Tag Archives: bruce heffner

Time to Revisit State-Based Regulation?

The states do not have a constitutional “right” to oversee insurance. Clearly, insurance and reinsurance is interstate commerce, which gives federal government the oversight. There are no states rights issues involved.

The McCarran–Ferguson Act, 15 U.S.C. §§ 1011-1015, which was passed by Congress in 1945, does not regulate insurance, nor does it mandate the state regulation of insurance. Section 2(b) of the act does specify that the business of insurance is exempt from the antitrust laws only if it is regulated by the states. It provides that “Acts of Congress” that do not expressly regulate the “business of insurance” will not preempt state laws or regulations that regulate the “business of insurance.”

What else was going on in 1945? Oh, yeah, that World War II thing. Perhaps congress then did not want more responsibility.

It is time that this war-generated act is revisited.

“Perfunctory” would be a kind word for how some of the states actually oversee the insurance process. I have personally experienced insurance departments that are totally unaware of the laws by which they are supposed to be regulating insurance. Regulators either do not know the law or do not care about enforcing it. While I have not witnessed the federal government’s efficiency, to continue the regulatory status quo is to argue that the demonstrated 50-plus (states and territories) individual messes are better than one big mess, while having to accept as a foregone conclusion that a federal system would be a mess.

The states have clearly proven to be lacking in both integrity and self-restraint. The 2015 State Integrity Investigation shows the reality of the situation. Only three states score higher than D-plus; 11 states flunked. The State Integrity Investigation is an in-depth collaboration designed to assess transparency, accountability, ethics and oversight in state government, spotlight the states that are doing things right and expose practices that undermine trust in state capitals. The project is not a measure of corruption, but of state governments’ overall accountability and transparency. The investigation looks at both the laws in place and the “in practice” implementation of those laws to assess the systems that are meant to prevent corruption and expose it when it does occur. State foxes are guarding the henhouse.

While the state insurance regulatory heads are adamant about keeping their perfunctory regulation of insurance based on the misnomer of “states’ rights,” they are by design or defect giving away that power to the quasi-private nongovernmental National Association of Insurance Commissioners (NAIC) or the private rating agencies, which may be thought of as shadow regulators.

In the name of commonality of law among the states, the NAIC produces model legislation, which the states are pressured to accept, lest they lose their cherished accreditation status by the NAIC.

See also: How to Bulletproof Regulatory Risk  

The tactic used by the NAIC is not unlike the federal speed limit of 55 MPH in the ’70s and ’80s. Where does the federal government have the right to tell any state what its speed limit should be? It doesn’t. But the Transportation Department said, Do this, or we won’t give you any highway funds.

So how does this NAIC model legislation thing work? Here is an example.

In the NAIC’s Deceptive Trade Practices Act (DTPA) or (Unfair Trade Practices Act), the NAIC said that if a company does something (bad) with regularity, that may be considered a “trade practice.” Originally, this was NOT anything but additional ammunition for the state insurance regulator, but when Texas passed this model, it did so with two big changes:

  1. A one-time act of bad by the insurance company could be considered a trade practice.
  2. There was a private right of action against the insurance company for violating the DTPA — the right didn’t just belong to the insurance regulator.

Oklahoma passed the act close to the way the NAIC wrote it, yet according to the NAIC both states have passed the model. But sameness in name does not mean sameness in fact.

Fighting Back:

Not everyone sees this drift toward private oversight as a good thing for the insurance consumer. The National Conference of Insurance Legislators (NCOIL) — those elected guys who actually pass the insurance legislation — are trying to do something about the drift.

At its fall meeting in November 2015, NCOIL urged each state legislature, the departments of insurance and insurance commissioners to foster competition in insurer rating.

No single insurer rating agency should be allowed to position itself to supersede state regulation. The message is clear; the state is in charge of insurance regulation, not some private rating agency setting up rules as to what an insurance company must do to get a certain grade.

Major intermediaries appear to favor state oversight, which is logical because reinsurance intermediaries are basically unregulated by the various states, and they are not so likely to remain unregulated if the federal government assumes its rightful place in insurance regulation.

Thomas B. Considine, now NCOIL’s chief executive but previously commissioner of the New Jersey Department of Banking and Insurance, used NCOIL’s spring meeting in New Orleans as the venue to raise public concerns about states becoming subject to the authority of the NAIC, a private trade association composed of the nation’s insurance regulators. The circumstance under which lawmaking authority may be delegated to private organizations is narrow. For that reason, delegation of states’ authority to a private organization (such as the NAIC) needs to be stopped.

The situation makes a good argument for the Treasury Department’s Federal Insurance Office, an agency whose existence has been questioned by the NAIC, as well as some other elements of the industry.

State oversight is not a good argument against federal oversight, especially when the state regulator is doing what it can to cede its power to the private industry and away from itself.

See also: Investment Oversight: Look Beyond Scores!  

Bigger issue

This is not just a turf war; it goes to the very core of the McCarran Ferguson Act itself. An analysis of the act will determine the scope of the antitrust exemptions. History paints a narrow picture. Issues are not centered on whether Congress has the power to regulate the business of insurance but rather whether the commerce clause precludes state regulation altogether. That changes the argument and the analysis.

This is also not a case of which oversight is more appropriate, federal or state, but whether the state should be allowed to continue its oversight in order for various federal exemptions to apply to the entities in the business of insurance. That is, the Sherman, Clayton, and Federal Trade Commission (antitrust laws) apply to insurance only “to the extent that such business is not regulated by state law.” If states regulate, then exemptions apply; if the states do not regulate, the exemptions do not apply. This is a very clear indication that any dismissive perfunctory attitude of some state regulators invites the application of federal law against those in the business of insurance.


  1. Is the activity part of the business of insurance? (Unfortunately, the act does not define the business of insurance, and the legislative history here is not clear.)
  2. If it is, then the analysis goes to the extent to which the activity is regulated by the state. § 2 (b) of the McCarran -Ferguson Act addresses the state regulation activity. (Case law shows that any uncertainty regarding the applicability of the exemption should be resolved against a grant of antitrust immunity.) Unfortunately, the U.S. Supreme Court has not defined what extent is necessary; however, lower courts hold that a statutory framework that is a mere pretense is insufficient. Perfunctory regulation won’t suffice. The legislative history indicates that Congress intended the exemption only when effective state law exists.
  3. If the activity is not regulated effectively by the state, or if the activity constitutes a form of boycott, coercion or intimidation, the activity will be subject to the scrutiny of the antitrust laws.

The wholesale delegation of authority by the various states to the NAIC or deferring to select private rating agencies brings with it the very real possibility of a successful challenge to the state’s current insurance regulatory status quo.

The 13 Oddest Aspects of Reinsurance

Looking behind the curtain of reinsurance, you find a most unusual business. Here are 13 anomalous features:

–Reinsurance is for the most part unregulated, but users — insurance companies — are regulated.

–Insurers must use a system of accounting that makes reinsurance attractive: If a reinsurer gives insurers a discount off a list price (ceding commission), they may show on their books that they paid the list price and may treat the discount as income.

–Reinsurance may be marketed by independent brokers that owe the insurance companies no fiduciary duties. The broker leads insurance companies to believe that it has their best interests at heart, but courts have ruled that the broker does not even have a duty to not inflate its commissions. The broker’s relationship with the reinsurer is much more important than the broker’s relationship with the insurers.

–The reinsurer can insist that all disagreements must be arbitrated, and that the arbitration does not set precedent or provide guidance should a similar issue arise in the future. That way, the reinsurer can argue the same issue over and over and over. The findings of arbitration are not only not recorded, they are often confidential.

–The outcome will not be determined by legal construction and interpretive rules but by the “custom and practice” of the industry — but which “custom and practice” is neither written down nor uniformly agreed upon or adhered to by those in the industry. That is, the contract can specifically say one thing, and the wording can be ignored in any arbitration finding if it is not in line with “custom and practice.” A reinsurer can do all this and at the same time argue that the lopsided arrangement is an “honorable engagement.”

–The reinsurance contract likely has an “entire agreement” clause, meaning that nothing from outside the contract can be used to establish rights or obligations. That is, the four corners of the contract supposedly set the parameters of the agreement. You may ask: Isn’t “custom and practice” contained outside the contract? Yes, it is. So, at the same time that there is the argument that the contract is the entire agreement, there is also the provision that unwritten rules outside the contract determine the interpretation of the contract.

–If there is a disagreement as to what the contract says, the dispute must be arbitrated as not a legal obligation — yet the contract says it applies the laws of the state where the insurer is based.

–Who is responsible for writing this convoluted and lopsided contract? Often, that is the broker — which is not a party to the contract.

–If a broker fails to even issue a memorialization of the product to the insurer, nine months after having “sold” the product, it is the insurance company that is punished, not the broker or the reinsurer.

–Even though some states specifically provide that reinsurance falls within the statutory definition of a regulated product, states do not regulate reinsurance directly. Reinsurance should be regulated federally, because it is clearly interstate commerce and falls within the U.S. Constitution’s commerce clause, but the federal government does not actually regulate reinsurance, apart from income tax issues. So, reinsurers do not have to obtain regulatory approval for rates or for products.

–Talk about a lobbying force. Legislatures have been convinced that taxing it would raise the price of everything for the general populace. That argument could be made for any business, because all taxes are ultimately borne by the general populace, but has not caught on for other industries.

–Reinsurance is amazingly simple. It comes in essentially one of two forms: treaty (for groups) and facultative (for individuals). Treaty comes in essentially two varieties: proportional and non-proportional. But reinsurance becomes esoteric by design. It has cloaked itself in mystery by avoiding the courts as a venue and by taking advantage of the fact that few legislators have ever dealt with the product.

–Although with similar financial products, courts would find that third parties might have rights, third parties have no rights under reinsurance.

I have not figured out why reinsurance is not fully regulated, as is insurance. I have heard the logic that the parties to the contract are equally sophisticated, and therefore no regulation is necessary. The problem with that logic is that the premise is false. Many of the parties do not have equal bargaining power; they are not equally qualified to enter into the transaction; and there are no real arm’s-length negotiations. Many small companies spend a great deal on reinsurance each year.

So why not at least tax reinsurance? I have heard the logic that this would be “double taxation,” because the original (the insurance) transaction was taxed. However, that ignores the realities of reinsurance. Reinsurance is not insurance of insurance. It is insurance on the performance of an insurance company’s core business, which happens to be insurance. Why does insurance covering loss from a collection of insurance products get to escape taxation on premiums when insurance covering loss from a fleet of cars does not? The same hurricane can cause loss to the core business of the car dealer and the insurance company, but coverage for the car dealer carries taxes on premiums while coverage for the insurance company does not.

I have also heard that reinsurance is like any other wholesale business, where sales tax is not applied. This logic ignores the realities of reinsurance. Reinsurance is not a commodity that is purchased in bulk to then subdivide into smaller units for sale by insurance companies. Reinsurance is a retail sale; it is not a wholesale transaction.

I am not necessarily advocating for regulation or taxation of reinsurance, but I am advocating for leveling the playing field and bringing transparency to the process of reinsurance.

I think that could be done with the abolition of any mandatory arbitration in reinsurance contracts by the NAIC. The plaintiff’s bar has a history of efficiently “regulating” where no regulation exists, if given the proper venue. Arbitration has not brought lower costs and timely determinations. Indeed, arbitration has proven to have none of the benefits and all of the problems of litigation.

It really is about time that reinsurance is made to come out from the shadows and to fully participate in the 21st century judicial system, rather than allowing it hold on to the faux vestiges of yesterday’s “gentlemen’s agreements.”

Many Agents Expose Themselves to Dangers

Many insurance agents are confused about their role, which brings about misplaced loyalties and greater E&O exposures.

Let’s start with a question: Does the agent owe the policyholder the common law duty of good faith and fair dealing? Most insurance agents would respond with a resounding “yes” – but they’re wrong.

The duty of good faith and fair dealing is a non-delegable duty that applies only between the parties to the contract, and the parties are the insurance company and the insured – not the agent. Put simply, the agent is not the agent of the policyholder. The duties of good faith and fair dealing belong to the insurance company, not the agent.

So what duties does an insurance agent owe to the policyholder/applicant? Under common law, there are really but two:

  • Use reasonable diligence in attempting to place the requested insurance.
  • Inform the client promptly if unable to do so.

That’s it!

Some states may provide for a “special relationship” to have been created, which may provide for some additional duties. However, such a relationship is state-specific, requires some acts of commission to create and is beyond the parameters of this article.

Under statutes, there is really only one duty: Refrain from deceptive trade practices.

Every agent knows that the insurance code has a lot of pages devoted to prohibited practices. However, a careful review of the NAIC model law (upon which all states base their deceptive trade practices code) finds that all deceptive trade practices applicable to an insurance agent involve commission of an act, not the omission of an act. Under the model law, doing something incorrect is worse than not doing anything. Insurance agents may assume some duties that are not imposed upon them by law, thinking that they have such duties. If duties are “assumed,” even through ignorance, the law will hold agents to a professional standard for those assumed duties. If you make yourself out to be a coverage expert, the law will hold you to that expert standard.

Some 90% of E&O suits against agencies could be prevented through careful attention to practices and procedures.

By contrast, the duties owed by the agent to the insurance company are many. As a fiduciary of the principal, the agent owes the company:

  • Loyalty
  • Utmost good faith
  • Candor/full disclosure
  • Refraining from self-dealing
  • Integrity, skill and care
  • Fair and honest dealing
  • Duty to follow instructions

Something many insurance agents may not have considered: Your responsibility to not breach your fiduciary duties to the insurance company are the largest part of your professional/ethical responsibilities as an agent.

(It is not a two-way street. The insurance company is NOT a fiduciary of the agent. In other words, an agent acts on behalf of the insurance company, but the insurance company does not act on behalf of the agent. Under common law, the insurance company only owes the agent: indemnification, payment of compensation and fair dealing.)

Some confusion may occur about agents’ responsibilities because of two issues: vicarious liability, which holds that a principal may be held liable for actions by its agent, and the legal maxim that a wrongdoer is ultimately responsible for his own wrongdoing. If an insurance company is held liable for the wrongdoing of its agent (vicarious liability), the insurance company can seek recovery from the agent, (holding the wrongdoer ultimately responsible).

If the insurance company is held vicariously liable for the agent’s wrongdoing, a decision to seek recovery from the agent may depend on:

  • What did the agent do wrong?
  • What recovery did the insured get?
  • What recovery is available to the principal (the insurance company)?
  • What was the agent’s thinking?

A common misconception is that all one has to do to avoid personal liability is to establish a corporation or limited liability entity. That is incorrect because:

  • Professional liability is personal liability.
  • Fiduciary liability is personal liability.


Insurance agents may assume many duties not imposed upon them by law. Assuming those duties holds the insurance agent to a professional standard not otherwise imposed.

The majority of an agent’s duties are owed to the insurance company, and it is the company’s vicarious liability for the actions of the agent that may ultimately get the agent sued. In other words, the biggest E&O exposure an agent may face is ultimately an action brought by the insurance company because of a wrong action or breach of fiduciary duties. Knowing this makes it all the more important that the agent fully understand and trust the insurance company before assuming the responsibilities and duties imposed upon agents.

A Dangerous Misunderstanding on the Reinsurance Broker’s Role

Reinsurance represents one of the most valuable but least understood assets for insurance companies. Unfortunately, it is sometimes, without much further consideration, assigned to be monitored by someone at the insurance company who is not savvy about reinsurance and who has other, primary job duties. As a result, by default, it can be the broker who sold the program who is left to advise management on such important issues as recovery, premium calculations and interpretation. Many insurance companies act as if the broker is a fiduciary working for them. This approach provides for a direct conflict of interest that the company ceding responsibility is often totally unaware of. Deferring reinsurance oversight to the broker is not an appropriate course of action.The misunderstood relationship with the broker

A recent court case (Workmen’s Auto Insurance Co. v. Guy Carpenter & Co., B211660 (c/w B213853)) specifically determined that the reinsurance broker does not owe a fiduciary duty to a reinsured company. The court rejected the company’s argument that the broker, as the company’s agent, had heightened duties including those of honesty, loyalty, integrity and faithful service, as well as a duty to make a full and fair disclosure of facts.

It was asserted that the broker breached its duty by failing to secure timely payments, failing to secure the best available terms of reinsurance and acting with the intent to injure the company by incurring inflated commissions. The court said the question was whether the broker was the company’s agent and, if so, whether that agency imposed fiduciary duties on the broker as a matter of law such that the broker can be held civilly liable for breaching those duties.

The court said that an “independent insurance broker is not an agent of the insurer, but rather is an agent of the insured.” But the court also said that a broker “cannot be sued for breach of fiduciary duty in a manner that conflicts with existing insurance law. In reaching this conclusion, we confess that agency law and insurance law are in conflict, resulting in a legal conundrum.”

The company suggested to the court that case law and statutory law involving insurance brokers should not be applied to reinsurance intermediary-brokers because they have far more complex and comprehensive relationships with their clients. The court responded that such an argument should have been brought up sooner and ultimately allowed the broker to prevail because of procedural rather than substantive issues.

Comparing the relationship of an insurance broker with an insured to the reinsurance broker’s relationship with a reinsured is amazingly naïve. Somehow, it escaped the court’s attention that the reinsurance transaction is not strictly regulated, and that applying the same rules to a relatively non-regulated transaction was inappropriate at best. Perhaps the court believed that insurance case law developed in a vacuum, and that it was not tempered by regulatory oversight and legislative consumerism.

Still, the author assumes that the court would apply its same “(il)-logic” to other reinsurance brokers.

The aha moment

The broker itself defines “broker” as a reinsurance intermediary that negotiates contracts on behalf of the reinsured. Yet the broker says it does not have the traditional duties imposed in the agency-principal relationship.

The attitude by the broker is, in my opinion, the single biggest takeaway for companies ceding management of their reinsurance. It is confirmation that is incorrect to believe that your broker owes you the duties of honesty, loyalty, integrity and faithful service as well as a duty to make a full and fair disclosure of facts, and that it is acceptable for brokers to generate inflated commissions. It is now been made clear that, when push comes to shove, the standards to which your reinsurance broker is held are not really a whole lot different than when you are buying a used car, where statements made concerning the sale are considered “puffing”; just an opinion or judgment that is not made as a representation of fact.

Companies that delegate reinsurance risk management to a broker may themselves be breaching fiduciary duties to stakeholders. That is, while the case concluded that the broker does not have a fiduciary duty to the reinsured, courts are quick to confirm that officers of the reinsured do have a fiduciary duty to the reinsured.   Obviously, officers cannot meet their fiduciary duties by assigning those duties to someone whom the court has found to have no fiduciary obligation to the reinsured.

I do not fault the particular broker in its defense. The issue is not the particular broker in the case or brokers in general; the real issue is the willful ignorance of the reinsured. Not questioning the motives of the broker is naïve. Remember, the broker, like the used car salesman,  makes his money based on how much comes out of your pocket in the sales transaction.  Risk management requires truly understanding the environment in which you operate.

The above case is not unique in bringing to light the ignorance of courts concerning reinsurance. Judges have been known to throw up their hands when dealing with reinsurance and admit that they do not understand what is being presented.  In the case of Indiana Lumbermans Mutual Insurance Co. v. Reinsurance Results, Inc., in the U.S. Court of Appeals for the Seventh Circuit, Case Number: 07-1823, the court stated:

“The lawyers’ oral arguments were excellent. But their briefs, although well written and professionally competent, were difficult for us judges to understand because of the density of the reinsurance jargon in them. There is nothing wrong with a specialized vocabulary – for use by specialists. Federal district and circuit judges, however, with the partial exception of the judges of the court of appeals for the Federal Circuit (which is semi-specialized), are generalists. We hear very few cases involving reinsurance, and cannot possibly achieve expertise in reinsurance practices except by the happenstance of having practiced in that area before becoming a judge, as none of us has.”

Ignorance is only part of the problem

The reinsured holds much power but is afraid of using it. The playing field is certainly not level to begin with, but all too often the ceding company’s management exacerbates this lopsided power arrangement. It is amazing how ceding company management knows instinctively that their clients have many alternatives, but somehow believe that they, as a client of the reinsurance broker, have no alternatives. Companies often do everything they can to protect the “long-term broker relationship.”

This demonstrates a complete lack of understanding by ceding company management of their own fiduciary duties. The fiduciary duties of officers of insurance companies are to the company stakeholders, not to the reinsurance brokers.

This lack of understanding should be of particular interest to regulators overseeing insurance. All states now have a statute or regulation pertaining to recognizing a company in “hazardous financial condition”; one telltale sign is the lack of competence and fitness of those in management. Breaching a fiduciary duty could indicate lack of fitness.

Most insurance companies are ultimately in business to make money and serve their clients. Mistakenly believing that you are in business to make friends and keep long-term broker relations will put you out of business.  Reinsurance is a commodity. Thinking of it as anything else makes you an uninformed consumer.

Your reality – the Wild West

Your business (insurance) is a highly regulated one that owes a fiduciary duty to its clients. To stay in business, you must depend on reinsurance, offered by an entity (reinsurers) that is, for all intents and purposes, unregulated. Additionally, this commodity must be purchased in certain quantities or an agency (AM Best) that gauges how viable you are will let everyone know that you face questions.  You may have to go through a salesman (broker) that the courts have determined owes you no fiduciary duties, and whose income is based on how much it can sell you. That is, there is no  incentive for “your” agent to advise you of ways to reduce your costs. To people in other industries, it would appear that “your” agent actually doesn’t work for you.

If the commodity you purchased turns out not to be what it was said to be, then you must arbitrate the matter with the entity that offered it. Reinsurance arbitration has proven to be every bit as costly and time-consuming as litigation but offers none of the advantages or safety nets provided by the courts. In spite of naïve judges, the court system is a better option. Judges are naïve only because reinsurance transactions so seldom land in court. Courts are a vastly superior forum that offers reason, rules and stare decisis, where precedent is followed, records are published and the same issues do not have to be determined multiple times. In arbitration, if a decision is made that is unfavorable, you may not appeal the decision. If this same scenario has been arbitrated before, you will never know it, because there is neither precedent nor a record. The outcome will not be determined by legal construction of the commodity you purchased and a set of interpretive construction rules but by the “custom and practice” of the industry, which coincidentally is neither written down nor uniformly agreed upon or adhered to. Arbitration only provides an advantage for the unregulated party to the transaction; it in no way benefits the regulated party. If the commodity you purchased does not measure up to the set of standards your regulator imposes, your regulator will punish you, not the entity that produced the commodity. Additionally, your clients to whom you owe a fiduciary duty have no recourse against the producer of the defective commodity you purchased even if it caused you to go out of business.

Substitute ANY other industry for insurance, reinsurance and broker in this scenario and you will quickly discern the absolute draconian forum in which you must operate.  Now you can see why I don’t believe that the ceding company has a reasonable basis to believe that deferring reinsurance oversight to the broker is appropriate.

The next time you sign your broker-of-record contract, try this experiment:

Ask to insert the clause  – “the broker agrees and understands that it is acting as a fiduciary for the Company in all matters in which it services the Company, with all duties and standards imposed in a fiduciary capacity.” While the court was not willing to assign such duties, the broker is free to contractually assume them!