grown far more rapidly than expenditures for the regulation of commercial banks and thrifts. GROWTH IN REGULATORY BUDGETS SINCE 1986 Figure 7 · Growth in Regulatory Budgets Since 1986, Comparing State Insurance Departments With Federal Banking and Savings & Loan Agencies Similarly, states have made a significantly stronger commitment to expanding the human resources needed for sound regulation than their federal counterparts (Figure 8). Not only have states increased their commitment to regulation more rapidly than has the federal government, but they have also devoted more resources when measured against the size of the insurance industry than their federal counterparts. While the relationship between industry size and the resultant regulatory burden is difficult to compare among the various financial services industry, one measure of the relationship is the regulatory budget GROWTH IN REGULATORY STAFFS SINCE 1986 Figure 8- Growth in Regulatory Staffs Since 1986, Comparing State Insurance Departments With Federal Banking and Savings & Loan Agencies as a percent of insurance industry premiums and bank and thrift deposits. When looked at this way, state insurance departments devote significantly more resources to the regulation of the insurance industry than their federal counterparts devote to the regulation of banks and thrifts (Figure 9). As these figures suggest, those who would argue that the federal government is more likely to provide a stronger commitment to solid regulation than the states simply have ignored the lessons of recent history. It is not simply a commitment of resources by the states, however, that provides REGULATORY BUDGETS VS. INDUSTRY SIZE Figure 9 Regulatory Budgets Compared to Industry Size, Comparing State insurance consumers with solid protection against the pitfalls of insolvency. The very One such advantage is the two layers of regulatory protection for insurance consumers: (1) regulation by the state of domicile of the insurer, and (2) regulation by the states in which the company is doing business. If regulation in the domiciliary state is inadequate, regulators in other states can still take actions to protect their policyholders. The NAIC's primary focus is on strengthening the first layer of protection, but some of its efforts also strengthen the second layer. Federal preemption of state regulation could undermine this second layer, which could be disastrous if federal regulation proved to be inadequate, as it did over the last decade for other financial institutions. Even short of complete preemption by the federal government is the possibility of federal involvement which could weaken this two-tiered system. A classic example of such a weakening of the second tier by federal involvement can be found in the Liability Risk Retention Act of 1986 (LRRA). Under this act, liability risk retention groups that are licensed in one state can escape the bulk of normal regulatory scrutiny in any other state in which they operate. This aspect of LRRA has created a number of problems for state insurance regulators and the consumers they are pledged to protect, problems that were the subject of a hearing only last month before a Senate Subcommittee. Yet another structural strength of state regulation can be found in the integration of insurance solvency regulation with other aspects of the regulation of the industry. These functions include company and agent licensing, regulation of policy forms and rates, policing insurers' and agents' marketing practices and claims handling, investigating fraud, conducting legislative and policy research, providing consumer information and handling complaints, monitoring competition, addressing availability problems with special market assistance plans, and collecting premium taxes. These activities are critical to protecting the interests of consumers and ensuring that the promises of insurance contracts are fulfilled. The integration of these responsibilities in one agency in each state offers tremendous advantages in coordinating public policy toward insurance and preventing conflicting regulatory actions. Adequate rates do not ensure that a company will remain solvent but inadequate rates will ultimately bring it down. Vesting these responsibilities in one entity helps to ensure that rates will not be allowed to fall to a level that would endanger an insurer's solvency. In addition, by monitoring and regulating all insurer operations, state insurance departments are able to take actions more quickly to prevent solvency problems from occurring. A further advantage of state regulation is one that has been portrayed by critics as a weakness: the incremental nature of change under state regulation. This advantage has two primary aspects. First, novel approaches to regulation in a changing economic environment may be tried by a state without committing the entire regulatory system to those new approaches. Thus, by utilizing the Jeffersonian concept of the states as "laboratories of democracy," state regulation is better suited to innovation than unitary national system. Second, the incremental nature of change in state regulation protects the national system of insurance supervision from sudden and sometimes radical swings in regulatory philosophy. Perhaps if federal and state regulators of the savings and loan industry had not moved a decade ago in lock-step toward deregulation of the industry, at the behest of the President and the Congress, American taxpayers would not be looking at a potential cost of a half-trillion dollar price tag for that policy blunder. IV. THE FINANCIAL CONDITION OF THE INSURANCE INDUSTRY There has been a great deal of speculation in recent months about the health of the American insurance industry. This speculation has ranged from alarmist projections that the industry is on the verge of becoming "the next savings and loan crisis" to the sanguine view |