Lecture 4: Insurance Regulation

Reasons for Insurance Regulation

1.) Industry members have monopoly, oligopoly, or other excessive power over consumers

2.) Information is imperfect

3.) Public policy calls for regulation

Perfectly competitive markets exist when:

Large # of buyers and sellers

Free entry and exit

Perfect product knowledge among buyers and sellers

Homogeneous prices for homogeneous products

No collusion

How does the insurance industry measure up against the reasons for regulation?

No single firm has excess power (+)

Information may be imperfect and companies have advantage over policy holders (-)

Insurance makes society better off (+)

Reasons for Insurance Regulation

1.) Solvency of Insurance Company - insureds are incapable of self-protection and impact of insolvency would be widespread

2.) Unequal Knowledge and Bargaining Power - company has advantage in technical expertise and consumers can not evaluate policy’s performance until it’s too late

3.) Prices - premiums are set BEFORE costs are known, not based on competition

4.) Promotion Social Goals - insurance should be widely available at affordable rates so insurers may be forced to accept poor risks at inadequate rates (may conflict with solvency goal)

Insurance Regulation

the rules of the insurance marketplace as established by law, administered by public officials (commissioners), and interpreted by the courts for the purpose of promoting and protecting the public

Paul v. Virginia Supreme Court Case (year and question)

1869

Is insurance an act of interstate commerce?

Paul v. Virginia Supreme Court Case (case and verdict)

Mr. Paul is resident in VA selling insurance in VA through a NY company

Paul was convicted of violating a VA law requiring a license to sell in VA

Argued did not need license (interstate commerce)

VERDICT: NOT interstate commerce, states regulate

Which 2 investigations caused NY to improve their insurance regulation practices?

Armstrong (1905) - life insurance industry

Merritt (1910) - fire insurers

Which court case reversed Paul v. Virginia?

Southeastern Underwriters Association (1944)

Southeastern Underwriter’s Association (case,verdict, and solution)

SEUA had near monopoly power on property insurance in SE U.S. and abused power by fixing rates

Violated federal anti-trust laws that only applied to interstate commerce

Verdict: Insurance IS interstate commerce and passed McCarren Act

McCarren Act

allowed states to continue to regulate insurance only if state laws give consumers protection similar to federal anti-trust laws

National Association of Insurance Commissioners (NAIC)

private, non-profit association of state insurance commissioners that develop model bills for various states to enact

Appleton Rule (1939)

an insurance company doing business in NY must be in compliance with all of NY’s rules in every state they do business

5 Arguments for STATE Insurance Regulation

1.) Known quantity (works well)

2.) Still needed for intrastate insurance companies

3.) Allows for experimentation

4.) Closer to the public and can respond to local conditions

5.) NAIC began accreditation program in early 1990’s

5 Arguments for FEDERAL Insurance Regulation

1.) Improved efficiency and uniformity

2.) Insurers can not withdraw from U.S. if don’t like regulations (helps avoid pick and choose)

3.) State insurance does not have enough expertly trained personnel and too small budget

4.) Better equipped to fund insolvencies

5.) Creates a barrier to foreign companies

Admitted Assets

assets available to pay claims

ex: real estate holdings

Non-admitted assets

ex: furniture, EQ

do NOT offset liabilities

How do reserves and surpluses work?

Insurers need reserves (liabilities) to recognize future obligations

Must have more assets than liabilities (surplus) in case of bad underwriting or investment results

What if an insurance company becomes insolvent?

Surviving insurance companies pay a proportional share of the cost based upon market share of premiums written

What happens before insolvency occurs to try to avoid it?

Regulators intervene, liquidation or another company may purchase it