Is state-based regulation here to stay in insurance?

(Bloomberg Opinion) -- The U.S. insurance industry offers a test case of decentralized authority: Unlike much of the investment business, which is supervised at the federal level, insurers are almost entirely overseen by the states.

So how are states doing? Judging from what promoters of insurance products can say in their marketing materials, not so well.

di-capitol-bb
The U.S. Capitol building, from right, Washington Monument and Lincoln Memorial stand in Washington, D.C., U.S., on Wednesday, March 8, 2017. House Speaker Paul Ryan said Wednesday he's confident that he’ll get the votes he needs in the House to send his Obamacare replacement bill to the Senate. Photographer: Andrew Harrer/Bloomberg

Consider an unsolicited email I recently received from a company called AnnuityFYI. As the name suggests, it was touting annuities -- products that, ideally, are supposed to guarantee a steady stream of income, typically to retirees. “The best of the bunch -- products offered by Atlantic Coast Life Safe Haven -- are paying just under or slightly above 4% annually, making it among the most generous no-risk investments in decades.”

A no-risk investment paying 4% annually? Sign me up! Just one problem. Atlantic Coast Life has only one financial-strength rating, a B++ from A.M. Best. Historically, 9% of companies with that financial rating have suffered impairment over the following 10 years, with “impairment” meaning a regulatory action ranging from restrictions on operations to insolvency and liquidation. Does that seem like “no-risk”?

Here’s another example. AnnuityAdvantage, an online insurance agent, pitches fixed rate deferred annuities as an “equally safe alternative to a bank CD.” Yet in many cases, the insurers standing behind those products are also rated B++. And unlike bank CDs, their annuities are backed not by the Federal Deposit Insurance Corp, but by state guaranty funds that sometimes don’t pay policyholders promptly or in full.

An AnnuityFYI managing member wrote by email that the company “stands by its review,” that B++ is a “good rating” and that “we have no information that any of [Atlantic Coast Life’s] products have ever failed to perform.” Neither Atlantic Coast Life nor AnnuityAdvantage responded to requests for comment.

It’s difficult to imagine federally supervised financial companies making these sorts of claims. It’s inconceivable for an investment advisor to advertise even an A+ rated bond as “no risk.” A mutual fund that called its B++ rated holdings as safe as CDs likely wouldn’t make it past the registration process at the Securities and Exchange Commission.

Why is state supervision so different? Most have laws on their books regulating insurance marketing, and one state, New York, has gone furthest by requiring insurance agents to act in their customers' best interests. But the laws have gaps, and many leave interpretation and implementation up to state insurance commissioners, not attorneys general or private lawsuits. Where there are regulatory shortfalls, states often look to their commissioners to identify them and propose fixes. Apparently, some commissioners aren't up to the task.

One solution would be to bring more investment-like insurance products under federal supervision. The SEC tried to do so in 2010, but a federal court stopped it. Former Iowa Senator Tom Harkin, whose state is the country’s third largest insurance hub, followed up by inserting an amendment into the Dodd-Frank Act making sure many annuities would remain under state supervision.

Dodd-Frank also largely excluded insurance from oversight by the Consumer Financial Protection Bureau. Republican Senator Tim Scott of South Carolina -- a former insurance agent who was named 2018 legislator of the year by “Big I,” an association of independent insurance agents and brokers -- has introduced legislation seeking to close any legal loopholes that might allow the CFPB to look at insurance sales tactics.

Perhaps a new administration or Congress will prove more dedicated to consumer financial protection. Until then, one can only hope that another financial crisis doesn’t intervene, causing B++ rated insurers to default on the “no risk” policies that savers are being advised to purchase.