THE TEXAS DEPARTMENT OF INSURANCE: WHERE IT CAME FROM, WHERE IT’S HEADED

BRUCE MCCANDLESS III, Austin Mitchell, Williams, Selig, Gates & Woodyard

PATRICIA FULLER MCCANDLESS, Austin Greenberg Traurig

State Bar of Texas 9th ANNUAL ADVANCED INSURANCE LAW COURSE April 12-13, 2012 Dallas

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Arkansas Texas New York Washington, D.C. MitchellWilliamsLaw.com

Mitchell, Williams, Selig, Gates & Woodyard, P.L.L.C.

BRUCE MCCANDLESS III

512-480-5128 512-322-0301 (fax) [email protected]

Education B.A., Plan II, University of Texas at Austin, with high honors, 1983 M.A., University of Reading, Reading, UK, 1984 J.D., University of Texas at Austin, 1989 Admitted to practice in Texas , 1995 Admitted to practice in New York, 1990 Admitted to practice in District of Columbia, 1992 Admitted to practice in U.S. District Court, Western District of Texas, 2001

Practice Area Insurance corporate and regulatory law, administrative law and governmental relations, contract negotiation, drafting, and disputes.

Professional Experience Bruce McCandless III is a former Assistant Attorney General for the State of Texas and Enforcement Attorney for the Texas Department of Insurance. Mr. McCandless specializes in insurance regulatory matters and in representing insurers, agents, and lenders in insurance-related disputes before the Texas Department of Insurance and in the state and federal courts of Texas; he has also prepared and fi led amicus briefs on insurance-related matters before the Texas Supreme Court. In addition, Mr. McCandless has handled insurer acquisitions, withdrawals and licensing matters, and recently obtained regulatory approval of a transaction involving merger of a non-insurance related entity into an affi liated life insurance company.

Publications Author, “A Brief History of the Texas Department of Insurance,” Journal of Texas Insurance Law, Vol. 3, Nos. 1 and 2 (Spring 2002 and Fall 2002); “Reforming the Texas Windstorm Insurance Association: The Politics and Policy of Catastrophe Risk Sharing,” FORC Quarterly Journal of Insurance Law and Regulation (Vol. 19, Ed. 2), Summer 2008; “Picking Up After High Tide: Thoughts on Title Agent Insolvencies in Texas,” August 2010, Mitchell Williams insurance regulatory blog.

Other Activities Austin Bar Association; State Bar of Texas, Litigation Section Member; President, Zilker Theatre Productions (2007-2008).

106 East Sixth St., Suite 300 | Austin, TX 78701 | 512-480-5100

The Texas Department of Insurance: Where It Came From, Where It’s Headed Chapter 5

TABLE OF CONTENTS

I. INTRODUCTION ...... 1

II. A HISTORY OF TDI ...... 1

A. The Origins of Insurance Regulation in the U.S...... 1

B. Early Regulation in Texas (1874-1888)...... 2

C. The Populist Influence (1888-1905) ...... 4

D. The Quest for Control (1905-1944)...... 7

E. The Bad Old Days (1945-1972)...... 11

F. Consumer Protection as Guiding Principle (1973-1997) ...... 15

G. ―The Best Financial Services Agency in the World‖ (1997-present)...... 19

III. TDI TODAY ...... 19

A. The New Commissioner...... 19

B. Inter-Agency Organizational Chart...... 20

C. TDI Organizational Chart...... 20

D. Where the Laws Come From...... 20

E. Sources of Texas Insurance Regulation ...... 21

IV. THE TDI OF TOMORROW ...... 23

A. Increasing Federal Participation in Health Insurance Regulation...... 23

B. Federal Insurance Office...... 25

C. Increasing Interstate Collaboration in Financial Regulation: Solvency II and the New Model Holding Company System Act...... 25

V. CONCLUSION ...... 27

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I. INTRODUCTION Made Upon the Bills of Mortality, contained information on deaths in London from 1604 to 1661. This paper presents an overview of the Texas Working with data kept by parishes of the Church of Department of Insurance (―TDI‖). In addition to England, Graunt analyzed who was dying, how often, sketching the development and present functions of and from what causes—including plague, syphilis, the agency, the paper addresses TDI‘s immediate rupture, worms, and "griping in the guts.‖ Graunt's future. Will the agency‘s power and influence wane in work may in turn have inspired the astronomer the face of federal regulation of the health insurance Edmund Halley's detailed analysis of population data market? How is TDI preparing for implementation of kept by officials in the German city of Breslaw. Using the Affordable Care Act? And what other factors are the Breslaw information, Halley was able to compile, influencing TDI and its mission? in 1693, the first modern table of life expectancies. From this he delved deeper into a detailed 1 mathematical analysis of annuities, including annuities II. A HISTORY OF TDI covering two and three lives as well as one. While Halley‘s work was for him a sort of intellectual TDI started as an administrative cubbyhole, staffed recreation—Halley was instrumental in publishing Sir by one commissioner and a single overworked, all- Isaac Newton‘s monumental Principia Mathematica, purpose clerk. It is currently run by one commissioner and did some work on comets, as well—it provided and a staff of over fifteen hundred men, women and the scientific foundation for a huge, and still-growing, animals, including actuaries, accountants, attorneys, industry.2 peace officers, and arson investigators (some of whom use dogs to sniff out chemical fire accelerants). This In the United States, the insurance industry took staff oversees every automobile, homeowners, title, life root in the country's northeastern metropolitan areas. and health insurance transaction in Texas. It approves The ubiquitous Benjamin Franklin, the Tony Stark of insurance policy forms and many of the rates insureds his day, was an innovator in the field. He established are charged for coverage. It oversees the state‘s workers America‘s first incorporated fire insurance company, compensation system and the State Fire Marshal‘s the Philadelphia Contributorship for the Insurance of Office, investigates violations of Texas‘s insurance laws Houses from Loss by Fire, in 1752. These early and keeps tabs on the financial health of every stock insurance companies were generally formed through insurance company, Lloyds plan, reciprocal exchange, legislative charters. It wasn't until 1849 that New York county mutual, and benevolent association licensed to passed the first general insurance law, which is do the business of insurance in the state. With a commonly thought to mark the beginning of systematic biennial budget of over $200 million, TDI is one of state regulation. New York laws forbade companies the largest insurance regulatory agencies in the United from engaging in multiple lines of insurance. Thus, a States. life insurance company could not sell fire insurance, and vice versa—a prohibition that was to be incorporated in A. The Origins of Insurance Regulation in the Texas's first regulatory statutes twenty-five years later. U.S. The origins of insurance as we know it today— Indeed, the distinction survives even today. simply put, the consensual transfer of risk for monetary consideration—can be found in several different times In 1868, the United States Supreme Court‘s and places. In his book Against the Gods: The decision in Paul v. Virginia established that states, Remarkable Story of Risk, Peter Bernstein paints a rather than the federal government, had the right to fascinating picture of the evolution of actuarial regulate insurance. Paul was an agent of a New York th science, the basis of modern underwriting. In the 17 insurance company who was fined by the Century, an English button merchant named John Commonwealth of Virginia for selling insurance there Graunt set out to calculate the death rates of his fellow without a license. In his appeal, Paul argued that the sale citizens. His study, Natural and Political Observations of insurance was interstate commerce and thus subject

1 These remarks are an updated version of a paper titled 2 Anyone interested in a discussion of the antecedents to ―You Can Take That, or Worse: A Brief History of the insurance as we know it should read Chapter Five of Texas Department of Insurance,‖ by Bruce McCandless III, Bernstein‘s Against the Gods: The Remarkable Story of published in two parts in the Spring 2002 and Winter 2003 Risk, John Wiley & Sons, Inc. (New York 1998). issues of the Journal of Texas Insurance Law.

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to the regulatory jurisdiction of the federal government Finally, the state was only semi-settled. As under the commerce clause of the Constitution. The mentioned above, the American insurance industry case went all the way to the United States Supreme started in urban areas. In 1870, Texas had just two Court, which ruled that the sale of insurance policies cities, Galveston and San Antonio, with a population of was not interstate commerce and that states were over ten thousand. Only six percent of the state‘s entitled to regulate insurers and agents operating within population of roughly eight hundred thousand people their boundaries.3 lived in towns with a population of over two thousand.5

B. Early Regulation in Texas (1874-1888). The state‘s lack of regulation allowed various evils Several years after insurance regulation was a going to flourish. While commercial consumers—generally concern elsewhere in the country, Texas still had not merchants, in port cities like Galveston, Indianola, and enacted legislation on the subject. This inaction was the Beaumont—bought coverage at their own risk, they had result of several causes. First, Texas suffered during at least some contractual sophistication. They could these years through the considerable distractions of bargain at arm‘s length. Other citizens were less secession, the Civil War, and Reconstruction. Business fortunate. As Commissioner of Life Insurance George matters languished as northerners and southerners, B. Butler once put it, ―during this pre-regulated era in Republicans and Democrats, struggled for control of the the history of insurance law in Texas, and for several sprawling state. Texans fought Comanches well into the years afterward, many various and sundry schemes of 1870s and Apaches for many years afterward. As late as insurance were prevalent...in the operation of which, 1916, violent border battles with Mexican nationals wholly irresponsible individuals used every technical erupted. In short, there were more important things to device and at times resorted to trickery and fraud to worry about. defeat and keep from paying their bona fide claims and losses.‖6 Second, there was relatively little insurance sold in Texas before 1875. This was at least in part because few Since there was no insurance regulation taking people in the predominantly agrarian state had either the place, it is difficult to know precisely what the major money or the motivation to buy it. Granted, Texans regulatory issues posed by the insurance industry in have always needed insurance. The state consistently Texas were before 1874. There were probably two. leads the nation in weather-related fatalities.4 The First, Texas was missing out on a significant source of region is plagued by hurricanes, floods, heat, hail, and revenue due to its failure to collect taxes and fees from tornadoes. And that‘s just during the summer. Come insurance companies doing business in the state. winter, blue northers sweep down off the plains, burying Second, the state generally lacked control over and even the northern regions of the state in snow and ice. Still, information about the industry, which led to consumers insurance has always been a product for the prosperous. being damaged by insurer fraud, insolvency, and willful Many Texans in this era had little to protect, and thus failure to pay claims. little incentive to buy financial protection. In 1874, the 14th Legislature enacted the state's first insurance law, ―An Act to Regulate Life and Health Insurance Companies.‖ The new law required

3 companies doing insurance business in the state to Paul v. Virginia, 75 U.S. 168 (1868). Policies purchased register with the state‘s Comptroller and to make by Virginians, wrote Justice Field for the majority, ―do not take effect—are not executed contracts—until delivered by certain financial disclosures. It also specified that the agent in Virginia. They are, then, local transactions, marine, fire, and casualty companies could not do and are governed by the local law.‖ 5 Carl H. Moneyhon, ―Reconstruction,‖ The Handbook of 4 The state‘s destructive weather events are cited by industry Texas Online (Austin: The University of Texas 2000). representatives to explain why Texans pay some of the highest homeowner‘s insurance rates in the nation. See, for 6 George B. Butler, ―History and Development of Insurance example, Terrence Stutz, ―Texans Pay Most to Insure Law in Texas,‖ revised by William J. R. King, published in Homes,‖ Austin American-Statesman, June 25, 2000, p. B1. 14 Tex. Civ. Stat.-1: West Publishing Company, Washington, D.C. 1979). 2

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business in life insurance and that companies that taxes from all insurance companies doing business in failed to pay losses on a policy were subject to the State of Texas. With the assistance of his staff of forfeiture of their right to do business within the state. one, a clerk named Paul McCombs, Commissioner King The Legislature followed up in 1875 with a more set about these tasks with his customary diligence. In comprehensive statute governing fire and marine 1879, King reported that forty-two fire and marine insurance companies. These laws were initially enforced insurance companies were registered to do business in by the Comptroller of Public Accounts. In 1876, the state, of which three were Texas corporations, and however, the newly-enacted Constitution of Texas—the that seven life and health companies, all from out of same decentralizing, much-criticized constitution in use state, were legally selling insurance in Texas. That year today—authorized creation of a ―Department of the Commissioner and his clerk collected a total of Insurance, Statistics, and History‖ to regulate the state‘s $12,176.90 in state fees and taxes. Since the free-range insurers. The Legislature established the Department‘s budget was a little over two thousand agency later that same year. dollars, the agency was clearly a money-maker for the cash-strapped state. The Department‘s first commissioner was Valentine Overton King, a former physician, Confederate medical The Commissioner of Insurance, Statistics, and officer, school superintendent, and lawyer from New History had little disciplinary power in this era other Orleans. It was fitting that the first commissioner was a than his ability to impair the license of a registered man of diverse talents. As indicated by the agency‘s insurer or agent. But this was a significant threat. "The title, the Department's executive officer had numerous power invested in this office to suspend or vacate...the responsibilities. Under the heading of Statistics, the license of a company," noted one early Commissioner, Commissioner was charged with gathering agricultural "may oftentimes have greater terrors to an insurance data from every county in Texas. Once gathered, the corporation, to which public confidence may be truly information was to be disseminated throughout the said to be the breath of life, than the judgment of a nation and abroad to publicize the Lone Star state's court."7 To their credit, these early officials were resources—chiefly, millions of acres of semi-arid but generally willing to use this power—oftentimes after highly affordable land, retained by the state upon its conducting the necessary fact-finding themselves. They entry into the Union in 1845—as a magnet for both were also possessed of formidable rhetorical skills. investment and immigration. In their duties as Wrote Commissioner Lafayette Lumpkin Foster in his commissioners of History, King and his successors were official report of 1888: charged with collecting material related to the state's origin and development. The Commissioner also served I revoked the authority of the Insurance as Superintendent of Public Grounds, responsible for Company of Dakota, July 18th, on account of overseeing and maintaining the state‘s properties in the insolvent condition of the company, which Austin, including the Capitol building and the new state was ascertained by me upon a personal cemetery. Finally, and almost as an afterthought, he was examination of its affairs... The statement of its put in charge of the state library. In 1885, the 20th condition December 31st, 1887, upon which it Legislature conferred substantial additional duties on the was authorized to continue business, was a agency, which had become a sort of governmental sock unique piece of perjury, and the subsequent drawer. It was renamed the ―Department of Agriculture, management of its affairs illustrative of a Insurance, Statistics and History.‖ The Commissioner species of financial jugglery rarely, if ever, was now expected to ―keep in constant communication equaled. The company is in a hopeless with the Department of Agriculture of the United States, condition, being without either assets or distribute annually seeds and plants solicited from that honor.8 office and transmit back all results of agricultural experiments and such other information as may be accessible.‖ 7 Id., p. 8.

8 In addition to all these tasks, the Commissioner was L. L. Foster, ―Report of the Commissioner of Agriculture, charged with identifying, registering, and collecting Insurance, Statistics, and History for the Year 1887,‖ December 31, 1888, p. 4. 3

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regulation of the railroads, for example—in his own But getting the insurance companies operating in platform that he was able to ride the whirlwind of Texas to submit to state regulation in the first place popular discontent that welled up in Texas rural proved to be a difficult proposition. As Commissioner communities in the last decades of the 19th Century. In King's successor, A. W. Spaight, put it in 1881, "Illicit those days, cash-poor farmers agitated against big insurance, like illicit distilling and smuggling—kindred business of all types, including the railroads, banking, offenses against the revenue laws—has ever been and insurance, because it was seen to be a tool of Eastern difficult to detect, and for that reason next to impossible financial domination. It was felt that such domination to wholly suppress."9 kept Western agriculturalists from receiving the cheap credit they needed to keep their farms afloat on seas of C. The Populist Influence (1888-1905) In dust. Because the overwhelming majority of insurance dealing with unlicensed insurers, known in those days companies operating in Texas were from out of state, as "wildcat" companies, the Commissioner was obliged they were prime targets for harassment and rhetorical to call on the office of the Attorney General of Texas. ambush. Attorney General and soon-to-be Governor James Stephen Hogg was happy to oblige. The state‘s first Though Populism as a viable political platform had nationally prominent demagogue, Hogg was an died by 1900, many of its sentiments (opposition to the imposing physical specimen (over six feet tall and gold standard, for example) made their way into the weighing some 250 pounds), a gifted orator and rabble- mainstream of the state‘s Democratic party and, rouser with keen political instincts. Leader of the state‘s eventually, into the national political debate.11 One of well-entrenched Democratic party, he played on popular the most lasting of these sentiments was an abiding passions without ever wholly succumbing to them. As dislike of ―combinations,‖ or ―trusts,‖ of businesses in a historian T. R. Fehrenbach notes in Lone Star, Hogg particular industry, which were seen as vehicles for the was a born populist, capable of rousing his fellow companies to control prices and supplies of products. A Texans to a fever pitch against Yankee capitalists and dramatic demonstration of the way such sentiments financiers. could be directed at insurance companies occurred in 1899. Legislators in Arkansas enacted a bill to combat Brilliantly intuitive, he chose the 'soulless trusts that forbade the presence in the state of any corporation' as the burning issue of his day. As ―combination‖ seeking to control the price of a Attorney General of Texas, he declared war on commodity or service. Despite its broad language, big business, wherever it might be found. He which could also have been interpreted to outlaw the became the center of attention and won a activities of labor unions, the bill was aimed quite million farmers' hearts. In office, Hogg struck deliberately at insurance companies. The state‘s attorney first against insurance companies and drove general promptly filed one hundred and twenty-six some forty from the state… On the stump, he lawsuits against fire insurance companies doing could hold a crowd of Texas farmers for hours, business in the state that had connections with blasting railroads, bloated capitalists, associations, exchanges, or rating bureaus, whether such 10 insurance companies, gold. associations or bureaus were located in Arkansas or not. Most, if not all, fire insurance companies operating in Hogg was never a Populist in the formal sense—i.e., Arkansas suspended their operations. a member of the farmer-dominated Populist Party that challenged the Democrats from the left in the 1890s. However, he incorporated enough Populist ideas— 11 The idea that poor but virtuous farmers needed protection from the predatory practices of Wall Street‘s plutocrats and 9 A. W. Spaight, ―Report of the Commissioner of Insurance, money-changers remained potent for at least the next fifty Statistics, and History for the Year 1881,‖ March 31, 1882, p. years. And not just in Texas. Indeed, Harry S. Truman won 13. the 1948 U.S. Presidential election in large part by playing on traditional small-town distrust of big business in terms not so 10 Lone Star, pp. 619-620. different from those used by Jim Hogg seventy years earlier.

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Sensing a crowd-pleaser, politicians in Texas apocalyptic 1906 earthquake in San Francisco was in promptly introduced essentially identical legislation in fact a result of fires that started in the wake of the Austin. Thus began a political fire storm of a sort that tremors. The results were appalling. ―The total value of was to be repeated many times over the course of the the property destroyed,‖ wrote a stunned Texas next century. Insurance men boarded trains for the Commissioner of Insurance William J. Clay of the San Capitol, sputtering that enactment of the law would Francisco disaster, ―is estimated at more than drive insurance companies, and capital, out of the state. $300,000,000, and the loss to fire insurance companies In the words of one contemporary account, ―everybody exceeded $225,000,000. This amount, it will be seen, is was here,‖ and ―an outsider had naught to complain of nearly double the total surplus of all fire insurance in having a free circus arranged for his especial benefit. companies reporting to this Department. In all the There were hundreds of men in and out of the history of fire insurance no condition approximating this legislature to whom this matter was no laughing one, one has arisen. It is estimated that the loss was sufficient however.‖12 The Arkansas Senate sent a telegram to to exhaust the surplus earnings for the last thirty-six legislators in Texas, urging them to ―stand by your guns. years of every company doing business in the United Pass your anti-trust bill, the corporations will complain, States.‖14 but the people will rejoice.‖ As if to underscore the desirability of insurance, a Fire Insurance fire in the autumn of 1881 destroyed the state capitol in Austin. At the time, the state's agencies shared the During these years, the insurance industry in Texas building with the governor and both houses of the was dominated by the fire insurance companies. It may legislature. When fire broke out in the building just after be difficult for us to comprehend 19th Century noon on November 9th, devoted agency officers and America's fear of fire. Fires still kill people and animals clerks, including Commissioner of Insurance, Statistics, and damage property, but the destruction they cause and History A. W. Spaight, dashed in and out of the today is minor compared to the results of the burning building to save official records. conflagrations that took place in the United States in the fifty years following the Civil War. The largest of these Texas‘s oldest insurance companies started in the was the Chicago Fire, in October of 1871. At least three 1880s and ‗90s as mutual aid associations, intended to hundred people died in the disaster. Another ninety enable their members, mostly farmers, to safeguard their thousand were left homeless. Frederick Law Olmsted, property against fire and weather-related risks. For who wrote a famous and not-altogether flattering example, Brenham‘s Germania Farm Mutual Insurance account of his travels through Texas in the 1840s, and Association can trace its roots back to the formation of later won fame as one of the principal designers of New the Germania Mutual Aid Association by thirty-one York City's Central Park, visited Chicago shortly after farmers in Perry, Texas in 1896. For years, disaster the Fire. He estimated that "the houses burned, set ten relief from such associations was as likely to come in feet apart, would form a row over one hundred miles in the form of neighbors arriving with hammers and saws length" (emphasis added).13 as it was in the form of a check.

Though not as destructive, there were similar large Life Insurance fires in Baltimore and Boston in these years, as well as a vicious blaze that gutted parts of Galveston. Life insurance became popular in the latter half of Conflagrations hit small towns in Texas as well, literally the 19th Century. Its virtues were touted by scores of wiping such communities as Elmina, Newtown, and new companies and agents, who competed aggressively Olive off the map. Much of the damage caused by the for business. They had in their favor a potent marketing pitch—the notion that here, finally, was a way the working man could provide for his loved ones in the 12 ―The 26th Legislature,‖ Austin Daily Statesman, April 19, 1899, Page 2a. 14 William J. Clay, ―Report of the Commissioner of 13 Frederick Law Olmsted, ―Chicago in Distress,‖ Nation, Agriculture, Insurance, Statistics, and History for the Year November 9, 1871. 1906,‖ October 15, 1906, pp. 6-7. 5

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event of his sudden death, which in those days, before extremely popular. A few of the fraternal benefit the advent of Social Security, workers‘ compensation, societies operating in Texas in 1900 were the Royal and 401(K) plans, was often a more devastating Tribe of Joseph; the United Order of Friendship and financial occurrence for surviving family members than Sisters of the Mysterious Ten; the Pecan Valley it is today. The insurance companies were not shy about Benevolent Society; the Modern Tonties; the Order of invoking such concerns, or about praising themselves Pendo; and the Knights of Kadosh. Most of these for addressing them. They painted their business as a organizations might just as well have been called the sort of sacred trust, and themselves as bow-tied cherubs. Order of Ponzi.16 Frequently the claims of early These were characterizations that would come back to investors were paid with funds obtained from later haunt them when financial scandals rocked the industry investors, while management of the societies grew rich in the early Twentieth Century.15 in the meantime. Insurance officials were frustrated but essentially powerless in the face of these societies, The so-called ―old line‖ legal reserve life which were phenomenally successful in warding off or companies of the northeast were best-positioned to take subverting legislative attention. In 1899, such advantage of life insurance‘s new popularity. In Texas, organizations were made subject to the Fraternal however, these companies were viewed with Beneficiary Law, which required little more than considerable skepticism. Waco journalist W. C. Brann, registration. It wasn‘t enough. The Department publisher of the Waco-based The Iconoclast, used his registered some two hundred and thirty-two new position as editor as the largest-selling magazine of the ―orders‖ between 1900 and 1904, many of which issued day to blast legal reserve life insurance as ―the most insurance policies that weren‘t worth the paper they colossal scheme of predacity known to human history,‖ were printed on.17 It wasn‘t until 1914 that fraternal and opined that ―the government should suppress these benefit societies were governed by any meaningful law eminently respectable gambling games. They have in Texas. caused more sorrow, destitution and crime than all the cards and dice this side of the dark dominion of the As the state‘s population and prosperity increased, devil.‖ more and more insurers, and an increasing number of insurance products, appeared in Texas. By 1900, some Brann‘s criticism focused on the notion that eighty-five stock companies were writing fire and ―reserving‖ was a sort of scam that entitled the insurers marine insurance in the state. Another thirty-one (not to accumulate vast reserves of capital for no good counting the fraternal benefit societies) were selling life reason. By attacking the old-line companies so and health insurance. None of these companies was vehemently, he must, intentionally or not, have given organized in the state. In addition, there were five assistance to their competitors. Among such competitors guaranty companies, thirteen accident companies, one were fraternal benefit societies, which were "lodges" or steam boiler inspection company, and three ―plate glass "orders" of mostly working class Americans. Some of these societies were legitimate social and service organizations. Many more, however, were sham societies that existed primarily as a vehicle for the sale of unregulated insurance. Because they were unregulated, and frequently unprincipled as well, they 16 could offer coverage at very low rates. This made them As early as 1883, Commissioner Spaight called the fraternal benefit societies ―three-card monte corporations,‖ and despaired of estimating the ―grand total of money 15 The notion was repeated by others. Former U.S. hopefully invested and hopelessly engulfed‖ therein. A. W. President Grover Cleveland, for example, asserted in 1905 Spaight, ―Report of the Commissioner of Agriculture, that ―life insurance has to do with the most sacred things Insurance, Statistics, and History for the Year 1882,‖ that stir the human affections…its management involves a January 15, 1883, p.7. higher duty and more constant devotion than we associate with a mere business enterprise.‖ Quoted in Patricia 17 W. J. Clay, ―Report of the Commissioner of Agriculture, Beard‘s After the Ball: Gilded Age Secrets, Boardroom Insurance, Statistics, and History for the Year 1903,‖ betrayals, and the Party that Ignited the Great Wall Street September 8, 1904, p. viii. Scandal of 1905, p. 27, New York, HarperCollins 2003. 6

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insurers‖ licensed in Texas. In that year the agency published shocking details of corporate misconduct— collected some $132, 283.47 in taxes and fees.18 nepotism, self-dealing, questionable stock deals and bookkeeping sleight-of-hand—on the part of officers Despite this growth in the industry, the agency and directors not only of the Equitable, but also of the continued to operate on a shoestring. In 1900, for New York Life Insurance Company and the Mutual example, the Commissioner led a staff that consisted of Life Insurance Company. Among the revelations were a chief clerk, three lesser clerks and a porter. The details of reduced-rate lending between executives of agency had a budget of only $9,120.00. With the one company and those of another, and the fact that Department so undermanned and poorly provided for, it the companies funneled revenues to political ―war is little wonder that unauthorized insurance (led by chests‖ to influence state legislators. One executive unlicensed but aggressive ―Lloyds associations‖ of explained that this was the way the companies kept unincorporated underwriters, which weren‘t officially from being ―badgered and harassed to death in every allowed to do business in the state until 1921) made a state in the Union by the introduction of bad bills of strong comeback in the last decade of the 19th Century. every kind.‖20 The growing number and sophistication of insurers demanded a more aggressive and professional In its day, the Armstrong Committee‘s findings regulatory agency. Consumers were victimized by were phenomenal, a sort of Unsafe at Any Speed of complicated policy forms and discriminatory pricing, the industry. Texas Commissioner of Insurance and the few domestic firms that struggled into existence William J. Clay wrote at the time that ―the year 1905 (and, generally, stumbled back out again) found it is the most eventful recorded in the history of life difficult to compete against the established eastern legal insurance. During the entire year life insurance reserve companies. underwent investigation of one kind or another. There was a spirit of unrest, distrust, and dissatisfaction D. The Quest for Control (1905-1944). The throughout the entire country.‖21 Clay himself traveled Department, which functioned as the ―Department of to New York in the autumn of 1905 to inspect the Insurance and Banking‖ from 1907 until 1923, began affidavits given to the Committee by various gaining power in the first part of the Twentieth insurance executives.22 Century. The agency‘s fortunes started to change in 1905, when the New York legislature‘s Armstrong The impact of the disclosures made during the Committee19 made national headlines with its Armstrong Committee investigation—disclosures investigation of fraudulent and financially reckless indicating that even some of the most illustrious practices at the highest levels of the life insurance companies in a major financial industry were being industry. The investigation grew out of allegations run on an irresponsible and sometimes corrupt basis— made by rivals for control of one of the nation‘s were immediate and sensational. Suddenly, just largest life insurers, the Equitable, and came to having (and taxing) an insurance industry in the state involve some of Wall Street‘s biggest names, appeared insufficient. It became clear that this including Henry Clay Frick, E. H. Harriman, and J. P. industry, like many others, needed aggressive Morgan. For months, New York newspapers policing. The result of the Armstrong Committee‘s investigation, says one source, "was the adoption of a 18 report making specific recommendations for industry Jefferson Johnson, ―Report of the Commissioner of Agriculture, Insurance, Statistics, and History for the Year 1900,‖ April 4, 1901, p. 4. 20 ―Most Insurance Bills Blackmail, Says McCall,‖ Austin Statesman, October 5, 1905, p. 1. 19 The committee was headed by New York state senator William W. Armstrong. In many people‘s minds, however, 21 William J. Clay, ―Report of the Commissioner of it was dominated by Charles Evans Hughes, the young Agriculture, Insurance, Statistics, and History For the Year judge who spearheaded the investigation. Hughes went on 1906,‖ October 15, 1906, p. 8. to become governor of the State of New York, a United States Supreme Court justice, and the Republican Party‘s 22 ―Commissioner Clay Returned From East,‖ Austin candidate for President of the United States in 1916. Statesman, October 10, 1905, p. 1.

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reforms, including standardized policy forms, limits Commissioner of this new incarnation of the agency on industry lobbying, a limit on commissions to was a heavy hitter: Dallas lawyer and former state agents, a prohibition on prizes and bonuses, legal legislator and Speaker of the House Thomas Bell Love, liability for misrepresenting the terms of an insurance who held the job until 1910. Highly influential in Texas contract, uniform accounting procedures, and a politics, Love later served in Washington as Assistant prohibition on investments by insurance companies in Secretary of the Treasury under President Woodrow common stocks.‖23 Because this was an era of Wilson. He was for many years known as a leading ―Progressivism,‖ or political reform, it is not advocate of Prohibition, sometimes called ―the Dry surprising that many of the Armstrong Committee‘s Moses.‖ recommendations were soon enacted into law in New York and other states. Also in 1907, under fire-breathing Governor Thomas Mitchell Campbell of Palestine, the Legislature Texas too began to increase its supervision of the passed the Robertson Act, which required life insurance insurance industry. As the success of the Populist Party companies to invest seventy-five percent of their legal in the 1890s demonstrated, many Texans were highly reserves on Texas policies in Texas securities. Named suspicious of the Eastern establishment, and eager to see for its legislative sponsor, former district judge and stronger regulation. In 1909, the Legislature Hogg confidante James Harvey Robertson, the act was incorporated many of the Armstrong Committee‘s pure populism, a heavy-handed attempt to keep Texas recommendations in a new law entitled ―Authorizing premium money within the state. The measure was Incorporation of Life, Accident and Health Insurance naturally resented by the industry, which had long Companies.‖ The law established a $100,000 minimum enjoyed a sort of financial colonialism in Texas and capital stock requirement for such companies. It placed other western states. Company representatives fought restrictions on the type and amount of real estate that the Robertson proposal tooth and nail, predicting companies could hold, set out certain provisions imminent disaster for the Texas insurance market if it required to be contained in policies issued in Texas, and became law. But Texas legislators refused to prohibited misrepresentations by insurers and their compromise. They passed the bill and, despite intense agents. In addition, Section Nineteen of the new law lobbying pressure, Governor Campbell signed it into stated that ―[n]o insurance company doing business in law. A contemporary account in the Dallas Morning this State shall make or permit any distinction or News portrayed the reaction of several dismayed discrimination in favor of individuals between insurants insurance company representatives: (the insured) of the same class and equal expectation of life in the amount of or payment of premiums or rates The governor was a visitor to the charged for policies of life or endowment insurance.‖ senate chamber a few moments after he Thus was born Texas‘s original insurance ―anti- signed the bill, and Thad Bell of the discrimination‖ law. Though it applied originally only New York Life walked in. He learned of to life insurance policies, the law was reconstituted over the bill being approved and started the years into a general anti-discrimination statute. See across the capitol to tell Mr. Hamilton TEX. INS. CODE ANN. 544.052. It continues to regulate Cook. Mr. Cook had already heard it the behavior of insurers today. and, with Charles T. Bonner of Tyler, was coming from the House. Mr. Bell There were other signs that the state was getting met them. “It’s 23, skiddoo for you,” serious about regulating the insurance industry. In said Bell.24 1907, for example, the 30th Legislature created the Department of Agriculture, leaving a newly streamlined At least twenty insurance companies did in fact skiddoo ―Department of Insurance and Banking‖ to deal with the shortly thereafter, choosing to leave Texas rather than state's two major financial industries. The first

23 Henry C. Dethloff, Forward to Douglas Caddy, 24 ―Signed Deposit Bill,‖ The Houston Post, April 25, 1907, Understanding Texas Insurance (College Station: Texas Page 7. A&M University Press, 1984), pp. xviii-xix. 8

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comply with the law, but the Robertson Act remained when the Legislature fused the three divisions back into on the books, albeit in a gradually watered-down form, one agency, headed by a single commissioner who was until the early Sixties. One observer has suggested that himself answerable to a three-man board of this large-scale defection of insurers from the state was commissioners. In 1991, the entire board system was crucial to the success of Texas‘s first domestic life scrapped, and control of the agency consolidated in a insurers—insurers like the now-gigantic American single, CEO-like commissioner who answered to the National Life Insurance Company, organized in governor. Galveston in 1905 by William L. Moody—which suddenly found themselves almost alone in a growing The power of the agency, and thus of each of its market.25 commissioners, had increased dramatically since Valentine Overton King‘s day. As Commissioner R. L. In 1910, the Legislature appropriated funds for the Daniels put the matter in 1936: hiring of the Department‘s first actuary, R. C. Burton, a graduate of the University of Michigan.26 Burton, who [The Commissioner] is the point of contact immediately became the agency‘s highest-paid between the state and the insurance business, employee besides the Commissioner, did much of the and it is through him that the insurance laws initial work associated with a new law requiring all life are executed and enforced. When he speaks, insurers doing business in the state to file their policies 'the State' speaks, whether he be addressing the for review by the Department--another example of the public, the companies, the Legislature or the state‘s increasing supervision of the industry. Burton‘s Courts. He looks for violations of the law, appointment embodied the movement of both the apprehends and cites the offender and industry and state regulators toward treating insurance prosecutes him in a tribunal wherein he is also ―scientifically‖—i.e., according to mathematical rules of jury and judge, and whose mandates he pricing and prediction—rather than as simply another executes himself, frequently basing the whole marketing-driven business enterprise. proceeding upon a rule which he himself has made because he can find no applicable In 1923, the Legislature created the Department of statute.27 Banking, leaving the Department of Insurance to focus on the state's rapidly growing risk-sharing industry. The Age of the Automobile Only four years later, the 40th Legislature created a three-member ―Board of Insurance Commissioners‖ to The biggest development in the insurance industry govern the industry. At the same time, it merged the in the first half of the 20th Century involved the Department with the State Fire Insurance Commission, phenomenal growth of the automobile market. Given the state‘s insurance rate-making body. The three the state‘s vast expanses and primitive public commissioners—R. B. Cousins, Jr.; Raymond Mauk; transportation systems, cars quickly became a necessity and Walter S. Pope—appointed by Klan-busting in Texas. The ascendance of the automobile led Governor Dan Moody had supervisory power over life, fire, and casualty insurance, respectively. The Life 27 Insurance Commissioner was also made the boss of the R. L. Daniel, ―State Supervision of Insurance,‖ Lecture bosses, the ex officio Chairman of the Board of Delivered to the Students of the Insurance Institute at Insurance Commissioners. The three divisions of the Austin, January 13, 1936, p. 4 (Texas Department of Insurance archival collection). Commissioner Daniel was new agency were run completely independently, with clearly proud of his job, which was at that time unconstrained separate budgets, personnel, and regulatory missions. by the dictates of the Administrative Procedure Act. At the This three-headed system was to continue until 1957, same time, one wonders if Mr. Daniel might have read one too many policy filings. In another portion of the same 25 Allen Duckworth, ―1907 Act Sparked Growth,‖ Dallas speech, he states, "I sometimes doubt whether any man ever Morning News, January 30, 1956, p. 1. conceives the beauty of this unfinished tapestry of insurance, or thrills at the opportunity to weave into its gigantic but 26 Annie N. and Lloyd K. Friedman, On the Trail of Actuaries harmonious design another appropriate figure of his own in Texas, 1844-1964 (San Antonio: The Watercress Press dreaming, until he has been an insurance commissioner." 1998), p. 53. And yes, this is a real book. 9

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unsurprisingly to a booming business in auto primarily as a consumer-protection measure. However, insurance—and to considerable work for the Board of at least as important to regulators in the first part of the Insurance Commissioners. 20th Century was the question, How do we keep insurers from harming themselves? One way to do this, they The destructive capabilities of a speeding decided, was to dampen competition among insurers by automobile became apparent early on. An article in the limiting the range of premiums each company could December 21, 1903 edition of The Austin Statesman offer. details ―the first fatal accident credited to automobiling in Texas,‖ which occurred in what was then the rural The impetus of this movement probably arose from expanse of land between Fort Worth and Dallas.28 In the repeated failures in the fire insurance market. In 1891, face of increasing litigation and often contradictory for example, the East Texas Fire Insurance Company, results in the various courts, the Casualty Division, one of the state's few domestic insurers, organized in joining with regulatory authorities in other states, 1875, went into voluntary liquidation. While worrying promulgated the state‘s first uniform automobile aloud about the alarming tendency of Texans to torch insurance policies—―consisting of the Liability Policy their own property in order to collect insurance Form, All Coverage Form, Fire and Theft Form, proceeds, Commissioner John E. Hollingsworth was Combination Form, and Garage and Liability Form, moved to warn Texas insurers that "companies must together with 110 endorsements‖—in 1934.29 The idea make a rate commensurate with the risks, for they was to create essentially standardized contracts that cannot live and do business at a loss."31 If they could reflected court rulings interpreting the various policy not make appropriate rates themselves, he implied, the provisions in use at the time. It was a massive state would do it for them. undertaking, requiring, as one Division official put it, ―much night work.‖ As Casualty Commissioner Walter Not everyone agreed with Hollingsworth. S. Pope said of this development, "From then on, these Commissioner Spaight wrote in 1882 that rate-making policies and contracts have probably been more appeared to him to be ―wholly impractical,‖ and that universally unread by the purchaser, and more money ―such legislation would have the inevitable effect of has probably been paid out thereon, than on any other driving out of the state a large proportion of the policy contract in existence." 30 The agency exercised insurance capital of other states and countries engaged strict control over the language and interpretation of in business here.‖32 provisions of the state‘s automobile insurance policy, as well as its residential property insurance policy forms, But the pressure to regulate rates only increased, at for decades. Legislation passed in 2003 cleared the way least partly in response to the disastrous rate-cutting for insurers to start using individual, ―proprietary‖ wars engaged in by the fraternal benefit societies. The forms. idea became a reality in 1909, when the Legislature created the Fire Insurance Rating Board, which was Rate-Making given authority to correct rates that were either "excessive or unreasonably high" or "not adequate to the The most important development in insurance safety and soundness of the company granting the regulation during this period, just ahead of policy same." In 1910, the ―State Insurance Board‖ replaced standardization, was the state's insistence on controlling the Fire Insurance Rating Board; in 1913, the State insurance premium rates. Rate-setting is seen these days Insurance Board was renamed the ―State Fire Insurance Commission‖ (later simply the ―State Insurance 28 The accident, which killed at least one young boy, was Commission‖) and given ―sole and exclusive power and blamed on a group of people who were racing their cars. 31 John E. Hollingsworth, ―Report of the Commissioner of 29 Walter Pope, ―59th Annual Report,‖ p. 22. Insurance, Statistics and History for the Year 1891,‖ May 12, 1892, p. 32. 30 Walter Pope, ―Scrapbook History of the First Seven Years of the Casualty Division,‖ p. 11 (Texas Department 32 A.W. Spaight, ―Report of the Commissioner of of Insurance archival collection). Insurance, Statistics and History for the Year 1882,‖ January 15, 1883, p. 5. 10

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authority…to prescribe, fix, determine and promulgate insurers from the competitive advantages enjoyed by the rates of premiums to be charged and collected by aggressive out-of-staters. fire insurance companies doing business in this State.‖ The State Fire Insurance Commission was composed of Many of the insurance laws enacted by the the Commissioner of Insurance and Banking (serving as Legislature through the 1950s were similarly biased. Chairman of the Board) and two appointed members Agent licensing rules were frankly insular, requiring (one of which was designated the State Fire Marshal). anyone who wanted a license to sell insurance in the Until 1927, the State Fire Insurance Commission and state to be a Texas resident. Some of those rules the Department of Insurance operated as separate and lingered on for decades. Until 2001, for example, distinct divisions of state government. Texas was one of the very few states in the nation that required all officers and directors of a corporate In 1927, when the Department and the State Fire insurance agency to be individually licensed by the Insurance Commission were merged under the auspices state. of the Board of Insurance Commissioners, the Board assumed responsibility for setting workmen‘s E. The Bad Old Days (1945-1972). As T. R. compensation rates. It was given authority to Fehrenbach drily put it in his history of the state, promulgate title insurance rates in 1929, and to "Political corruption apparently increased in the promulgate auto insurance rates in 1937. In 1939, at or 1950s."33 Austin writer Billy Lee Brammer was less near the high water mark of Franklin Delano diplomatic. His novel The Gay Place brilliantly evokes Roosevelt‘s New Deal and its use of government to the lives of several young men and women working on supervise the workings of the economy, the Board the fringes of state political power during the enacted a retrospective rating plan for all lines of gubernatorial reign of Arthur Fenstemaker, an earthy, commercial casualty insurance. Since personal lines of profane literary amalgam of Earl Long, Beauford Jester, coverage were already subject to promulgated rates, and Lyndon Baines Johnson. Brammer speaks of the Texas thus became one of the most restrictive rate political corruption in Texas in the Fifties several times. regulators in the nation. Indeed, the plot of "The Flea Circus," the first of three interlinked stories in the book, revolves around the While Texas generally controlled rate-making in attempts of a loan association lobbyist to bribe selected the property and casualty area, there were significant legislators. In the story, Fenstemaker makes passing loopholes that eventually destroyed the system. For reference to "Phillips," a ―minor state official now example, while homeowners‘ insurance premium rates serving time in the penitentiary" partly as a result of in the standard market were regulated by the evidence of corruption developed by a progressive Department, policies sold by Lloyds plan companies newspaper obviously patterned after Ronnie Dugger's were not regulated. Unsurprisingly, standard-market muckraking Texas Observer. At one point Fenstemaker insurers began to acquire or organize their own Lloyds fields a telephone call from a lawyer friend who has just plan companies of their own and shift business to been asked by his client, an indicted insurance these affiliates. Thus, by the late 1990s, some ninety- executive, to fix a jury. Fenstemaker is unsurprised by five percent of homeowners‘ policies issued in Texas this turn of events. He offers the lawyer words of were sold by Lloyds plan companies. County mutual warning: insurers were similarly exempt from automobile insurance rate regulation. While a ―gentleman‘s Charley, they'll drink your blood if you let 'em. agreement‖ existed for many years, under which the That insurance company of his just didn't county mutuals undertook to write insurance only in happen to collapse—it wasn't the [expletive] the non-standard market—i.e., for drivers who weren‘t law of gravity...He milked the business dry and able to get insurance elsewhere—the agreement broke stuffed the profits somewhere… no tellin' down in the 1990s. Large insurers simply acquired where—but he got away with it for four years county mutuals of their own and used them to write all or a large part of their auto insurance, free from rate regulation. The purpose of the county mutual laws 33 was protectionism—an attempt to shelter domestic Lone Star, p. 661.

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and now he's hired a smart lawyer like you they would have exercised with any federal, and thinkin' he can buy his way out...34 necessarily much larger, insurance authority. Large insurers argue back that it is time-consuming and Regulatory failures and corruption in the insurance expensive to deal with fifty different regulatory schemes industry were not unique to Texas. The stage was set in and authorities. Whoever is ultimately right, there is no 1944, when the United States Supreme Court reversed denying that in Texas, at least, the state‘s oversight of its 1868 decision in Paul v. Virginia and held, in United the insurance industry has occasionally proven to be States v. South-Eastern Underwriters Association, that woefully inadequate. the federal government did have authority to regulate insurance because the business of insurance was in fact At no time was Texas regulation worse than it was interstate commerce.35 The context of this decision is at during the ten-year period between 1947 and 1957. At least as important as the conclusion. The case involved least three factors combined to create the dynamics of the failed efforts of the State of Missouri to stop South- this dark era. First, the political climate in the U.S. after Eastern Underwriters, a trade association with a the Second World War changed dramatically. The Cold membership of nearly two hundred private stock fire War settled in for a prolonged engagement. insurance companies, from allegedly fixing prices in the Conservatism reigned, and for a time anything that Missouri market. Frustrated, the state sought the smacked of state supervision of the economy—a sort of assistance of the Justice Department. The Association interference, some sniffed, that could only lead to full- was subsequently indicted in federal court for numerous fledged socialism—was suspect. While the Board of violations of the Sherman Anti-Trust Act. When a Insurance Commissioners was no doubt lackadaisical in district court judge dismissed the indictment, the Justice its efforts to enforce the new Texas Insurance Code, Department appealed, setting the stage for the Supreme published in 1951, and to oversee the solvency of Texas Court‘s dramatic reversal of almost eighty years of companies, its laissez-fare approach was, in some broad insurance law. sense, in accord with the times.

State governments and the insurance industry Second, the state was still trying to ―grow‖ its immediately joined forces to prevent assertion of federal domestic insurers. Texas laws were meant to encourage control. This was accomplished in 1945 with enactment the formation of insurance companies, not to make it of the McCarran-Ferguson Act, which gave states the more difficult. As the postwar economy gradually right to regulate insurance in all instances except where picked up steam, however, capitalization laws that were federal law specifically pre-empts state law. The adequate during the 1930s quickly became outmoded, McCarran-Ferguson Act dominated the field of leading to a situation in which it was simply too easy to state/federal relations in the insurance industry for form and obtain regulatory approval of an insurance decades. It is unclear that its effects have been company. Scores of new companies sprang to life— uniformly beneficial. Indeed, the conflict between those some with little or no financial backbone. Although as who want federal regulation of the country‘s insurance late as 1904 there was not a single stock insurance markets and those who prefer state-by-state regulation company incorporated in the State of Texas, fifty years is now more heated than ever. Proponents of state later the scene was considerably different. By 1954, control argue that the populations of different regions of Texas was home to some 1,102 insurance companies— the country want and/or need various amounts of control almost a third of the national total!36 over the activities of companies doing business there. Critics of the arrangement have frequently pointed out Third, there was a strong tradition of cronyism and that insurance companies have had more clout in influence-peddling in state government. This was an era dealing with under-funded state regulatory bodies than of unabashed bribery and vote-buying, a time when a

34 Billy Lee Brammer, The Gay Place (Austin: The 36 ―Insolvency in the Texas Insurance Industry 1939-1954,‖ University of Texas Press 1995), p. 110. Staff Research Report to the Texas Legislative Council No. 53-5 (Austin, Texas 1954) (Texas Department of Insurance 35 United States v. South-Eastern Underwriters Association, archives). 322 U.S. 533, 64 S.Ct. 1162 (1944). 12

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few bottles of booze and an attractive blonde could and insurance examiner charged with certifying the occasionally did alter the course of regulatory policy. company‘s solvency. Testimony also indicated that a The men who ran the state‘s Board of Insurance prominent state senator was on the company's payroll. Commissioners were allegedly among the most In a concurring opinion that dripped with contempt for egregious offenders. Penn Jackson, first chairman of the the Board‘s sloppiness and venality, one judge reorganized ―State Board of Insurance,‖ acknowledged referred to a record ―replete with evidence of this situation in an October 1957 speech to the Texas fraudulent and corrupt abuse of our insurance laws Life Convention. Commenting on the Legislature‘s and gross if not criminal laxity in their reorganization of the Board, and his own commitment enforcement.‖40 to cleaning up the agency‘s operations, Jackson assured the assembled agents and company representatives that: In late 1955, the Board of Insurance Commissioners announced the bankruptcy of the U.S. Now you can come down to see us and Trust and Guaranty Company, a financial transact your business on a friendly but conglomerate that controlled seventy-four insurance impartial basis, without worrying and finance companies in twenty-two states and about entertaining us or what brand we Alaska. An estimated 150,000 investors and would prefer. And they tell me we have policyholders faced losses.41 The Board was widely made a real contribution to the attacked for failing to place the company in solvency of companies by diminishing receivership until long after its own examiners had considerably the expense accounts of warned it of the company‘s insolvency. Some critics those coming to Austin.37 insinuated that the delay had been bought—either directly, or through legislators in the pocket of U.S. The changes were long overdue. Eighty-six Texas Trust and Guaranty. This ―insurance mess,‖ opined insurance companies failed in the first ten years after the Houston Chronicle, was giving the state a World War II. Among the fallen were General ―scandalous reputation‖ throughout the nation.42 American Casualty Company; Lloyds of Great State; Unified Lloyds of El Paso; and Lloyds of North Presiding over the Board of Insurance America, organized in Houston in the early fifties by Commissioners during this dismal period was Garland Ralph W. Hammonds, a flamboyant former Olympic A. "Chink" Smith, a dark-haired, good-looking wrestler.38 confidante of Governor Allen Shivers. A former bandleader, journalist, and Senate secretary, Smith was 1954 saw the collapse of the Texas Mutual appointed Casualty Commissioner in 1952. To the job Insurance Company, a Beaumont enterprise that he brought no apparent familiarity with any aspect of started out as a fraud, capitalized by means of bogus the insurance industry. Despite (or perhaps because of) loans and significantly overvalued real estate this glaring ignorance, he moved up quickly. In October holdings, and quickly got worse. The story of Texas 1953, following the retirement of George B. Butler, Mutual illustrates many of the flaws in the state‘s Shivers appointed Smith to be the state‘s Life Insurance insurance regulatory system at the time. According to Commissioner and thus Chairman of the Board. It was a one account, the company was organized in 1949 with difficult time for the three essentially autonomous stated capital of $20,000—$19,500 of which was repaid to its lender within a week.39 The company‘s 40 Moreland v. Knox, 268 S.W. 2d 744 at 751 (Tex. Civ. downfall brought out ugly testimony at a subsequent App.—Austin 1954, no writ). civil trial concerning bribes taken by the state 41 ―At Least 400,000 Policyholders,‖ The Texas Observer, 37 On the Trail of Actuaries in Texas 1844-1964, p. 163. January 11, 1956, p. 1 (the headline refers to a count of policyholders affected by a number of Texas insurance 38 Understanding Texas Insurance, p. xx. solvencies, not just the U. S. Trust and Guaranty situation).

39 ―An Old Pattern,‖ The Texas Observer, January 25, 1956, 42 As reported in ―Papers Lash Out,” The Texas Observer, Page 7. January 4, 1956, p. 2.

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agencies overseen by the Board. In the midst of decision was an important one. Because of it, perjury numerous grotesque insolvencies, Smith‘s downfall was charges that had been brought by the Travis County hastened by allegations that he had accepted an all- District Attorney‘s office against hapless former expenses-paid vacation trip to Hawaii from an insurance Chairman Garland Smith and his son-in-law, Max company under his jurisdiction. His wife, meanwhile, Wayne Rychlik, also had to be dismissed. had reportedly received a real estate loan from another insurance firm.43 It didn‘t help appearances that the In the face of such conflicts of interest, the agency itself was housed in offices leased from the Legislature finally changed the structure of the Board of International Life Insurance Company for much of this Insurance Commissioners in 1957. The various period—that, in other words, one of the companies the commissioners on the Board—Life, Fire, and Board was attempting to regulate was in fact its Casualty—were stripped of their personal bailiwicks landlord. and made jointly responsible for the operation of the agency, which was renamed the ―State Board of Smith resigned as Commissioner on January 30, Insurance.‖ The three divisions were melded into one, 1956, purportedly for medical reasons. But his under the day-to-day supervision of a sort of ―retirement‖ had no immediate salutary effect. In 1957, governmental CEO, the Commissioner of Insurance, Ben Jack Cage, a businessman with labor connections who answered to the Board. The agency now employed and what one observer has called "movie-star good over three hundred people. New Chairman of the State looks," was indicted for embezzling a hundred thousand Board Penn Jackson characterized the operational dollars from ICT Corporation. ICT Corporation was changes this way: closely affiliated with ICT Insurance Company. Both were controlled by Cage. Though at one point he fled to There will be no more private Brazil, Cage was eventually returned to the U.S., meetings, secret persuasions, or convicted, and sentenced to ten years in prison.44 surprise decisions. We have substituted due process for ex parte in all hearings The news just kept getting worse. In the course of before the Board and the Cage‘s criminal trial, evidence was presented that ICT Commissioner. We are operating as a had made some sixteen payments to Garland Smith‘s unit, and no member is undertaking to successor, Life Insurance Commissioner J. Byron make any decision or take any action Saunders. Though the payments were ostensibly for as an individual.46 "legal services," no one could recall any particular services Saunders had actually performed for the The Commissioner also served as State Fire Marshal, a company. Saunders, a Tyler attorney and former head dual responsibility he held until 1975, when the 64th of the State Welfare Board, exercised his Fifth Legislature created a separate State Fire Marshal's Amendment right not to testify at the Cage trial and was Office. later convicted of perjury for lying under oath about the sixteen payments to a legislative investigating While it may have seemed like a good idea to committee. His conviction was subsequently overturned relieve the individual commissioners of sole control of by the Texas Court of Criminal Appeals, which ruled certain agency functions, the practical effect of the that Commissioner Saunders had committed the lesser change was, of course, to let each commissioner have an crime of "false swearing," not perjury, and therefore equal say in every function. This led, inevitably, to dismissed the prosecution altogether—a holding the conflicts among board members—and set the stage for dissent called "inconceivable" and "shocking."45 The the Legislature finally to do away with the ―board‖ structure altogether in 1991. But the dismal performance 43 ―Smith Quits Job,‖ The Houston Post, January 31, 1956, p. of Commissioners like Chink Smith and Byron 1. Saunders in the Fifties, along with the gleeful exposes 44 Cage v. State, 320 S.W.2d 364 (Tex. Crim. App. 1958). of their shenanigans run relentlessly by Ronnie

45 Saunders v. State, 341 S.W.2d 173 at 180 (Tex. Crim. App. 1960). 46 Quoted in On the Trail of Texas Actuaries 1844-1964, p. 163. 14

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Dugger‘s Texas Observer, at least alerted Texans to the only convinced to enact its own insurance practices law regulatory responsibilities exercised by the state‘s when the Federal Trade Commission initiated insurance officials. Never again would the agency administrative proceedings against several insurers function in such utter obscurity. doing business in Texas. At this point, insurance companies as well as state officials suddenly decided that they were in favor of incorporating the NAIC F. Consumer Protection as Guiding Principle model into Texas law. There was little thought for (1973-1997). consumers at the time. Indeed, the emergency clause of the legislation stated that ―substantially the same Act The Strange Origins of Consumer Protection has previously been enacted in thirty-nine states, and…it is designed to prevent federal regulation and taxation of It is now commonplace to look at TDI as, at least in the business of insurance‖ (emphasis added). Note, too, part, an organization that exists to assist policyholders. that the statute did not create any private cause of action This was not always true. In fact, the agency took its for disgruntled consumers. Rather, it was up to the first steps toward being a consumer protection agency Board, even after 1957 a staunchly pro-industry body, to almost in spite of itself. As discussed above, the refer enforcement cases to the Office of the Attorney practical effect of the McCarran-Ferguson Act was to General.48 Such were the humble origins of Article allow states to ―reverse pre-empt‖ federal authority over 21.21 (now Chapter 541) of the Texas Insurance Code. insurance matters. In most instances, as long as the state had adequate laws governing insurance, those laws Still, the winds of change were blowing. The simple trumped federal jurisdiction; it was only where a state fact that there was an unfair insurance practices statute did not have adequate statutes, or any statutes, that emboldened those with what were called ―consumerist‖ federal law would apply. sentiments to press for further protections. Eventually, in the marginally more liberal atmosphere of the late Like most states, Texas was prepared to do almost Sixties and early Seventies, the Legislature gave the anything to prevent federal regulation of insurance, if Board power to issue rules and regulations governing only to protect its claim to the millions of dollars it unfair insurance practices in the state. The Board took collected in taxes and fees from insurers each year. In an this authority to heart. During the brief tenure of attempt to demonstrate the coherence and completeness Chairman Larry Teaver, the Board in 1971 issued Order of its regulation of the field, legislators moved to collect 18663, which outlawed ―not only unfair practices ‗as all of Texas‘s many scattered insurance related laws in defined by the provisions of the Insurance Code of one place. Thus, in 1951, the Texas Insurance Code was Texas or as defined by these and other Rules and born.47 Regulations of the State Board of Insurance authorized by the Code,‘ but also any ‗improper trade practice‘ While organization of the insurance laws was a step that, though not defined as unfair in any of the rules and in the right direction, certain areas of regulation were regulations, had been determined to be so ‗pursuant to thin at best. Though the National Association of law.‘‖49 Insurance Commissioners had, in response to McCarran-Ferguson, promulgated a model deceptive trade practices statute for use by the states, Texas 48 declined for several years to adopt it. This left the field This didn‘t change until 1991, when the Office of the wide open for federal action—or, as it was known in Attorney General was given statutory authority to prosecute certain insurance-related cases at its own discretion, without Texas, ―interference.‖ In fact, according to Austin insurance agency‘s approval. attorney and author Philip K. Maxwell, the state was 49 Philip K. Maxwell, History of Article 21.21 of the Texas Insurance Code, unpublished manuscript, p. 13 (presented 47 Departmental officials—including Commissioners in connection with ―Article 21.21 of the Texas Insurance Charles Austin in 1918 and George Waverly Briggs in Code: A Historical Review,‖ a Continuing Legal Education 1925—had been calling for issuance of such a code for presentation made by Bill Goodman and Philip K. Maxwell years. at the Texas Department of Insurance, October 20, 1999).

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TDI‘s development into a consumer protection agency became more than ever a political football. At agency was aided by passage of the first major one point in the early 1970s, Governor Preston Smith consumer protection statute in the state, the Deceptive unsuccessfully attempted to appoint four different Trade Practices Act of 1973 (the ―DTPA‖). While it candidates to the position of chairman of the State took awhile for the repercussions of the act, and the pro- Board. Larry Teaver, Ray Kirkpatrick, Bob Bullock and consumer sentiments behind it, to percolate upward, Dorsey Hardeman all ran into politically related consumer protection eventually became a profound confirmation difficulties.51 It wasn't until newly-elected influence on the agency. The DTPA might never have Governor Dolph Briscoe appointed El Paso attorney and seen the light of day if it hadn't been for the Sharpstown former state senator Joe Christie to head the Board that Scandal of the early Seventies. The Scandal and its the agency saw any stable leadership. many seedy subplots are too complicated for full treatment here. The essence of the affair lay in Boyish and charismatic, a dabbler in the esoteric allegations that Houston banker and financier Frank New Age philosophies espoused by Austin‘s Arica Sharp attempted to bribe several state officials in return Institute, Christie touted himself as a friend of the for favorable treatment of bank deposit insurance consumer. He advocated for the use of plain language in legislation he favored. Three men—House Speaker Gus Texas insurance policy forms and refused to grant the Mutcher, Jr.; Rush McGinty, an aide to Mutcher; and industry‘s request for an automobile insurance premium State Representative Tommy Shannon, also known as rate increase on the basis of the high policyholder the ―Abilene Three,‖ for the venue of their criminal dividends paid out by one company. Christie touted the trial—were each eventually convicted of conspiracy to benefits of an innovative new way to insure against accept a bribe and given five-year terms of probation. health risks, an exotic entity called the ―health Despite this fairly slight criminal outcome, the scandal maintenance organization.‖ He also headed the State derailed the political careers of many others, including Board‘s successful efforts to establish minimum benefit Governor Preston Smith and Lieutenant Governor Ben standards for individual accident and health insurance Barnes. policies. But while Christie made much of his consumerist sentiments, he was criticized at the time for The biggest impact of the affair came at the polls his failure to refer even a single insurance case to the during the statewide elections in 1972. Texas was still Attorney General's office for prosecution.52 Christie effectively a one-party state. Thus, election fights resigned in 1977 to launch a campaign for the United weren‘t generally between Republicans and Democrats. States Senate. The campaign was unsuccessful, and he Rather, the real battles occurred between conservative eventually faded from public life. Democrats and liberal or ―reformist‖ Democrats. In 1972, ―reform‖ won big. Texans elected a new governor In 1982, automobile insurance consumers received (Dolph Briscoe), lieutenant governor (Bill Hobby), and help from an unlikely source when Board Chairman attorney general (plaintiff‘s lawyer John Hill).50 William Daves, an appointee of conservative Republican Governor Bill Clements, acted to reshape This era also saw the polarization of critics of the the rate-setting process. The Board had for years agency into two now-familiar coalitions: industry and allowed annual rate increases as a matter of course, industry supporters on the one hand, with their dire engaging in just the sort of administrative ―rubber- economic predictions and ever-ready statistics, and trial stamping‖ critics were learning to hate. But Daves lawyers and consumer advocacy groups on the other, began to wonder if such increases were necessary in armed with populist rhetoric and an occasionally light of soaring interest rates, which were pushing paranoiac distrust of big business. For the first time but insurance company investment income to record levels. certainly not the last, citizens began to question the Working secretly with Board member Lyndon Olson, Jr. purpose of the State Board. Did it exist to support the industry or to protect the industry‘s consumers? The 51 Lee Manross, ―Joe Christie: Politician for a New Era,‖ Austin People Today, October 1974, p. 6.

50 See, generally, Sam Kinch, Jr., ―Sharpstown Stock-Fraud 52 ―Consumerists Wary of New Insurance Chairman,‖ Dallas Scandal,‖ Handbook of Texas Online (Austin: University of Times Herald, September 5, 1977, p. 1A. Texas, 2000). 16

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(but not, evidently, with long-time Board member Durwood Manford, rumored to have become set in his The failure of National County Mutual left behind ways after more than two decades on the Board), Daves millions of dollars in unpaid claims against the company and agency staff member David Eley pored over and seemed like a nightmare rerun of the Fifties. investment research data compiled by Best's. "Sure Because claims against the company would have to be enough," said Daves in a contemporary account, ―the paid out of the state‘s property and casualty guaranty trend had continued. 1979 was the best investment year fund, and thus, indirectly, out of state tax revenues, the in [industry] history," with after-tax returns on Legislature howled. The Board appointed former stockholder equity averaging 25.6 percent. Citing these Department of Public Safety Colonel Jim Adams to record investment income levels, Daves and the Board conduct a full investigation into whether and how the substantially scaled back the industry‘s rate hike agency had mishandled the National County Mutual request, insisting that the overall profit/loss numbers situation. Under a sort of organizational martial law, used to justify any request for a rate increase should morale at the Department fell to abysmal lows— more broadly reflect the company‘s financial especially when Adams issued his highly-publicized performance. Since that time, agency rate-setting has conclusion that the agency had known of problems at taken investment income into account, often applying a the company for some two years prior to the insolvency negative underwriting profit factor as a result of the new but failed to do anything to solve them. methodology. Despite vehement industry protests at the time, other states and the NAIC eventually fell into line Standing squarely in the spotlight of these with the ―total return‖ approach pioneered by Texas.53 allegations was Commissioner Doyce Lee, a former state legislator and agency general counsel. Lee The agency's biggest setback in recent years resigned in December of 1988, leaving a farewell letter occurred when National County Mutual Fire Insurance that was both poignant and practical: Company went into receivership in 1988. National County Mutual, a Dallas-based company that wrote I have become a symbol...It has been a pleasure automobile insurance in the non-standard or ―high risk‖ working with each of you and I will treasure market, was the largest property and casualty insurer your friendship. My keys and telephone credit ever to collapse in Texas. Like other spectacular card have been given to the Chairman. I elect implosions before it, National County Mutual was only to receive my accumulated leave in a lump sum. one entity in a network of insurance-related businesses controlled by the same person. Its principal, Robert The Department‘s Head of Liquidation resigned the Walker, was a high-flying Dallas millionaire who same day. Within a year, every one of the members of delighted in showing off his expensive baubles: the State Board of Insurance—Jack Smith, James airplanes, boats, and a ―pair of ornamental saddles Nelson, and David Thornberry—had moved on. valued at $100,000 apiece.‖54 He went on the lam shortly after the scandal broke, leaving 125,000 The National County Mutual debacle taught the policyholders to find a new insurer. Later, after an agency one lesson that it has so far not allowed itself to anonymous tip to Chairman of the State Board of forget. There is nothing more disastrous for Insurance James E. Saxton, Jr., Walker was located and policyholders, or damning for regulators, than the apprehended in Barbados, where he owned a tourist insolvency of a major insurer. Fortunately, the affair led resort, and extradited to the United States to stand trial to some much-needed changes. For example, the on fraud charges. Department was given a criminal fraud unit, charged with investigating just the sort of financial wrongdoings that led to the collapse of National County Mutual.55 53 Quote from Lee Jones, ―Newsmaking Leadership,‖ Texas Insuror, November/December 1980, p. 16; additional 55 While the Fraud Unit was created to ferret out insurance- information supplied by Lee Jones. related fraud generally, including corporate misdeeds, its greatest successes so far have come in combating the illicit 54 Bruce Tomaso, ―Walker Lived Idyllic Life Before Arrest acts of claimants and agents. Perhaps its highest-profile in Barbados,‖ Dallas Morning News, July 10, 1990, page case involved the investigation and conviction of Michael 1A. Lee Davis of Plano, better known by his previous name of 17

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The situation also led to passage of laws aimed at was ―not sorry to see her go‖ when Johnson resigned in increasing the accountability and solvency of managing 1994.57 Johnson, considered by many to be a rising star general agencies and reinsurers, and to the in the Texas Democratic Party, never sought political establishment of the agency‘s ―early warning‖ system, office again. designed to ―red flag‖ the business affairs of carriers in response to certain statistical indicators. The Health Insurance Wars. Things didn‘t work out as well for managed care as Commissioner Christie and The Department Swings Left. Under Governor Ann other advocates predicted in the 1970s. In fact, while Richards, TDI placed consumer protection front and HMOs made a significant impact on the Texas health center on its regulatory agenda. Richards appointed care market in the following decades, they attracted Washington-based consumer advocate J. Robert Hunter opposition from many of the same people who once to be Commissioner of the new, streamlined agency. criticized physicians for being aloof, expensive, and This was a deliberately confrontational move, somewhat irresponsible. Some of the biggest critics of managed akin to naming Ralph Nader the CEO of Ford Motor care were doctors themselves, who saw their ability to Company. Hunter picked fights with the industry on a dictate the terms of medical treatment to patients being regular basis, and spoke of taking one major property eroded by the HMO industry. In Texas, the feud and casualty insurer ―to the woodshed‖ when he ordered between medical providers and managed care played the company fined.56) Governor Richards also picked a out with particular ferocity. brilliant young environmental lawyer, Amy Johnson, to head up the newly-created Office of Public Insurance In stark contrast to the long period of relative Counsel, established in 1991 to provide a voice for obscurity of health insurance issues, the last thirty-five Texas insureds in what Governor Richards declared to years have seen a mystifying proliferation of health be an industry-friendly regulatory environment. Johnson insurance products—HMO and PPO health benefit campaigned successfully for insurers to offer premium plans, consumer choice plans, consumer driven health discounts for cars with airbags (uncontroversial these plans, health savings accounts and high deductible days, but at the time a source of contention) and joined health plans –along with a welter of state and federal others, including the Austin American-Statesman and laws, rules, and regulations designed to delineate certain state legislators, in accusing Texas automobile them. In this field, far more than has ever been the and home insurers of ―redlining,‖ or declining to write case with life or property & casualty insurance, the business in areas where minority populations lived. federal government has proven eager to "supplement" Johnson earned high marks for her efforts from the state jurisdiction—or, more recently, to replace it Governor, but one publication stated that the industry altogether. Congress enacted the Employee Retirement and Income Security Act in 1974, creating Walter Alfred Waldhauser, Jr. Waldhauser was a convicted a system of self-insurance outside the scope of state murderer who ran afoul of the Department as a result of his regulation. In 1996, President Bill Clinton signed into involvement in a viatical settlement ―clean-sheeting ring,‖ law the ambitious Health Insurance Portability and in which brokers allegedly conspired with HIV-positive Accountability Act (―HIPAA‖). HIPAA guaranteed men to submit false life insurance applications to carriers the renewability of group and individual health doing business in Texas. When policies were issued insurance plans, allowed for portability of health (without a medical examination, because the policies had insurance coverage by limiting application of relatively low stated values), the brokers were said to have preexisting condition exclusions, and prohibited plans purchased them at a discount from the insureds, on the expectation that the insureds would soon die. Convicted on from discriminating against eligible employees on the charges of money laundering and securing the execution of basis of their health status. HIPAA also made small documents by deception, Davis was sentenced in the spring group policies ―guaranteed-issue‖ throughout the of 2000 to sixty years in prison and ordered to pay $3.6 nation: carriers writing in this market were required to million in restitution. cover small employers regardless of the health status of their employees. Finally, in 2010, Congress passed 56 ―Hunter Fines [Insurer] $850,000 for Unfair Discrimination.‖ Texas Department of Insurance Press 57 Release, May 2, 1994. ―State Public Insurance Counsel Leaves Office,‖ The Victoria Advocate, May 13, 1994, p. 7A. 18

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the Affordable Care Act (the ―ACA‖)—which, if it The particulars of the AIG situation, and the survives a Constitutional challenge and the 2012 wisdom of the federal government‘s response to it, are elections, will fundamentally change the delivery of still being debated. The issue state regulators have health insurance in the United States. Salient raised is that no insurance department had a clear view provisions of the ACA are discussed in Section IV of of the AIG system‘s activities as a whole. Thus, when this paper. one unit of AIG was stressed, there was lag time before federal agencies and regulators in other states could G. “The Best Financial Services Agency in the coordinate their efforts to safeguard the various World” (1997-present). Starting with the appointment constituent companies under their watch. of Jose Montemayor as Commissioner of Insurance in 1999, TDI shifted focus. While consumer protection While only one of the various widely-publicized efforts certainly continued, Montemayor stated that his financial contretemps of the last fifteen years directly ―whole goal [was] to make the consumer better off, and involved TDI, federal legislation (including the the avenue to do that in my view [was] to minimize the Sarbanes-Oxley and Dodd-Frank Acts) that resulted regulatory burden.‖58 He also on at least one occasion from these situations affected all state insurance voiced an ambition to make TDI the ―best financial regulators. And attempts to safeguard against future services agency in the world.‖ The agency began to financial threats to insurance entities in a large—and, in think of itself as more of a financial regulator than a some cases, multi-national—holding company system market conduct policeman. There is a consumer are being implemented in NAIC model legislation even protection aspect to solvency, of course. An insolvent as we speak. insurance company can‘t pay anyone’s claims. But the confrontational, State versus Industry, rule-making III. TDI TODAY approach to regulation that flourished during the Ann Richards era faded after the election of George W. Bush A. New Commissioner. In August of 2011, as governor in 1994. Governor Perry appointed Eleanor Kitzman as

st Commissioner of Insurance for a term that will expire The early years of the 21 Century saw a series of on February 1, 2013. Kitzman is an attorney and has financial crises that started with the collapse of Enron significant experience in the insurance industry. She Corporation in 2001 and seemed to grow more ominous served as the Director of the South Carolina with the widely-publicized struggles of Worldcom, Department of Insurance and, subsequently, as Lehman Brothers, Bear Stearns, and, in 2008, American Executive Director of the South Carolina Budget and International Group (―AIG‖). AIG is a large holding Control Board. Her private employment experience company system with insurance and financial operations includes positions in the insurance industry, an around the world. Press reports have alleged that a investment banking firm, and the law firm Akin Gump London-based financial unit of AIG (not an insurance Strauss Hauer and Feld, L.L.P. entity) over-invested in credit default swaps earlier in the decade. There were fears that financial losses Kitzman shared her regulatory philosophy in a incurred by the unit on the swaps, as well as increased recent speech at the 2011 annual conference of the collateral requirements brought on by related credit Texas Association of Health Plans. She said the rating downgrades, would have to be paid for by other agency‘s job is to enforce the insurance laws as companies in the AIG system. According to one senior specified by statute and that agency rules and regulator at TDI, the agency was one of the first to raise positions must be based on clear statutory authority. concerns about the financial links between members of She is not a supporter of ―desk drawer rules,‖ where the holding company system, and to call for increased an agency uses informal positions to make decisions inter-state cooperation in addressing those concerns. impacting the industry. She highlighted the expertise

and professionalism of agency staff and emphasized her goal of making the agency more efficient and expeditious in terms of regulatory decisions. She said 58 ―Past Poverty Gives Focus to Job, Says Insurance Chief,‖ that a prompt answer, even if the answer is ―no,‖ is Austin-American Statesman, December 20, 1999, p. B1. preferable to drawn-out decision making. 19

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John Smithee and Senator Robert Duncan, B. Inter-Agency Organizational Chart. TDI‘s respectively. links with various organizations under its control, supervision, or influence, through the ability to ii. Texas Sunset Commission. On a periodic appoint board members or otherwise, is set out in basis, typically at least once every twelve Appendix A, attached. Note that the precise nature of years, every state agency in Texas the various affiliations suggested in the chart are undergoes a review by the Texas Sunset somewhat undefined, and may be subject to dispute. Commission to determine if a public need The chart is neither an argument for nor a concession for the existence of the agency remains. of TDI supervisory authority over any particular The Sunset Commission also makes entity. recommendations for legislation related to the agency and the industry it regulates. C. TDI Organizational Chart. TDI‘s current TDI underwent sunset review in 2008 and internal organization is set out in Appendix B. Note legislation was considered, but was not that the Division of Worker‘ Compensation, formerly passed, during the 2009 legislative session the Texas Workers‘ Compensation Commission, was to continue the agency and make changes grafted on to TDI in 2005. The history of to the state‘s regulation of homeowners workers‘compensation regulation in Texas deserves insurance, among other things. The 2009 its own lengthy paper. TDI Sunset bill died in the House when the bill got caught up in a political maneuver by Democratic House members D. Where the Laws Come From. The Texas who wanted to kill Voter ID legislation. legislature meets for 140 days beginning on the Governor Perry had to call a special second Tuesday in January of every odd-numbered session in July of 2009 to pass a stop gap year. Over 5,000 pieces of legislation are filed during bill to ensure TDI was not ―abolished‖ as a regular session of the Texas Legislature, with of August 1 of that year. The agency was numerous bills aimed at the business of insurance in continued for two additional years and Texas. TDI‘s latest annual report to the Governor and HB 1951 was passed in 2011 to continue the Legislature indicated that the agency tracked over TDI‘s functions until September 1, 2023. 1,000 insurance and workers‘ compensation-related bills during the most recent (82nd) legislative session, iii. NAIC. The National Association of of which 214 were eventually signed into law. Insurance Commissioners (the ―NAIC‖) is

an association of state insurance officials Where do these bills come from? Legislators that functions primarily to rationalize and typically file bills in response to a perceived problem promote similarity—if not always or deficiency in the system. An individual constituent uniformity—in state regulation. The or an advocacy group may contact a legislator and NAIC meets several times a year and request legislation. The most common sources of committees of regulators work on model insurance legislation in Texas are: statutes and regulations. Numerous

industry and other stakeholder i. Texas Department of Insurance. Prior to representatives attend NAIC conferences every legislative session, TDI makes to monitor and influence the development recommendations for legislative changes. of model laws. NAIC has continued to Typically, the agency‘s recommended increase in power over the years as changes are contained in bills filed by the interest in uniformity in state regulation Chairman of the respective committees has gained ground. In addition, the ACA with jurisdiction over most insurance delegated certain functions to the NAIC, related issues, the House Insurance directing Secretary of the Health & Committee and the Senate State Affairs Human Services Department Kathleen Committee, chaired by Representative Sebelius to act on recommendations of the 20

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NAIC related to Medical Loss Ratio organizations is a frequent source of regulation and development of uniform insurance-related bills, as is the terms and definitions in health insurance consumer-oriented Center for Public materials. Policy Priorities (CPPP).

iv. NCOIL. The National Conference of vi. Constituent Requests. Constituents of Insurance Legislators is also a source of legislators are another source of insurance model insurance laws. The official legislation. In terms of health insurance purpose of NCOIL as posted on the legislation, mandated benefits (a bill that organization‘s website is ―to help requires a health plan to cover a legislators make informed decisions on specific treatment or health condition) are insurance issues that affect their the most common insurance-related bills constituents and to declare opposition to resulting from constituent concerns. federal encroachment of state authority to Constituents may also have concerns oversee the business of insurance, as about claims payment delays or authorized under the McCarran-Ferguson underwriting practices that result in new Act of 1945.‖ State Representative Craig insurance laws. Eiland, a former Speaker Pro Tem of the House and a long-time member of the vii. International Association of Insurance House Insurance Committee, is an active Supervisors (the “IAIS”). This multi- member of NCOIL and was the entity‘s national group of insurance regulatory President in 2005. Other Texas legislators officials was established in 1994, and has actively participate in NCOIL meetings been influential in a number of recent held across the country several times a financial initiatives, including the Model year. Holding Company Act amendments discussed in Section IV below. IAIS has v. Industry and Special Interests. The Texas been a primary proponent of the so-called Ethics Commission website, the Own Risk and Solvency Assessment, or regulatory authority over state lobbyists, ―ORSA,‖ an NAIC-endorsed method of lists hundreds of associations getting insurers to engage in self- representing, among others, doctors, cattle examination of the sort of enterprise risk ranchers, energy producers, summer discussed in Section IV. Expect to see camps, deer breeders, tort reform ORSA made the subject of NAIC model supporters, trial lawyers, parents, legislation in the near future, and to show teachers, unions, realtors, and a laundry up on the desks of state legislatures within list of organizations representing every the next two years. Many insurance type of licensed and regulated entity in regulators hope to have state ORSA the state, including the insurance industry. requirements in place in time for the Industry-related groups include America‘s International Monetary Fund‘s next Health Insurance Plans (AHIP), the review of the U.S. financial system in American Insurance Association (AIA), 2014. Property & Casualty Insurers Association

of America (PCI), the Texas Association E. Sources of Texas Insurance Regulation of Health Plans (TAHP), the Texas Association of Life & Health Insurers viii. Texas Insurance Code. The annotated (TALHI), the Texas Association of version of the Texas Insurance Code now Benefits Administrators (TABA), the merits two volumes containing almost Texas Association of Health Underwriters 3500 pages of insurance laws. The (TAHU), and the Independent Insurance Legislative Council has been involved in Agents of Texas (IIAT). Each of these 21

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a recodification effort for over ten years, with the result, widely deplored by x. Bulletins. TDI issues agency bulletins, or insurance regulatory lawyers, that much directives, on a broad variety of matters. of the Code has been renumbered and Often, the agency may issue a bulletin to revised. Beware reliance on references to alert the industry or regulated parties of enactment dates of statutes because in an agency position on particular practice many cases the legislative history refers or an agency interpretation of a statute or only to the recodification bill and not the regulation. Bulletins are also used for date of original enactment. For lawyers routine reporting and collection of data that practice at TDI, many of the forms from regulated entities. and checklists may refer back to original citations. Recodification is not supposed xi. Manuals. To make matters more to affect the substance of any restated complicated, some areas of the industry— law; whether it does, or has, is a subject automobile, workers‘ compensation, and for another CLE course. title insurance, for example—are regulated in part in ―manuals‖— ix. Texas Administrative Code. TDI collections of forms and procedures regulations are contained in Title 28 of adopted by rule but not to be found in the the Texas Administrative Code. TDI has Administrative Code. initiated a more collaborative process in the development of regulations. On xii. Orders. Commissioner‘s Orders can also controversial rules or rules impacting be a valuable source of information about multiple stakeholders, TDI typically TDI‘s interpretation of the Insurance issues an informal draft rule and will host Code and related rules, and its judgments a stakeholder meeting to solicit feedback. regarding the relative severity of After vetting the draft, the agency then violations of the law. Commissioner‘s proceeds with the formal Administrative Orders are available here: Procedure Act requirements of publishing http://www.tdi.texas.gov/orders/index.htm a proposed rule in the Texas Register and l and holding a formal hearing if requested. A https://wwwapps.tdi.state.tx.us/inter/aspro practice warning to insurance lawyers: not ot/commish/da/clips2011.asp . all rules are updated to reflect statutory xiii. “Desk Rules” A ―desk rule‖ or ―desk changes. For example, 28 TEX. ADMIN. drawer rule‖ is a position of the agency CODE 3.504 requires health insurers to offer ―conversion‖ policies. The that is not formalized by statute, Legislature made this an optional practice promulgated rule, or bulletin. How does a in the mid 90s but the rule has yet to be lawyer unfamiliar with agency workings updated. Conversely, if you can‘t find a know that a desk rule may come into rule that a given statute seems to mandate, play? He (or she) doesn’t. Traditionally, don‘t despair. There may not be one. One the agency has utilized ―desk rules‖ most very valuable resource for understanding often in connection with the review and the scope and nuance of a particular rule approval of insurance policy forms, in is the particular rule‘s adoption order. determining what language is acceptable Typically the adoption order will contain and what is not. For the most part, many a recitation of various consumer and of the desk rules are related to statutes industry comments to the rule, and the that are very broad or are not totally clear. agency‘s responses to the comments. They serve a purpose—promoting Refer to the Texas Register citations uniformity in what TDI will or will not related to the rule to locate the full approve—but their informality can be adoption order and regulatory comments. frustrating. It will be interesting to see 22

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what changes may appear in light of Texas Legislature, enabling legislation was proposed Commissioner Kitzman‘s apparent dislike to authorize TDI and the Texas Health & Human of such practices. Services Commission to begin the task of implementing a health insurance exchange. Despite IV. THE TDI OF TOMORROW the urging of the bill‘s sponsor, Rep. John Zerwas, a conservative Republican member of the Legislature Predictions are a foolish business. But some and practicing anesthesiologist, HB 636 did not even trends seem inevitable. Health insurance will continue make it out of committee. The Texas Legislature to be a political football. TDI will face increasing soundly renounced any bills that appeared to support pressure to align state law and solvency requirements ―ObamaCare.‖ Thus, Texas has been noted in the with the laws and policies of other states—and media as having done little to prepare for possibly even other nations. Finally, TDI and the implementation of a health insurance exchange. system of state regulation generally will face continued scrutiny from the federal government. Without enabling legislation or executive direction, TDI is in the difficult position of monitoring A. Increasing Federal Participation in Health but taking no action in regards to an exchange. Under Insurance Regulation. The federal health care reform ACA, the federal government will establish an bill of 2010, widely referred to now as the Affordable exchange if a state is not willing to do so. Notably, Care Act or ACA (or, in some circles, ―ObamaCare‖), fourteen states have implemented an exchange to date, is the elephant in the room in terms of regulation of primarily Democratic controlled states such as health insurance across the nation. If the law survives California, Colorado, Oregon, and Washington. Four Supreme Court review and the 2012 elections, it will states have plans to establish exchanges, and twenty- fundamentally change the landscape of health three others are studying options. For more insurance coverage in our state. information on the status of state implementation of ACA, see the Kaiser Foundation healthcare reform Texas is a plaintiff in Florida, et al. v. U.S. website at www.statehealthfacts.org. Department of Health and Human Services, the so- called ―multi-state‖ lawsuit, challenging the TDI is, however, enforcing the current provisions constitutionality of the ACA. (See attached Appendix of the ACA, such as ensuring that health plans comply C for a summary and current status of the health care with the mandates related to coverage of children up reform-related lawsuits.) Oral arguments before the to age 25; the mandate for preventive care benefits at U.S. Supreme Court are scheduled for March 26 no cost; and new restrictions on annual and lifetime through 28, 2012, with some observers predicting that benefit limits. In addition, the agency recently a decision will be handed down this summer. If the announced its external review process was compliant Court upholds the law and President Obama is with federal minimums, assuming health insurers reelected, implementation will likely go forward. voluntarily complied with several missing However, any other results could result in radical requirements. (See TDI Bulletin B-0051-11, changes to ACA as currently adopted. December 28, 2011). TDI is also charged with enforcing minimum loss ratio requirements and rate The centerpiece of ACA is the creation of state reviews related to potentially unreasonable rate health insurance ―exchanges‖ where individuals and increases (those in excess of 10% without adequate small employers can purchase health insurance. Under actuarial justification). the new law, states are required to have an exchange implemented in time for enrollment effective on While ACA initially seemed to take all discretion January 1, 2014. Federal subsidies are available only away from the states, it now seems apparent that the for insurance purchased through the health insurance tug of war between federal and state regulatory exchange. In addition, the exchange is supposed to be authority will continue. For example, while the the access point for individuals who may be eligible Department of Health and Human Services recently for Medicaid or the Children‘s Health Insurance rejected the State of Texas‘s application to allow Program (―CHIP‖). During the last session of the phased-in compliance with ACA‘s Medical Loss 23

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Ratio requirements, the federal government did cede last few years have related to balance billing and the some discretion to the states on the subject of defining amounts health plans pay for services provided by out ―essential benefits‖—the minimum benefits that all of network health care providers (providers without a health plans must cover. (See Appendix D for a contract with the health plan). TDI continues to tinker timeline of ACA implementation dates, courtesy of with network adequacy regulations contained in rules AHIP and the Texas Association of Health Plans.) related to preferred provider benefit plans (commonly Also, an excellent source of "consumer friendly" referred to as ―PPO plans‖). (See TDI Bulletin B- information on health care reform is the Office of 0051-11 dated December 28, 2011). In addition, the Consumer Information and Industry Oversight, or agency is working on new rules related to Exclusive ―OCCIO.‖ OCCIO is a division of the Centers for Provider Organization plans or EPOs. (See HB 1772, Medicare and Medicaid Services (―CMS‖), which is 82nd Legislative Session, 2011). An EPO plan is an part of the U.S. Department of Health and Human HMO look-alike health plan that does not generally Services (―HHS‖). OCCIO is implementing the provide benefits for services from out of network provisions of ACA related to private health insurance; providers other than emergency care. However, the see. http://cciio.cms.gov/ for further information. health plan is offered by an insurance company and generally is subject to the insurance code provisions Side Note. The impact of health care reform on related to PPO products. (See TEX. INS. CODE ANN. the Medicaid population in Texas. While this paper Chapter 1301). focuses on TDI, it is impossible to mention health care reform without at least touching on the impact to our HMOs in Texas. HMOs remain part of the health state Medicaid population. Programs administered by care landscape, but they are less prominent than they the Texas Health & Human Services Commission, once were. For much of the 1980s, HMOs were touted primarily Medicaid and CHIP, absorb around 32% of as the answer to the nation‘s health care problems. By the total two year budget for the state of Texas. (This the 1990s, though, HMOs were the villain that percentage represents the percent of all funds—both everyone loved to hate.59 The vitriol reached a general revenue and federal matching dollars). In crescendo in the 2002 movie John Q, in which the general, childless adults are not eligible for Medicaid decisions of a heartless HMO cause Denzel in Texas regardless of income levels. The Texas Washington to run amok in a Chicago hospital. HMOs Medicaid program currently covers children, pregnant were also a popular target at the Texas Capitol, where women, the disabled, and the elderly. As of June the Legislature passed several omnibus bills, including 2011, there were 3.6 million Medicaid enrollees and the patient protection act and managed care liability almost 600,000 children enrolled in CHIP in Texas. legislation, that were duplicated across the country. Under health care reform, all states must expand Most of the major commercial health plans doing eligibility for Medicaid beginning January 1, 2014 to business in Texas today continue to offer both HMO childless adults under 133% of the federal poverty and PPO products to their customers. However, HMO level (that equates to an annual income of slightly products have changed as a result of consumer under $15,000 in 2012). ACA is expected to add over disfavor (most plans eliminated the ―PCP gatekeeper‖ 1.2 million more Texans to the Medicaid and CHIP requirement) and market share for HMO products population. dropped dramatically, with many employers favoring PPO options for their employees. Much of the Other Regulatory Trends Related to Health Plan premium dollar in the HMO market relates to the Coverage. TDI spent much of the first ten years of this federal Medicare Advantage and Texas Medicaid decade regulated disputes between health plans and managed care program. The majority of the Texas providers, primarily related to ―prompt pay‖ issues. Medicaid and CHIP population are now enrolled in a TDI routinely assessed fines of $1,000,000 plus managed care plan operated by HMOs contracted with against health insurers and HMOs for violating the the Texas Health & Human Services Commission. Texas prompt pay laws. While much of the prompt pay enforcement actions have tapered off, the agency continues to monitor and enforce prompt pay 59 requirements. Much of the regulatory focus over the See, for example, ―The Doctor is Not In,‖ by Dr. Ronald J. Glasser, Harper’s, March 1998, p. 35. 24

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B. Federal Insurance Office. The Federal companies, though as yet no one knows of any such Insurance Office (―FIO‖) is a new office within the companies the FIO has tried to ―resolve.‖ U.S. Department of the Treasury established by the Dodd-Frank Wall Street Reform and Consumer In 2011, FIO Director Michael McRaith called for Protection Act of 2010. According to the FIO itself, public input on a report to be issued by FIO on the the FIO ―establishes needed insurance expertise at the state of U.S. insurance regulation, and how it could be Federal level‖—for what purpose, is left unstated. improved. The report was due out in January of this year. So far, nothing has been issued. This could mean The FIO is also charged with advising the that FIO has found nothing at all to criticize in the Secretary of the Treasury on major domestic and way the states regulate the industry. But it probably international insurance policy issues and consulting doesn‘t. with the states and state insurance regulators regarding ―insurance matters of national and international C. Increasing Interstate Collaboration in importance.‖ The Office will monitor all aspects of Financial Regulation: Solvency II and the New the insurance industry, including the availability of Model Holding Company System Act. One final affordable insurance to traditionally underserved, low influence on TDI‘s role going forward is coming from to moderate income, and minority persons and Europe. European insurance regulators have communities. The Office‘s authorities extend to all traditionally taken a more ―holistic‖ view of solvency lines of insurance except health insurance (which is oversight, looking beyond individual insurance now regulated, to a significant extent, by the entities to the corporate groups to which they belong. Department of Health and Human Services), long- This ―European approach,‖ reflected in the ―Solvency term care insurance (except that which is included II‖ regulatory initiative of the European association of with life or annuity insurance components), and insurance regulators, is beginning to find advocates in federal crop insurance. the U.S. as well. Insurance companies in this state have long been subject to the Insurance Holding State regulators and some insurers view the FIO Company Systems Act, originally promulgated as a with thinly veiled suspicion, suspecting it to be the model act by the NAIC in 1969 and codified in federal government‘s first beachhead in the invasion Chapter 823 of the Texas Insurance Code. The NAIC of the property and casualty industry. While the FIO amended its model act in 2011. Texas was the first has no actual regulatory authority yet, it does have large state to adopt the amendments and, as of this limited subpoena powers, which also rubs many writing, one of only three states to have done so. insurers and regulators the wrong way. Unsurprisingly, the Legislature added a few minor tweaks to the amendments. Probably the FIO‘s most popular proposed function—one that almost everyone agrees could One major reason for the recent changes to the actually be useful—will be to represent the United Holding Company Systems Act was the AIG situation States in dealing with other nations on insurance discussed above. The amendments were drafted to issues. While the NAIC occasionally attempted to do address the need of state insurance regulators to assess this, it had no authority to negotiate on behalf of the the ―enterprise risk‖ within a holding company nation as a whole. The FIO also has ―authority to system, rather than simply overseeing constituent identify issues or gaps in the regulation of insurance members of the system. Specifically, there were fears that could contribute to a systemic crisis in the that the financial activities of non-insurer affiliates— insurance industry or the broader US financial system; large investments in over-valued real estate mortgage and to make recommendations to the Financial securities, for example—could result in significant Stability Oversight Council as to whether an insurer, damage to the solvency of affiliated insurers. The including affiliates of an insurer, should be an entity point of the model act‘s new provisions is to try to subject to supervision by the Board of Governors of obtain a more ―holistic‖ reporting of possible risks to the Federal Reserve.‖ No such entity has been a regulated insurer‘s solvency by looking at the identified yet. The Office also says it will play a role financial activities, and liabilities, of the entire group. in the ―resolution‖ of certain troubled insurance 25

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Enterprise Risk Reporting. The biggest change to to the HCA may be required to pay for the expenses of the HCA is a new requirement that the ultimate the Commissioner in participating in a ―supervisory controlling person in the insurance holding company college‖ involved in overseeing the insurer. system provide TDI with annual reports of potential Presumably, TDI will promulgate rules that lay out the ―enterprise risks‖ that may spread to insurers and detail related to these supervisory colleges. negatively impact their financial condition. ―Enterprise risk‖ is defined as ―any activity, Disciplinary/Enforcement Provisions. There are circumstance, event, or series of events involving one several new provisions that provide the Commissioner or more affiliates of an insurer that, if not remedied with investigative tools and disciplinary measures promptly, is likely to have a material adverse effect on relevant to the statute‘s new focus on enterprise risk the financial condition or liquidity of the insurer or its management. One of high importance is new Section insurance holding company system as a whole.‖ TEX. §823.351, which provides that the Commissioner can INS. CODE ANN. Sec. 823.002(4-a). order an insurer to produce books and records from non-insurer affiliates related, not just to the insurer The enterprise risk report will be filed annually, itself, but to the enterprise risk faced by the holding along with the holding company system‘s registration company system as a whole, if the insurer is entitled statement, known as the Form B. This new report will to get them through ―contractual relationships, be designated as a ―Form F,‖ and will be promulgated statutory obligations, or other methods.‖ The by rule by TDI. The amended statute adds to the list of Commissioner can fine an insurer not less than $100 a documents and information that an insurer must day for delays in producing requested information. provide. The new law requires companies to provide Furthermore, the Commissioner can petition a court of financial statements for all affiliates of the holding competent jurisdiction to compel a person, not company system. The insurer will also have to file necessarily an insurer, or anyone employed by an information about the ―corporate governance and insurer, to give evidence related to an investigation by internal control responsibilities‖ of the insurer‘s board the Commissioner under the HCA. Code § 823.452 of directors—an echo of the corporate governance specifies that if the Commissioner determines that a concerns contained in the Sarbanes-Oxley Act— person has committed a violation of provisions including a statement that the insurer‘s senior relating to the control of a domestic insurer that would management or officers have approved and tend to obscure the true enterprise risk faced by a implemented, and continue to maintain and monitor, holding company system, the violation may serve as corporate governance and internal control procedures; an independent basis for disapproving dividends and, and the insurer‘s board of directors oversees corporate more drastically, for placing an insurer in supervision governance and internal controls; plus any other or receivership. information the Commissioner requires by rule.60 No such rule has been promulgated to date. The Legislature‘s recent amendments to the Holding Company System Act have been and will Supervisory Colleges. Section 823.0145 provides continue to be the subject of much speculation. Who that the Commissioner may participate in what is decides what rises to the level of an “enterprise risk,” called a ―supervisory college,‖ established to monitor for example? How must such risk be reported? the regulatory compliance of insurance holding Several provisions, most notably those pertaining to company systems with international affiliates. It is enterprise risk reporting and supervisory colleges, will unclear what such colleges are meant to look like, have to be supplemented considerably by TDI who will belong, and exactly what they will do. One rulemaking before we can come to any definitive point of interest is that the Commissioner can understanding of them. Likely, the rulemaking will be participate in such colleges with regulators of non- fairly substantive, with significant impact on subject insurer affiliates. Apparently, this could include the insurers. Some of the law‘s new provisions may also SEC or one or more banking regulators, or any other be subject to judicial review and scrutiny, since they number of regulators. Also, note that insurers subject at least arguably grant TDI broader authority than its mandated jurisdiction of regulating the conduct of

60 insurance in the State of Texas. See Section 823.052(c)(12) of the Code. 26

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V. CONCLUSION

The amended Model Holding Company System Act is another effort by the NAIC to nudge its constituent regulators out of their state-by-state, entity-by-entity mindset and into a broader, more holistic approach to regulation. The effort isn‘t completely altruistic. Behind it is the knowledge that if the states don‘t become more consistent, proactive, and sophisticated in their analysis and regulation, the federal government may step in and do these jobs for them. Federal participation in the health insurance market is already occurring at a level that seemed far- fetched only a few years ago. State regulation of the property and casualty industry seems safe for now, through the Federal Insurance Office may be looking for a reason to change that. The next battleground may well be financial oversight. If an insurance and financial holding company system faces significant enterprise risk in the future without state regulators being able either to predict the consequences or prevent adverse risks from spreading, the results could provide some final impetus to federal financial oversight. If this happens, the days when TDI consisted of a commissioner, a single clerk, and an overstuffed filing cabinet may return sooner than anyone anticipates.

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