, rather than destroying the system and starting over, or developing a competitive system that confers special regulatory benefits that could otherwise skew the nature of market competition.”

The possible benefits from optional federal chartering—a reduction in inefficient regulation of rates and forms, achievement of regulatory scale and scope economies and promotion of desirable regulatory competition—are all hypothetical, the study found. They are subject to real uncertainties and are probably modest at best, while the potential risk and costs of optional federal chartering are comparatively large. A federal system would necessitate “modifications in insurance guaranty funds and data sharing arrangements that would undermine safety, soundness and healthy competition. It also would ultimately produce broader restrictions on insurance pricing and underwriting, which would increase cross-subsidies among policyholders, place taxpayers at risk and inefficiently distort policyholders’ incentives to reduce the risk of loss. The better and more prudent policy is to reject federal chartering and encourage and support further modernization of state regulation,” the study states.

“State insurance regulators already have responded admirably to the challenge, with a vast majority passing producer licensing reciprocity legislation in response to the Gramm-Leach-Bliley Act,” Lawson noted. “In addition, nearly half the states have eliminated costly prior approval regulation of rates and/or policy forms for commercial policyholders, while many others have taken other steps to streamline operations.”

In its efforts to improve the current state system, the Alliance advocates

• Standardization of company licensing requirements.
• Adoption of self-certification system for forms.
• Adoption of comprehensive commercial lines rate reform.
• Standardization of filing memoranda and procedures for review.
• Passage of producer licensing model acts where needed.
• Development of a management system that will allow the development of comparative information on department performances.
• Doing as much as possible immediately within existing laws and regulations.

“The Alliance has a long history of research and discourse to promote the public interest, and in commissioning this study, it hopes this research will enable public policy makers to respond wisely to the arguments for change being presented,” Lawson said. “It also is the Alliance’s hope that this study will encourage ongoing efforts to improve the efficiency of the regulation of the property/casualty insurance industry.”

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