Since its inception, state insurance regulation has been confronted with the problem of regulating a business that crosses state lines. The insurance business is state, regional, national and international in scope. To cope with a regional and national business, early on the states joined together through the facility of the NAIC to coordinate their activities and achieve the necessary degree of uniformity and/or similarity to enable a nationwide industry to function while at the same time addressing state regulatory concerns. As evidenced by the host of activities discussed throughout this book, for over 120 years the NAIC and the individual states have proven to be resilient and flexible in dealing with insurance regulatory problems. Although far from perfect, this voluntary collective state effort has proven to be a remarkable phenomenon of long duration.

Nevertheless, the virtual exclusivity of state control over the insurance business has long since vanished. Other regulatory disciplines, such as federal antitrust and federal securities laws, have increasingly been applied to the business. Although to date the states continue as the prime regulator of the insurance business, the competing demands of the other relevant regulatory disciplines have needed to be accommodated. This has resulted in a substantial amount of dual state and federal regulation of the business of insurance.

Although not new in nature, perhaps new in intensity have been recent efforts to supplant substantial portions of state insurance regulation with direct federal insurance regulation. The proposed legislation for direct solvency regulation and a federal guaranty fund under a two-tier approach is a recent and dramatic illustration.

The states responded in both characteristic and uncharacteristic manners. The traditional response to addressing defects in solvency regulation, as well as to averting federal intervention, has been activity at the individual state level and voluntary cooperative activity through the NAIC to develop appropriate model laws, model regulations and other coordinated activities. But unlike the past, through the NAIC, the states have moved beyond simply accepting individual states' voluntary selection of which elements of the NAIC work product to adopt and reject. To improve the quality of regulation and in recognition that what one state does or does not do can have a dramatic impact on the fate of regulation by other states, the NAIC has introduced an element of coercion to gain widespread state compliance with its solvency program, that is, the NAIC accreditation program.

Both individual states and the NAIC have undertaken an unprecedented and monumental effort to improve the regulation for solvency and related matters in response both to the insolvency experience over the past 10 years and to the pressures arising from congressional oversight and activity. Specific aspects of solvency regulation and guaranty fund legislation have been considered in some detail earlier. In addition to ongoing individual state and collective NAIC efforts to improve solvency regulation—both prevention of insolvency and dealing with those insurers which have become financially troubled—the NAIC has undertaken a program to encourage individual states to upgrade the level of regulation to meet standards promulgated by the NAIC. In doing so, it is anticipated that greater uniformity and consistency between the states in solvency regulation will be achieved. Furthermore, this effort to establish national standards within the more flexible framework of state insurance regulation was, in part, undertaken to demonstrate the absence of need for and desirability of direct federal regulation for solvency.

In 1989, the NAIC established Financial Regulation Standards to serve as baseline standards for quality insurance solvency regulation. The standards cover three elements of a state regulator’s capability: (1) the laws enacted and the regulations adopted, (2) regulatory practices and procedures with respect to effective financial analysis and financial examinations, and (3) department organizational practices and procedures. Periodically, the NAIC can add to, modify or eliminate standards in response to new situations, improved regulatory techniques, etc. It should be noted, however, that the requirement for the adoption of NAIC models typically embraces a substantially similar statute or regulation. In response to the NAIC standards, state legislative activity has been described as "phenomenal" as more model insurance legislation has been enacted than at any other time in recent history.

In 1990 the NAIC adopted an Accreditation Program to provide both guidance and an incentive for states to improve their solvency regulatory programs to meet the NAIC standards. Under the NAIC Model Examination Law, a commissioner must ensure that any report of examination of a foreign or alien insurance company, which is accepted in lieu of an examination conducted by his or her own insurance department, must be conducted in accordance with the standards of the Model Act. This requirement may be met in one of two ways. First, the examination may be conducted by the domiciliary state of the insurer if that state is accredited. Or, second, the examination may be conducted with the participation of at least one examiner employed by an accredited insurance department with the examiner stating under oath that the examination was conducted in accordance with the standards and procedures of his or her own department. The incentive to meet the accreditation standards is that, commencing January 1994, accredited states will not accept examination reports from nonaccredited states without the prescribed assurances that the examination is conducted in accordance with the standards of the NAIC Model Act. In the absence of such assurances, the ability of insurers of nonaccredited states to do business in the accredited states is impaired until they undergo a second examination acceptable to the accredited states. Furthermore, an accredited state may decide not to license an insurer domiciled in a nonaccredited state. Through these means it is contemplated that insurers domiciled in nonaccredited states will bring pressure to bear upon their domiciliary commissioner and/or legislature to achieve accreditation. More recently, in late 1994, in order to afford commissioners more flexibility in accepting examination reports on insurers domiciled in nonaccredited states, the NAIC Financial Regulation Standards Subcommittee decided that states could opt to accept such reports.

States seeking accreditation must undergo a multiphase accreditation review. A state initially conducts and reports upon a self-examination of its regulatory capabilities describing how it meets the NAIC standards as to model laws and regulations in place, sufficient staffing in terms of numbers and expertise, and other technical capabilities. After a preliminary review by the NAIC and after suggested changes are dealt with by the state, the insurance department is subjected to an on site review by an independent audit team selected by the NAIC Accreditation Committee. The on-site audit seeks to assure that the state not only complies as to the enactment and adoption of the models laws and regulations contained in the NAIC accreditation standards, but also complies with the regulatory practices and procedures and with the organizational practices and procedures that are also part of the standards. Subsequent to the findings of the audit team, the Committee votes whether to accredit.

Even after a state has been accredited, to assure continued compliance, a state annually faces a desk audit and a full on-site review every 5 years. If the NAIC changes its standards, states are afforded a specified period of time, such as 2 or 3 years, to bring their laws, regulations and practices into conformity to preserve their accreditation.

Attesting to its seriousness, for example, in early 1993, the NAIC suspended New York's accreditation for failure to enact two model laws and a part of a third. In late 1993 Connecticut was denied accreditation due to insufficient staff and funding, especially in the financial examination area. Until very recently Vermont has been unable to achieve accreditation because of its unwillingness to comply with NAIC standards on risk retention groups. In early 1994, the NAIC had under consideration decertification of Texas for failure to adopt the NAIC extraordinary dividend provision in the holding company law. However, in view of the commissioner’s efforts to carry out the intent of the standard and to achieve the needed change when the Texas legislature next reconvened in 1995, the NAIC determined to continue the Texas accreditation. In 1995, Texas did amend its extraordinary dividend law to bring that state into compliance with the accreditation standards.

As of fall 1995, 46 states had been accredited with insurers licensed in those states accounting for greater than 98 percent of all the premium volume in the insurance industry.

The accreditation program has not been free of criticism. First, since the NAIC develops and adopts model legislation and regulations with a view toward their adoption by the individual states, state legislators urge not only that they should have more input and participation in the development of such models but also that they should have a role in the actual decisions. It is argued that a state’s insurers should not be subjected to the legislative agenda of the NAIC without the active input and involvement of state-elected legislators. Pressures to adopt the NAIC legislative program are seen to usurp the constitutional authority and responsibility of state legislatures to determine what is and what is not appropriate public policy in their various states. Being a rubber stamp to NAIC initiatives does not sit well with the legislative branch of state government.

Second, the minimum standards adopted by the NAIC are sometimes vague in that the standard does not always specify minimum or benchmark requirements to give concreteness to the standard.

Third, many state legislators have expressed serious concern over being compelled by the NAIC to pass new and updated model laws every year to achieve or retain accreditation. Experience has shown that state legislatures do not meet often enough or long enough to readily keep pace with the number of model laws that the NAIC keeps adding to its standards for accreditation. This gives rise to increasing resentment in the various state legislatures, and may ultimately lead to individual state refusal to pass such laws. Even though failure to certify or action to decertify a few states may add to the credibility of the standards by demonstrating that minimum standards must be continuously met, over the long term it would become self-destructive if the NAIC were to adopt a legislative agenda that several states are either unable or unwilling to meet.

To alleviate this problem, it has been suggested that the NAIC adopt a moratorium on adding new standards for accreditation for some period of time. As an alternative, once a state receives an accreditation, such accreditation would continue for a specified period of time, such as 4 years. Approaches such as these could avoid confronting state legislatures with a constantly moving target of NAIC standards every year.

Fourth, although the legislative process in the individual states is subject to due process constraints and open meeting laws, the NAIC functions in a somewhat less restrained fashion.

Fifth, in addition to the concerns of state legislatures, criticism has arisen as to the very efficacy of the program itself. The enforcement mechanism to induce states to comply with the adopted standards is the unwillingness of accredited states to accept a financial examination conducted by nonaccredited states. However, this requirement was somewhat softened when the NAIC determined that an examination of a nonaccredited state may be accepted by an accredited state if an examiner from an accredited state assists and participates in the preparation of the examination report and validates the process by attesting that the examination was conducted in accordance with his or her accredited state’s standards. This may give rise to a loophole through which nonaccredited states can escape implementation of some of the standards adopted by the NAIC. It is said that by permitting states to circumvent the consequences of failing to become accredited, the NAIC has effectively removed the teeth from the program, thereby compromising both its effectiveness and its credibility. In the view of some, the inherent voluntary nature of the program, with a lack of direct NAIC authority to compel states to participate, or even to ensure that states that do participate will effectively and consistently conform to the standards in the future, will continue to invite criticism from those viewing direct compulsion as the only answer. In response, some have suggested the use of interstate compacts as a means to strengthen the NAIC accreditation program.

Not only has the accreditation program been subject to a variety of criticism, it is also being subject to various assaults that may threaten its very survival as an effective mechanism to achieve uniformity. In both Texas and New York, the decertification problems arose in the context of the legislatures being openly hostile to being "dictated to" by the NAIC as to what form insurance laws should take in their states. The lack of accreditation of two prominent states, which are generally regarded as possessing strong regulation, poses a serious threat to the viability of the NAIC accreditation program. Furthermore, the threat increased when the Texas, New York, and Alaska legislatures enacted laws authorizing their own states to retaliate against states imposing restrictions or extra financial burden on domestic Texas, New York, and Alaska insurers because of the lack of accreditation of those states by the NAIC. And Vermont and the NAIC have been locked in a dispute over the manner in which that state regulates its risk retention industry, resulting in the denial of accreditation and an ensuing potential legal challenge against the NAIC.

The assault has become more widespread than simply a few individual states. In late 1994 the National Conference of State Insurance Legislators (NCOIL) voted to establish a subcommittee to review the NAIC accreditation program. This action reflects the sense among many state legislators that the NAIC has essentially bypassed them by coercing states to pass NAIC adopted model laws, and that the NAIC program affords individual states too little flexibility to meet diverse needs. The resolution calls for an examination of whether executive branch officials have used the accreditation process to enact certain bills, whether accreditation has been awarded and/or retained on merit or other considerations, whether the accreditation process contains adequate due process protection for all those affected, whether the process should contain sanctions against insurers domiciled in nonaccredited states, and whether the NAIC possesses authority to impose sanctions. There has been a threat of a withdrawal of support of the NAIC by the National Governors Conference. And there has been a suggestion that the state legislators might bring an antitrust action against the NAIC for its accreditation program.

Subsequently, following its unflattering report concerning the NAIC accreditation program and processes, NCOIL adopted a resolution calling for each state to "consider enacting legislation providing for state legislative oversight of the NAIC. . . ." Furthermore, NCOIL seeks a return of control over insurance regulation to the individual states, calls upon the NAIC to preserve due process in its proceedings, to publicly account for its budget, and to reform the accreditation program so that no new accreditation standards would be adopted unless a significant number of states adopted the standards first. In several states (for example, New Jersey, New York, Texas, and Vermont), NAIC oversight legislation was introduced. While not identical in each state, as a whole, such legislation calls for the NAIC to annually report on its operations to the state legislature and requires the state legislature to give prior approval authority over the fees the NAIC assesses that state's domestic insurers.

At its June 1995 meeting, the NAIC affirmatively responded to some of the criticism. While stopping short of adopting a moratorium on new accreditation standards or halting new decertification of states no longer meeting the accreditation standards, the NAIC did adopt stricter guidelines for proposing new standards and charged the appropriate subcommittee to review all aspects of the accreditation program. In addition, the NAIC opened up its executive and plenary meetings to the public, reexamined its budgetary process, and moved to create a "legislative participation board" for more legislator input to NAIC activities. By the end of September 1995, the NAIC resolved the accreditation issues with New York, Texas, and Vermont, resulting in the accreditation of Vermont, paving the way for the reaccreditation of New York and allowing the continuing accreditation of Texas. Furthermore, confronted with the fact that several states would be unable to meet newly adopted standards, coupled with the ongoing review of the accreditation process, the NAIC accreditation subcommittee voted to delay the effective date of the new standards for 6 months, that is, from January 1, 1996, to July 1, 1996.

The saga of the NAIC accreditation program is ongoing. But whatever the validity, or lack thereof, of criticisms of particular aspects of the NAIC accreditation program for solvency regulation, the approach adopted (with any subsequent amendments deemed necessary to make the program work) has heralded a new era in state insurance regulation. Although directed at regulation for solvency, the basic approach of standards, coupled with some coercive element to gain individual state compliance, possesses the potential of being applied to other facets of regulation. Once again, the NAIC has demonstrated substantial flexibility in attempting to combine the virtues of regulation at the state level with the necessity of adequately regulating a nationwide business.

Although the NAIC accreditation program has commanded the most attention, the concept of interstate compacts has been advanced as an alternative state response to the need for coordinated and consistent regulation of a nationwide industry.

An interstate compact is a legal instrument providing a constitutional base for a contractual and statutory relationship between states becoming parties to the compact. Under the Compact Clause of the United States Constitution, the states may enter into an agreement with one another, subject to the approval of Congress, to institute uniform standards, rules and enforcement mechanisms deemed necessary and appropriate to regulate certain aspects of the insurance business. The compact is a formal agreement or contract voluntarily entered into by each member state in accordance with the requirements of the state’s legislative process. It is binding upon each member state in accordance with the powers and duties delegated to the collective member states. As legislatively enacted statutes, compacts take precedence over previously enacted statutes. Since compacts are legally binding contracts with other states, they take precedence over subsequently enacted conflicting statutes. State actions contrary to the compact impair the contractual rights of the other states in violation of the Contract Clause of the United States Constitution. A state may not unilaterally abrogate its compact responsibilities. Thus, interstate compacts afford a constitutional, statutory and contractual basis for uniform legislation.

Commonly, elements included in the compact embrace (1) a statement of purpose or goals to be achieved, (2) a delineation of the powers and duties to be exercised and the establishment of necessary administrative mechanisms for the exercise of such powers and duties, (3) provision for financing, and (4) provisions pertaining to the ratification, amendment, enforcement and termination of the compact.

The creation of an interstate compact involves negotiations between two or more states as to the compact’s terms. The compact is then enacted by a state at which point it becomes the law in that state and constitutes a contractual offer to other states. Enactment by other states constitutes an acceptance, thereby forming a contract. The compact is then subject to congressional approval, thereby enabling that body to prevent a binding agreement among states contrary to the national interest and the will of Congress. Once in effect, the interstate compact takes precedence over state law of the member states in the event of a conflict.

Although the Interstate Compact Clause on its face strongly suggests that Congress must approve any compact among states, the Supreme Court has held this is not always the case. In Virginia v. Tennessee, the Court interpreted the clause to require congressional approval only with respect to those compacts involving the

In view of the broad power which Congress has conferred upon the states through the McCarran Act to regulate the business of insurance, a strong argument can be made that Congress need not explicitly approve an interstate compact which merely enables more effective exercise of insurance regulatory powers already being performed by the states.

As an agreement entered into by the states, the states can determine the precise nature and scope of an interstate compact’s authority and mechanisms. Not uncommonly, interstate compacts establish a compact agency(s) which serves as a subordinate agency(s) of all states party to the compact. This agency often possesses rulemaking and enforcement powers to establish uniform standards in those areas deemed to require uniform treatment while leaving the majority of regulatory issues to be handled under the current system of regulation. In the context of insurance regulation, a natural candidate as the primary compact agency would be the NAIC although other possibilities might be and have been considered.

The criticism has often been raised that insurance solvency regulation and guaranty fund operations demand a uniform system with minimum national standards. The NAIC and the individual states have sought to address this issue through the NAIC accreditation program. The GAO has criticized the accreditation program on the basis that the NAIC lacks enforcement powers to compel implementation of its standards on a nationwide basis whereas a federal regulatory agency would possess such power. However, it can be argued with force that the issue is not whether the states can be forced to comply but whether or not they are in fact doing so. However, whatever the other advantages and disadvantages of the interstate compact for insurance regulation, the implementation of an interstate compact answers the lack of enforcement power criticism by creating a legally enforceable system with uniform standards at the state level.

Although to date the interstate compact concept has not yet been endorsed by the NAIC as a whole, in recent years the concept has received increasing attention as a possible mode of regulation. In particular, the interstate compact has been considered as a means to deal with liquidations/rehabilitations and guaranty fund operations in the context of multistate insolvencies.

The mid-1980s and early 1990s witnessed a number of insurer insolvencies giving rise to questions as to the ability of the states to deal with large multistate insolvencies, which has an impact on policyholders in several states, not just the domiciliary state. The current system places the domiciliary insurance commissioner in charge of the rehabilitation or liquidation. He or she is responsible to marshall the assets, pay off creditors and liquidate or rehabilitate the company. The guaranty fund associations are to pick up the shortfall. However, all is not simple. For example, individual state regulators are primarily and properly concerned with protecting the policyholders in their own states. In multistate insolvencies, commissioners may disagree with the domiciliary commissioner as to how the liquidation/rehabilitation should be handled. Another problem is the lack of a formalized mechanism for other commissioners to obtain information and have input into the conduct of the process. Furthermore, not all states possess equal competence in dealing with a large multistate delinquency proceeding. Laws, rules and procedures may vary from state to state. Ancillary receivers may be appointed in the nondomiciliary states to marshall the assets contained therein thereby depriving the domiciliary commissioner of the ability to deal with the whole problem. The potential for conflict among the states is considerable. The key issues are who governs the process and how is it to be governed. The interstate compact approach offers an alternative method of answering the problems of governance.

Similarly, an interstate compact may also be a means to resolve conflicts arising from the current multistate guaranty fund system. Among the asserted problems with the current system are the failure of some state guaranty laws to cover certain types of contracts (for example, unallocated annuities), varying limits on coverage between states, varying definitions of an insured event causing gaps in coverage, and the questioned capacity of state funds to deal with a large insolvency. An interstate compact might be used to standardize the process and the rules, promulgate rules defining the benefit levels and coverage, and clearly define who pays. Of course, under an interstate compact, it would be possible to establish a single guaranty fund for the member states rather than a separate guaranty fund in each state.

Other possible areas suggested as suitable for interstate compacts are enforcement of NAIC accreditation standards, agent licensing, insurer admission into states, regulation of alien insurers, and regulation of insurance agent sales practices.

A group of state legislators, the National Conference of State Legislators (NCOIL), took the lead in 1991 and 1992 by holding public hearings and drafting an interstate compact to oversee state guaranty funds and coordinate insurer liquidations. The proposed compact called for the creation of a commission consisting of insurance commissioners of the states enacting the compact. The commission would promulgate rules to facilitate the orderly liquidation of insolvent insurers, bring uniformity to the various state guaranty fund coverages and procedures, and coordinate state guaranty fund activities to efficiently service policy obligations of insolvent insurers on a multistate basis. In its role as receiver of an insurer placed in either rehabilitation or liquidation, the commission could delegate its receivership functions to a commissioner of a member state. However, the compact commission could amend any action of an appointed commissioner-receiver.

In a separate effort, by early 1994 some insurance regulators entered into serious consideration of the interstate compact approach. A draft proposal for an interstate compact of midwestern states to govern receiverships and liquidations was prepared by the Midwest Zone of the NAIC. The NAIC formed a Special Committee on Interstate Compacts, on behalf of the NAIC as a whole, to undertake the process of considering the use of interstate compacts in the area of receiverships and liquidations and perhaps other areas as well. In addition, compact legislation has been drafted and is in various stages of being introduced in several states.

While drawing inspiration from the NCOIL effort, the NAIC Midwestern Zone approach differs in that it contemplates the compact commission's being more an overseer than a doer with the powers of execution left more to the participating states. The compact commission would act in an oversight capacity role for multistate receiverships with the actual administration remaining in the hands of the domiciliary commissioner. In the NCOIL version the compact commission would actually serve in the administrative role. Furthermore, in contrast to the state legislators’ version, the Midwest Zone compact does not establish a national guaranty fund. Instead it relies on coordination of the existing guaranty funds. The focus of the Midwestern Zone approach has been to work alongside of rather than supplanting state regulatory functions. The Midwest Zone compact may not require congressional approval since the compact appears to meet the two constitutional tests in that the compact would not be exercising any authority which the states do not already have and the states do not surrender their sovereignty because they may resign from the compact.

By late 1994, it appeared that the NAIC Midwest Zone of insurance regulators and NCOIL came to an agreement as to a joint interstate compact to govern multistate receiverships. This version is akin to the one put forth by the Midwest Zone as described above except that it no longer encompasses overseeing guaranty funds and it now contains an "opt out" provision. This enables an individual state legislature to avoid a receivership-commission-adopted rule if the state opts out within 2 years. If a majority of the states opt out, the rule ceases to be effective. Under the compact, the commission will act in an oversight role for multistate receiverships with the actual administration remaining in the hands of the domiciliary commissioner. At least several member commissioners in the 13-state Midwest Zone contemplated pushing for legislative action on the proposed compact in their own states in 1995.

Although the ultimate fates of the specific proposed interstate compacts for insurance regulation are not clear, the concept not only affords a viable alternative to direct federal regulation of insurance but also provides a significant evolutionary step beyond the NAIC accreditation approach.