Regulating without a net: States must walk a tightrope of regulatory reform and consumer protections or risk losing their oversight of the nearly $1 trillion insurance industry.

• Author: Calvo, Cheye
• Position: Statistical Data Included

When Kentucky Representative Steve Riggs discusses the value of state insurance regulation, he likes to tell the story of the Lakedreamland Volunteer Fire Department of Jefferson County. The small local company took out a group life insurance policy from an out-of-state company. Years passed until a tragic event took the life of one of the firefighters. When the widow filed the claim on her husband's life, however, the insurance company falsely told her that the policy only covered career firefighters--excluding the entire company of volunteers who had paid a decade's worth of premiums. Riggs called the state insurance department, and the claim quickly was paid.

This story isn't an isolated incident. But it is an example of how state regulation works--at a time when some in the industry are pressing for federal oversight of the $956 billion business.

"One hundred and ninety-nine claims out of 200 are paid without a problem, but it's important that the state has the authority to act when that one problem occurs," Riggs says. "If insurance was federally regulated, consumers would have to go through Washington, D.C., and an IRS-style bureaucracy. The policyholder probably would have to hire an "inside the Beltway" attorney, claims could take months, if settled at all, and people could miss mortgage payments or go without basic needs."

Insurance serves as the cornerstone of the economy. It guards against unforeseen risk and allows people to take chances that they otherwise may not. In a day when a corporate giant like Enron can disappear virtually overnight and take with it billions in retirement funds, insurance companies maintain reserves to pay claims when and if benefits are due, years in the future, even if the company goes bankrupt. And if the unthinkable occurs--as on Sept. 11--insurers provide the money to rebuild and cover economic losses.

Yet the insurance marketplace has changed. State regulators are under continuous fire to reform the 150-year-old system of regulation to meet the needs of the modern economy. The industry wants some combination of uniformity, deregulation and greater coordination among states. It now has the support of key members of Congress, who echo industry calls for modernization and show serious interest in direct federal oversight. Some in the industry have backed proposals for an optional federal charter, which would preempt state laws and allow companies to select state or federal regulation.

What's become clear is that states will no longer regulate the industry simply because they always have. State insurance commissioners have made impressive strides over the last two years to upgrade and coordinate regulatory practices--and their work continues--but Congress wants states to go further. The real test is whether legislatures can enact reforms that meet federal and industry pressures while maintaining the consumer protections that give state insurance regulation its value.

A MODERN MARKETPLACE

When Congress dealt with insurance regulation in the past, the industry united behind continued state oversight. Now some groups are leading the charge for a federal role.

These groups argue that state inefficiencies and patchwork requirements place some national insurers at a competitive disadvantage against federally regulated banks and securities firms in the modern financial marketplace. Pressure on insurance companies heightened with the passage of the Financial Modernization Act of 1999-also called Gramm-Leach-Bliley. This act tore down Depression-era barriers and allowed insurance, banking and securities firms to affiliate with one another.

Traditional industry supporters--like groups that represent life and some property and casualty insurers-haven't turned to the federal option casually, but are responding to specific grievances. For example, as the growth areas of life insurers have shifted from traditional policies to annuities and other innovative products, these companies find their primary competitors to be banks and securities firms. Where federally regulated banks may self-certify that new products meet federal standards, and mutual funds can obtain the approval of the Securities and Exchange Commission in a couple of months, it commonly takes 12 to 18 months for a life insurer to get an annuity product approved in all 50 states.

"That was fine when the shelf life of a new product was seven or eight years," says Gary Hughes, general counsel for the American Council of Life Insurers. "But it's now about two years, and that's just not good math for the industry."

Life insurers don't seek to avoid consumer protections, Hughes says, but instead want consistently applied uniform standards that allow them to speed products to market in all states within a reasonable time.

Property and casualty insurers, on the other...