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US insurance regulation is unconstitutional
Insurance regulation in the United States differs markedly from other types of financial services regulation. While banks and securities firms must comply with extensive federal regulations, insurers are regulated primarily by the states.
In practice, however, the most important and powerful entity in insurance regulation is not a state at all. In fact, it isn't even a government entity. It is, instead, a private, nonprofit corporation known as the National Association of Insurance Commissioners (NAIC).
Comprised of elected and appointed insurance commissioners from across the country, as well as a roughly 500-person staff, the NAIC produces handbooks and manuals that have the force of law in every U.S. state.
These materials contain many of the most important rules of insurance regulation. For instance, they determine what pieces of information insurers must report to their regulators, how much money insurers must set aside to pay future claims and what accounting standards insurers must use when calculating assets and liabilities.
The NAIC's handbooks and manuals determine these core rules of insurance regulation because each state has passed laws incorporating these materials "by reference." As a result, when the NAIC's members vote to update the materials, as they do on a regular basis, the effect is to change insurance laws and regulations in every state across the country.
This process long has been taken for granted as simply the way things are done. It shouldn't be. There are real and important questions - raised by observers who range from congressmen to former commissioners to prominent think tanks - about whether the NAIC's power over insurance regulation is constitutional.
State constitutions vary, but they all vest power to make law in a legislative branch and they all limit legislatures' authority to delegate that power elsewhere, especially to a private entity like the NAIC.
Given these constitutional limitations, one might expect insurance companies to challenge the NAIC's authority in court. Thus far, they've refrained from doing so, perhaps mindful of the retaliation they would face. Emboldened by this lack of resistance, the NAIC has crammed more and more of the substance of insurance regulation into its cross-referenced materials. The result has been to increase the organization's power and to decrease democratic accountability.
The reasons why are threefold. First, while the NAIC is controlled by state insurance regulators, it is not subject to the safeguards that usually apply to government bodies, such as freedom of information laws and notice-and-comment requirements. Second, the NAIC's actions aren't subject to dedicated and independent oversight by any court or administrative agency. Third, and most importantly, state legislatures lack any practical means to claw back their authority from the NAIC.
This last point requires some explanation: state legislatures' inability to limit the NAIC's power stems from the organization's unique accreditation program. The U.S. system of regulation requires that states defer to the financial supervision of each insurer's home-state regulator; otherwise, multi-state insurers would face regulatory scrutiny in every state where they sold coverage.
But the NAIC's accreditation program prohibits accredited states from deferring to non-accredited states. At the same time, the program requires that accredited states incorporate-by-reference the various NAIC materials described above. As a result, states that tried to take back their power from the NAIC would soon face a crisis; their insurance departments would lose their NAIC accreditation, causing local insurers to flee or else face independent scrutiny in every state where they do business.
But there are options to reassert home rule and democratic accountability without losing the undeniable benefits that flow from state regulators' nationwide coordination. For instance, states could create an interstate compact to review NAIC materials that have the force of law.
This would rein in the power currently held by an unaccountable private organization and limit the risk of biased rules, while preserving the efficiencies that come from centralizing the production of insurance rules. Whether though an interstate compact or alternative approach, states can and should take back their power over insurance regulation by holding the NAIC accountable.
Daniel Schwarcz is professor of law at the University of Minnesota Law School and the author of "Is U.S. Insurance Regulation Unconstitutional?" R.J. Lehmann is director of finance, insurance and trade policy at the R Street Institute in Washington, D.C.