Pressure Mounts to Curb Insurance Industry Guard

In early 1993, Kentucky Central Life Insurance Co. was on the brink of insolvency, threatening policy-holders throughout the country with losses that could have run to hundreds of millions of dollars.

Although few consumers knew it at the time, an obscure organization called the National Assn. of Insurance Commissioners played a central role in staving off catastrophe. Its early-warning systems alerted state insurance departments, leading them to cooperate to save many Americans from buying policies issued by a failing company. And it spared those who already held Kentucky Central policies from a much more costly collapse.

But in the year of its 125th anniversary, the NAIC, composed of state insurance commissioners, has come under unprecedented attack, both from the insurance industry and from within its own ranks.

Some regulators and consumer advocates contend that the consequence could be a catastrophe of savings-and-loan proportions. And because insurance policies, unlike bank and S&L; accounts, are not federally insured--instead, they are backed up by relatively small state guaranty funds--much of the blow could fall directly on consumers.

The federal government regulates the banking, savings-and-loan and securities industries, but it does not regulate insurance. The Kansas City-based NAIC has moved into the vacuum, evolving into the closest thing to a national regulator of the insurance industry.

Regulators say that in less than a decade, a drive by the NAIC to closely monitor insurance company solvency and spur states to act quickly at the first signs of trouble has saved consumers and state guaranty funds billions of dollars.

But now that eight-year effort to greatly beef up the monitoring of insurance company solvency, launched under pressure from Congress in the aftermath of a wave of major insurance company failures in the 1980s, appears to be on the verge of collapse.

Call for Nonpayment

A key insurance industry trade group has issued a thinly veiled call for its members not to pay the fees that provide the NAIC with about 45% of its revenue. The group, the National Assn. of Independent Insurers, whose 366 members include such giants as Allstate Corp. and Geico Corp., said in a memo last year that the NAIC’s efforts to monitor solvency had “gone beyond what was necessary to achieve its goals.”

Some giant companies, including Geico and some that are not even NAII members, such as State Farm and Los Angeles-based Farmers Insurance, are already in arrears to the NAIC by a combined total of nearly $500,000.

In addition, a new generation of conservative, Republican state insurance commissioners is taking aim at the NAIC’s accreditation program, created over the last six years to prod states that did little to supervise their insurance companies. They contend that the tough standards the NAIC has imposed on the states take too much authority away from individual states.

The attacks on the NAIC come at a time when the financial shape of the insurance industry appears to be sound--although storm clouds are gathering. Insurance commissioners say a collapse of the troubled Lloyd’s of London could lead to a wave of insurance company insolvencies here because many U.S. companies have insured much of their own risk with Lloyd’s.

A Lloyd’s official said in Washington Monday that the venerable firm’s future was threatened by American state securities regulators, who are trying to prevent Lloyd’s from collecting money from Americans who have invested in it.

In addition, some large companies, led by Cigna Corp., are seeking to take advantage of a more favorable regulatory climate by spinning off their riskiest policies into separate holding companies. J. Robert Hunter, the former Texas insurance commissioner who is now director of insurance for the Consumer Federation of America, contends that such spinoffs are badly undercapitalized, leaving policyholders at risk that their claims may not be paid.

David B. Simmons, a lawyer who stepped down last month after four years as the NAIC’s executive vice president and head of its staff, said: “There is a danger that if the current deregulatory mode moves too fast you will wind up with . . . a failure in the insurance industry of the same size as or larger than the failure in the savings-and-loan industry.”

Lee Douglass, Arkansas’ insurance commissioner and the NAIC’s immediate past president, said the organization in recent years “got good at making sure that insurance companies that do business on a multi-state basis will be around to pay their claims.” But that effort, he warned, is now at risk and, if it is dismantled, “consumers are going to be left holding the bag.”

Denial by Industry

Insurance companies deny that there is cause for alarm. Many argue that the NAIC has overstepped its bounds by looking into insurance company marketing practices and dictating standards for how much capital companies must have.

Bennett L. Katz, director of regulatory affairs for Farmers Insurance, says the effort to rein in the insurance commissioners’ association is merely intended to return power to state commissioners and poses no risk to consumers.

Brian Atchinson, the Maine insurance commissioner and president of the NAIC, elected with the support of new, mostly conservative commissioners, denies that its programs are being gutted or that the industry’s soundness is threatened. “I don’t see a wave of major insurance company failures,” he said.

Responsibility for examining an insurance company’s books and making sure it keeps enough money on hand to cover potential claims has always been the main responsibility of the state in which the company is based--even though a company may sell policies in many states.

Some states have been more diligent than others, and consumer organizations have long accused some state regulators of cozy relationships with big insurance companies.

Collapse of Companies

As a series of major insurance companies collapsed, from Baldwin-United in 1983 to Los Angeles-based Executive Life in 1991, pressure grew for the federal government to step in. House Commerce Committee Chairman John D. Dingell (D-Mich.) organized several rounds of hearings, beginning in 1988, to demonstrate that state regulation alone was not enough.

Executive Life collapsed while the hearings were still in progress, providing critics with evidence that the state regulatory system had failed. The company had invested heavily in high-risk, high-yield junk bonds, whose value plummeted in 1989.

The NAIC, seeking to head off federal regulation, established computer databases with every company’s financial statement, and checked them for errors or signs of fraud.

The cornerstone of the NAIC’s efforts was an ambitious accreditation program. The association would examine each state to make sure it had adopted model regulatory laws and had adequate staff to do the job. As of this year, the NAIC had accredited 47 states and the District of Columbia.

Douglass contends that if the NAIC programs had been in place earlier, the Executive Life debacle would not have happened. Thanks to tougher state monitoring under the NAIC’s watchful eye, he and other regulators say, there have been few major insurance company failures since Executive Life’s.

Some state legislatures, however, chafed under the NAIC’s requirement to adopt model laws.

Then came the 1994 elections. The Republican takeover in Congress stripped Dingell of his committee chairmanship. Sen. Howard M. Metzenbaum (D-Ohio), the leading force in the Senate for tougher requirements on the insurance industry, retired.

At the same time, many newly elected Republican governors appointed Republicans to replace Democratic state insurance commissioners. And in some of the 12 states that elect their commissioners, voters installed Republicans to replace Democrats. In California, for example, Republican Chuck Quackenbush succeeded Democrat John Garamendi, who stepped down.

In all, 28 of the NAIC’s 55 members--from the 50 states, the District of Columbia and four territories--were new. Many came directly from the industry they now regulate and supported industry demands that the NAIC’s powers be curtailed.

Richard Baum, the former California chief deputy insurance commissioner and now a consultant, contended: “Along with the ‘contract with America,’ there was a contract put out on the NAIC.”

Another key part of the NAIC’s effort to prevent insolvencies also appears on the verge of collapse: development of a model investment law. Many of the biggest insurance company failures stemmed from risky investments and the law would limit certain kinds of investments.

But now insurance commissioners from New York, Pennsylvania and Michigan have led a campaign to develop a weaker law, requiring only that investments be consistent with what a “prudent person” would consider reasonable.

Hunter and others say the Kentucky Central episode stands as a textbook example of the risk of leaving regulation to a company’s home state.

Based in Lexington, Kentucky Central was among the nation’s biggest sellers of universal life policies. In the late 1980s, it began investing heavily in questionable real estate deals. As the value of those investments dropped, Kentucky Central’s reserves for paying customers’ claims dwindled.

As the problems grew, Kentucky’s insurance department did nothing to stop the company from selling new policies.

The Louisville Courier-Journal unearthed evidence that when Kentucky Central started to get into trouble, it went to great lengths to court state officials. Court records show that weeks before Gov. Wallace Wilkinson’s inauguration in 1988, Kentucky Central paid $12.6 million to buy a money-losing hotel from him in the state capital. The price included a $120,000-a-year “consulting fee” payable throughout his term in office.

(The company’s liquidator is suing Wilkinson to try to get the money back. A Wilkinson spokesman said the governor never tried to influence state insurance regulators.)

In 1992, the NAIC’s newly beefed-up computer system began kicking out warnings. As Kentucky Central’s problems worsened, one state after another, including California, suspended the company’s license to sell policies.

Finally, in late May 1993, the Kentucky Insurance Department banned the company from writing new policies and put it into liquidation.

A lawyer for Kentucky Central’s liquidator said the company then had on hand $141 million less than it needed to cover potential claims. The liquidator estimated, however, that once all assets are disposed of, Kentucky Central’s customers will have suffered no permanent loss.

Hunter, Texas’ insurance commissioner at the time, says the quick access to information from the NAIC helped save consumers from buying policies of doubtful value.

Accreditation Issue

The key issue that the NAIC’s members are now battling over involves the terms by which the association will continue to accredit state insurance departments.

The NAIC formed a working group last year to rewrite the accreditation standards. The chairwoman of the working group is Linda Susan Kaiser, Pennsylvania’s insurance commissioner.

Like many of the new commissioners, she comes directly from the industry she now regulates. Before Republican Gov. Thomas J. Ridge named her commissioner last year, Kaiser spent 10 years as an assistant general counsel of two insurance companies, Reliance Insurance and Cigna Corp.

Kaiser contends that she is equally concerned with the needs of consumers, and says overly rigid standards hamper effective regulation. Her working group last month issued a proposal that would eliminate many of the mandatory parts of the program.

The industry is in a strong position to influence the NAIC because it supplies nearly all of its funding. About 45% of its revenue comes from the fees companies pay for filing their financial statements with the NAIC for entry into its database. Most of the rest comes from services purchased by the industry.

As the NAIC’s regulatory activities grew, some companies quit contributing. The National Assn. of Independent Insurers issued a letter, a copy of which was supplied to The Times by the NAII, noting that some of its members had withheld some or all of their fees to the NAIC.

The letter urged recipients “to exercise your own judgment on this important policy issue.” Attached was a memo summarizing laws in the states that require the payment of fees, and suggesting legal grounds that companies might have to withhold at least part of their fees.

Raised Fees

To finance the cost of its expanded monitoring program, the NAIC in recent years has raised its fees, although the maximum any insurance parent company is required to pay is $150,000. Geico has declined to pay the increases and owes $42,250.

Since 1992, State Farm also has refused to pay the increases. The Illinois-based company is now more than $315,000 in arrears to the association.

Scott Schaffer, assistant counsel in State Farm’s law department, says withholding the fees reflects a belief that the NAIC’s budget has grown too rapidly. He contends that the database fees are being used “for purposes they weren’t intended to be used for.”

But recent NAII memos make clear that the objections have at least as much to do with the NAIC’s evolution into a de facto regulatory agency.

An August 1995 NAII memo says the NAIC’s accreditation program had “gone beyond what was necessary to achieve its goals.”

Not all insurance trade organizations are taking such a militant stance against the NAIC. The American Council of Life Insurers, for example, says it supports payment of fees.

Meanwhile, Craig Travis, California’s assistant insurance commissioner, said Quackenbush had no intention of urging Farmers Insurance to pay the more than $125,000 the NAIC says it owes. Noting that insurers face no obligation under state law to pay their NAIC fees, Travis said: “I just don’t see it as that urgent of an issue.”