State regulation of insurance involves four agencies: (1) the state legislature, (2) the courts, (3) the insurance commissioner, and (4) the National Association of Insurance Commissioners (commonly referred to as the NAIC).

For reasons such as those stated earlier, the insurance business has long been recognized as a proper subject of regulation. Within the constraints imposed by the federal and state constitutions and congressional permissive authority as set forth in the McCarran Act, the state legislatures possess the ultimate power to enact and amend insurance law. Legislation establishes the broad legal framework governing the functioning of the insurance system. General standards are set forth which are applicable not only to the insurance mechanism but also to the administrative agency responsible for the day-to-day regulation of insurance. And, not uncommonly, the legislature will set forth detailed mandates or requirements in particular areas.

Following the significant efforts in developing and enacting uniform laws in response to the McCarran Act, many states have enacted comprehensive revisions of their insurance laws, sometimes referred to as "codes," sweeping away the accumulated layers of legislation of many decades and reducing insurance laws to a uniform style and a fairly systematic order. Whether or not a state has codified its insurance laws, state insurance laws usually cover such areas as the organization and operation of the state insurance department; the formation and licensing of insurers; controls over unauthorized insurers; the licensing of agents and brokers; financial solidity of insurance companies and insurance guaranty funds; market conduct by insurers and agents including policy forms, rates, discrimination and advertising; consumer affairs and complaint handling; holding companies, and rehabilitation and liquidation of insurers. Elaboration on the substantive content of state insurance legislation commences in Part Two below.

State legislatures recognized their inherent limitations in overseeing the day-to-day activities of the insurance system. As a general proposition, not only do most legislators lack the requisite expertise in the area of insurance, it is impractical (if not impossible) to pass laws dealing with every phase of a complex and rapidly changing industry. The effectuation of legislative standards, prescriptions and restraints needed more than legislative proclamation and sporadic judicial enforcement. Consequently state insurance departments were created with broad administrative, quasi-legislative and quasi-judicial powers over the insurance business.

Typically the insurance department is headed by a commissioner, superintendent or director (hereafter the common term commissioner will be used). A few states vest ultimate responsibility in a commission or board which selects an individual commissioner to carry out policy. Nearly one-fourth of the states elect the commissioner while the remainder are appointed, usually by the governor. In some states the insurance department is combined with some other department (such as the department of banking or securities). In some states the insurance commissioner has other duties such as state auditor, comptroller, etc.

The nature and scope of the commissioner’s authority is derived from the legislative enactments. To provide greater specificity and procedures than those set forth in general legislative standards, the insurance commissioner will often promulgate regulations. However, the commissioner cannot adopt regulations on a capricious basis. The validity of regulations are subject to constitutional due process limitations. These limitations require that a regulation be adopted by fair procedures including advance notice to those who must comply with the regulation, once adopted, and the opportunity to be heard on the proposed regulation through a hearing process. Most states have enacted administrative procedure acts which establish carefully delineated procedures for administrative agencies to follow. State insurance codes prohibit commissioner exercise of authority in an arbitrary or capricious manner. A commissioner’s acts or orders are subject to judicial review. Once a regulation is finalized, it usually has the same legal effect as a statute. In addition, the commissioner may issue bulletins and other communications setting forth his or her expectations or guidelines for compliance with statutory or regulatory requirements. However, while alerting the regulated as to the commissioner’s views, noncompliance of such advisories is not necessarily a violation of the law.

Enforcement of the insurance laws is achieved through a variety of techniques including the power to grant, deny or revoke licenses to do business; the power to compel disclosure and conduct financial and market-conduct examinations; the power to conduct investigations and promulgate regulations or administrative rules; the power to approve or disapprove filings of such items as rates and policy forms; the power to order rehabilitation, liquidation or conservation of an insurer; the power to issue cease and desist orders and/or levy penalties or fines; the power to remove officers and directors, etc. These powers and sanctions, coupled with alternative informal powers, sanctions and alternative modes of relief and control stemming therefrom, afford the insurance commissioner with substantial "clout" with which to regulate the insurance business.

The role of the courts in insurance regulation is fourfold. First, courts adjudicate conflicts between parties to disputes, such as an insurer and its policyholder (for example, whether coverage applies or the amount of the claim). Second, courts enforce criminal penalties against those violating the insurance laws. Third, occasionally insurers, agents and/or others seek to overturn statutes, regulations promulgated by the insurance commissioner and/or orders issued by the commissioner as arbitrary and unconstitutional. With the exception of the fourth function noted next, the judiciary (while very important to the individuals involved) has not emerged as a major player in the scope and nature of state insurance regulation. Fourth, the federal courts in particular have become involved in a plethora of cases seeking to define the parameters between state and federal authority under the McCarran Act.

By the 1870s insurers were expanding into regional and national operations whose activities crossed state lines. Not only did the ability of regulators to cope with numerous insurers doing business across state lines come under increasing strain, but also insurers experienced increasing difficulties with multiple state regulation. Uncoordinated state activity resulted in conflicting and sometimes discriminatory laws and substantial duplication of effort.

To alleviate these problems a meeting of insurance commissioners was held in 1871. Out of this arose the formation of the National Association of Insurance Commissioners (originally called the National Convention of Insurance Commissioners). The NAIC is an unincorporated association whose membership has come to consist of the principal regulatory authorities of each state, the District of Columbia, Guam, Puerto Rico and the Virgin Islands. As such, the NAIC is the oldest association of state government officials.

Much of the NAIC’s attention in its early years centered on coping with interstate insurers within a state regulatory framework. Particular attention focused on financial condition of companies. The NAIC developed detailed accounting regulations and standard annual statements which the individual states required to be filed with each of them. A Committee on Valuation of Securities was formed in 1907 to provide annually recommended valuations of securities contained in insurer portfolios. As a result all insurers reported the same values for the same securities to all states. In 1909 a permanent NAIC Securities Valuation Office was established to perform this and other functions. A mechanism to exchange examination reports among the states was followed by the establishment of the zone examination system in 1936 and the development of the first examiners handbook in 1947. These developments reduced the burden of multiple examinations of the same insurer by different states as well as standardizing the examination procedures.

Although the major focus of the NAIC in the early years was the financial area, it began to serve as a common forum for the development of model laws and regulations. This function moved to center stage following the South-Eastern Underwriters decision. An NAIC committee developed the concept and the prototype legislation which served as the basis for the McCarran Act. Following McCarran’s enactment, the NAIC became the institutional focus of bringing together state regulators and insurance industry groups that resulted in a series of model laws being developed and adopted. These were ultimately enacted on a widespread basis. The NAIC has been active in model law and model legislation development ever since.

The NAIC performs a variety of functions. It provides a mechanism for regulators to exchange information and share expertise. NAIC meetings afford various industry, consumer and other groups, individuals, and other government agencies an opportunity to speak out on and participate in solving regulatory issues. As noted earlier and elaborated upon in the discussion of the substantive content of insurance regulation, the NAIC provides the mechanism for standardized annual statements, a coordinated examination system, a uniform valuation of securities and the development of model laws and regulations.

Furthermore, consistent with the objective to reserve regulation to the states, the NAIC takes serious interest in federal legislative and regulatory activity. It tracks significant federal insurance-related activity, supports commissioners in the conduct of federal liaison activity, prepares statements on federal issues and supports commissioners testifying on behalf of the NAIC before congressional committees and federal agencies.

The NAIC utilizes two basic mechanisms to perform its functions: an extensive committee system and a permanent staff.

(1) The NAIC operates through an extensive system of committees, subcommittees and task forces (hereafter referred to as committees). Some committees are permanent in nature while others are created to deal with specific problem areas. These committees draw upon the expertise of not only the insurance departments but also industry and nonindustry expertise. Furthermore, others desiring to provide input are welcome to do so either in writing or through testimony before the relevant committee. The various committees gather information and develop recommendations regarding policy, programs, and model laws and regulations. The resulting recommendations are then offered for consideration and adoption by the NAIC as a whole.

Much of the work of NAIC committees is done at national meetings. Additional meetings are frequently held during the interim. The various committees hold hearings, akin to legislative hearings, affording commissioners, the industry and other interested members of the public an opportunity to be heard on regulatory problems.

(2) To supplement the committee structure, the NAIC has created permanent staff operations. Staff operations that have evolved over time have been aimed at assisting the states in the performance of their regulatory responsibilities. Staff activity falls within five general areas: (a) support the collective substantive regulatory efforts of the NAIC through research, securities valuation and other activities, (b) provide reports, data and other services to individual states, (c) perform a variety of functions relating to the NAIC’s government liaison program, (d) conduct administrative activities essential to the operation of a national association and (e) carry out activities supporting two or more of the preceding functions, such as the development and maintenance of an extensive computer database containing substantial financial information on the preponderance of insurers.

Each insurance commissioner is responsible for the insurance regulation in his or her state. As a voluntary organization, the NAIC possesses no authority over its individual members who may or may not adopt, in whole or in part, a particular NAIC work product for implementation in their own states. Thus the traditional role of the NAIC has been to offer its adopted work products for consideration and use by the individual states.

Nevertheless, over the years, a substantial number of NAIC recommendations have been enacted in or adopted by all or many states including, for example, use of the annual statement, participation in coordinated examinations, and adherence to numerous model laws and regulations. Thus, despite its voluntary nature, the NAIC has been a vital force in the development and preservation of state insurance regulation. Although as a general proposition the NAIC is not an official state agency, it has played and promises to play a crucial institutional role in the regulation of the insurance business.

Despite traditional state sensitivity to being instructed by the NAIC, arguments have been made that stronger efforts are needed to encourage the use of NAIC work products. Individual states have a stake in the nature and quality of regulation provided by other states. Insolvencies, underwriting results, market conduct, financial disclosure, for example, all give rise to interstate implications. The actions of one state can impact another state. Furthermore, the quality or lack thereof of state regulation as a whole can substantially impact the allocation of regulatory authority between the states and the federal government. Thus, to the extent a particular NAIC work product can promote the effectiveness and efficiency of regulation and the consistency of treatment as between states, there is strong justification to foster its implementation in the various states.

While encouraging use of NAIC work products has in the past been conducted informally when most commissioners believed that a particular program, such as a model law, required widespread adoption at the state level, in 1981 the NAIC adopted nine overall strategic objectives including "[f]oster[ing] the implementation of NAIC work products." In very recent years, the NAIC started exerting greater pressure for widespread adoption of programs deemed crucial to effective regulation of insurer financial condition when it adopted and implemented an accreditation program. There has even been serious discussion of the concept of an interstate compact to give NAIC actions the force of law. Thus the question no longer appears to be whether crucial NAIC work products should be fostered for widespread state adoption, but rather the issue has moved to the most appropriate, effective and acceptable manner of doing so. The future viability of state insurance regulation may depend upon the answer reached.

The role of the NAIC has been and continues to be an important and apparently increasing factor in the state insurance regulatory process. It provides an ongoing means to share information and coordinate regulatory activities between individual states. It fosters a certain degree of uniformity in insurance regulation. It has pioneered in developing new regulatory techniques, conducted several major research projects on a wide range of insurance regulatory issues and has entered the development and maintenance of computer databases directed specifically towards the needs of state insurance regulators.

Although great diversity of legislation and regulations between states poses little problem for insurers operating only in one state, multiple-state regulation would be extremely onerous for insurers functioning across state lines doing business on a regional or nationwide basis. Such a burden would have proven intolerable but for the uniformity, or at least high degree of commonality, achieved by the states through their collective efforts in the NAIC and cooperation as between state insurance departments in administering their laws.