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Thursday, April 10, 2003
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance, and
Government Sponsored Enterprises
Committee on Financial Services,
Washington, D.C.

    The subcommittee met, pursuant to call, at 10:09 a.m., in Room 2128, Rayburn House Office Building, Hon. Richard Baker [chairman of the subcommittee] presiding.

    Present: Representatives Baker, Shays, Kelly, Ney, Biggert, Miller of California, Tiberi, Garrett, Kanjorski, Meeks, Inslee, Lucas of Kentucky, Clay, Baca, Matheson, Miller of North Carolina, Emanuel and Scott.
    Chairman BAKER. [Presiding.] We would like to call this meeting of the Capital Markets Subcommittee to order and welcome all of those in the hearing room.
    Today's hearing is to focus on the causes and factors that relate to the availability of insurance for the myriad reasons consumers need to have access to insurance.
    It appears that the regulatory environment is a direct contributor to not only availability but as to affordability of the insurance product marketplace.
    In reviewing many of the witnesses' comments today for the hearing, it appears that there is almost a direct relationship between the sophistication of the regulatory environment and the availability of product. And it is not a good relationship. It seems the more stringent the regulatory constraints, the fewer the number of providers, the lesser the number of consumer choices, and the more expensive those choices become.
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    However, it is a certainty that a regulatory system is warranted, but it seems as though some States have adopted systems which are more conducive to a free market environment that does in fact aid the consumers directly.
    It is my hope that in the course of today's hearing to understand more fully the current regulatory system, how improvements might be offered and how we can assure availability of insurance product to any and all who may need those services.
    At this time I would like to recognize Mr. Kanjorski for his opening statement.
    Mr. KANJORSKI. Mr. Chairman, we meet today to examine how different forms of State regulation in the personal property and casualty marketplace affect the availability of insurance, the affordability of policies and the profitability of the industry. This hearing also represents the first time in the 108th Congress that our subcommittee has met to consider insurance issues.
    Before we hear from our experts, I believe it is important to make some observations about the insurance industry. Insurance, as my colleagues already know, is a product that transfers risk from an individual or business to an insurance company. Every single American family also has a need for some form of property and casualty insurance, especially products like auto and homeowners insurance.
    Additionally, according to the National Association of Insurance Commissioners, more than 3,200 property and casualty companies helped to meet the insurance needs of American families and businesses in 2000. A.M. Best also reports that insurers underwrote $163 billion in personal line premiums in 2001, slightly more than half of the total property and casualty industry.
    In addition, the largest lines of the personal property and casualty marketplace are auto and homeowners insurance. The insurance industry underwrote nearly $128 billion in net premiums in 2001 for private passenger auto insurance, up from $113 billion in 1997.
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    The net premiums for homeowners insurance also grew in the same timeframe from $26.9 billion to more than $35 billion. Furthermore, insurance differs from most other products in that insurers must price and sell their policies before knowing the full cost of the coverage. As a result, insurers often pay out more in claims than they collect in premiums.
    For example, in 2001, insurers paid out $1.16 for every dollar earned in premiums. One of our witnesses today will also make the point that property and casualty insurers paid $22 billion more in claims and expenses than they collected in premiums in 2002.
    To compensate for these balance sheet shortfalls, insurance companies have increasingly relied on income from their investments. Fortunately, the net investment income of property and casualty insurance companies has trended upwards since 1980, and this income stream has helped insurers to offset their annual underwriting losses.
    In particularly good years on Wall Street, some have suggested that the investment income may have also helped to keep premiums artificially low. I would like our experts today to address this point.
    As you know, Mr. Chairman, the McCarran-Ferguson Act also authorizes the States to regulate the insurance business, and Congress recently reaffirmed this system in approving the Gramm-Leach-Bliley Act. As a result, each State currently has its own set of statutes and rules governing the insurance marketplace. Traditionally, the States have highly regulated the personal property and casualty insurance industry with rate controls and pre-approval of new products.
    In recent years, however, many States have begun to experiment with their regulatory models. In an effort to promote greater competition in the marketplace, some States have even decided to exempt the industry from long-standing anti-trust protections.
    From my perspective, promoting competition through fair and effective regulation should ultimately result in better and more affordable insurance products for many customers.
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    The States, in my view, must also continue to work proactively to modernize their systems for regulating the insurance marketplace.
    Absent continued advances in these state insurance regulatory efforts, the Congress may need to consider altering the statutory arrangements through the creation of an optional Federal chartering system or the promotion of greater uniformity in insurance regulation.
    In closing, Mr. Chairman, I want to commend you for bringing these matters to our attention. I believe it is important that we learn more about the views of the parties testifying before us today and, if necessary, work to further reform and improve the legal structures governing our nation's insurance system.
    I yield back.

    [The prepared statement of Hon. Paul E. Kanjorski can be found on page 51 in the appendix.]

    Chairman BAKER. I thank the gentleman for his statement.
    Ms. Kelly?
    Mrs. KELLY. Thank you, Mr. Chairman. I want to thank you for holding this hearing this morning. It is an important issue that is of great concern to this committee and to consumers all across the country.
    I strongly believe that Americans deserve to have affordable insurance. And today, the insurance market faces a perfect storm—growing losses, lower investment returns, and inefficient regulation coupled with price controls that have left many States in a crisis.
    It is the responsibilities of these States and their insurance commissioners to promote competitive climate in which consumer choice can be achieved.
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    Unfortunately, some States have chosen to adopt heavily priced regulated models, that have driven insurers out of the market and stifled competition. When States determine what prices insurers are allowed to charge, whether it is in the form capping premiums, or imposing price controls, we have seen this over-regulation place a tremendous strain on the system.
    Last Congress, I held a hearing in the Oversight and Investigations Subcommittee on the effects of state over-regulation of automobile insurance. In the hearing, we touched on the competition based reforms that South Carolina and Illinois enacted, two States that are represented here on today's panel.
    As a result of their reforms, both of these States currently have numerous automobile insurance companies providing consumers with real choices at competitive prices. The answer to high auto insurance rates is clear—more competition is more effective than just more regulation.
    I am very happy that when it comes to auto insurance we have also gotten it right in my home State of New York. But I am concerned that the price controls in the nearby State of New Jersey may have a negative impact on other out of state consumers.
    So today we are going to hear from witnesses that I hope will talk more and lead us more in the direction of understanding what needs to be done to make sure that price controls and over regulation does not pull the entire insurance market.
    I thank the witnesses for appearing today, and I look forward to their testimony.

    [The prepared statement of Hon. Sue W. Kelly can be found on page 53 in the appendix.]

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    Chairman BAKER. Thank you, Ms. Kelly.
    Mr. Baca?
    Mr. BACA. Thank you very much, Mr. Chairman. Thank you for hosting this hearing. I am going to be short and brief.
    I look forward to getting the information that should be available in terms of availability of insurance affordability and then look at home it might impact and what changes may need to be done as it affects not only our customers, but our consumers, but also the industry as well.
    I look forward to the hearing, and hopefully it can be productive, and look at changes that need to be done as we deal with the free market environment, look at reform for competitive prices as well.
    Thank you.
    Chairman BAKER. I thank the gentleman for his statement.
    Mr. Miller?
    Mr. GARY MILLER OF CALIFORNIA. Thank you. I applaud you for holding this hearing. This is an issue of tremendous importance to me. And specifically with the State of California, I mean, if you look at what is going on nationally, there just seems to be a lack of uniformity of laws. I mean, it is become very difficult or insurance companies to even do business. The inability to provide new products in a timely fashion with the insurance industry is very obvious compared to security firms that can generally provide new opportunity within 90 days in banks, can virtually do it immediately.
    I mean, the process has become a logistical and administrative nightmare in most States. Dual banking systems has proved to be highly successful of an approach. I am not sure that it not be the same success if we looked at a dual system for insurance. One would be a Federal charter.
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    Many States have just created the absolute shortage of opportunity for consumers. I know if you are a business person, you try to get liability. There is more exclusion with a liability policy than there are inclusions today. And much of that is caused by the state's process and what they require.
    You cannot mandate a business to lose money. And in many States, that is just about what they are doing to the insurance companies. They require them to provide such an extensive list of coverages instead of allowing them to be competitive and offering it based on what the market demands. And many States, you have seen insurance companies, the larger ones, just pull out of that state or stop writing new policies. And it is not because business people do not want to provide a product.
    It is because businesses will not be mandated to lose money. And in being involved in areas that States mandate that they should not otherwise be involved in.
    And in closing, Mr. Chairman, I—this is of tremendous interest to me. I have—if you had asked me 10 years ago I would never have thought of the concept of a Federal charter. The more I watch what is going into the industry today, and what impact is being placed upon consumers, the more I am becoming to believe that a Federal charter might be a very viable option, and I would like to hear if anything, reasons why I am absolutely wrong. And I believe we have individual States that will try to make that presentation. And I look forward to hearing it. I yield back.
    Thank you.
    Chairman BAKER. I thank the gentleman for his statement.
    Mr. Inslee?
    Mr. INSLEE. Thank you.
    I just want to make a comment, and it may not be exactly on the topic we have had here today. But I think it is important to make today.
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    I was reading in Mr. Hartwig's statement that the 1990s and these opening few years of the new millennium have been very difficult for insurers. Natural disasters of unprecedented frequency and ferocity cost the industry nearly $110 billion between 1990 and 2002, while September 11th terrorist attacks produced the largest insured losses in the United States in world history, amounting to $40 billion.
    The reason I note that today is many, many scientists believe that the rate of natural disasters that your industry will be exposed to in the coming century, that rate will increase both as to frequency and ferocity due to global warming. And changing very, very systemic ways are climate systems.
    And I am very concerned that your industry is going to be exposed to that over the next century in part because the U.S. Congress is failing abjectly in dealing with this threat that is going to expose your industry to losses no matter who your charter is in. And you know it does not matter who your charter is in, if these hurricanes become more severe, you are going to have significant losses. And I just want to appraise you today that the U.S. House has before it an energy bill. And the energy bill that will pass will do absolutely nothing effectively to deal with this threat of global warming.
    And I am just advising you of that, because even if we fix charter problems, whatever they may be, it is not going to solve this problem of you being exposed to these enormous losses.
    So I will look forward to your comments about that particular aspect about what light you can shed on that and your concern in this regard.
    And look forward to your testimony. Thank you.
    Chairman BAKER. I thank the gentleman. I would like to call on Ms. Biggert at this time to make a particular introduction.
    Mrs. BIGGERT. Thank you very much, Mr. Chairman.
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    I am absolutely delighted to introduce to the committee today a good friend and long-time adviser to me in my work in the Illinois legislature and in Congress.
    He is Nat Shapo, who served for four years as the Director of Insurance for the State of Illinois. As the Insurance Director, Mr. Shapo consulted with Congress and Federal bank regulators on the Gramm-Leach-Bliley Act and helped draft the National Association of Insurance Commissioners or NAIC statement of intent for the future of insurance regulation.
    Mr. Shapo has been a leader in the insurance regulation field. He was twice elected to a national office at the NAIC—as Secretary-Treasurer and Vice President—and twice served as chair of the NAIC mid-western zone.
    As a NAIC official, Nat was responsible for inviting me to visit New Orleans for the first time in my life to address a NAIC annual meeting. ''Come to New Orleans,'' he said. ''You will love the big easy.''
    Well, I came; it poured. It poured some more and the hotel swimming pool overflowed into the ballroom during the hurricane and I never left the hotel once to see the city.
    So—but I digress.
    I will try to put all parochial interests and personal bias aside and objectively state that Illinois has one of if not the most efficient insurance systems in the country. I believe that Mr. Shapo's experience will be most helpful for the committee. He will be sorely missed as director of insurance, but he will continue to share his expertise as a partner in the insurance regulatory group for the law firm of Ssonnenschien's Chicago office.
    So thank you very much, Mr. Chairman.
    Chairman BAKER. Thank you, Ms. Biggert. I would observe that your personal experience with the city of New Orleans in the rain is not uncommon. In fact, some have observed about many Louisiana elected officials there seem to be either under water or under indictment. So it is——
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    ——but we would like to invite you back for another attempt to enjoy our hospitality, I assure you.
    Mr. Garrett, did you wish to make an introduction at this time, sir?
    Mr. GARRETT. Yes, I would. Thank you.
    First of all, Mr. Chairman, let me just say thank you for having this hearing. You know, as someone who has in the state legislature for a number of years in New Jersey and has had the opportunity to chair the banking insurance committee for a number of years in New Jersey, the auto insurance was one topic that we grappled with for a long time. We just could never get our hands around and get the political will to get the job done. But I appreciate the chance now to see how some other States are and maybe we can get things moving in the right direction.
    But I am pleased at this point to introduce a gentleman who I know for some time, John Marchioni, who is now I see the Vice President and Director of Government Affairs with Selective Insurance Group. That is in my district. That is in my home county of Sussex County, New Jersey. And that is actually my old employer, with Selective Insurance for a number of years back.
    Now John brings to this panel and to this hearing today, I guess you could say just about all sides of the equation. He like I and like other past or current residents of New Jersey bring a consumer side and know exactly what it is like to have to pay a bill or a high premium for auto insurance in the state. So we have that perspective there. And then if you go back in his career, where I first met him, he had the opportunity to serve as a staff with an assemblyman when I was in the state legislature, Assemblyman Jerry Zecker. There were only a couple of us in the entire state legislature who had a background in insurance. I had it and the other assemblyman did, being an agent. And so John had the opportunity to work with the legislature in his office from the legislative, the public side as far as tackling the issue.
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    Following that, he went on to bigger and better things, and worked with the Commerce and Industry Association up in Bergen County, New Jersey. So he got to work on the private sector, the commercial side, and again to see what the problems were there. And to try to lobby and work for changes.
    Well, and finally now, it brings us to where he is today, and that is with my old employer, Selective Risk, the private industry, the insurance company itself.
    You know, Selective always has the policy, I remember over the years of saying they were going to be an insurance company that did not proactively lobby, if you will, for changes in insurance regulation. They would just simply say, we will take whatever the government dishes out and we will try to make a buck at it and do the best we can.
    And a number of industries tried to do that—companies did that as well. But I think you will see over time that in New Jersey, because of the over-regulation, all of the companies have realized that now it is come to the point that we have to do something to get out of this deadlock that we are in.
    So I am pleased that he is able to represent all perspectives, but the one that he is most educated in comes from the private sector as well. And I presume that the testimony that we will hear from him and the others is that more competition is part of the answer. Less regulation is part of the answer. And at the end of the day that we have to achieve some sort of solution to this problem for our state and the rest as well.
    So thank you, Mr. Chairman.
    Chairman BAKER. I thank the gentleman.
    If there are no further opening statements by members at this time, I would like to recognize our first witness here this morning.
    Welcome Dr. Robert Hartwig, Senior Vice President and Chief Economist for the Insurance Information Institute. Welcome Dr. Hartwig.
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    Mr. HARTWIG. Thank you, Mr. Chairman and members of the committee. The committee asked me to testify today regarding the overall economic performance of the property casualty insurance industry, the industry's rate of return, and to contrast that performance to other industries.
    As we just heard from Mr. Inslee, the 1990s and these opening years of the new millennium have indeed been very difficult for insurers. Natural disasters, terrorist attacks and tort costs have all taken their toll.
    Insurers are also subject to an extraordinarily complex array of rules and regulations that significantly impair an insurer's ability to earn an adequate rate return and to attract and retain the capital needed to cope with these problems.
    Earning an adequate rate of return is a core concern for all heavily regulated industries. From 1988 through 2002, profitability in the property casualty insurance industry displayed in exhibit one under performed the Fortune 500 by an average 5.3 percentage points.
    Return on equity is essentially the rate of return to investors who put their own money into the business. Exhibit one clearly indicates that investors in most years would have done better by investing in other industries or a broadly diversified portfolio of stocks such as the S&P 500. The performance gap is even more striking when the high relative risk of investing in property casualty insurers is taken into account.
    The inevitable consequence of repeatedly disappointing investors is the diminished ability to attract or retain capital, shrinking capacity on a global scale, rating agency downgrades and a loss of investor confidence as manifested by falling share prices.
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    Underwriting losses over this same period are displayed in exhibit two, which represent the amount by which losses and associated expenses exceed premium income, were also enormous, totally nearly $350 billion. Focusing on insurers more recent performance reveals that the period from 1999 through 2002 witnessed four of the six largest underwriting losses in the history of the industry.
    Last year's $22 billion underwriting loss, while a marked improvement from the terrorism impacted $52 billion loss in 2001, indicates a continued drain on the industry's capital.
    In the final analysis, it is investor money that is lost. Investors observing these losses and low rates of return will be unlikely to invest in the P&C insurance industry unless they have a reasonable expectation that financial performance will improve in the near future.
    Not surprisingly, the three most heavily regulated lines of insurance, auto, homeowners, and workers compensation produced below average returns in recent years and generated some of the largest losses. These three products alone account for roughly 60 percent of all premiums earned by insurers. Consequently, when underlying losses or loss trends shift adversely, pushing costs up sharply, insurance costs that sell heavily regulated insurance products are guaranteed to lose money.
    Deliberate suppression of rates, delays in the rate approval process and delays in the approval of new forms and products invariably cost insurers billions of dollars in unnecessary losses each year, leading to reduced availability for customers.
    Presently the availability of property-causalty insurance is shrinking and prices are rising as a result. A sharp drop in the pool of capital available to underwrite insurance is a principle factor fueling the rising cost of insurance today.
    Capital held by U.S. domiciled property-casualty companies has plunged by nearly 20 percent or $63 billion since mid-1999. Foreign capital which is critical to the U.S. insurance market, is also shrinking.
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    Globally, capacity fell by an estimated 25 percent or $230 billion over the past two years.
    Over the past year, industry critics have attempted to lay blame for higher insurance prices on so-called reckless investment strategies by insurers. While earnings from investments declined as they have for all investors, the P&C insurance industry still generates significant cash flow from its investment portfolio, an estimated $39.5 billion in 2002 alone.
    Investment earnings are simply returning to their pre-bubble levels. Two-thirds of the industry's invested assets are in fact in the form of bonds. About only 20 percent is held in the form of common stock.
    The decline in investment gains over the past several years merely reflects downward trends in interest rates which now stand at 40-year lows as well as fewer opportunities to realize capital gains on the stock portfolio.
    Critics of the P&C insurance industry have also asserted that recent increases in the cost of insurance are unjustified and that insurers are simply gouging consumers.
    The rate of return and underwriting loss figures discussed earlier clearly suggest otherwise. Moreover, the cost of auto, home and commercial coverages remains very reasonable by historical standards.
    The cost of homeowners' insurance, for example, relative to the cost of the home itself, has decreased or remained stable every year since 1994. Likewise, the cost of managing risk for businesses relative to revenues is roughly the same today as it was a decade ago.
    Thank you.

    [The prepared statement of Robert P. Hartwig can be found on page 64 in the appendix.]
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    Chairman BAKER. Thank you very much.
    A particular pleasure for me to introduce our next witness. I am pleased that he was able to accept out invitation.
    Mr. Dan Juneau, President of the Louisiana Association of Business and Industry, an organization back home which has been particularly progressive in addressing the issues of government regulation. And I might add that Mr. Juneau has been particularly aggressive as President of that aggressive organization in helping to assist Louisiana government in making appropriate changes to its regulatory environment.
    So Dan, it is good to have you here. Welcome.


    Mr. JUNEAU. Thank you, Mr. Chairman, and warm wishes from your home district back home.
    My organization is a combination of state chamber of commerce, state manufacturers association. We have 3,500 members in all, all sizes, all different types of business classifications. We are represented in every parish in Louisiana that corresponds to your counties.
    I am not an insurance expert. I am simply a mirror, Mr. Chairman. I am a mirror of the concerns of the business community in the State of Louisiana about this subject and about this topic.
    Every year I enjoy doing something very much. Right before our legislative session starts, and it just started in Louisiana, I get to take the month before that and go all across the State of Louisiana meeting with almost every chamber of commerce of any size in discussing the issues that are coming up in the session and hearing from those small business people.
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    And this year I think I got the strongest message that I have ever received from the business community in Louisiana. And it was about the affordability and the availability of insurance in our state.
    Mr. Chairman, I remember two faces in particular who came up and talked to me after some of my presentations. One of them was a small businessman in Louisiana who sells tractors and tractor parts. And he was telling me that last year his property and casualty insurance was $145,000 for his premium. This year when he finally found a writer, it was $560,000, a 385 percent increase in his premium.
    I remember another gentleman from south Louisiana who owns a wrecker service, obviously a small business person. And at that time his carrier still could not get him a quote for his liability insurance in the state.
    The insurance crisis is hitting hard in Louisiana. Huge cost increases are inhibiting growth, profitability and employment levels and bringing some businesses to the edge of closure.
    It is our opinion that the most critical ingredient of that problem in our state is the declining number of carriers writing policies. Give you a little example of what I mean by that.
    Let's look at homeowners insurance in the State of Louisiana. Prior to 1992, that is when Hurricane Andrew hit in our state, 120 carriers were writing home owner's policies in Louisiana. Today, only 19 are writing them. And when you get to I-10 and south of that in the coastal areas, there is less than that.
    Only six carriers are writing new home owner policies in our state, a real, real crisis. And commercial lines, the market is tightening for commercial auto insurance very greatly. My residential contractor members tell me that only A-rated carrier is writing them in the state. Many of our oil industry service companies say they also have only one or two carriers writing. You certainly are not going to get a bargain when that few people are writing new policies.
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    Our automobile dealers are down to two carriers who will write them and are facing such a crisis that they are looking to self insure, which is a very risky venture in this type of marketplace.
    Interestingly, the crisis in Louisiana, has lead to the formation of a unique coalition. It is the group called the coalition to ensure Louisiana. It is composed of retailers, bankers, automobile dealers, oil field contractors, independent oilmen and representatives of the insurance industry, which these business groups often disagreed with quite—you know, quite often when it came to insurance.
    But they realized that more competition is absolutely critical to stabilizing our market and eventually bringing prices down in the State of Louisiana.
    So what needs to be done in our state to do that? Our organization and the coalition of others are pursuing reforms in the current session of our legislature to do several things. First of all, and I think one of the most important problems we have is our structure of regulation. We have an insurance rating commission in Louisiana. Most States allow some form of free market pricing.
    In Louisiana, there has to be prior approval from our insurance rating commission for any increase to go into effect. The commission consists of an elected commissioner who chairs the commission and commission members who are appointed, who are political appointees of the governor or our state. That is not a very good system for regulation in our opinion.
    Carriers are often delayed and denied when attempting to get rate increases. In the year 2001 legislation passed in our state house that would have actually moved to a more free market approach and reformed the regulatory system. Unfortunately, that legislation was vetoed. And when that happened, many more carriers started leaving the state after that veto.
    Legislation has been introduced in this session to allow increases or decreases of up to 10 percent without prior approval of the insurance rating commission. It is a step we believe towards the free market approach that is needed.
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    Another problem in Louisiana is our residual market, our market of last resort for numerous lines of insurance. Carriers writing in Louisiana in the voluntary market are assigned policies from this residual market pool. It is a very unprofitable book of business. This is the policies that nobody wanted to write to begin with.
    The losses in that book of business are not generally alleviated by greatly increasing the premiums on those people getting that insurance. It has been primarily by—or often cases by assessments on the carriers. So what this has led to in Louisiana is carriers trying to shuck their voluntary book of business because of that growing assessment that is being placed on them coming out of that residual market.
    This is something that is absolutely going to have to be cleared up we think if we are going to get more carriers to write in Louisiana.
    We are a direct action state. Only two States, Wisconsin and Louisiana, allow a lawsuit to be filed directly against an insurance company. When that happens, obviously the presence of insurance is known. And in Louisiana, through the discovery process, you get to very quickly find out what the policy limits are. This often results in higher awards we believe, since the amount of insurance present is overshadowed by the merits—overshadows the merits of the lawsuit in hand.
    We also have a collateral source rule. Some States have a ban on plaintiffs getting multiple recoveries from various insurance sources when they file a lawsuit. In Louisiana, there is no such ban. Most States allow collateral payments, medical insurance, workers comp, disability et cetera, to be introduced into evidence at our trial. We do not allow that also in Louisiana.
    Jury trial threshold also is another problem that is being worked on in Louisiana. Most States give defendants an unfettered right to a trial by jury. Louisiana limits a defendants right to a jury trial to suits involving $50,000 or more.
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    So in conclusion, Mr. Chairman, our organization is working with the coalition and others to enact reforms to return competition to the insurance marketplace in Louisiana. High premiums and reduced coverages are negatively impacting jobs and economic development. And we believe that competition fostered by free market principles is the key to recovery.
    High premiums are one thing, but when insurance companies refuse to take your money, you know you have a problem.
    And that is a problem we are facing in Louisiana today.
    Thank you.

    [The prepared statement of Dan Juneau can be found on page 77 in the appendix.]

    Chairman BAKER. Thank you, Dan. We appreciate your participation here today.
    Our next witness is the Director of the South Carolina Department of Insurance, the Honorable Ernest Csiszar. Welcome, sir.
    Did I get that right?


    Mr. CSISZAR. Absolutely, Mr. Chairman.
    Chairman BAKER. Okay, thank you.
    Mr. CSISZAR. Thank you, Mr. Chairman, distinguished members of the subcommittee. I am the Director of the South Carolina Department of Insurance and this is clearly a topic that is dear to my heart. So I welcome the opportunity to appear before this committee and share what I hope you will agree is a success story.
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    I can quite affirmatively state here today that our consumers, particularly when it comes to personal lines, are not experiencing an availability problem. I can also state categorically that 5 or 10 years ago that was not the case. And if I were to look to the one cause of how this change came about, that cause I can only attribute to the fact that South Carolina moved from what was a very stringent intrusive regulatory, prior approval type of process to what I can only describe as a more market driven competition driven, if you will, approach to the entire regulatory process.
    In South Carolina, we have on the automobile side, we passed reform legislation in 1997 which through a transition period of two, two-and-a-half years, is now entirely in place. We have significant, as I will share with you in a moment, significant numbers of companies have come into the state, in the hundreds in the thousands. And they continue to come into the state to write insurance.
    In our commercial lines, we have deregulated that process. There are no—there is no rate review. There are no policy review, no product review, if you will. There are DEEMER provisions in place. And there are no restrictions on premium or anything. So we have deregulated in essence, the commercial market. And this is particularly beneficial when you have small business owners who are looking for the right kinds of coverages.
    I can also say that as a next step this year, hopefully within the next week, we will be introducing legislation in South Carolina that will deregulate the homeowners' market. We are slightly—we have a slightly different situation there from the automobile side, not the least because we have hurricane exposures and earthquake exposures in South Carolina. So we are going about it a little differently, but the ultimate aim I can only describe as is to implement the type of market-drive regulatory process that Illinois now has in place.
    So these are the three prongs on which we are proceeding. And again, I attribute the fact that we do not have an availability problem in our personal lines or our commercial line largely because of this market-driven process.
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    Now to give you a little bit of history of where we were, and I will try to be brief on this because it is a rather sordid history. We in South Carolina had a rate making process that was driven by politics. The actuaries had nothing to do with the process really. Supply and demand did not have anything to do with it. IT was driven by politics.
    And the end result was that it was rate suppression. And not only was their rate suppression, there was what I would call a peanut buttering of rates. So that the good driver really did not get much credit for driving well, and the poor driver really did not get punished for being a very poor driver. The end result is that quite apart from the rate suppression there was also the wrong signal being sent to the consumers. Why improve your behavior, your driving behavior is you are not going to get much credit for.
    We had a residual facility. It was called the South Carolina Reinsurance Facility, and I can tell you from personal experience, that you can always judge how well a market works by looking at the residual market and seeing how many are covered through the residual market.
    In South Carolina's case there residual market which was designed to be the market of last resort, became the market of first resort. It had the lowest premium in essence, and those premiums were never raised because of politics once again.
    So the end result was that we had over 40 percent, actually close to 43 percent at one point, at one point 2 million policies going through our reinsurance facility at an annual deficit of over $200 million. It varied of course from year to year, but at its highest, it was $200 million.
    That deficit was recovered by a recoupment fee. Who paid for that? Well, everyone paid for that. The good driver paid for that, and the lousy drivers paid for that as well.
    And again, the wrong signals to the market.
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    We—in 1997, finally things came to a head. And through a bipartisan effort, this was not the Democrats or not the Republicans. This was truly a bipartisan effort—South Carolina passed automobile reform legislation.
    We did away with a mandate to write. We did away with the pre-approval process by way of implementing a flex rating type of system at plus or minus 7 percent. We did away with what were rather stringent underwriting restrictions. That actually probably chaffed more than the rate restrictions, a fact that you really could not underwrite a bad risk appropriately, or a good risk for that matter.
    So we did away with the entire scheme, if you will. We replaced the reinsurance facility with a joint underwriting facility which is not an assigned risk facility. And I can only tell you that the true measure of successes in this is that having gone from 1.2 million policies at one point in the facility, we now have less than 350 policies. I repeat that—350 policies in the residual pool.
    It is proof that the private market works if you let the private market work. So we are very much in favor of a market-drive type of regulatory system.
    Now to give you some indications on the rates, certainly we have improved. If you look at averages, for instance, we look at—we have improved. But quite frankly, the averages do not tell us a lot. I would rather see a scheme where a rate of $500 premium is averaged out with a $3,500 premium than have two premiums at $2,000 each because again, the signal to the market here is important in terms of improved driving.
    We are still a lousy state when it comes to fatalities for instance. We still have too many DUI fatalities. The only way you can send a signal to the market or to the driver is by charging them an appropriate rate. So this is where I think where the prime accomplishment really comes in when you look at the rate differentials.
    We have now in our market, we have attracted and we actively go out to recruit companies. We have, I believe, the number is somewhere around 170, 180 companies and I cannot keep track of it, actually because every week we have new companies coming in. And by the way, when they come in to write automobile insurance, many of them also write homeowners insurance.
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    And that is a welcome mark in South Carolina, where we always deal with capacity constraints along the coast because of hurricane exposures.
    So it brings success in other markets as well, I think.
    We certainly are—complaints, we do not hear about rates. The best way I can describe it, Mr. Chairman, is the Chairman of our Insurance Committee in the House probably put it best. His name is Harry Cato and he said to me quite recently said, ''You know, for the first time in years,'' 10 years I think he used, ''I can go to the barber on Saturday and get a haircut and not have to listen to bitch and moaning about automobile rates and homeowners rates.
    So that is probably the best indication that something good has happened here. As I said, we are replicated this on commercial lines, and we are about to replicate it on the homeowners line.
    I will conclude on this point, and the point very simply is that the market indeed does work, and South Carolina is a good example of it.
    Thank you.

    [The prepared statement of Hon. Ernst Csiszar can be found on page 56 in the appendix.]

    Chairman BAKER. Thank you, sir.
    And I need to get that barber's number when we are done here today.
    Our next witness is Mr. John Marchioni who is Vice Chairman of the New Jersey Coalition for Auto Insurance Competition.
    Welcome, sir.
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    Mr. MARCHIONI. Thank you. Good morning, Mr. Chairman, and distinguished members of the committee.
    My name is John Marchioni, and I am Vice President and Director of Government Affairs and compliance for Selective Insurance Group, a New Jersey-based property and casualty insurer.
    This morning I am testifying in my role as Vice Chairman of the Coalition for Auto Insurance Competition, a coalition consisting of insurance companies, insurance trade associations, business groups and over 20,000 consumers who are rallying to the cause of restoring competition to New Jersey's auto insurance marketplace.
    New Jersey residents face an auto insurance availability crisis of unprecedented proportions. During the past decade, over 20 insurers have left New Jersey, seven companies having left or filed plans to leave within the last year alone.
    When State Farm, the state's largest carrier completes its withdrawal, five of the six largest writers in the nation will not be going business in New Jersey.
    As we speak, over 4,000 motorists each month receive notice that their insurer is leaving the state having to scramble for coverage. One million drivers could ultimately be impacted if significant reforms are not achieved.
    The disaster that is facing drivers in New Jersey is neither a natural disaster or an accident. It is a disaster of the state's own making. It is the result of a politicized auto insurance regulatory system.
    New Jersey operates arguably the most strictly regulated system in the nation and consumers are paying a heavy price.
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    Virtually every aspect of the auto insurance business is controlled by statute and or regulation. The state dictates how much coverage must be provided and who companies must insure.
    They control the prices, they determine whether an insurer can come into the state, and when an insurer can leave.
    And if a company can successfully manage to navigate this complex regulatory scheme and earn a profit, the state tells you how much you may keep and how much you must return.
    However, unlike the state's cap on profits, the amount of losses an insurer can be forced to absorb is unlimited. The result of this regulator morass is that insurers have headed for the exits. There are a third fewer carriers in New Jersey than in neighboring States, despite having a population with one of the highest per capita incomes in the nation.
    As carriers leave, consumers lose coverage.
    Numerous newspapers reports document that replacement coverage is increasingly hard to come by because many of the remaining insurers simply do not have the capacity nor the capital to take on additional business.
    New capital has not been invested in the state because many insurers do not want to do business in this highly politicized overly burdensome regulatory climate.
    Adding to this lack in capitalization is the fact that the majority of the state's largest insurers, including four of the top five, write their business in single state subsidiaries in an attempt to insulate their parent company from this turbulent market.
    That is the bad news. The good news is that progress has been made towards reversing this decades-old problem. To solve the capacity and availability crisis, additional capital must be invested by the private sector in New Jersey's auto insurance market. The private sector, however, is unlikely to do that until the many regulatory barriers to competition are dismantled. Reforms must give existing insurers confidence they can generate a competitive rate of return and attract additional insurers to the market place.
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    Insurers must know that regulatory decisions will be made fairly and will not be the result of political manipulation. Fortunately, the legislation that is moving in Trenton goes a long way towards restoring competition to the state's auto insurance system.
    By restoring a competitive insurance market, New Jersey drivers will reap the benefit through increased availability and choices.
    Senate bill 63 has passed the state senate and we anticipate the state assembly will take it up in May. Called the New Jersey Auto Insurance Competition Choice Act, it is backed by Governor McGreevy and a bipartisan group of legislators in both houses.
    While not a panacea, we believe it will ease the availability crisis and if fully implemented lead to long-term stability in this troubled market. S. 63 phases out the take all comers law, expedites the rate setting process, eases the excess profits law and streamlines withdrawal restrictions.
    Again, this bill is not a panacea, but it is an important and positive first step. It is only a first step because after the bill is enacted the administration must fully implement the various regulatory components of this reform package.
    New Jersey has a checkered past in this regard as well. It took four years to implement an expedited rating law passed by the legislature in 1997. The redrawing of a 50-year old territorial rate map dictated by statute in 1998 has still not been implemented.
    If S.63 becomes law, the administration must act quickly and they have committed to doing so on the regulatory changes called for on expedited and prior approval rating, withdrawal, excess profits, and territorial rating.
    The current reform effort could be a significant step to move New Jersey into the mainstream of state insurance regulation. It took decades to create this dysfunctional system, so dramatic results are not likely to occur over night.
    Assuming S.63 is signed into law, the required regulatory changes are swiftly enacted and the reforms are allowed to take root without political interference, New Jersey could become a more attractive market for insurers, and the ultimate beneficiaries will be the state's consumers.
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    Thank you, Mr. Chairman, and that concludes my remarks.

    [The prepared statement of John Marchioni can be found on page 83 in the appendix.]

    Chairman BAKER. Thank you very much, sir.
    Our next witness is Mr. Nathaniel Shapo, who is a Partner in Sconnenschein Nath and Rosenthal and former Director of the Illinois Department of Insurance.
    Welcome, sir.


    Mr. SHAPO. Thank you, Mr. Chairman and good morning to you. It is a pleasure to see you again. I enjoyed working with you when I was at the NAIC. It is a great opportunity to be here today before you and our Ranking Member, Kanjorski and Representative Biggert who was very kind in her introduction of me earlier.
    Mr. Chairman, in Illinois, the government does not regulate the price of insurance. Rather supply and demand and the anti-trust laws do. This is sufficient and consumers are well protected.
    Since insurance is not a monopolist product, it is strange that this model is viewed as an usual approach. Well settled public policy holds that in a market with many sellers, supply and demand and the anti-trust laws, true competition, should regulate price.
    Insurance is such a non-monopolistic product. It is sold by hundreds of carriers who aggressively challenge consumers to compare their prices against their competitors. Consumers routinely shop for coverage and price through conversations with agents, calls to toll-free numbers, and by surfing the Internet.
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    If I described any other business this way, one would be surprised at the notion that price controls were necessary or appropriate.
    Yet government rate regulation is commonly used in insurance to keep prices down. Price controls, which were put on the table to deal with unique but now completely absolute conditions in the market have not gone away. State rate regulation has historical, legal and policy roots not in ensuring affordability, but in ensuring solvency.
    The purpose of price controls was to facilitate the propping up not the suppression of rates.
    Because in the 1800s and the early 1900s insurers were prone to severe underpricing and insolvency, for decades they were encouraged not to compete but rather to cooperate on prices. Rating bureaus produced recommended rates and States having encouraged the practice, regulated the resulting anti-competitive prices through prior approval requirements as they usually do with monopolies.
    In fact, 89 years ago, the Supreme Court invalidating the constitutionality of insurance price controls in the case of German Alliance v. Lewis, explicitly cited the quote, the monopolistic character, unquote of the insurance marketplace as the basis for its decision.
    Since prices were not regulated by what the court called quote, the higgling of the market, unquote, that is to say competition, they should be regulated by the state.
    The cooperative rate making allowed by the Supreme Court was essentially encouraged by Congress in the McCarran—Ferguson Act, which provides an anti-trust exemption for insurers if States occupied the field with rate regulation. But the market has changed dramatically since Congress passed McCarran in 1945. Solvency regulation has drastically improved beyond the point of needing to rely on a rate regulation. Bureaus no longer produce rates and companies develop their prices independently.
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    Monopolistic practices have been replaced by competition. But the create regulation used to control the monopolistic market endures as a tool not to protect solvency, but affordability.
    Studies show however, that prior approval of insurance rates does not in the long run produce prices lower than competition. Furthermore, since price controls deter supply, they often spur availability crisis characterized by large residual markets as Director Csiszar just testified.
    In Illinois, competition benefits insurance consumers as it does throughout the rest of the economy. Illinois has the highest number of carriers writing homeowners policies in the country. This ample supply produces a marketplace which by statistical analysis is competitive and non-concentrated. The residual market is infinitesimal. The uninsured rate is below the national average. And rates are or below national norms, 27th highest in auto and 39th in homeowners.
    In short, consumers are well protected. They are protected in the following ways. First, rates are regulated. They are regulated by supply and demand. They are also regulated by the anti-trust laws because since the state does not regulate rates, McCarran's anti-trust exemption does not apply.
    Furthermore, Illinois has added an additional safeguard, the Cost Containment Act, which requires the Department to collect data from insurers, analyze that information using recognized statistical indexes and report to the legislature to confirm the competitiveness of the market.
    The Department does not proactively regulate rates because empowered consumers can and do utilize supply and demand by shopping for price.
    Consumers cannot protect themselves in all aspects of their transactions though, so Illinois funnels its scarce regulatory resources toward vigorous solvency, market conduct, policy forum and consumer complaints regulation. The market cannot regulate these activities itself, so the government must. For instance, since consumers cannot be expected to understand the balance sheet of the company, the Department actively regulates solvency.
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    Illinois' success in solvency and market conduct regulation is renowned. It originated many of the model laws at the heart of the National Association of Insurance Commissioners' accreditation program. And it is had three winners, the most of any State of the NAIC's Robert Denine award, the association's highest honor for professional regulators.
    Insurance is infused with the public good. As Chairman Oxley said, it is the glue that holds our economy together. For that reason, insurance is and should be a heavily regulated industry.
    I think that Illinois's experience indicates that as one would expect in a market with many competitors, proactive government regulation is best focused on areas where unlike with respect to price, only the state can protect consumers.
    I believe Illinois' experience demonstrates that the same rules for price regulation that apply throughout the economy should also be considered by policy makers in this vital but no longer unique insurance marketplace.
    I have used up my time, and I thank you for your indulgence, Mr. Chairman.

    [The prepared statement of Nathaniel Shapo can be found on page 90 in the appendix.]

    Chairman BAKER. Thank you, Mr. Shapo.
    It is rare in this committee's jurisdiction where we have an issue that the resolution of it seems to be so clear cut. I want to thank each of you for your testimony and for the rather dramatic differences in your presentation between those who have relied on the competitive model and those who are struggling to reform the regulatory model.
    It—at least for me and others may have differing opinions, it is dramatically clear what would be in the consumer's best interest. And I had intended to spend more time in trying to heighten those differences to make the public case stronger, but I do not think given your testimony, that is really necessary.
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    Rather, I will jump ahead a little bit. As you all know we have been discussing in this committee now for almost two years the advisability of some national system to help expedite the competitive model adoption.
    And let me add a quick caveat, I see and will constantly maintain support for the state regulatory model as to consumer affairs and to the capital adequacy of the companies which may be domiciled within your state. So there will always be a strong need for a state regulatory model in that regard. But with particular focus on the question of product availability, and the need now to go to 50 differing state systems to apply for permission, given the impact of your testimony and where less regulatory inhibition has resulted in more product availability at lower cost, am I making a leap that is inappropriate to assume that if companies—let's just take for example, were able to get licensed in five or six States, to sell a particular product in a particular line, then it would be automatically acceptable for them to move into all other States.
    Or is there value in having a 50 stop review in order to be able to sell your product on a national scale, which also lends to the question is there an advantage in having a company have the access to a national market to enable them to even further reduce price? As I am interpreting your comments, it seems as though when you got rate makers out of the way, and let the market work, prices came down because the competition would undercut you and take more of the market if you did not.
    It is just really an open question to the panel. Somebody help me here. Mr. Csiszar, your testimony was great. Anybody who can go from 1.2 million policies, to 350 needs to be heard.
    Mr. CSISZAR. I think—let me add one—just one word of caution for perspective. There—it is not entirely always the case of the competitive model versus the regulatory model and that one works and the other one does not work. I mean, I use our neighbor to our north for instance, North Carolina, which very much is in the mode of applying a regulatory model, but has a very stable and a very good market.
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    I think there is a lot of difference in how the model is actually applied. It is the—the model itself is probably a neutral tool whether it is the competitive or the regulatory model. It is how you go applying it and the intrusiveness of it and the minutia that you get into.
    So I think it is—there is that gray area as to markets in which there is a regulatory model that actually does work. Now having said that, clearly in South Carolina's case, we felt that in order to change things and to change them for the better, we had to move away from that regulatory model entirely.
    And it was not so much a philosophical discussion. It was a very, very practical decision that was made. We had drivers who were upset by their recoupment fee that they were being charged and the politicians heard about it.
    From the standpoint of how this fits into a national kind of market, I think—I am a state regulator and I am a believer in State regulation. Truly, truly am. And I think there is a difference first of all between the life market and the property and casualty market.
    I think on the property and causality market, there is less of a national market, less of a national market than there is on the life side, looking just at South Carolina for instance. I have Charleston that sits on a earthquake fault. Nowhere else in the state do we have that problem.
    We have a coast that has hurricane exposures. We have an inland part that has hail and tornado, but does not have hurricane exposure. We have of course, our own individual torte laws state by state.
    So I think there are enough state differences to warrant a state-based system. Does that mean the system should remain as is in terms of applying in 50 States? No. I agree with you. It has to be modernized. And I think the NAIC is making an effort and a good effort in that respect. Is it as fast as some of us would like to see it? Probably not, but on the other hand, we are making progress in that respect.
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    So I think that—I think that the hearings like this help. They clearly help because they bring out best practices, I think. And if we take a best practices approach to a state by state approach, I think it can be made to work.
    Chairman BAKER. I will come back to that. I do not want to go beyond my allotted time. We will just wait for another round to come back and investigate that more.
    Mr. Kanjorski?
    Mr. KANJORSKI. Thank you, Mr. Chairman.
    I am wondering whether the panel is avoiding the other side of the question, because you all sounded so uniformly satisfied that we can get to a very stable insurance market without any problems. There must be some problem out there.
    I am trying to think of one of them. One could be if this model has worked so well, for instance in South Carolina, how has it applied to the health insurance industry? Do you have steady and uninterrupted markets for health insurance down there? Very competitive?
    Mr. CSISZAR. I wish I could say that. No, we do not.
    Mr. KANJORSKI. Why?
    Mr. CSISZAR. In large part because we also have the Federal government to deal with. Give you an example. We have a small group market that I would describe as highly dysfunctional at this point. We have very few companies left writing in that—one to 15 employees kind of market.
    Mr. KANJORSKI. What does the Federal government do to affect the health insurance marketplace?
    Mr. CSISZAR. The HIPAA, the HIPAA imposes guaranteed issue and reissue requirements. And when you talk to our companies, we have had over 100 companies exit our state on this small group health insurance policy. And when we speak to them and when we to an exit interview each time, what we get back is, ''No, it is not the state mandates. No it is not the rate bands that States impose on us. It is the guaranteed issue and reissue mandated by HIPAA. That is the real problem with it.''
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    So you have got this mix of state and Federal in the health insurance side that you really do not see prevailing the property and causality or the life side.
    Mr. KANJORSKI. In the auto, property and causality industry, you can refuse coverage at will on the part of the company?
    Mr. CSISZAR. That is correct, and you have the residual market to go to if you are refused. Now if——
    Mr. KANJORSKI. Why don't you just adopt that regulatory system on the health side?
    Mr. CSISZAR. Because we cannot. It is a Federal law that——
    Mr. KANJORSKI. Okay.
    Mr. CSISZAR. ——states——
    Mr. KANJORSKI. But if we did, you do not think that going to the residual market would bankrupt the state?
    I mean, if everybody is losing money in health insurance coverage and they pull out of the state and say go to the state fund to get covered, how can the state cover the costs? They are obviously not leaving because they could make money. They are leaving because they could lose money and are losing money generally.
    Mr. CSISZAR. Right, right.
    Mr. KANJORSKI. So, they want to extricate themselves from the loss of the market, and put it on the residual market. Can the state support that burden?
    Mr. CSISZAR. The way we—the way we resolved that on the property and casualty side is to make sure that the rate charged at the residual level, is in fact an adequate rate, an actuarially sound rate.
    I think if you were to do that on the health side, you would at least have a partial solution to it. We do not do it on the health side. And we cannot do it on the health side right now, again because we also have Federal mandates out there.
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    Mr. KANJORSKI. A lot of the reform that has been talked about here, particularly in auto insurance, is a capping of recovery elements, going after multi-policies and everything else.
    That is not a form of regulation and control in the reverse? You are lessening the opportunity for the victim or for the individual that is injured to seek out a recovery, and obtain a potential recovery. You are getting into a very controlled area, one policy to go against, whatever the limits of that policy are, that is your cap.
    Mr. JUNEAU. Well, my understanding of insurance is it is there to make the insured party whole. And you know, I guess maybe you could say that is form of a cap. I just think it is a logical if someone is—if you allow multiple recoveries from various different policies maybe owned by the individual or owned by other people who are the employer or whatever else, and those multiple recoveries have to have an impact in cost not just in one line of insurance but in other lines as well.
    I mean, again, I thought the purpose was to make the party whole, not to stack up many, many layers of recoveries.
    Mr. KANJORSKI. Well, when they are recovering, they are not recovering above and beyond their damages. They are just recovering from several sources to contribute for the payment of proved lost damages.
    Mr. JUNEAU. Not in my state.
    Mr. KANJORSKI. Are they not?
    Mr. JUNEAU. In my state, they can very easily recover beyond their level of damages.
    Mr. KANJORSKI. Well, that would be in the particular facts of a case, and of course we cannot go into that.
    How do we protect consumers? I am open to a competitive market, except I worry about how we protect individual people without weight in the marketplace to be assured that they can get coverage and that they do not get taken advantage of?
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    In your markets, if I have a home on the same street as another person, and ABC company underwrites a neighbor's policy for $200,000 casualty insurance at X number of dollars, and I have a home within that rate, can I go to that company and get a guarantee that I am going to pay the same price? Or is there a differential?
    Mr. MARCHIONI. If I can just respond to that. I think clearly in a healthy and competitive marketplace, one of the primary roles for a regulator is to ensure that consumers have appropriate and adequate information as to what is available to them out there.
    So I think when you have sophisticated buyers that are capable of doing that by themselves——
    Mr. KANJORSKI. Well, I am not talking about sophisticated buyers. I am talking about unsophisticated buyers.
    Mr. MARCHIONI. And I think it is appropriate for regulators and I believe most of them do, post rate comparisons and do a lot of the leg work in terms of the price of the product.
    Mr. KANJORSKI. So, you do it by rate comparison, but am I not guaranteed if I live next to my neighbor to get the same price from the same company as he got?
    Mr. MARCHIONI. Well, that is where the various or the individual loss characteristics of a particular risk come into play. I think the base rates would be no different, but the risk characteristics of that given exposure would come into play in determining whether that rate would differentiate.
    Mr. KANJORSKI. Well, that is nothing to worry about. In other words, there is no guarantee that I am going to get it. It depends on how it is rated out by the company. It is a one-on-one negotiation between the insured and the insurer.
    We had the same situation when we deregulated the telecommunications industry. There was a bonanza in savings for huge companies. They were able to go in and negotiate telephone service prices with major providers down to darn near nothing, but unsophisticated buyers have literally been rapped over the last several years.
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    I mean there are some people still paying 20 cents a minute for long distance when you could probably in the competitive field get it for a nickel.
    Mr. MARCHIONI. Well, and the response to that is when you look at the competitive market places, those regulators whop are not spending the vast majority of their time pouring over rate filings, could really focus their attention on unfair business practices and market conduct examination processes to do the back end regulation that provides the consumer protection that I think it is—that you are looking to. And I think it is absolutely appropriate.
    But again, if the regulator is forced to spend their time handling prior approval of rate and forms, they probably do not have adequate staffing or resources to dedicate to the business practice review that it is that they are responsible for.
    Mr. KANJORSKI. So, you want to get them out of the regulation business and get them out of the competition business, but get them into the policing business that they comply with good practices?
    Is that what happens in Illinois?
    Mr. SHAPO. Yes, sir. That is what I was trying to get at in my testimony is that there are certainly aspects to the business where consumers cannot protect themselves. And that is what the department of insurance should be for.
    You cannot expect a consumer to understand the balance sheet of a company whether it is financially stable or not. That is what our financial examiners are for.
    You cannot expect a consumer to understand the ins and outs of claims practices. That is what market conduct examiners would be for to deal with that on a global method. And individual consumer complaints as well, thousands and thousands a year.
    The department would serve as an ombudsman to help consumers and that would include perhaps a case where a consumer felt they were not getting the same price and the same coverage offered to them by a company of someone of the same risk characteristics.
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    But I think when you are talking about say, telecom, I think the insurance business is different. Insurance is just a—has no monopolistic characteristics at this point and it has not for decades. You would expect that that bargaining going back and forth between the consumer and the company particularly because it is being driven on a global scale by millions would produce the right results.
    Mr. KANJORSKI. All of your testimony is so compelling. I have got to ask this last question. If you have such great things happen in places like Illinois and South Carolina, how is it that some insurers came up to the Congress and asked for catastrophic insurance coverage to cover hurricanes? If you are so able to price out and cover these catastrophic occurrences, why did they come up and ask the Congress to underwrite those losses when they occur?
    No, no, no, I am not talking about terrorism insurance. I am talking about when they came up here and noted that in the State of Florida, all of the insurance companies were leaving because they had such huge losses after Hugo, was it? Hurricane Hugo or whatever it was. They were leaving Florida unless the Federal government stepped in and became the reinsurer of the high-risk factor.
    If the private market is working so well, we should not be involved in it.
    Mr. CSISZAR. I would agree with you that the government should not be involved in it from that standpoint.
    And in Florida, as it turns out, I do not think—I do not think the Federal government ever became the market of last resort other——
    Mr. KANJORSKI. No——
    Mr. CSISZAR. ——than the floor insurance program.
    Mr. KANJORSKI. Only because some of us had faith in the private market and kept the Congress from passing a stupid act.
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    And the private market has——
    Mr. CSISZAR. I commend you for that.
    Mr. KANJORSKI. ——provided insurance.
    I take that responsibility for my side of the aisle rather than my colleagues——
    Chairman BAKER. And I comment my colleague for his defense of free enterprise.
    Ms. Kelly?
    Mrs. KELLY. Thanks.
    I have a question for Mr. Shapiro—I mean, Shapo. I am sorry.
    Did I pronounce that right?
    Mr. SHAPO. Shapo.
    Mrs. KELLY. Shapo. I will get there. Mr. Shapo, if New Jersey and Louisiana impose price controls on insurance, does not that force the insurance companies to raise prices in the other parts of the country to make up for the shortfall until they can get out of places like New Jersey and Louisiana?
    Mr. SHAPO. I think it essentially has that effect, Representative. Some of the—some States will have laws that on paper prohibit that kind of subsidy, but when you are talking about a national company, the fact of the mater is that company has got to back up the risk in each state with appropriate amounts of surplus. And that the surplus used there is surplus ultimately comes out of the hides of policyholders in other States.
    And in fact, as you alluded to, this—the dynamics there can be so bad that companies will have to in order to prevent that from happening, and in order to do the responsible thing to their owners and policy holders, throughout the county, they will in essence have to quarantine the risk by doing business in a tough state through a subsidiary a single state subsidiary. And the dynamics there are that that subsidiary is not as well capitalized. It cannot take on as much risk. And it eventually will face the risk of insolvency if capital is not able to earn an adequate rate of return.
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    And then of course, that company will have to take steps to withdraw from the market.
    Mrs. KELLY. So basically, if I understand it putting it down into a very simple formula, what is happening is that it is forcing in the short run, those States are really forcing out of state consumers to subsidize the risk.
    Is that right?
    Mr. SHAPO. I believe it has that effect in the end, because the surplus; the capital that will have to come in to support the risk because premiums are not adequately supporting the risk, more capital will have to come in from out of state. And that is surplus that is coming out the hide of other consumers. So yes, consumers in other States will end up subsidizing consumers in States where companies cannot earn an adequate rate of return.
    Mrs. KELLY. Thank you. Mr. Csiszar, since we are discussing the effectiveness of State regulation, I want to touch on something that is rather close to my heart and that is NARAB. It is a section of the Gramm-Leach-Bliley bill. We tried to hit at the heart of burdensome, inefficient over regulation with an NARAB section in that bill. And I wonder if you are familiar enough with the issue, if you could give me your thoughts on where NARAB is now. And whether or not we can help you in any way get some effective control there with NARAB.
    Mr. CSISZAR. I think you will find that there has been good progress with NARAB in so far as implementation is concerned. I know in South Carolina, for instance, we are one of the States that passed the Uniform Model Producer Act.
    I think what you will find is a couple of things, and let's be very fair and practical about this, States are to some extent passing them with some individual variation. So the entire uniformity that perhaps was anticipated is not quite there. But it is being passed and overall, I think a majority of States—I would have to check—but it is close to—38 States. I thought the number was 38—38 States have passed it.
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    Some of the larger States are balking at it and I think again where you can help us is by making your voices heard that those States are also included in this NARAB process.
    We have not quite reached a reciprocity stage or we have reached a reciprocity stage but we have not reach a uniformity state I should say.
    So we are a good way a long the way, but not quite there yet. Even thought we have fulfilled I think the letter of the law, if you will.
    Mrs. KELLY. Thank you very much.
    I yield back the balance of my time.
    Chairman BAKER. Thank you, Ms. Kelly.
    Mr. Scott?
    Mr. SCOTT. Yes. Mr. Shapo, you testified that the Illinois model of regulation could serve as a successful model for other States, that it could produce a healthy market and provide necessary consumer protections in virtually any state in America.
    In your opinion, is there any reason why we could not make the Illinois law the national model? Do you believe it is time for us to give that serious consideration?
    Mr. SHAPO. Whether Congress should mandate that?
    Mr. SCOTT. Right. Make the Illinois law national law?
    Mr. SHAPO. Through congressional action?
    Mr. SCOTT. Yes, yes.
    Mr. SHAPO. My belief is that there is nothing about insurance as I just described at length in my testimony, that would make it so that this product could not be regulated in that competitive fashion to the benefit of consumers essentially in any state.
    My view while I was Commissioner, and it remains so today, is that this state system is—deserves the opportunity to work and without creating a Federal regulator. And I think—Representative Kelly talked about NARAB before. And I think Congress is right to be trying to think of methods by which it can bring about change and use its authority to help the States help themselves.
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    I mean, you have a classic collective action problem in insurance regulation. And that is—and Congress was of course formed to help the States deal with their collective action problems by being a national instrument for facilitating interstate commerce.
    At some point I think that Federal preemption is the only way for States to help themselves. And in fact can help the state system—can save the state system. You can have limited Federal preemption as Mr. Scott is suggesting, that allows—that does not create a Federal regulator but certainly simply puts certain mandates on the States.
    And I think that depending on how urgent the problem Congress thinks it is, that if the States have not been able to do it themselves, individually through the NAIC or through an NARAB type model, that at some point the most severe problems in the regulatory system particularly those that impede capital investment and that impede the globalization of the business for the benefit of consumers, I think that that that reluctantly I think that may be necessary at some point.
    And again, I think eventually that becomes a benefit to the state system because it allows you to keep the state system in place while not creating a Federal regulator by simply smoothing out the rough edges through congressional mandate.
    Mr. SCOTT. It just seems to me that in listening the testimony that New Jersey and Louisiana are suffering in large measure because they are not doing some of the things that Illinois and South Carolina are doing.
    Let me go to South Carolina for a moment. Mr. Csiszar is it?
    Sorry about that. Hope I did not do your name too bad.
    You testified that by moving from a strict prior approval process to a more open market process, that you have been better able to focus on what is essential to insurance regulation. Could you tell us how this reallocation of resources better protects the consumer?
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    Mr. CSISZAR. It does it in a number of ways. And some are really a byproduct. Let me start with the byproduct. The byproduct is that is also allows the legislature to focus more on what is essential for instance. When you look at the cost structure of insurance, by in large the cost structure, yes, there are expenses. But it is made up of claims.
    And it is a fact that you have poor drivers, or you have accidents and so forth.
    In our case, it is allowed our legislature to really focus on DUI laws for instance, seat belt laws, helmet laws, things that we did not have, even highway safety—the dividers on a highway.
    And that is where the true impact on the cost structure, I think, can be had.
    So one benefit comes from the legislative focus. In the case of our Department, we are doing very much what Nat described a moment ago. We are focusing very much on the financial side, the solvency side of things. And we are focusing very much on the market conduct side to avoid the kinds of problems that Mr. Kanjorski, for instance mentioned.
    The market conduct side has become much much more active than we ever were I think within the last few years.
    We focus on discrimination, the redlining. You know, these are things that in the past we talked about. We just did not have the resources to do them with. So it is a different process, and I think a more effective process.
    Mr. SCOTT. If I may—because I just want to go over to Louisiana for a second.
    Chairman BAKER. Take all of the time you need.
    Mr. SCOTT. Thank you. I wanted to just talk because there is this dichotomy. It is like they are doing what is right, and maybe if you all did some of these it might solve some of that problem. But and each state is unique. And in my State of Georgia has its concerns on this issue as well.
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    I want to talk to you about the negative effect of price controls on availability. You testified that the problem in Louisiana comes down to one critical point, that insurance carriers continue to leave your market. And as the insurers disappear, the availability shrinks. Could you please explain how the State of Louisiana's use of price controls have caused the insurer flight in Louisiana.
    Mr. JUNEAU. Well, if they cannot get the premium increases that they deem necessary to price their product in our marketplace, they are faced with a choice of just continuing to face losses which you know—I am not an insurance expert, but Representative Kelly was talking about if they are losing money in Louisiana do they have to make it up somewhere else. And I guess to the extent that they can, they try to do that.
    But they either have to continue to build losses in to their operations or they try to not write as much as possible. They really increase their underwriting standards. They judge risk much more carefully in a state where they are operating like that, which means they chose not to write policies to a lot of people. Or if when it comes down to the final analysis, they leave. We have had a lot of them that have left, particularly in automobile insurance, property and casualty. Some of the health lines in Louisiana, these carriers have just up and left.
    You know, are there ancillary things that impact that? Yes. I will mention some that exist in our law. But I do think that the primary thing to focus on in Louisiana to begin to change the situation is our regulatory scheme that we have in the state. I mean, when you politically appointed people and an elected commissioner sitting on the commission and they are looking at will people look badly upon them if they grant a 10 or 15 percent rate increase?
    The tendency of them is to not—to deny or delay. They will just keep telling the people well come back or we will give you 2 percent, but you cannot—it sounds like bargaining in a bazaar somewhere sometimes. You know, the people come in with their book with their actuarial data and they put it down and they say, ''Here is what our costs are and we would like to recoup those costs and make a reasonable profit.''
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    So I do think that the structure that we have, the prior approval structure has lead to the out-migration of a lot of those carriers in the State of Louisiana.
    Mr. SCOTT. Could you tell the committee how severe is this insurance crisis? What impact is it having on jobs? Or does it, and economic development in Louisiana?
    Chairman BAKER. And that would have to be the gentleman's last question, please.
    Mr. JUNEAU. Yes, sir. I will mention a couple of anecdotal things in my testimony of companies facing some severe problems. This is rampant through the State. But basically, when you are faced—there are two main problems. When you are faced with a sizable increase and I mean a really sizable increase in your liability insurance as a company, it affects your profitability. It affects your ability to expand. It affects your ability to hire people. It affects your ability to buy machinery and equipment that you need in your business. And those have repercussions that operate throughout the business.
    The other main thing is that if your coverages are reduced, if exclusions are put in your policy, if you simply cannot get it and have to go bare, then one instance where you have a loss or a claim can really put you out of business. And some companies have just stopped doing certain operations because of fear of liability exposure because either they could not get the insurance or they got it at very reduced coverages which increase their exposure. And so they stopped certain types of operations.
    Mr. SCOTT. Thank you, Mr. Chairman.
    Chairman BAKER. Thank you, Mr. Scott. Just on a personal note, my homeowner's insurance carrier withdrew last November. And I had to scramble around in December, and try to find that. For all of the agents, I have coverage in effect.
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    But it happens to everybody.
    Mr. Gary Miller?
    Mr. GARY MILLER OF CALIFORNIA. Thank you, Mr. Chairman.
    You talked about liability insurance, and often on the Housing Subcommittee, we debate the impact of government and the regulatory process and how that impacts affordable housing.
    And I know specifically in California, liability insurance for builders is almost impossible any more. And if you do buy a policy, it does not cover attached product which by in large is entry level in most areas. It includes also subsidies and it goes on and on to where when you get through with the policy, there is very little that in fact it does cover.
    And that puts a builder in a very difficult situation because without adequate coverage, lenders are not going to provide loans, because they know they are going to be liable. And it goes on and on to subcontractors.
    And State regulation has been criticized as imposing enormous cost and restricting rather than facilitating competition.
    Is it Mr. Shapo? I did that correctly?
    I know that in Chicago like Los Angeles, is a large densely populated city. Yet insurance is much easier to achieve in Chicago than it is in Los Angeles. Could you address that?
    Mr. SHAPO. Well, I can address the Chicago part of that probably easier than——
    Mr. SHAPO. ——the Los Angeles part.
    Illinois is a State that—it is a large State. It has urban and rural. It has all kinds of different weather problems. It has hail, ice, tornadoes, et cetera. So I think it serves as a example to virtually any state because of its very conditions. And it is comparable to any state's—any other state's large cities.
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    And the—what we—what we found is by focusing on encouraging capital it benefits the consumers because in the first place you avoid the availability crisis that you get. Often what will happen is the price controls and trying to keep prices down will simply in the end cause a major availability crisis. And by focusing on availability in Illinois, going the opposite way. In the first place you have the availability, the residual markets are tiny. They are virtually non-existent which means that people can find coverage through the regular insured market.
    And in the second place, it has the effect in the end of keeping rates affordable. So by focusing more on availability up front, you end up avoiding the crisis, where people cannot get coverage. And you end up producing more like the price controls we are trying to get which is affordable coverage.
    Mr. GARY MILLER OF CALIFORNIA. There has been discussion about NARAB and a lack of uniformity in application. Would somebody contrast the benefit of NARAB versus a possible Federal charter as it applies to opportunity and price?
    Mr. CSISZAR. I wonder if you could clarify that question, because I am a bit confused.
    Mr. GARY MILLER OF CALIFORNIA. Well, NARAB was intended to serve a specific purpose. And yet applications not uniform from state to state, which is somewhat self-defeating in and of itself, you are looking at various States that over regulate the industry. And in the industry is fleeing those States. And you look at some insurance companies that might provide some sort of a policy for builders for improvements of a subdivision or whatever, that if you apply that over 30 States, every state is different. One state allows a third party insurer, and another state does not allow a third party insurer.
    And many of these companies are smaller companies that provide that type of an insurance. And it is becoming increasingly difficult in this country, except for a few States obviously, to acquire insurance and for business people to acquire liability policies which is in some fashion hampering the economy from growing as it should.
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    If we had a, let's say reasonable applied Federal charter, that was similar to what we have for banks. You know, a bank can go from state to state, can get a business. Yet there are state laws that apply that banks fall with under. But it does not take you two years to have an a new approach applied equally throughout the United States if it can do something that did that much more rapidly and was much more consistent, and somewhat eliminated much of this paperwork process they are having to go through from state to state. It is almost like an industry in and of itself filling out forms.
    If we had a reasonable Federal charter, compared to something like NARAB that is not being implemented uniformly, do think there would be a benefit to that?
    Mr. SHAPO. Mr. Representative, could I suggest as a matter of public policy, that there is at least one step in between NARAB and a Federal charter.
    Mr. GARY MILLER OF CALIFORNIA. I am talking about the option of Federal charter, not a mandatory——
    Mr. SHAPO. Understand.
    Mr. GARY MILLER OF CALIFORNIA. It can go either way.
    Mr. SHAPO. I understand, but I would suggest——
    Mr. GARY MILLER OF CALIFORNIA. What would that step be?
    Mr. SHAPO. I would like to suggest that there is at least one step in between which——
    Mr. SHAPO. ——is just pure Federal mandates and preemption, which is—the step that you did not get to in NARAB because the States achieve the hurdle of——
    Mr. GARY MILLER OF CALIFORNIA. So an absolute Federal mandate rather than an optional Federal mandate be applied rather than an optional Federal charter or allowing state option?
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    Mr. SHAPO. Well, what I was going to suggest in terms of if you are assessing policy options, that there is at least one policy option between NARAB and the optional Federal charter, which is limited Federal preemption, but pure Federal preemption in certain cases but that is preemption of certain state practices, without creating a Federal regulator.
    So instead of going, hopping all of the way to creating a Federal regulator and allowing that as an option, you could go, you could stop, make one stop before that and say, and in certain areas where we have discussed and believe it is necessary, we would have limited preemption. We would tell the States that you simply cannot do X or you simply cannot do Y. We are not going to Federalize the implementation of the regulation, but we are going to tell the States that because of the collective action problem and because we have not been able to fix it either the States voluntarily or through an NARAB type of approach, you just simply tell the States you cannot—you cannot apply this type of a law or so forth.
    Mr. GARY MILLER OF CALIFORNIA. Well, quickly, in closing, is there agreement on this panel with that approach?
    Mr. CSISZAR. Clearly that is an option that you have. I would add one other thing to it as you move—since you had bought up the Federal charter. My fear with respect to even an optional Federal charter would not be that no, you are not going to cure some of these problems. Clearly you would cure some of the problems if you go with the Federal charter.
    But you are introducing other risks. By that I mean a new Federal bureaucracy for instance. I am an immigrant to this country, and I have had the distinct pleasure of dealing both with the IRS and the INS.
    Mr. GARY MILLER OF CALIFORNIA. Are you not lucky.
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    Mr. CSISZAR. And quite frankly, my fear would be that you are—by the way, the IRS is downright customer friendly by comparison.
    Mr. GARY MILLER OF CALIFORNIA. Well, the chairman will never approach that direction of even complimenting the IRS or these other agencies.
    So thank you, Mr. Chairman, for your patience on that.
    Chairman BAKER. Certainly. I think the gentleman's point as I was generally understanding it was that produce uniformity is a distinctly different issue from consumer advocacy, and that the 50-state consumer advocacy approach is something I believe everybody is in defense of. It is simply trying to figure out how to get product across state lines with the least amount of encumbrance.
    Mr. Brad Miller?
    Mr. BRAD MILLER OF NORTH CAROLINA. Thank you, Mr. Chairman. I am not entirely used to the idea that I should come into a committee meeting an hour and 15 minutes late and immediately begin to ask questions. But let me do it nonetheless.
    There was just one set of questions that did not appear to be answered, and I suppose the best person to direct it to would be Mr. Csiszar?
    Yes. How much regulation—I know the bulk of the testimony and questions have been about rate regulation. But how much regulation is there of policy forms in South Carolina and other States that you may know about?
    Mr. CSISZAR. Again, we were in a situation where everything was prior approval five, 10 years ago. And we have within the last few years moved away from that. We are now on the commercial side. For instance, we are no longer reviewing policy forms, just property and casualty.
    On the life side, we used to review everything from a very simple whole life policy, to the most sophisticated indexed annuity that you might find. What we are doing now is we are exempting clients from review when there clearly is no plain vanilla kind of policies for instance, where there is no need to review. So we have a selective review process on the life side based on the sophistication of the product, a judgment on how sophisticated the product really is or how complex. Maybe sophistication is not the word. Complexity in a better word, how complex the product is. Whereas, on the commercial side, it is an open market entirely in South Carolina.
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    Let me make one exception to that, our malpractice, medical malpractice forms for instance are still regulated on that side, as is our credit products. I apologize. We do make those two exceptions.
    Mr. BRAD MILLER OF NORTH CAROLINA. Well, basic coverage is like automobile liability and homeowners. Is there a standard form that applies to every insurer offering that?
    Mr. CSISZAR. We have standard forms of course. And there are minimum mandated coverages for instance, for automobile. There are different—right now as I said we are still on the personal line side. We are still reviewing products to make sure that the consumer actually gets the appropriate coverages.
    Mr. BRAD MILLER OF NORTH CAROLINA. Okay. And are you familiar with other States? Is that the case in——
    Mr. CSISZAR. Other States I think with rate exceptions are also prior approval. I think Colorado might be an exception. Nat, you might remember. I do not think they review products. But I think most States have the prior approval process in place.
    Mr. BRAD MILLER OF NORTH CAROLINA. Okay. Mr. Juneau, are you familiar with Louisiana in that respect?
    Mr. JUNEAU. I am not an expert on insurance and all of that in Louisiana. I represent a trade association, so a business association, a state chamber of commerce in Louisiana. So I mean, I do not know that I could help——
    Chairman BAKER. Let me jump in to help Mr. Juneau a little bit. Yes, there is significant prior approval. We have one of the longest delay times from application——
    Mr. BRAD MILLER OF NORTH CAROLINA. You are talking about——
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    Chairman BAKER. ——to the entry into market for new product, typically averaging 180 days, but it can go up to a year.
    Mr. BRAD MILLER OF NORTH CAROLINA. Well, then that—can I continue to address my question about Louisiana to the chair?
    Mr. JUNEAU. I think he still votes there.
    Mr. BRAD MILLER OF NORTH CAROLINA. Are there standard form policies basically every insurer in the State offering automobile liability insurance has the same standard form?
    Chairman BAKER. Yes, yes.
    Mr. BRAD MILLER OF NORTH CAROLINA. And the same is true of homeowners?
    Chairman BAKER. Correct for a minimum policy. There are minimum levels, and there is standardization.
    Mr. BRAD MILLER OF NORTH CAROLINA. All right, and as to the forms that allow insurers to giveth or taketh away, are those standardized as well?
    Chairman BAKER. Yes.
    Chairman BAKER. The gentleman has no further questions. Mr. Garrett?
    Mr. GARRETT. Thank you.
    You know, New Jersey is proud to be number one in a number of things, in a number of different areas. I think the length of time, we exceed yours as far as approval. So besides having the highest rates in the nation, we also take the longest times to approve them—the forms.
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    It seems a consensus of this panel is that the regulatory side is part of the equation as far as where the reform is necessary. And a question from a member from the other side of the aisle that is still here that raised an interesting—and the answer that we got from it—raised an interesting question. It is done a little different here, but this was brought up. And that was if things are working along the way, they are in a couple of States where they are, without the intrusiveness of excessive regulation, the question was raised, ''Well, then how come it is not working in the health side?'' And the answer was, ''Well, that is because the Federal government got its finger into it and started messing things up.''
    So would it help for those States that have made the conscious decisions to allow their local citizens decide what level of coverage you have which varies from state to state. And that will be my follow up question in the insurance on the auto side, how does that differ?
    Would it help for those States to have on the health side of the equation to have exemptions or waivers from the Federal preemption on the health side to give the States the opportunity where they so chose to run on the health systems and provide their consumer with the exact type of health coverage that they want to have?
    Mr. CSISZAR. My answer to that would be a resounding yes that clearly there is room, if nothing else, for States to opt out of some of these. There ought to be some room for States to opt out of some of the Federal mandates particularly when it comes to for instance small group health where you have a particular group of employees. You do not have any cancer problems. Well, why do you need cancer coverage for instance?
    So there ought to be some room to opt out of the Federal mandates. And it would be helpful. Overall, I think the health insurance is a classic example of being over regulated whether it is the privacy issue which we are now going through, whether its the rate making issue. Believe me, I do not blame entirely the Federal government for this. We have done our fair share at the state side.
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    We have rate bands in place. We have state-based mandates in place. Some very onerous ones, fertility mandates for instance, very onerous mandates.
    And so we have also done our fair share. But ultimately I can tell you at least from my experience as I talk to companies exiting these lines of business, the uniform reply that we get that ''Yes, there are problems. These state-based things are problems, but the real, real problem lies with HIPAA and the guaranteed issue.'' That is the answer we are getting.
    Mr. GARRETT. Maybe it is because, and I speak as a former state legislator who is now in Congress, maybe it is because we have so many former state legislators who saw the attributes of regulating on the state level, that now that we are here we say, ''We just cannot give up this idea of passing mandates on the States.'' Maybe this is where this comes from.
    But I would be glad to explore that possibility of seeing what we can do in that area.
    The question along that lien then is, is it possible though for why we see such a divergence of costs and why we see such a divergence of success in these areas, in part due to what the citizens or the legislature in the States have opted to say, ''This is what we want for our insurers.''
    Now in New Jersey we have some reform, and then you can comment in a moment if you would as to what reform is not being done, but you would like to see. And maybe some of the other States that are represented here could say it is in part that you are not requiring mandatory coverages that other States such as New Jersey is requiring?
    If New Jersey wants to start, if John wants to start.
    Mr. MARCHIONI. In terms of the mandates and the coverage levels that are dictated by individual state legislatures, that is really a public policy issue that state legislative bodies should be making along with the insurance departments. The issue here is whether or not the market who serves that product has the ability to adequately price the product. From a public policy standpoint, a state legislature decides that certain levels of first party medical benefits and certain minimum levels of liability coverage are what should be provided as a minimum to every consumer in the state.
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    That is fine. But the private market has got to be able to price that product. And the problem you run into is when we dictate very high levels of mandatory coverages, it generates a very high cost product, which then attracts political interest amongst the voters and them obviously amongst the legislature which leads to price controls.
    So it becomes at the start they are separate issues, but then they become intertwined once the cost of the product rises to the level in fact the mandatory benefit is too high.
    Mr. SHAPO. Also, representative I think that is as matter of public policy, that is what some of us are testifying is that the desires as you described it, for the legislature to quite appropriately say, ''This is what we want for our consumers here,'' that what ends up happening is that these methods that are used to try to get there end up having the opposite effect.
    And that by saying, we want lower prices for our consumers, what you are—using the tool of heavy rate regulation and rate roll backs and things like that, what happens in the end is that the goal of trying to get more affordable or available coverage for consumers, the result is quite the opposite. By focusing so much on price, you end up withering supply. Capital does not come into the market. So then you have an availability crisis, and then in the end rates have not gone down.
    Chairman BAKER. Thank you, Mr. Garrett.
    Mr. Clay?
    Mr. CLAY. Thank you Chairman Baker.
    Dr. Hartwig, if reforms are not enacted to address this availability crisis, and the States continue to impose artificially low rates while losses continue rising, will things get better or worse for consumers? Is this a cyclical or long term problem for consumers?
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    Mr. HARTWIG. What we have today here for consumers under the current regulatory environment is a long term problem. It is not something that is going to go away on its own. It is not cyclical. It is here to stay.
    Now we have heard testimony from New Jersey, for example. This is a problem that has lasted at least a quarter century. That is far more than cyclical.
    In the end what is going to happen is that you have a situation where more capital will drain from the system over time. Invariably that means there will be less insurance available. What insurance is available will be available on more restrictive terms and at higher costs. That is precisely what is happening today. And to the extent that there is any acceleration in the exiting of that capital from the industry, or there are more stresses put on this industry, say from another terrorist attack, or from anything like this, you have a situation where you have an acceleration in terms of the pricing and a decrease in availability.
    Mr. CLAY. Well, does that force us to mandate less coverage? I mean, if that is the way you are going with the argument.
    Mr. HARTWIG. I think that what we are looking at or what we need is an environment where customers determine what they need in terms of how much coverage and what types of coverage they want. It is that way on the commercial side in a number of sectors. It is not that way in the personal lines side in very many States today.
    And so I think we can allow customers who are today are more knowledgeable than ever by the way, in terms of finding out not only about the price, but what is included in a product. There is more information available. We can allow them to take some of that into their own hands as they do when they buy just about any other product out there today.
    Mr. CLAY. Thank you.
    Mr. Juneau, you testified that you believe competition is the best regulator of rates. Why do you believe this?
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    Mr. JUNEAU. Well, from our experience right now in Louisiana, when you have so few carriers available to write to businesses in the various lines, I mean there is no shopping. There is not bargaining. There is no playing one company against the other. You are just kind of over a barrel. The companies that remain and are writing, you know, it is just a very, very difficult situation.
    There is no impetus to bring prices down. I mean, quite often the regulatory scheme does not allow them to raise their prices very fast, so they simply continue to disappear. They continue to simply not write certain types of insurance so you have to simply exclude a lot of different coverages that you need in running your business.
    And just to me, it has been a picture of a real failure of the market to work in the State of Louisiana. The gentleman next to me talks about the companies that are moving into South Carolina to write, and when they do they often write in more than one line of insurance. I do not know any lien of insurance in Louisiana in which we have companies in to write.
    I know about every lien of insurance and we have companies leaving the state. Part of it may be some things in our law which I touched on, but part of it is the fact that they think that we have a very strange regime for regulating the market. And like I said before, when actuarily they go before a commission and state, ''Here is what we raised in premiums, here is what our costs are. Here is the book, look at the book. Check and see what the loses are. We need premium increases to continue to write.'' And they are told come back in—you know, next month. Of come back in three months, or we will give you 3 percent, but not 145 percent.
    It is just not a market they want to write in, sir.
    Mr. CLAY. Okay, thank you. Mr. Csiszar, you talked about how you all had been able to confront redlining in your state. Can you elaborate for me? How do you actually focus on that issue? What measures do you take to discourage that? And when you do find incidents of redlining, what measures do you take against those companies?
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    Mr. CSISZAR. Interestingly enough, when the other reform legislation passed, one of the objections by consumer groups to that legislation had to do with the fact that the legislation specifically permitted zip code rating. And the argument was that that only calls for redlining.
    Well, as it turns out when companies rate by zip code as most of them do, that is one of the best ways to determine whether any redlining is going on. Because you have the data siting in front of you. And my point very simply was that I can now devote resources to that issue. And we have had cases that we have actively investigated for redlining. I can now devote the resources to that to me which is more important than the rate making process when I have 200 companies competing with each other to write the business.
    We have a very active consumer outreach program now which we did not have before. We make sure we go out into communities. Churches—I have got one man on staff who just goes out into the low country in South Carolina, for instance and speaks to groups and informs them of how insurance works. Goes to high schools, for instance, Rotarian clubs. These are things that we just did not do before because we were shuffling all of this paper around. You know, it is become like a—my actuary, by the way who is sitting behind me, some years back said to me, ''You know when we moved to this system, it is like a breath of fresh air.'' And it really is.
    Mr. CLAY. You have become more proactive with the——
    Mr. CSISZAR. Yes.
    Mr. CLAY. ——with consumers. When you find an incident of redlining, I guess a number of variables and factors come into play? Do you look at an insurer's driving record and say it is impeccable, do you then make a determination that that is redlining?
    Mr. CSISZAR. Oh, yes. Actually if there is no redlining if nothing else, we have a very active consumer assistance program. We pull them out of that company and find another company to write for him.
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    Now we are still going to pursue the redlining issue as a matter of discrimination as an issue of law, but we are not going to let them sit with that company. We are going to place them with another company.
    Chairman BAKER. Thank you, Mr. Clay.
    I want to try again to see if I can get agreement as to the observation I was making earlier to distinguish access of product from consumer advocacy.
    Mr. Csiszar, you just made a very persuasive argument that in South Carolina, that when once relieved of the product approval and paper shuffling responsibilities, it released the ability of your employees to go out and actually help consumers proactively.
    That is exactly what I am contemplating if we were to act on a national basis to have every state's insurance regulatory aimed at helping and informing consumers while getting out of the product approval process.
    That is a very simplistic explanation, but the current system of 50 state approval processes, rate setting systems, form setting requirements, counter-signatory requirements serves no consumer interest.
    I mean, there is nothing inherent to that process which automatically insures that a homeowner in south Louisiana is going to get property and casualty insurance.
    But if you take the barriers down and let all of the folks roam where they may, I would suspect that there would be people to come to me and offer a myriad of products where frankly I have few choices today. When some one told me the final four was in New Orleans, I thought, my God, that is the end of the insurance world.
    You know, I did not know what they were talking about.
    If you take the fences down and let people offer product on terms and conditions as they seem fit, what is it that i hear and not to characterize any particular person, but among the NAIC membership, is the concern about that national structure? If we are not building a 13 story building on K Street, if we are merely talking about the way in which product get to the market?
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    Can you respond to that, because I hear concerns that we are moving too far too fast if we contemplate that methodology?
    Do you want to respond? All right.
    Mr. CSISZAR. I will give you my first cynical response.
    Rates and forms are a way of exercising power, and if nothing else you are touching upon a power base that has been traditionally the territory of commissioners. And that is just the reality whether we like to hear that or not. That is just the fact.
    I will tell you my own personal view, and I will speak as director of South Carolina here. That I think it is excellent or insurance commissioner to hear what you have to say on this topic, because there is no doubt in my mind that change is needed.
    Even where we are in South Carolina, we have got a long way to go still. While insurance is somewhat of a unique product in a sense that you pay now and have to wait for the benefits to see them later.
    There is a regulatory process that is needed. No one is talking about taking a libertarian approach here and doing away entirely with regulation. No, there is clear room for regulation.
    And it needs to be changed. So I would welcome, I welcome your interest in this and your pursing this issue because I come out of an investment banking environment for instance. We did not have these problems. What we went after was disclosure and transparency, for instance.
    Well, there is a lot of need for transparency in this industry still. These are the things that we really ought to be pursuing.
    But it is not a uniform view amongst commissioners at this point.
    Chairman BAKER. Oh, I—that is clearly understood.
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    I thank you, sir, for your comment.
    Mr. Shapo, assuming that you may generally agree with the gentleman's comments, how long is it—I have been asking this question now for a decade—how long do we set the clock and ask States through the NAIC structure to adopt some not just reciprocity, but real uniformity at least with regard to product? Or is it advisable to help by having the Congress say do it by such and such a date certain or a Federal action is taken?
    What is your response to that?
    Mr. SHAPO. My chair just got very warm.
    The—I think as policy makers, you have to gauge yourself just how tough to get at what point. But clearly, I believe that—I will say it again. This is the active collective action problem with the States. And it is up to a certain point to the extent that deviations are allowed and not specifically preempted, they will exist. That will always happen.
    I mean, to the States, I think virtually every state insurance department in the country does a good solid job of regulating insurance. They know their jobs. They do it well. They have experience and so forth.
    But if the test is not, are they competent and trustworthy to their job, if their test is will they have the right policies and or uniform policies, the States at some level are ultimately going to fail that test.
    I mean, it is just impossible with 51 equally sovereign actors to expect them all to achieve uniformity on their own. So I think that to the extent that I do not want to get into the business of publicly offering advice on this, that the thing to do is to very directly state the goal that you want and say these are the options on the table, a NARAB type of approach which is preemption, but it is preemption that could be preempted. Right, the NAIC preempted the NARAB preemption by reaching the goal, the 29 jurisdiction goal which allowed several key States to not join up.
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    So you could say, well, there is another step down the road which could be just an outright preemption saying you can prior approve or if you prior approve, you have to have a DEEMER or whatever would be. And you could say that that is the next option, and the option after that is the mother lode, you know the 13 story building in K Street. And I think you directly lay out those options and you pick, you know, a reasonable timetable probably in consultation with the key players, including NAIC officers on it. And then you just publicly state these are the goals. And at some point those last two, a direct Federal mandate that cannot be preempted by States and or a Federal charter. Those we will actively pursue those. And I plan to sponsor those on a certain date.
    And you know, I think that the date on the first one of those, the plain mandate probably should not be too far in the future. I mean, my experience as a public administrator, as a public policy maker was that you need to in order to get people to do things, you have to have the hammer, you know, visible. It cannot be little dot on the horizon.
    Chairman BAKER. Well, I hope folks can at least hear footsteps. I mean, they do not need to see us, but they at least need to hear us. I mean, we have been talking about this for so long.
    Mr. Kanjorski?
    Mr. KANJORSKI. You know, we have been talking for about two hours, and I am starting to conclude that I have not really heard anybody. When you really think about what we are arguing here, we are saying we want to provide coverage for the business community and the consumer community. We are obviously not discussing that you are being inhibited or that the insurance industry is being inhibited from cutting their rates. Is that what I am supposed to gather from today? Or am I correct that what you are really all talking about is there has to be an increase in rates? We are all talking about how we go about doing that, whether we get to do away with rate regulation or policy content control. More money has to flow into the insurance industry to give the coverage that is requested to meet the claims that are out there and underwritten.
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    Is that not about the simplest way to summarize what we are talking about?
    Mr. HARTWIG. I think so, sir, and it is definitely the case that the issue of changing rates in the insurance industry is not symmetrical. No one stops you from lowering them very frequently. But you are very frequently prevented from raising them.
    Mr. KANJORSKI. Right.
    Mr. HARTWIG. And that creates a problem——
    Mr. KANJORSKI. That is what we are talking about then. The insurance industry needs higher rates, and how are we going to do it and how will you make it look nice.
    I am not opposed to an efficient insurance marketplace. I want to go to Louisiana's problem because it is a problem. I have been sort of an obstacle in Congress to providing catastrophic insurance. You raise the question, Mr. Juneau, that you are losing companies in the southern part of Louisiana. That fact does not surprise me and it does not necessarily mean it is because of rate regulation or content regulation, or product regulation.
    Louisiana is subject to hurricanes. Under every forecast I have heard, it is reasonable to assume within the next 20 or 30 years, a class-one hurricane is going to hit New Orleans and cause great decimation. There is not any property and casualty company that wants to be insuring that risk without some protective cover from the Federal government or the ability to spread that risk loss across the country to a very large base.
    But I do not care what kind of a product it is, you know what the rates are, the risk of writing casualty insurance in New Orleans in Miami Beach—I will not single out only Louisiana is higher. We have identified about 13 major population centers in the United States that are at extreme risk for higher losses of property and causality insurance. In a way, everybody is trying to find a way to allow these communities to continue to exist at the same insurance rates they are paying now. Continued growth however, means greater exposure to be picked up in the case of a loss.
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    I think that if Hurrican Andrew had come 25 miles north of where it hit and if it came today the insured losses would be $75 billion. That point has always been my argument. Why should the guy in Idaho underwrite someone who wants to build a building on Miami Beach? Part of the risk of building a building in Miami Beach or New Orleans is the fact that you have got a chance, a much higher chance, of catastrophic loss. The marketplace should reflect that risk with higher costs in that particular marketplace.
    I am in favor of that principle. Unfortunately, I do not think you are going to get an awful lot of economic development started in a higher risk area because your rates are going to be extraordinary compared to all of the rest of the country.
    If you are sitting on top of a volcano or if you are sitting on top of a fault in California, you have got a problem. All of us are trying to find some way to subsidize or ameliorate that problem. If we go to a real free market economy model and we say the rates should reflect the exposure, the potential exposed loss that is going to come through natural circumstances, you are not going to have a very positive economic development future in southern Louisiana or in Florida or in California along the coastline.
    It is just not going to happen. I, for one, representing the State of Pennsylvania say, ''Hey, why should we give a rate guarantee or underwriting advantage regardless of how you do it, whether it is through the Federal government of whether you spread it the base across the country, the rate, why should we encourage capital to flow artificially by being subsidized by other areas of the country or by the Federal government to go into higher risk areas?
    Clearly, if you are going to spend $10 million on a building, and if you build in Kokomo, Indiana, your appreciation is likely not going to be that great. If you put it in Miami Beach however, it is going to appreciate significantly over the next five or 10 years. So if you can just meet the period of time where the loss does not occur, the exposure does not occur, your investment is going to appreciate a great deal.
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    But the reason it is appreciating a great deal is because they are getting an artificially low insurance rate to cover the potential loss or cost that is there.
    Maybe your argument should be, let's let the marketplace handle that. I am for that. But it is going to be very disadvantageous to some of the high growth areas of this country if they adopt that policy. I am, however, for it as long as we can find, I think, a uniform product.
    I think Mr. Miller brought that point up and that is very important. I mean, I do not want to read that insurance policy or hire an insurance lawyer to figure out what I am covered for and what I am not covered for, as we discussed up here on the dias when some of you were talking. I cannot think of many people other than business people, executives specifically hired to study insurance policies, that spend the time reading their policies. They call up their insurance companies and say, ''I am buying an automobile, give me automobile coverage.''
    Assume you get a good policy from the company. I could not tell you what it excludes or includes. I only find that out after they do not want to pay for the damages that I have had after an accident or after something happens. That is when I read my policy, and find out what they do not cover and what I thought they did.
    The homeowners policy has the same problem.
    Now as far as I am concerned, if we can get some balance either on the state level or across the country for a uniform product that people do not have to hire a Philadelphia insurance lawyer to interpret their policy every time they file a claim, and if we go to the natural market driven rate, I am of the opinion that we may favor some of the more disadvantaged economic areas of the country that have been subsidizing the economic growth areas of the country for a long time, particularly in the private market through insurance by having companies go in there and suffer huge losses in Florida and Louisiana and having to pick up those losses in other States or get out of the business.
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    Now the one other thing that bothers me is that I feel someone could interfere with the insurance business. Let me ask you this. I like the idea that we have small insurance companies. I am not sure that if we get into this market-driven system we are not just putting such favoritism to huge, well capitalized companies and eventually forcing the smaller companies out of business that just cannot write because they have such a limited base or pool to write on.
    What is the panel's thinking on that point? Are we going to materially shrink the number of companies that are engaged in the business?
    Mr. HARTWIG. I might start first here. Already in virtually in every state and those that are competitive of course, like Illinois, and like South Carolina, you have the presence of major insurers who have a significant market share. But for decades you have had them competing with very small insurance companies who might only write within that state or within that region. They might only write a single line within a single state.
    The obituary of small insurance companies has been written many, many times and always prematurely. And so these companies have been able to demonstrate their ability to compete with large insurance companies in the current environment and I would expect that to be the case under any regulatory scheme.
    Mr. KANJORSKI. In Illinois we changed the system. Will they be able to continue to exist, we are not going to disadvantage small companies?
    Mr. HARTWIG. What I am saying is that yes, small companies now compete with large companies under all regulatory schemes today.
    Mr. KANJORSKI. Yes.
    Mr. SHAPO. In Illinois, Representative, we have the highest number of companies competing in the homeowner's market. So I think it would have the opposite effect. I think it enables small companies to be able to compete it. And I think that makes sense if the regulatory system is very burdensome, probably a larger company with more surplus would be able to afford the—those transactional costs than a smaller company would.
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    And if I could make one quick comment on when you said earlier as kind of a bottom line, when you were talking about rates being too low or too high, I think it is—I do not think we can say that it is just what this is all about is the insurance company needing higher rates. I think what we are saying is that insurance companies need to be able to raise and lower rates quickly. And in accordance with market driven decisions, as opposed to driven by regulatory considerations and a long delay. And that has to do with not only raising but also lowering rates.
    And it is also not just——
    Mr. KANJORSKI. Well, that is true in a measured area, but as the doctor said, the industry is undercapitalized. It has to attract more capital.
    Mr. SHAPO. Right.
    Mr. KANJORSKI. That means more profit. That means higher rates.
    Mr. SHAPO. Well, but it also means that companies need to be able that they can charge higher rates when they need to.
    I think what is happening in a lot of States, with the tighter regulatory systems, because companies are concerned that their capital will be subject to government capture, they do not invest it in the first place. Not necessarily because they might need a higher rate right away but because conditions might change and the industry needs to be able to charge the right premium to deal with those changing conditions. If they cannot do that, they will not subject their capital to government capture, and that is why they would be undercapitalized.
    Mr. MARCHIONI. If I could just respond to your original question. I think you could probably make a pretty strong argument that the strict rate regulatory environments are more difficult on the small comapnies than would be a competitive rating market. And the reason I say that is when you have a competitive rating law when a small company realizes they need to make an adjustment either in their pricing structure or their underwriting structure, they can do that rather quickly.
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    Whereas, in a prior approval system, when we used the example of a state where it takes 18 months to get a prior approval filing done, if a small company realizes they need to make an adjustment and it takes then 18 months to get there, that 18 months may put them out of business.
    So I think—you know, you could probably make a pretty strong argument that just the opposite would apply if in fact we were to go to a competitive rating law on a national basis.
    Mr. CSISZAR. If I could just pick up on that point that Nat picked up on a moment ago on a point that you made, Mr. Kanjorski, is that what it really means is higher rates fro some and lower rates for others. On average of course, I think we are talking about an increase in rate. The other comment that I would make on some of the subsidizing that you were mentioning that make on currently. I mean when you look at one of the most dysfunctional programs when it comes to subsiding, is the Federal flood insurance program.
    Mr. KANJORSKI. Yes, I was going to raise that with you.
    Mr. CSISZAR. Yes. Where people are rebuilding in that same flooded location through——
    Mr. KANJORSKI. So, you agree with many members of Congress that South Carolina's people have got to start paying the real rates for damages, and South Carolina has a responsibility to exercise zoning and control development laws along that coast.
    Mr. CSISZAR. And enforcing building codes. Yes, indeed, I do.
    Mr. KANJORSKI. Well, why have you not just on a state basis pursued that policy?
    We do not have to enact anything up here for you to say, ''Whoa, citizens of South Carolina, the rich northerners are coming down from the Cold Belt. Stop building your million-dollar homes on areas we know are going to flood every 10 years.''
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    Mr. CSISZAR. Well, there is always the question of political will, I suppose.
    Mr. KANJORSKI. You mean South Carolina does not have the political will?
    Mr. CSISZAR. Well, our commissioner previously did not. He had political ambitions.
    Chairman BAKER. Nothing further, Mr. Kanjorski?
    I want to express my appreciation to all of our witnesses. This has been, I think, a particularly informative hearing for the committee. We obviously are not poised to take any immediate action but your recommendations are certainly helpful in dictating the course of these discussions.
    And it is my hope that we can find some manner of mechanism to facilitate increased affordability and accessibility to insurance products for more Americans. It is clear that the current system from a national perspective at least, is in a difficult state and that some modifications are in order.
    Exactly what those modifications might look like are yet to be determined, but we do appreciate your comments and observations in this effort to bring about reform.
    We have votes pending on the floor so our meeting is now adjourned.
    Thank you very much.
    [Whereupon, at 12:18 p.m., the subcommittee was adjourned.]