Government Regulation of Insurance Chapter 8 Government Regulation of Insurance

AGENDA Explain the major reasons why insurers are regulated. Identify key legal cases and legislation that have had an important impact on insurance regulations. Identify the areas that are regulated. Explain the objectives of rate regulation and the different types of rating rates. Explain the major arguments for and against state regulation of insurance.

U.S General Accounting Office: “ There are serious shortcomings in state law and regulatory activities with respect to protecting the interests of insurance consumers”

Reasons for Insurance Regulation Transparency Master 1.2 Reasons for Insurance Regulation Maintain insurer solvency Compensate for inadequate consumer knowledge Ensure reasonable rates Make insurance available

1- Maintain the insurer solvency First reason: In order to ensure that claims will be paid if an insurer goes bankrupt, the financial strength of insurers must be monitored. Second reason: Possibility of great financial insecurity if insurers fail and claims are not paid. Third reason: Certain social and economic costs due to bankruptcy can be minimized if insolvencies are prevented.

2- Compensate for inadequate consumer knowledge This is difficult for most consumers to compare and evaluate dissimilar policies with different premiums because the necessary price and policy information is not readily available. Therefore, with regulations insurers could not draft contracts so restrictive and legalistic that is worthless.

3- Ensure Reasonable Rates Regulations protect the consumers from the excessive because rates should not be so high that consumers are being charged excessive prices nor should be so low that the solvency of insurers is threatened.

4- Make Insurance Available Because of underwriting losses, inadequate rates, and adverse selection the insurers are unwilling to insure all participants. The public interest may require regulators to take actions that expand private insurance markets to make insurance available to all persons who need it.

Historical Development of Insurance Regulation Insurers were initially subject to few regulatory controls. State legislatures first granted charters to new insurers; insurance commissions were first created in 1851. In Paul v. Virginia (1868), 1-The Supreme Court ruled that insurance was not interstate commerce 2-The states rather than the federal government had the right to regulate the insurance industry.

Historical Development of Insurance Regulation In U.S. v. South-Eastern Underwriters Association (1944) Reversed the Paul v.Virginia decision 1-The Court ruled that insurance was interstate commerce when conducted across state lines and was subject to federal antitrust laws. 2- The decision cast doubt on the legality of private rating bureaus and the power of the states to regulate and tax the insurance industry.

The McCarran-Ferguson Act (1945) states 1-That continued regulation and taxation of the insurance industry by the states are in the public interest Federal antitrust laws apply to insurance only to the extent that the insurance industry is not regulated by state law

Historical Development of Insurance Regulation The Financial Modernization Act (1999) 1- Allows banks, insurers, investment firms, and other financial services forms to compete in financial markets outside their core area. 2- Both state and federal regulatory authorities are now involved in insurance regulation.

Methods for Regulating Insurers The three principal methods used to regulate insurers are: Legislation, through both state and federal laws 1-State laws regulate the operations of insurance companies. These laws regulate: Formation of insurance companies;licening of agents and brokers; financial requirements for maintaining solvency; Insurance rates; sales and claim practices; taxation; rehabilitation or liquidation of insurers. 2-Federal laws- mail-order sales; advertising, sale of variable annuities, private pension plans

Courts 1- Constitutionality of state insurance laws Courts 1- Constitutionality of state insurance laws. 2- interpretation of policy clauses and provisions. 3- Legality of administrative actions by state departments.

State insurance departments All states, the Distinct of Columbia, and U.S territories have a separate insurance department or bureau. An insurance commissioner has the responsibility to administer state insurance laws. Based on the administrative ruling, the state insurance commissioner has considerable power over insurers doing business in the state. The insurance commissioners has the power to hold hearings, issue cease-and-desist orders, and revoke or suspend an insurer's license to do business.

What Areas Are Regulated? All states have requirements for the formation and licensing of insurers Licensing includes minimum capital and surplus requirements

What Areas Are Regulated? Insurers are subject to financial regulations designed to maintain solvency Assets must be sufficient to offset liabilities Admitted assets are assets that an insurer can show on its statutory balance sheet in determining its financial condition States have regulations that address the calculation of reserves An insurer’s surplus position is carefully monitored by state regulators

What Areas Are Regulated? Life and health insurers must meet certain risk-based capital (RBC) standards Insurers must hold a certain amount of capital, depending on the riskiness of their investments and insurance operations An insurer’s RBC depends on asset risk, underwriting risk, interest rate risk, and business risk.

What Areas Are Regulated? The purpose of investment regulations is to prevent insurers from making unsound investments that could threaten the company’s solvency and harm the policyowners. Laws generally place a limit on the proportion of assets in a specific asset category, such as real estate

What Areas Are Regulated? Each insurer must file an annual report with the state insurance department in the states where it does business. The state insurance department assumes control of insurance companies that they determine to be financially impaired.

What Areas Are Regulated? State insurance commissioners have the authority to approve or disapprove new policy forms before the contracts are sold to the public. Purpose is to protect the public from misleading, deceptive, and unfair provisions

What Areas Are Regulated? Sales practices are regulated by the laws concerning the licensing of agents and brokers All states require agents and brokers to be licensed All states require agents to obtain continuing education to upgrade their knowledge and skills

What Areas Are Regulated? Insurance laws prohibit a variety of unfair trade practices, such as misrepresentation, twisting, and rebating Twisting is the inducement of a policy owner to drop an existing policy and replace it with a new one that provides little or no economic benefit to the client Rebating is the practice of giving an individual a premium reduction or some other financial advantage not stated in the policy as an inducement to purchase the policy

Case Study 2 chapter 8

What Areas Are Regulated? State insurance departments typically have a complaint division for handling consumer complaints Most complaints involve claims Information is provided to consumers on insurance department websites and in brochures Insurers pay numerous local, state, and federal taxes

State versus Federal Regulation Proponents for federal regulation argue that federal regulation: would provide uniformity in state regulations is more effective in negotiations of international insurance agreements is more effective in the identification and treatment of systemic risk would enable insurers to become more efficient

State versus Federal Regulation Advantages of state regulation include: Quicker response to local insurance problems Federal regulation could lead to a dual system of regulation and increase costs Poor quality of federal regulation, e.g., in the banking industry Reasonable uniformity of laws can be achieved by the model laws of the NAIC Greater opportunity for innovation Unknown consequences of federal regulation

State versus Federal Regulation Shortcomings of state regulation include: Inadequate protection of consumers Critics have argued that state insurance department do not have systematic procedures for determining whether consumers are being treated properly with respect to claim payments, rate setting, and protection from unfair discrimination.

Improvements needed in handling complaints Although many states prepare complaint ratios(ratio of complaints to premiums) for each company , the information may not be readily shared with the public.

Inadequate market conduct examinations Market conduct examinations refer to insurance department examinations of consumer matters such as claims handling, underwriting , complaints , advertising , and other trade practices.

Insurance availability Many states have not conducted current studies to determine whether property and liability insurance availability is a serious problem in their states.

Regulators may be overly responsive to insurance industry. Insurance regulation is not characterized by an “ arm’s –length” relationship between regulators and the regulated. Many state insurance commissioners were previously employed in the insurance industry, and many return to the industry after leaving office.

Insolvency of Insurers Insolvency of insurers continues to be an important regulatory concern. Reasons for insolvencies include: Inadequate rates Inadequate reserves for claims Rapid growth and inadequate surplus Problems with affiliates Overstatement of assets Alleged fraud Failure of reinsurers to pay claims Mismanagement Catastrophic losses

Insolvency of Insurers The principal methods of ensuring insolvency are: Financial requirements, such as minimum capital and surplus requirements Risk-based capital standards Review of annual financial statements Field examinations Early warning system (IRIS ratios) FAST system analysis