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Monday, February 14, 2011

Insurance Regulation: Federal Charter Legislation

Baird Webel
Specialist in Financial Economics

Insurance is one of three primary sectors of the financial services industry. Unlike the other two, banks and securities, insurance is primarily regulated at the state, rather than federal, level. The primacy of state regulation dates back to 1868 when the Supreme Court found in Paul v. Virginia (75 U.S. (8 Wall.) 168 (1868)) that insurance did not constitute interstate commerce, and thus did not fall under the powers granted the federal government in the Constitution. In 1944, however, the Court cast doubt on this finding in United States v. South-Eastern Underwriters Association (322 U.S. 533 (1944)). Preferring to leave the state regulatory system intact in the aftermath of this decision, Congress passed the McCarran-Ferguson Act of 1945 (P.L. 79-15, 59 Stat. 33), which reaffirmed the states as principal regulators of insurance. Over the years since 1945, congressional interest in the possibility of repealing McCarran-Ferguson and reclaiming authority over insurance regulation has waxed and waned.

Particularly since the Gramm-Leach-Bliley Act of 1999 (P.L. 106-102, 113 Stat. 1338), the financial services industry has seen increased competition among U.S. banks, insurers, and securities firms and on a global scale. Some have complained that the state regulatory system puts insurers at a competitive disadvantage. Whereas the insurance industry had previously been united in preferring the state system, it has now splintered, with larger insurers tending to argue for a federal system and smaller insurers tending to favor the state system.

Some Members of Congress have responded with different proposals ranging from a complete federalization of the interstate insurance industry, to leaving the state system intact with limited federal standards and preemptions. A common proposal in the past has been for an Optional Federal Charter (OFC) for the insurance industry. This idea borrows the idea of a dual regulatory system from the banking system. Both the states and the federal government would offer a chartering system for insurers, with the insurers having the choice between the two. OFC legislation was offered in the 107
th, 109th, and 110th Congresses.

Proponents of OFC legislation typically have cited the efficiencies that could be gained from a uniform system, along with the ability of a federal regulator to better address the complexities of the current insurance market and ongoing financial crisis as well as the need for a single federal voice for the insurance industry in international negotiations. Opponents of OFC legislation have been typically concerned with the inability of a federal regulator to take into account local conditions, the lack of consumer service that could result from a nonlocal administrator in Washington, DC, and the overall deregulation contained in some of the OFC proposals.

The recent financial crisis gave greater urgency to calls for federal oversight of insurance and has changed the tenor of the debate. The National Insurance Consumer Protection Act of 2009 (H.R. 1880) was introduced in the 111
th Congress by two previous sponsors of OFC legislation. This bill differed significantly from previous OFC bills as it included the creation of a new systemic risk regulator with the power to mandate the adoption of a federal charter by some insurers. The broad Dodd-Frank Act (P.L. 111-203) that was enacted to reform the financial system included some insurance aspects, but did not include a federal charter for insurance. Such legislation has not been introduced in the 112th Congress.

This report offers a brief analysis of the forces prompting federal chartering legislation, followed by a discussion of the arguments for and against a federal charter, and summaries of previous legislation.

Date of Report: February 3, 2011
Number of Pages: 13
Order Number: RL34286
Price: $29.95

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