NATIONAL ASSOCIATION OF INDEPENDENT INSURERS TESTIMONY OF JOHN R. GRAHAM Subcommittee on Oversight & Investigations Mr. Chairman, Members May 22, 1991 of the Subcommittee, John R. Graham and I am Ladies and Gentleman, my name is Executive Vice President and Chief Executive Officer of the Kansas Farm Bureau Mutual Insurance Company. I am speaking today on behalf of the National Association of Independent Insurers (NAII), a trade association of more than 560 property/casualty insurance companies. NAII members account for more than 25 percent of the total property/casualty insurance premium written in the United States today. I am appearing in my apacity as a member of the Board of Governors of the NAII and Chairman of the NAII Task Force on Improved Solvency Regulation. means - The National Association of Independent Insurers firmly believes that the best of providing sound, solvent insurance companies for the consumers of America 1S the National Association of Insurance Commissioners' (NAIC) solvency policing agenda and certification program a program that builds on and upgrades the Current system of state insurance regulation. Imposing federai regulation 25 standards on insurance companies would lead to dual federal, state :egulation. This would create enormous financial burdens for insurance companies without improving availability or affordability for Consumers. This Subcommittee and its Chairman are to be commended for their diligent work in identifying existing flaws and for giving a push to the process that we believe will result in an improved, and even more effective solvency system ader state regulation without the need for federal legislation. - The NAII is vitally interested in insurance solvency regulation and the cost to the public when insurance companies fail. There are two basic motivations for NAIX interest in insurer solvency. First, the reliability of the insurance promise is essential to maintaining public confidence in insurance services. To the extent insurer insolvencies shake this public confidence, it becomes more difficult for all insurers to maintain credibility with their policyholders. Second, through the operation of state insurance guaranty associations the cost of insurer insolvencies is absorbed by financially sound insurers and their policyholders. While it is sometimes alleged that this passed 2 policyholders as an invisible Cost Even if these expense of the insurance product. he fact :S that market competition and rate regulatory pressures ften prevent juch 3 result. costs can be passed to policyholders. however. they lead to policyholder dissatisfaction with higher insurance premiums. Thus, NAII member companies have a very direct and practical interest in minimizing the cost of insurer insolvencies. Background The NAII as played a leading role in advocating improvements to insurer solvency regulation. In April 1989 our NAII Task Force on Solvency published 3 report entitled "Insurer Solvency: Public Policy Recommendations for Improvement". The report was the culmination of a year-long study of insurer solvency requiation to determine what specific regulatory actions were needed to coister insolvency detection and prevention. The study produced 26 specific recommendations. most of which have been incorporated into the NAIC Minimum Financial Pegulation Standards. These standards are now being actively implemented in the states. As of May 1991, more than 169 bills have been introduced in 28 states in an effort to enact specific components of the NAIC Minimum Standards. We at the NAII are proud of our role in recommending improvements to insurer solvency regulation and working to implement those Improvements in the various states. Cur work to improve insurer solvency regulation neither with started nor stoped 1989 report. however. In July 1990 the NAII Board of Governors established 313 Second Task Force on Improved Solvency Regulation. I am Chairman of Task Force. The focus of our second Task Force has been on possible structural changes to the current regulatory system that can make the System Fore effective in reducing the frequency and cost of insurer We ave examined a number of proposals for improving the Turrent system from both a pre-insolvency and post-insolvency perspective. My Comments today are based principally on the evaluations made within the ramework :: our NAII Task Force on Improved Solvency Regulation. Goals of Insurer Solvency Regulation In ur work identify proposals for enhancing insurer solvency regulation we determined that 12 was necessary to first identify the public policy goals of insurer Davency equiation. Considerable attention was devoted to this were identified. First, the Task Force determined nat WAS ssential that the public be protected from insurer failures. This means finding some mechanism for replacing the essential benefits of the .nsurance contract written by an insolvent insurer. Second, it was determined hat any system for regulating insurer solvency should attempt to minimize the the pubiic if an insolvency occurs. Four particular approaches to ost were identified: (1) early detection and quick action to prevent roubled insurers from becoming insolvent, (2) timely removal of falling ::surers from the marketplace. (3) efficient and effective liquidation insurers. and (4) minimizing the cost of guaranty fund The NAII believes that any proposals for improving existing insurer solvency regulation should be evaluated within the framework of these minimizing f inso.vent protection. In the course of our discussions two additional considerations regarding the goals of insurer solvency regulation were highlighted. First, it was recognized that it is neither possible nor desirable to eliminate all insurer insolvencies. The risk of insolvency is the price to be paid for a competitive, frèe market economy. Although greater security can be provided by tightening requirements for market entry and performance standards, this can only be achieved at the cost of reducing players in the market and diversity of insurance services. Secondly, all regulation generates costs. The goal of protecting the public from insurer insolvency must be balanced with the resources available to achieve that goal. While complete security is theoretically achievable, the cost of complete protection is not practical. The challenge to public policy makers is to assess the relative cost of additional solvency regulation and choose those enhancements which improve protection at acceptable costs. NAII Supports State Solvency Regulation Having identified the goals of insurer solvency regulation as protecting the public from insurer failures and minimizing cost when failures occur, our NAII Task Force believes the current state system for insurer solvency regulation meets both goals but can be improved. We strongly support state regulation of insurer solvency and the NAIC effort to upgrade state regulation through the NAIC Minimum Financial Regulation Standards. We recognize that no regulatory system is perfect; there are ample examples at both the federal and state levels of regulatory systems that have failed to achieve their stated objectives. States have regulated insurer solvency for more than 100 years, however, and have weathered a major economic depression, numerous recessions, severe natural catastrophes and volatile business cycles. We see no benefit in replacing this time-tested state system for an undefined, unproven and less responsive federal system. State regulation of insurer solvency is not perfect but it works: we support improvements, not replacements or substitutions, to the current system. Protection of the Public. Any system of insurer solvency regulation must as its primary goal seek to protect the public from insurer failures. A primary vehicle for achieving this protection is a mechanism that "insures" or "guarantees" performance of the insolvent insurer's obligation. This is achieved for property/casualty insurers through state guaranty funds in each of the 50 states, the District of Columbia and Puerto Rico. Insurers doing property/casualty insurance business in each state are required to pay to the state guaranty fund. These assessments are used to pay whose insurer has been declared assessments claims of policyholders and claimants insolvent. Despite imperfections, the property/casualty state guaranty fund system has worked well in paying claims of insolvent insurers. This Committee has not been deluged with complaints from insurance policyholders and claimants that their property/casualty guaranty fund protection has failed. To the contrary, few policyholders and claimants protected by state property/casualty insurance guaranty funds have Cost the benefit of their insurance protection. We believe the state effort to protect the public through property/casualty insurance guaranty funds is exemplary. Questions have been raised recently about the capacity of property/casualty insurance quaranty funds to meet potential future insolvencies. As a whole. that state guaranty fund system is capable of generating approximately $4 billion in assessments based on 1990 written premium. Cumulative assessments to cover the cost of claims of all property/casualty insurer insolvencies from 1969 to 1989 amounted to less than $3.5 billion. Thus, as a whole. the state system is capable of generating more assessment capacity in a single year than has been needed to cover every property/casualty insolvency occurring over the past 20 years. While circumstances can be imagined that would severely test and possibly cause the system to fail, the reasonableness and probability of such circumstances must be considered. Taken as a whole, the NAII believes the existing state property/casualty guaranty fund system is capable of meeting the cost of any reasonably foreseeable future insolvencies. In short. the state system protects the public as well as any system can. Reducing Cost of Insolvency. Even though the public is protected by the current state property/casualty insurance guaranty fund system, the cost of such protection must be examined. Insolvency costs can be reduced by reducing the number of insolvencies or by reducing the cost of insolvencies. From our perspective. the NAIC Minimum Financial Regulation Standards offer a reasonable likelihood of both reducing insolvencies and reducing the cost of insolvencies. The NAII, therefore. supports the NAIC Minimum Financial Pequiation Standards as the most feasible vehicle for improving insurer solvency regulation. We believe the NAIC Minimum Financial Regulation Standards will work to reduce the number of insurer insolvencies by implementing regulatory requirements that improve the early detection of potential insolvencies. Requiring independent CPA audits and actuarial certification of loss reserves are two important components of the NAIC program that will certainly improve detection of insolvency. Improvements to examination scheduling and resources devoted to solvency regulation will also greatly increase the likelihood of detecting insurer insolvencies. These and many other elements of the NAIC program lead the NAII to strongly support the NAIC effort. We urge this Committee to allow the NAIC and its state certification program sufficient time to demonstrate its capacity to improve insurer solvency regulation. We urge that no federal action be taken until enough time has elapsed to properly judge the effectiveness of the NAIC effort. Even though the NAII strongly supports the NAIC Minimum Financial Regulation program, we believe improvements can nevertheless be made to the minimum standards and state regulation of insurer solvency. One area which we believe deserves particular attention is the timely removal of insolvent insurers from the marketplace. NAII member companies which pay assessments to state property/casualty guaranty funds are concerned that regulatory action to remove an insurer sometimes comes too late and too infrequent. Although the NAIC Model Regulation to Define Standards and Commissioner's Authority for Companies Deemed to be in Hazardous Financial Condition provides a tool to the regulator to take action against troubled insurers, market and political pressures can often act to dilute the :egulatory will. While We recognize here are 112 easy answers timely action against potentially insolvent insurers. Our NAII Task Force on Improved Solvency Regulation is focusing heavily 20 ideas for enhancing timely action. Phased implementation of a properly structured risk-based capitalization requirement new +2 taking -4 is one such idea that holds promise for improving the likelihood of prompt regulatory action. We would simply observe that timely removal of insolvent is as much a challenge to state regulation of banking and other financial institutions from the market insurance regulation as it is to federal financial institutions. Role of Federal Government The NAII believes Congress and the federal government can play an important part in improving insurer solvency regulation. One important role which this Committee has played has been to review the performance of the states in regulating insurer solvency. This Committee's report Failed Promises Insurance Company Insolvencies was a major catalyst in the development of improved state regulation of reinsurance transactions. Attached is a chart that highlights the major findings of the Failed Promises report with respect to reinsurance and actions taken by the NAIC to bolster oversight of reinsurance transactions. By highlighting weaknesses in the regulation of reinsurance this Committee has been instrumental in strengthening state laws. Historically, Congressional investigations have precipitated legislative actions in the states to address vexing insurance problems. The Dodd hearings he mid-1960s, for example, eventually led to the promulgation of property casualty Juaranty funds in the 1970s. The NAII applauds this Subcommittee for its diligence and professionalism in raising public Consciousness Concerning needed improvements to state laws. We welcome and encourage the ngoing oversight of state insurance regulation provided by Congress and particularly by this Subcommittee. In addition to its ongoing oversight function, Congress has another important role to play in attacking the problems of insurer insolvencies. That role is to address the complex socio/economic issues that underlie threats to insurer solvency. One 1s the cleanup of hazardous waste sites and the uncertain liabilities imposed under Superfund. Another is the potential disaster facing the United States in the event of a catastrophic earthquake. Yet another is he disincentives for capital formation that exist under current federal tax policies. We believe these and other issues pose serious long-term threats to insurer solvency hat can only be addressed at the federal level. We urge Congress and the federal government to address these real threats to insurer solvency by making the difficult public policy decisions that must be made to preserve the integrity of the insurance promise. Finally, it 15 the strong sentiment of the NAII that regulation of insurer solvency be retained exclusively at the state level. We see no role for the federal government as a regulator of insurer solvency that would in any respect improve upon the existing state system. Existing problems and obstacles to insurer solvency would continue to exist if the locus of regulation was moved in whole or in part from the state to the federal level. In our opinion. it is not the level of government that is the problem; it is the economic forces and social environment in which insurance functions that poses he most serious insurer solvency. Disintermediation, internationai ompetition. the movement from a manufacturing to a service economy. taxation pressures resulting from budgetary deficits, environmental pollution, the liability explosion and the demographics of an aging population present formidable challenges to the stability of our financial institutions. amply demonstrated by the recent savings and loan crisis, the federal 1 threat |