Is Insurance Regulation Unconstitutional?

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Scholar argues that the National Association of Insurance Commissioners’s power to regulate violates states’ constitutions.

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Insurance regulation differs noticeably from other types of financial services regulation in the United States. Most financial services, like banks, must follow federal regulations. Insurers, on the other hand, are primarily regulated by the states.

The entity with the most power to regulate insurers is not a state or a government entity. That power lies with a nonprofit corporation known as the National Association of Insurance Commissioners (NAIC). Much of the NAIC’s power to regulate comes from its publication of various handbooks and manuals creating standards for insurance. These handbooks and manuals are subsequently “incorporated by reference” into state insurance codes, which then gives these materials the force of law.

In a recent paper, Daniel Schwarcz of the University of Minnesota Law School says this scheme is unconstitutional and “violates basic separation of powers and non-delegation principles embedded in every state constitution.” He urges states to eliminate their references to NAIC materials and instead establish an interstate compact that would independently review the NAIC’s authority.

The NAIC currently produces over a dozen handbooks and manuals that have the force of law throughout most of the United States. These materials establish requirements for insurers and other regulated entities and specify what information they must report to regulators, how often they must report, and what standards and methodologies they must employ in preparing their reports.

The NAIC documents have the force of law because most states’ insurance laws require state insurers and regulators to follow the rules found in these NAIC materials. But this means that when the NAIC updates its materials, the state’s insurance rules automatically change as well—but without any action or oversight by those elected to represent the state and make its laws.

In addition, the NAIC effectively forces state lawmakers to delegate authority to the NAIC to set insurance rules. The NAIC accomplishes this through its Financial Standards and Accreditation Program, which requires states to adopt NAIC model laws, or a “substantial equivalents,” to gain accreditation. The NAIC enacted this program to cure the deficiencies found in state insurance solvency regulations in the 1980s and 1990s. Accreditation certifies that the state’s departments meet the “minimum standards.” Failing to gain accreditation could result in tax revenue and employment reductions.

Because the NAIC is a private organization, it does not need to follow the typical steps required to create regulation, including public notice, an opportunity for comment, transparency related to interest groups’ participation in the regulation’s creation, or judicial review and subsequent routine oversight.

Although Schwarcz acknowledges that not all state constitutions contain the same language, he notes that they all give the legislative branch the power to create laws and that legislatures can give this authority to others but with limits. He argues that this delegation of authority to the NAIC particularly violates the constitutions because the NAIC is a private authority and is not subject to any formal review process.

One of the most troubling aspects may be that state legislatures have been unable to reclaim the authority that they have given to the NAIC. No state could even threaten to revoke the authority given to the NAIC, because  it would have tax and employment implications.

Schwarcz recognizes that the existence of state statutes incorporating NAIC materials into state law might suggest that the NAIC’s role in state insurance regulation is constitutional. But he remains unconvinced by that argument because of the “scope of the NAIC’s power and the limited resources of most state insurance departments.”

Schwarcz asserts that the legal problems raised by states’ reliance on the NAIC can be easily remedied. The legislatures or the courts could remove the unconstitutional parts of these laws such that only cross-referenced finalized versions of NAIC materials—which are not delegations of power, but “legislative short-hand”—are given the force of law. This would then allow legislatures to review changes to the cross-referenced materials and decide whether to approve the changes before the material becomes law.

The result of this change would increase the NAIC’s accountability and return power to the states, where Schwarcz argues it “rightly resides.” He asserts that this change might also impact the substance of the materials the NAIC adopts and produces and prevent “shoe-horning controversial or substantive provisions into its manuals and guides.”

Schwarcz admits this approach could have serious implications for the consistency of state regulations. The current approach allows the NAIC to respond uniformly in each state to any regulatory issues that arise. He also notes that the lack of uniform insurance regulation across states has proven to be a problem in the effectiveness of insurance regulation and increases the cost of compliance.

Instead, Schwarcz suggests that states should create an independent entity that would “review the NAIC’s exercise of delegated authority from the states.” This would maintain the NAIC’s role in creating the standards for insurance regulation, but, more importantly, it would subject NAIC actions to review and oversight. This entity, he argues, should be completely separate from the NAIC and state regulators.

Creating this independent entity to review NAIC actions would limit the excessive power exercised by the NAIC while also allowing it to continue creating consistent standards.