Current Issues Seminar: Changing the Regulatory Landscape
Former Superintendent Levin's Remarks as Prepared for Delivery
January 12, 2000
New York State and the New York State Insurance Department welcome the long anticipated arrival of comprehensive modernization for the financial services industry.
This legislation is 20 years in the making since Secretary Regans first comprehensive proposal in 1981, S.1720, which was proposed in the era of "stocks and socks."
With the passage of the Gramm-Leach-Bliley Act, we look forward to the United States capital markets remaining preeminent.
We also look forward to the U.S. financial services industry being able to rationalize their operating structures and to compete more effectively in the global market.
Up until now, the domestic industry has operated within a regulatory landscape which was a patchwork of court cases and administrative actions.
More specifically, I will also tell you about the legislation from the perspective of the New York State Insurance Department. On the whole, let me say that I am pleased with the final outcome of the legislation and its adherence to functional regulation.
I have long been an advocate of functional regulation and continue to believe that it serves the interests of consumers and companies alike.
I know that during the long public debate over H.R. 10 and S.900 some were concerned about the role state insurance regulation would have under this new structure.
But, the final legislation preserves the traditional role of state insurance regulators as primary supervisors of insurance underwriting and sales.
As Congressman Leach noted during the House deliberations on the Act, the "bill provides for functional regulation with state and federal banking regulators overseeing banking activities, state and federal securities regulators governing securities activities and the state insurance commissioners looking over the operation of insurance companies and sales."
And Representative Bliley said: "[A]ctivities should be regulated with the same strong consumer protections and safeguards no matter where the activity takes place. This is called functional regulation, and functional regulation means that everyone gets the same oversight, the same rules, with no special advantage towards any party. . . . It is common sense, and it is right."
The legislation explicitly reaffirms the McCarran-Ferguson Act, recognizing, in the words of the Conference Report, "the primacy and legal authority of the states to regulate insurance activities of all persons." This is very important relative to what might have happened to McCarran-Ferguson.
The states' role in licensing insurers and producers, and in regulating certain affiliations, insurance sales and other activities is also spelled out.
And as you all know, Financial Holding Companies that wish to engage in insurance underwriting must do so in an affiliate and cannot locate those activities in a subsidiary of a depository institution. While I recognize the preference of the banking industry to underwrite insurance out of the bank, or at least out of an operating subsidiary, I believe the affiliate structure facilitates functional regulation and protects the FDIC and the surplus of any insurance underwriting affiliate.
At the same time, such a fundamental change in the way financial services will be regulated does inevitably present challenges for all financial regulators.
One of the first challenges will be to establish a meaningful dialogue amongst the various financial regulators.
The passage of Gramm-Leach-Bliley should also cause Insurance regulators to examine their fundamental supervisory practices and regulatory issues.
In each instance, we must examine whether the results of a particular regulatory activity justify continued reliance on it?
And, if it does, are there less intrusive methods of achieving the same regulatory goals?
Our responsibilities increasingly will overlap with those of other state and federal regulators and, quite frankly, our performance will be judged in relation to their results as well in terms of both effectiveness and efficiency.
In actual fact, many insurance regulators have been considering these questions for several years, and have been re-thinking their approach to solvency regulation and consumer protection.
In New York over the last few years we have been preparing to move away from performing triennial exams to conducting more frequent risk-based exams, following the lead of the bank regulators.
I believe that a move towards real-time insurance supervision is essential as we begin to see the emergence of these new Financial Holding Companies engaged in banking, securities underwriting and insurance underwriting, and as other regulators begin to rely on our work product.
The day of the "one size fits all" regulatory approach is over. In the future, regulators will need to be flexible, tailoring their oversight to reflect the activities and risks being undertaken by each company they supervise.
I would like now to address some of the major thematic issues or challenges insurance regulators will be considering in implementing the Financial Modernization Act.
Let me begin with interagency consultation which I mentioned earlier.
One of the first challenges for regulators is to establish clear and efficient lines of communications with the other state and federal agencies who share responsibility for the institutions and markets we supervise. Post- BCCI bank regulators enhanced their communication and cooperation. We in the regulatory community must meet the challenge, and we must do it quickly.
As you are all aware, the Act establishes the Federal Reserve as the umbrella supervisor for Financial Holding Companies in recognition of the Feds important national role in preserving the stability of our financial system and conducting monetary policy.
As I mentioned previously, the Act also strongly promotes the concept of functional regulation.
The Fed is directed to rely, to the fullest extent possible, on existing examinations and reports prepared by or for other regulators, including state insurance regulators. Moreover, in general the Fed is not authorized to prescribe capital requirements on functionally regulated subsidiaries and the same provisions apply to the other federal banking regulators.
State insurance regulators also retain authority to prohibit capital contributions the Fed may have directed an insurer to make to a subsidiary or affiliate depository institution, if such contributions would have a material adverse effect on the insurer.
The Fed can require in such cases, however, that the holding company divest itself of its depository institution.
Obviously, this will make for an interesting regulatory minuet. This legislation demands that the regulatory work together fully and cooperatively.
Regulators will need to coordinate their efforts in order to provide the most effective regulation with the least possible inconvenience to the companies being supervised.
Regulators will need to avoid duplicative requests to our companies, though hopefully, under the parameters of functional regulation of holding company subsidiaries, regulatory overlap should be kept to a minimum.
And we will need to be aware of each others examination and reporting schedules. That way, when we do require information about an affiliate of one of our regulated institutions, those needs can be identified and articulated in a timely fashion and, wherever possible, addressed as part of the regular ongoing dialogue between that affiliate and its primary functional regulator. By doing so, we can avoid unnecessary and disruptive special requests for information.
We in New York have already begun to establish a dialogue with bank regulators. For some time now, the New York Insurance Department has been participating in regularly scheduled meetings with banking regulators to discuss issues of mutual concern. In addition, the Connecticut Insurance Department, as the home regulator for Travelers Insurance has been working closely with the N.Y.Fed in overseeing Citigroup.
The Act also encourages federal banking regulators to share and to receive information, in each case on a confidential basis, and to provide notice and to consult with state insurance regulators before taking actions that affect any affiliates engaging in insurance activities.
Of course, this information sharing is predicated on the ability of the state insurance regulator to similarly keep such information in confidence and make all reasonable efforts to oppose disclosure of such information.
We have reviewed New York law and determined that no Freedom of Information Law or other statutory provisions impede a full and confidential exchange of information between other financial regulators and us.
I should add as well that, while Gramm-Leach-Bliley naturally focuses on the need for state-federal regulatory coordination, there is an equally important interstate and even intrastate dimension to be considered.
The New York Insurance Department has been partnering actively with the other states, through the National Association of Insurance Commissioners, to coordinate the increased sharing of electronic databases. This will facilitate more efficient communications and access to information for consumers and the industry while, at the same time, reducing compliance costs. It also will allow the individual state insurance departments to redirect resources to other critical areas.
At the intrastate level, New Yorks Insurance and Banking Departments have worked closely together over the past several years in monitoring the border area where insurance and banking converge and in addressing issues arising under New Yorks Wild Card law with respect to bank insurance sales activities.
FINANCIAL HOLDING COMPANIES
Next I would like to touch briefly on a few issues relating to the Financial Holding Company provisions.
Financial Holding Companies are permitted to engage in activities that are financial in nature or incidental or complementary to such financial activities.
The definition of "financial in nature" includes insurance underwriting, agency activities and insurance company portfolio investments.
The Fed has primary jurisdiction to flesh out what additional activities not specifically included in the definition will be deemed financial in nature, or incidental or complementary thereto.
Insurance regulators will need to monitor closely how these definitions evolve because of their potential to complicate the functional regulation of bank insurance activities.
One would hope that the creativity of the marketplace does not give rise to regulatory conflict over product definitions.
The Act is clear that insurance underwriting and insurance company portfolio investment activities cannot occur in the bank, or a subsidiary. Rather, these functions must be located in an affiliate within the Financial Holding Company.
At the same time, bank subsidiaries that meet certain criteria now will be permitted to engage in many new non-bank activities, including activities that are financial in nature or incidental to a financial activity.
The NAIC, for one, has suggested that an expansive reading of these terms could include many aspects of the insurance business, including: sales, acting as third party administrator, acting as managing general agent, handling claims and investment and reserve services.
To the extent these insurance activities will be performed in a bank subsidiary and as the lines of functional regulation begin to blur, the need for communication among regulators and a clear understanding of each supervisors responsibilities is further underscored.
Another issue to be addressed is the potential impact on insurer solvency as a result of the limitations on commercial activities by non-bank Financial Holding Companies. Existing commercial activities will be permitted for a ten-year period, with a possible extension for an additional five years, but only to the extent such activities do not account for more than 15% of the holding companys annual gross revenues (not including revenues from depository institutions).
Insurers will need to have a plan to divest themselves in an orderly fashion of any excess commercial activities upon joining a Financial Holding Company, and of all such activities within the statutory time frame.
In general, states are not allowed to prevent or restrict a depository institution from an affiliation permitted under federal law, including, of course, affiliations with insurers.
An only slightly less rigorous standard preempts state laws that prevent or significantly interfere with the ability of insurers themselves to become a Financial Holding Company or to acquire control of a depository institution.
When an affiliation between a bank and an insurer is proposed, state insurance regulators are allowed to collect information about the transaction if it involves a company doing an insurance business in their jurisdiction.
But, only the regulators in the insurers state of domicile have the authority to approve or disapprove the proposed change or continuation of control.
The affiliating insurer's state of domicile also may require that capital is maintained at, or restored to, the level required under state law.
These provisions offer yet another illustration of the need for interagency consultation under the Act.
In affiliations between banks and insurers, insurance regulators in states where the insurer does business, but is not domiciled, will need to coordinate closely with their counterparts in the state of domicile in order to voice any concerns they may have with respect to the proposed affiliation.
The Act also imposes a time frame for making these comments, which also will need to be clarified. The statute describes a sixty-day period measured backwards from the transactions effective date, but, of course, it may not be possible in all cases to know the effective date sixty plus days in advance.
The Conference Report, on the other hand, declares that any such action must be taken within sixty days of receiving notice of the affiliation, a more readily measured, but potentially different time period from the one articulated in the Act.
The Act further provides that state regulators actions cannot discriminate, intentionally or unintentionally, against the depository.
The standards focus on effect rather than intent adds some measure of uncertainty to the review process since it is possible that state actions that are facially neutral nevertheless could be determined to have a discriminatory effect.
It may not be tenable, to say nothing of fair, to have one set of time frames, procedures and scope of review applicable when a bank is a party to the transaction and another, presumably more cumbersome, intrusive and time consuming one that applies when a bank is not involved. There is clearly a burden on insurance regulators to accelerate their review process for all transactions.
In practice, insurance regulators will need to reevaluate their procedures governing all affiliations so that a consistent and fair set of standards will apply.
Certainly, it cant be the right answer to invite a situation where an affiliation transaction is structured to include a bank, less for business reasons, than in order to secure expedited regulatory review.
INSURANCE SALES ACTIVITIES
The standard set forth in the Barnett Bank case is adopted with respect to insurance sales activities. States may not prevent or significantly interfere with such activities by depository institutions or their affiliates.
Thirteen safe harbors are provided, however, identifying areas such as anti-tying rules and consumer disclosures, where states are permitted to impose a number of restrictions on the insurance sales process.
State laws addressing these topics are not subject to federal preemption.
A number of the safe harbor provisions already are contained both in New Yorks Insurance Law as well as in the Banking Law and were adopted as part of New Yorks Wild Card statute.
As I mentioned earlier, the two Departments have worked closely together in policing bank insurance sales practices since, and even prior to, the Barnett decision in 1996. We will be reviewing whether New York law requires any further revisions to reflect the safe harbor provisions. Other states will, no doubt, be doing the same.
The Act also directs the federal banking agencies, in consultation with state insurance regulators, to prescribe customer protection regulations to address bank insurance sales practices.
Federal and New York State regulators went through a similar exercise in 1996 after the Barnett decision.
For example, the New York State Insurance Department worked with the State Banking Department on an advisory letter to identify issues banks might wish to consider when they engage in insurance sales programs.
The Act permits states to override the federal provisions by adopting legislation within three years of the regulations adoption.
But this override authority appears to be contingent upon the state having adopted regulations to implement the privacy protections outlined elsewhere in the Act.
Therefore, insurance regulators should be prepared to provide constructive suggestions as the new federal customer protection regulations are formulated.
They will, simultaneously, need to be moving forward with respect to privacy regulations in order to preserve the override option should they wish to avoid federal preemption of portions of their own consumer protection provisions.
Finally, the Act directs the federal banking agencies to establish a consumer complaint mechanism to address alleged violations of the customer protection safeguards.
Many states already have well-established consumer services programs in their insurance and banking departments.
For example, the New York State Insurance Departments Consumer Services Bureau handles 60,000 consumer complaints each year and has recently launched an innovative online computer tracking and management system to streamline and speed the dispute resolution process.
If the federal and state consumer complaint functions are not coordinated, there is the risk that effort and resources will be wasted, confusion will result, and the effort to assist consumers will be retarded rather than helped.
OTHER INSURANCE ACTIVITIES
Except with respect to insurance sales, states may not prevent or restrict a depository institution or its affiliate from engaging in any activity permitted under the Act.
State regulation of insurance activities will not be preempted, however, to the extent it:
- Is for the purpose of regulating insurance in accordance with the McCarran-Ferguson Act.
- Such regulation applies only to non-depositories.
- It doesnt speak to insurance sales activities.
- And it isnt prohibited pursuant to Acts non-discrimination standards.
Insurance regulators will need to watch closely how this area evolves because the reverse preemption provision described above does not explicitly apply to activities conducted directly in a bank or a bank subsidiary.
As noted above, a number of insurance functions may be allowed to take place inside the bank.
The concern is that an over-broad reading might result in federal preemption of state regulation of non-sales-related insurance activities conducted inside the bank.
If that occurred, then many important state laws and regulations addressing issues like consumer protection, fair claims settlement and medical privacy could be nullified to that extent.
For example, in early November Congressman Dingell was reported to have expressed concerns that this might mean that HMOs could evade state regulation by having a bank process their claims.
Although it also must be pointed out that Sullivan & Cromwell, among others, have suggested that the ability of insurers with managed care operations to affiliate with banks may be open to question.
Such results would not appear to serve a compelling purpose to the extent these laws are uniformly applied to everyone that engages in the insurance activity being regulated.
Neither would they further the Acts goal of promoting broad powers under a system of strong functional regulation.
Nevertheless, ongoing review will be required.
The applicability of the Acts discrimination standard results in some complication determining how disputes between federal and state regulators are to be resolved.
The Act provides that, except for regulations concerning sales activities as permitted by the safe harbors, states cant regulate insurance activities permitted under the Act to the extent such regulation:
- Discriminates on its face against depositories;
- Has a "substantially more adverse" impact on depositories than others;
- Effectively prevents depositories from engaging in insurance; or
- Conflicts with the Acts intent generally to permit affiliations.
This discrimination standard does not apply, however, to state regulations governing insurance sales, outside the specific safe harbor provisions, if such regulations were adopted before September 3, 1998.
At the same time, the Acts equalized dispute resolution mechanism which provides that courts will adjudicate conflicts between a state insurance regulator and a federal regulator concerning insurance issues "without unequal deference" to the federal agency also does not apply in such cases.
As a result, two different procedures will be used to resolve such disputes between state and federal regulators.
In challenges concerning state insurance sales laws or regulations adopted prior to September 3, 1998, OCC deference will still apply, but the state provision will not be held to the Acts discrimination standard.
With respect to laws or regulations adopted after that date, the reverse will be true. Courts will adjudicate the dispute "without unequal deference" to the federal regulator. On the other hand, the state action will be subject to the discrimination provision.
Obviously, opportunities exist for confusing results and the process will require close monitoring.
REDOMESTICATION OF MUTUAL INSURERS
One of the more significant insurance provisions contained in the Act creates a federal law right for mutual insurers to redomesticate to another jurisdiction in order to form a mutual holding company if the state in which they are domiciled has not adopted reasonable terms for them to do so.
Governor Pataki proposed in each of the last two legislative sessions a comprehensive mutual holding company bill which would provide New Yorks mutual life insurers access to capital markets, combined with important policyholder safeguards that are superior to provisions found in many other state mutual holding company acts.
The New York State Assembly failed to pass this legislation, however, citing philosophical objections to the mutual holding company concept.
But, the question for New York, and for other states without mutual holding company legislation, is no longer whether or not we like mutual holding companies.
With the passage of this Act, the only real question remaining is, since we cannot prevent their formation, shouldnt we enact reasonable terms to permit insurers to establish mutual holding companies in their current states of domicile and thereby protect jobs and our role as these insurers primary state regulators?
We again will be urging the Assembly to enact the comprehensive, balanced and reasonable provisions contained in the Governors mutual holding company legislation.
Note, however, that the exception to the Acts redomestication provisions is not automatic. It only applies to mutual insurers in states that adopt legislation to establish "reasonable terms and conditions" for the formation of mutual holding companies.
Let me repeat that, the exception is for legislation whose terms are reasonable. States that attempt to enact legislation loaded up with onerous impediments to the formation of mutual holding companies still may find themselves exposed to challenge and possibly subject to the Acts redomestication provisions.
NATIONAL ASSOCIATION OF REGISTERED AGENTS AND BROKERS
Another of the Acts major insurance provisions concerns the proposed National Association of Registered Agents and Brokers which is meant to encourage the states to establish uniform or reciprocal requirements for the licensing of insurance agents.
Representative Sue Kelly (R-NY) observed that such efforts are long overdue and read the following quotation:
"The Commissioners are now fully prepared to go before their various legislative committees with recommendations for a system of insurance law which shall be the same in all statesnot reciprocal, but identical, not retaliatory, but uniform."
The quote belongs to a predecessor of mine; New York Superintendent of Insurance George W. Miller and was made at the NAICs very first meeting in 1871!!
It is not necessary to review here the detailed provisions set forth for the establishment and operation of NARAB, other than to note that NARAB will not be created if a majority of the states are able to establish uniform or reciprocal licensing provisions within three years.
The clear preference of the states is that they meet the challenge imposed by the Act and establish uniform or reciprocal laws within the three-year time frame.
The NAIC is in the advanced stages of developing a Producer Licensing Model Act designed to help states satisfy the Acts reciprocity requirement and New York is participating actively in that process.
Finally, let me touch briefly on the Acts important provisions concerning the transfer and use of nonpublic personal information by financial institutions.
Federal regulators, in consultation with state insurance authorities, are directed to establish comprehensive standards for ensuring the security and confidentiality of consumers' personal information maintained by financial institutions.
The relevant agencies are required to consult and coordinate with one another in order to assure, to the maximum extent possible, that the regulations each prescribes are consistent and comparable with those prescribed by the other agencies.
These privacy provisions and related regulations are to be enforced by the state insurance authorities with respect to any person engaged in providing insurance.
The Conference Report declares that it "is the hope of the Conferees that state insurance authorities would implement regulations necessary to carry out the purposes of this title and enforce such regulations as provided in this title."
To further encourage that result, as I mentioned earlier, if a state insurance regulator fails to adopt such regulations, it may lose its right to override the insurance consumer protection regulations to be adopted by the federal banking regulators.
State privacy laws are not superseded by the Act to the extent it is determined that the protections they offer to consumers are greater than those provided by the Act.
State insurance regulators are eager to work with their federal counterparts to implement these privacy requirements.
New York will be working with the NAIC and the broader financial services industry and regulatory community to examine how this sensitive issue of customer privacy should be addressed.
New York will undoubtedly also be looking at areas where additional consumer privacy protections may be warranted. However, it is critical that states attempt to move in the direction of uniformity.
I appreciate the opportunity to participate on todays panel to share the perspectives of the New York State Insurance Department on the Financial Modernization Act.
Thank you also, for your kind attention.
I look forward to continuing our dialogue as we address the challenges and opportunities in the implementation of this historic legislation.