Marketplace & Regulation

Framework of Regulation


Given the central role the insurance industry plays in millions of American lives and businesses, it is no wonder that it is subject to a number of regulators – the federal government, state governments, and industry watchdogs. The primary purpose of this regulation is to promote the public welfare by maintaining the solvency of insurance companies.  After all, policyholders depend on a company’s financial stability to pay benefits well into the future. One insolvent company can jeopardize thousands of insureds. In addition to ensuring the financial strength of individual insurers, regulators also provide consumer protection, enforce fair trade practices and take care that insurance contracts are offered to the public at fair prices. It is very important that insurance agents be aware of and comply with all insurance laws and regulations. 


History of Regulation

Before exploring the current regulatory framework, a little background is necessary. The history of insurance regulation in the United States reveals a tug-of-war between the authority of the states and the federal government. Though a balance between these two bodies has been reached and maintained for many years, arguments favoring control by one governing authority over another are still being waged.  For example, in 2008, the SEC proposed expansion of its jurisdiction to include equity index annuities.

In 1868, the U.S. Supreme Court, in the case of Paul v. Virginia, was faced with one state's attempt to regulate an insurance company domiciled in another state. The Supreme Court sided against the insurance company, ruling that the sale and issuance of insurance is not interstate commerce, thus upholding the right of each state to regulate insurance within its borders.

In 1905, the New York state legislature appointed a commission to investigate life insurers in that state. The Armstrong Commission, named for the New York state insurance commissioner, responded to public outcry over abuses by insurers.  The result was the New York Insurance Code, which set a precedent and pattern for insurance regulation by other states throughout the country.

In 1944, the Supreme Court revisited the issue of continued state regulation of insurance in the case, United States v. Southeastern Underwriters Association (SEUA). In the SEUA case, the court overturned the decision of Paul v. Virginia – ruling, instead, that insurance is a form of interstate commerce to be regulated by the federal government.  This case subjected insurance companies to a series of federal laws — many of which were in conflict with existing state laws.   This decision did not affect the power of states to regulate insurance, but it did nullify state laws that were in conflict with federal legislation. The SEUA case resulted in a radical shift in the balance of regulatory control to the federal government.

The states responded angrily to the decision in the SEUA case, prompting Congress to enact the McCarran-Ferguson Act in 1945. This law made it clear that continued regulation of insurance by the states was in the public's best interest. However, it also made possible the application of federal antitrust laws " ... to the extent that [the insurance business] is not regulated by state law." As result, each state enacted an Unfair Trade Practices Act to conform to the federal law. Today, the insurance industry is considered to be state regulated.

In the mid-1950s, new insurance products such as variable annuities appeared in the marketplace.  The question arose: “Are these insurance products to be regulated by the states or securities to be regulated federally by the Securities and Exchange Commission?” The Supreme Court answered “Yes” federal securities laws applied to the underlying product, while the insurers that issued variable annuities were subject to state insurance regulators.  As a result “variable” insurance products must conform to both SEC and state regulation.

During the Great Depression, the Glass-Steagall Act of 1933, barred common ownership of banks, insurance companies and securities firms -- and erected a regulatory wall between banks and nonfinancial companies.  Glass-Steagall came under repeated attack in the 1980s as financial institutions merged. In 1999, Congress passed the Financial Services Modernization Act, which repealed Glass-Steagall. Under this new legislation, commercial banks, investment banks, retail brokerages and insurance companies can now enter each other's lines of business.  

The ongoing story of insurance regulation reflects the roles the courts and the federal government have played in regulating the insurance industry.  As a rule, insurance companies have tended to side with the regulators they deemed weakest.  In the early years of this country, the federal government was seen as the less stringent regulator.  Now states are seen in that light – and by and large, the insurance industry has been content to keep primary regulation in the states’ hands.  


Before exploring state regulation, let’s take a brief look at federal regulation of insurance. 




Federal Regulation of the Insurance Industry


Although the primary regulation of insurance is left to the states (under the McCarran-Ferguson Act of 1945), the federal government influences the annuity industry in three ways:


Internal Revenue Code:  Insurance companies are taxed differently than most other corporations.  Policyowners pay premiums, which insurance companies invest.  Generally speaking, interest earned by insurance companies is not taxed.  Uncle Sam is willing to defer taxation on that income until the policyowner withdraws it from the policy.    In the case of life insurance (but not annuities) benefits paid from an insurance policy are free of income taxation.


Retirement Plans:  The Employee Retirement Income and Security Act of 1974 (ERISA) regulates pension plans, other retirement accounts and employee benefit plans.  This law overrides any state laws governing retirement plans and investments within those plans.  Plans that meet ERISA requirements are said to be qualified, that is, they qualify for special tax treatment that allows their values to grow faster.  ERISA also governs “employee benefit” plans such as employer-provided health care coverage.


Variable Contracts: as mentioned above, the Supreme Court ruled that variable annuities and variable life policies are considered securities under federal law.  Investments within a variable annuity contract or insurance policy itself falls under the jurisdiction of the SEC, while the companies issuing these contracts or policies are subject to regulation by the states. Likewise, agents selling variable products must be dually licensed: a state license as an insurance agent and federal license as a securities representative.  


Federal Securities Laws


Securities Act of 1933: requires companies issuing securities (stocks, bonds, etc.) to register those securities with the SEC.  It also requires all sales of “new issues” to be accompanied by a prospectus.  Most variable annuities must be registered under this Act (some group variable annuities sold to qualified retirement plans need not register).   Some equity indexed annuities are registered, but most remain unregistered. 


Securities Exchange Act of 1934: regulates trading of securities once they have been issued.  It also requires registration of broker/dealers and their sales representatives.  The Financial Industry Regulatory Authority (FINRA) currently administers registration of broker-dealers and sales personnel. [This organization resulted from the merger of regulatory powers of the New York Stock Exchange and National Association of Security Dealers (NASD)].  FINRA's jurisdiction covers securities registered under the '33 Act.  As such, FINRA rules apply to variable annuities (and a few equity indexed annuities), but do not extend to fixed annuities (including most indexed annuities) or other insurance products. 


Investment Company Act of 1940: imposes requirements on professionally managed investment portfolios such as mutual funds.  These portfolios must be registered with the SEC.  The Supreme Court ruled that “separate accounts” of variable life insurance and variable annuities are also subject to this Act.  This law treats sales of these types of investment companies as “new issues”.  As a result, they are subject to the prospectus requirement of the Securities Act of 1933.    


We will explore FINRA regulations governing suitability of annuities in Chapter 6.  At this point, however, it is important to note that FINRA suitability regulations apply only to the sale of "registered" products: namely individual variable annuity contracts (and a few equity indexed annuities). 


In addition, many other federal laws have an impact on the operations of insurance companies and their agents -- including disclosures under the Fair Credit Reporting Act and privacy guidelines imposed under the Financial Services Modernization Act. 



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