Is U.S. Insurance Regulation Unconstitutional?

U.S. insurance regulation is ostensibly the primary domain of individual states, rather than the federal government. In practice, however, the most important and powerful entity in U.S. insurance regulation is not a state at all, but a private non-profit corporation known as the National Association of Insurance Commissioners, or NAIC.

Much of the NAIC’s power lies in its production of various ‘handbooks’ and ‘manuals’ that have the force of law, because the latest versions of these documents are ‘dynamically’ incorporated by reference in state insurance codes. Under this scheme, when the NAIC updates or changes any of its cross-referenced materials, it also changes state insurance law and regulation. Using this power delegated to it by state legislatures, the NAIC dictates (among many other things) the information that insurers and other regulated entities must regularly report to regulators, the methodologies they must use to determine their capital levels, and the accounting standards that they must employ to calculate their assets and liabilities.

In my new article, Is U.S. Insurance Regulation Unconstitutional?, I argue that this scheme violates basic separation of powers and non-delegation principles embedded in every state constitution. Although state constitutions vary, they all vest in a legislative branch the power to make laws, and they all are understood to limit the legislature’s power to delegate this authority elsewhere. Under any reasonable version of this principle, I argue, the delegation of state regulatory authority to the NAIC is unconstitutional. This conclusion follows from three key features of the NAIC scheme.

First, although the NAIC has both public and private features, it is clearly a private entity under states’ non-delegation doctrines, meaning that legislative delegations to it are subject to heightened scrutiny. As a privately chartered corporation, the NAIC is not subject to any of the procedural safeguards that ordinarily accompany the production of regulation, whether at the state or federal level.  For instance, the NAIC is not required by any law to provide the public with notice and an opportunity to comment on the materials it adopts, even when they have the force of law. And it need not be transparent about the role of interest groups in producing regulatory materials.

Second, unlike other constitutional delegations of power to private entities, the NAIC’s law-making authority is not subject to any dedicated and independent oversight by a public actor. In fact, none of the NAIC’s alterations to its dynamically-incorporated manuals are routinely reviewed by any court or administrative agency. State insurance regulators’ direct participation in the NAIC’s internal processes is no substitute for such independent oversight. To the contrary, state insurance regulators operating under the auspices of the NAIC may have substantial interests in using the NAIC’s delegated authority in ways that promote their own biased interests.  For instance, state insurance regulators may use the NAIC’s authority to inflate the scope and complexity of the special accounting principles that U.S. insurers are required to use. Doing so can increase the value of regulators’ specialized insurance expertise, limit the risk of perceived encroachment on their turf by federal officials, and improve the NAIC’s capacity to fund its operations by selling new publications or services. Alternatively, state regulators can, and do, use the NAIC to raise, pursue, and implement difficult policies in a private forum, away from democratic accountability. All this contrasts sharply with, for instance, the SEC’s oversight over a similar private delegate at the federal level, the Financial Accounting Standards Board (FASB).  

Third and perhaps most importantly, the NAIC’s exercise of its delegated authority is immune from implicit oversight by state legislatures, who lack any realistic capacity to claw-back their delegations of power to the NAIC by amending state law. This is a result of the NAIC’s unique Financial Standards and Accreditation Program. Under this program, state insurance departments can only be accredited if their state’s laws dynamically incorporate NAIC manuals and handbooks. The NAIC has cleverly designed the accreditation program so that states effectively have no choice but to maintain their insurance department’s NAIC accreditation. It accomplished this by including a seemingly innocuous provision in the model laws that states must adopt to be accredited: accredited state insurance departments are only permitted to defer to the solvency regulation of an insurer’s home state if the home state’s insurance department is itself accredited. The upshot of this provision is that no insurer would base its operations in any state that was not accredited, because doing so would effectively subject that insurer to financial scrutiny in every single state where it sold coverage. This, in turn, means that any state that lost its NAIC accreditation would lose the jobs and tax revenue generated by its local ‘domesticated’ insurance companies. In a real sense, then, the NAIC – a private entity subject to none of the normal safeguards that ordinarily constrain the administrative state – has developed a complex system that effectively compels states to delegate to it the authority to produce many of the key details of state insurance regulation as it sees fit.

The Article concludes by suggesting a solution to the unconstitutional structure of U.S. insurance regulation that would allow states to hold the NAIC accountable. In particular, it suggests that states can create, through an interstate compact, an independent entity responsible for reviewing the production of new NAIC materials that have the force of law. This new structure would reign in the NAIC’s excessive power, limit the risk of bias in the production of insurance regulation, and preserve the efficiencies that come along with centralizing the production of detailed rules of state insurance regulation.

Daniel Schwarcz is Professor of Law at the University of Minnesota.