Ch 8 ACSC

4 major reasons for regulation of insurance

1. Maintain insurer solvency — possession of assets to pay liabilities. Solvency important because:

• premiums paid in advance but protection extends into future

• individuals are exposed to great economic insecurity if insurers fail to pay claims

• when insolvent → social and economic costs (insurance jobs lost, reduction in premium taxes paid to states, freeze on withdrawal of cash values by life insurance policyholders)

2. Compensate for inadequate consumer knowledge — contracts could be worthless to policyholders if too restrictive and legalistic, coverages are hard to compare, want to protect consumers from unscrupulous agents 

3. Ensure reasonable rates — policyholders should not be excessively charged/not charged enough that would lead to insolvency, and rates should not be increased to exorbitant levels 

4. Make insurance available 

Paul v. Virginia (1868)

Affirmed right of states to regulate insurance. Other businesses regulations by gov. didn’t apply to insurance companies

South Eastern underwriters Association (SEUA)

found guilty of price-fixing (against anti-trust laws)

US v. SEAU (1944)

Insurance is commerce and can be interstate commerce

Result: subjected insurers to federal regulation including anti-trust statutes 

McCarran-Ferguson Act (1945)

States that continued regulation/taxation of the insurance industry by states are in public interest 

but federal anti-trust laws apply to insurance only to the extent that the insurance industry is noy regulated by state law

3 principal methods to regulate insurers (ways insurers are regulated)

1. Legislation — laws that regulate formation of insurance companies, licensing of agents and brokers, financial requirements for maintaining solvency, insurance rates, marketing, sales, claim practices, taxation, rehabilitation/liquidation of insurers.

• Laws have been passed to protect rights of consumers (ex: laws restricting right of insurers to terminate contracts)

• Federal regulation (ex: Obamacare)

2. Courts — courts periodically hand down decisions concerning constitutionality of state insurance laws, interpretation of policy clauses/provisions, legality of administrative actions by state insurance departments

3. State insurance departments — all states, district of Columbia, and US territories have a separate insurance department or bureau.

• the insurance commissioner (who are either elected or appointed) has power over insurers doing business in the state—they can hold hearings, issue cease-and-desist orders, and revoke/suspend insurer’s/agent’s license

National association of insurance commissioners (NAIC)

• founded 1871

• meets periodically to discuss industry problems

• state insurance commissioners belong to the NAIC

• no legal authority, but most states adopt all/some of NAIC’s recomendations

7 Areas of regulations

1. formation and licensing of insurers

2. solvency regulations\

• min capital/surplus requirements

• admitted assets, reserves, surplus

3. rate regulations

• prior approval rates, modified prior-approval rates, file-and-use law, use-and-file law, flex-rating law, state-made rates, no filling required 

4. policy forms 

• because insurance contracts are technical/complex, the state insurance commissioner has the authority to approve or disapprove new policy forms before the contracts are sold to the public

• purpose: protect against misleading/deceptive, unfair provisions

5. sales practices and consumer protections

• regulated by laws concerning licensing of agents and brokers, laws prohibiting twisting, rebating, unfair trade practices

6. taxation of insurers

• federal income tax, state premium tax—raise revenues for the states 

7. miscellaneous: cybersecurity

• theft (stolen date), ransom, malicious tampering

7 state rate regulation methods

1. prior-approval rates — insurance rates are filed and approved by state insurance department before they can be used and must be filed in every state

can lead to delays in obtaining needed rate increase (if accepted)

2. modified prior-approval laws — if the rate change based solely on loss experience, insurer must fie the rates with the state insurance department, and rates may be used immediately.

But if the rate change is based on changing rate classification or rating algorithm (introducing new variable)

3. file-and-use laws — insurers required only to file rates with state insurance department. Rates can be used immediately.

Overcomes delay issues

4. use-and-file laws — insurers can put into effect immediately any rate changes, but rates must be filed with regulatory authorities within a certain period of days (usually within 15 days)

5. flex-rating law — prior approval of rates only required if rate increase/decrease exceeds a specified range.

Insurers can make rate changes more rapidly in response to changing market conditions (it is file and use unless rates are +- 10% (or 5%)).

6. state-made rates — apply to a small number of specialized lines. state determines rates, forms, classifications. Insurers can deviate with approval.

7. no filling requires — insurers do not need to file rates with state insurance department but may needs to furnish rate schedules and supporting data to state officials.

Market force determines price.

licensing of agents and brokers

agents and brokers must be licensed and must pass 1+ written exams to ensure they have knowledge of state insurance laws and contracts.

They must continue education.

unfair trade practices

misrepresentation, twisting, rebating, deceptive/false advertisement, inequitable claim settlement, unfair descrimination

twisting def

the inducement of a policyholder to drop and existing policy and replace it with a new one that provides little/no economic benefit to the client (applies to life policies)

rebating def

giving an individual a premium reduction or some other financial advantage not states in the policy as an inducement to purchase the policy

ex) partial refunds

purpose: preventing one insured from obtaining and unfair price advantage over another\

critics: 1) rebating increases price competition and lowers insurance rates 2) current laws protect the income of agents rather than consumers 3) purchasers denied right to negotiate price with agents

4. advantages of federal regulation

1. uniform state laws and regulations — less costly/time consuming. New products introduced sooner.

2. more effective negotiations of international insurance agreements

3. more effective treatment of systemic risk — risk of collapse of an entire system/market due to the failure of a single entity that can result in the breakdown of the entire financial system

4. greater efficiency of insurers — insurers doing business nationally would have to deal with only one federal agency

Advantages of state regulation

1. quicker response to local insurance problems — insurance problems vary widely by location and state regulators can resolve these problems quicker

2. increased costs from dual regulation avoided

3. poor quality of federal regulation

4. promotion of uniforms laws by NAIC (reasonable uniformity by model laws/proposals of the NAIC). Many differences still exist

5. greater opportunity for innovation — individual states can experiment and only one state is affected if experiment fails

6. unknown consequences of federal regulations

disadvantages of state regulation

1. inadequate protection of consumers — are customers treated fairy? complexity of insurance products make hard to compare.

2. suboptimal handling of complaints — improvements needed.

• consumers are not aware of the NAIC website that offers info on complaints against insurers

3. inadequate market conduct examinations — examinations of consumer matters

• ex: claims handling, underwriting, complaints, ads

• it is easier to have a national body regulating these things

4. insurance availability

5. regulators overly responsive to the insurance industry — state insurance commissioners have close ties to insurance industry — they often make decisions that favor insurers at the expense of consumers