1. Chapter 8
Government Regulation of Insurance

2. Agenda Reasons for Insurance Regulation
Historical Development of Insurance Regulation
Methods for Regulating Insurers
What Areas are Regulated?
State versus Federal Regulation
Modernizing Insurance Regulation
Insolvency of Insurers
Market Conduct Regulation

3. 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

4. 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), the Supreme Court ruled that insurance was not interstate commerce, and that the states rather than the federal government had the right to regulate the insurance industry.

5. Historical Development of Insurance Regulation (Continued)
In U.S. v. South-Eastern Underwriters Association (1944) the Court ruled that insurance was interstate commerce when conducted across state lines and was subject to federal antitrust laws
The McCarran-Ferguson Act (1945) states 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

6. Historical Development of Insurance Regulation (Continued)
The Financial Modernization Act (1999) changed federal law that earlier prevented banks, insurers, and investment firms from competing outside their core area
State insurance departments regulate insurers
State and federal bank agencies regulate banks
The Securities and Exchange Commission (SEC) regulates the sale of securities
The Federal Reserve has umbrella authority over bank affiliates that engage in underwriting insurance

7. Historical Development of Insurance Regulation (Continued)
The Dodd-Frank Wall Street Reform and Consumer Act (2010) was enacted to address abuses in the financial services industry. It has numerous provisions designed to:
Reform the financial services industry
Deal with destabilizing practices of commercial banks, investment firms, mortgage companies and credit-rating agencies
Provide protection for consumers
The Act also created the Financial Stability Oversight Council (FSOC)

8. Methods for Regulating Insurers
The three principal methods used to regulate insurers are:
Legislation, through both state and federal laws
Court decisions, e.g., interpreting policy provisions
State insurance departments

9. What Areas Are Regulated?
All states have requirements for the formation and licensing of insurers
Licensing includes minimum capital and surplus requirements
A domestic insurer is domiciled in the state
A foreign insurer is an out-of-state insurer that is chartered by another state, but licensed to operate in the state
An alien insurer is an insurer that is chartered by a foreign country, but is licensed to operate in the state

10. What Areas Are Regulated? (Continued)
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

11. What Areas Are Regulated? (Continued)
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
A comparison of the company’s total adjusted capital to the amount of required risk-based capital determines whether company or regulatory action is required

12. What Areas Are Regulated? (Continued)
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
Many states limit the amount of surplus a participating life insurer can accumulate, rather than pay as dividends

13. What Areas Are Regulated? (Continued)
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
All states have guaranty funds, guaranty laws and guaranty associations that pay the claims of policyowners of insolvent insurers
The assessment method is the major method used to raise the necessary funds to pay unpaid claims

14. What Areas Are Regulated? (Continued)
Rate regulation takes a variety of forms across states
Forms of rate regulation for property and casualty insurance include:
Many states exempt insurers from filing rates for large commercial accounts
Life insurance rates are not directly regulated by the states
Prior approval law
Flex-rating law
Modified prior approval law
State-made rates
File-and-use law
No filing required
Use-and-file law

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

16. What Areas Are Regulated? (Continued)
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

17. What Areas Are Regulated? (Continued)
Insurance laws prohibit a variety of unfair trade practices, such as misrepresentation, twisting, and rebating
Twisting is the inducement of a policyowner 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

18. What Areas Are Regulated? (Continued)
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

19. 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

20. State versus Federal Regulation (Continued)
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

21. State versus Federal Regulation (Continued)
Shortcomings of state regulation include:
Inadequate protection of consumers
Improvements needed in handling complaints
Inadequate market conduct examinations
Insurance availability

22. Current Problems and Issues in Insurance Regulation
Should the McCarran-Ferguson Act be repealed?
Critics of state regulation argue:
The insurance industry no longer needs broad antitrust exemption
Federal regulation is needed because of the defects in state regulation.
Counterarguments include:
The insurance industry is already competitive.
Small insurers may be harmed.
Insurers may be prevented from developing common coverage forms

23. Modernizing Insurance Regulation
Critics believe the current regulatory system is broken, and lax regulatory oversight at both the state and federal levels contributed to the financial meltdown
The Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) contained numerous provision to reform the financial services industry
Created the Financial Stability Oversight Council (FSOC) to identify and treat systemic risk
Created the Federal Insurance Office (FIO)

24. Modernizing Insurance Regulation (Continued)
The Financial Stability Oversight Council (FSOC) has the authority to treat systemic risk and to classify nonbank financial companies, which include insurance companies, as systemically important financial institutions (SIFIs)
A financial company that is classified as a SIFI receives tougher oversight and is regulated by the Federal Reserve

25. Modernizing Insurance Regulation (Continued)
The Federal Insurance Office (FIO) has the authority to:
Monitor all aspects of the insurance industry
Identify gaps in insurance regulation and identify issues that contribute to systemic risk
Assist the FSOC in identifying insurers that could create systemic risk
Represent the federal government in international discussions of insurance regulation
Negotiate international agreements with foreign countries that pertain to insurance regulation.

26. Modernizing Insurance Regulation (Continued)
The Dodd-Frank Act required the FIO to study and report on the regulation of insurance.
The report (2013) recommends a hybrid model of insurance regulation, with many areas for state-level reform.
The FIO also recommends direct federal involvement in several areas, including:
Supervision and standards for mortgage insurers
Collateral requirements for reinsurers

27. Modernizing Insurance Regulation (Continued)
Another approach to insurance regulation is an optional federal charter
Proposals would allow insurers to choose either a federal or state charter.
Proponents argue that national insurers are at a competitive disadvantage under the present system.
Opponents suggest this creates a dual system of insurance regulation which will increase the cost of insurance regulation

28. 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
Mismanagement and fraud
Bad investments
Problems with affiliates
Overstatement of assets
Catastrophe losses
Failure of reinsurers to pay claims

29. Insolvency of Insurers (Continued)
The Solvency Modernization Initiative (SMI) is an ongoing program that began in 2008.
Provides for a critical self-examination of insurance solvency regulations in the US
Includes a review of international development
Key parts of SMI include:
Capital requirements
Risk management
Corporate governance
Group supervision
Reinsurance
Statutory accounting and financial reporting

30. Insolvency of Insurers (Continued)
The principal methods of ensuring solvency are:
Minimum capital and surplus requirements
Risk-based capital standards
Reserve requirements
Restrictions on investements
Review of annual financial statements
Field examinations
Early warning system (IRIS ratios)
FAST system analysis

31. Market Conduct Regulation
Market conduct refers to the marketing practices of insurers and agents that involve interaction with insureds, claimants, or consumers.
Practices include:
Sales of insurance policies
Advertising of insurance products
Underwriting and rating
Collection of premiums
Policy renewals, termination, and changes
Claims settlement

32. Market Conduct Regulation (Continued)
Regulators are concerned that certain industry practices may have an adverse effect on policyholders, beneficiaries, claimants and insurance consumers
Concerns include:
Sale of unsuitable insurance products
Misrepresentation of coverage
Excessive sales pressure
Rates that are excessive or unfairly discriminatory
Denial of legitimate claims
Improper termination of policies

33. Market Conduct Regulation (Continued)
The FIO report makes several recommendations regarding market conduct, including:
Every state should participate in the Interstate Insurance Product Regulation Commission (IIPRC) to improve the approval of products
Each state should adopt the Suitability in Annuities Transactions Model Regulation drafted by the NAIC
States should identify regulatory practices that best promote competitive markets for personal lines insurance consumers

34. Insight 8.1: Credit-based Insurance
The credit based insurance score is derived from an applicant’s credit history and is combined with other underwriting factors
Proponents of credit-based insurance argue:
There is a high correlation between an applicant’s credit record and future claims experience
Insurance scores permit insurers to accept more high-risk consumers for whom otherwise an appropriate premium could not be determined
Most consumers have good credit scores and benefit from credit scoring

35. Insight 8.1: Credit-based Insurance (Continued)
Critics of credit-based insurance argue:
The use of credit data in underwriting or rating discriminates against minorities and other groups
Credit-based insurance scores may penalize consumers unfairly during business recessions
Most states have enacted legislation that regulates the use of credit-based insurance scores