Ch. 8: Government Regulation of Insurers

insurance regulation

insurance is regulated on the state level

goals of insurance regulation

1. maintain insurer solvency

2. educate consumers

3. ensure reasonable rates

4. make insurance available for all

maintain insurance solvency

main goal of insurance regulation, making sure companies can indemnify those they insure

• potential for significant hardship for consumers when an insurer goes bankrupt

• state guarantee fund to pay a capped amount when an insurance company becomes insolvent

educate consumers

main goal of insurance regulation, prevent unethical insurers or agents from taking advantage of consumers

necessary because insurance contracts are complex legal contracts of adhesion and it’s difficult to understand and compare coverages and costs

ensure reasonable rates

main goal of insurance regulation, ensure economically feasible rates for needed coverages

also ensure premiums are sufficient to pay losses and prevent excessive or unsubstantiated rate increases

make insurance available

main goal of insurance regulation, make insurance available to consumers through FAIR plans and restrict market exit of insurers

6 key areas that are regulated

1. formation and licensing of insurers

2. solvency regulation

3. rate regulation

4. policy forms

5. sales practices and consumer protection

6. taxation of insurers

formation and licensing of insurers

regulation of minimum capital and surplus (assets-liabilities) requirements

• domestic, foreign (out of state), alien (out of country) insurers

solvency regulation

regulations to prevent insolvency, 6 key areas

1. ensure sufficient assets to offset liabilities

2. regulate how reserves are calculated (funds set aside to pay claims or settle other financial obligations - liabilities) (varies by state

3. premium:surplus ratio

4. investment types and quality 

5. filing of annual statements (assess the financial health of company)

6. regulate the state guarantee fund

premium:surplus ratio

1:1 ratio is best, this means that the company has $1 in surplus to $1 in premium, with premium representing the amount of coverage they’re liable for

1:2 and 1:3 is very bad, if significant losses occur they’re surplus goes ½ or 1/3 as far

rate regulation

regulation of rates varies by state, 2 main types:

1. prior approval: rates must be filed with state for approval before they’re used

2. file and use: rates filed with state but can be used immediately; if the state decides they cannot continue using those rates the company must issue refunds and submit new rates for approval

policy forms

the language used in policy forms and endorsements (amendment to existing policy) must be filed with state department of insurance

• protects consumers from misleading, deceptive, or unfair provisions

• important when new exposures, technologies, etc. become relevant that must be considered in policies

sales practices and consumer protection

all states require licensing of and continuing education for brokers and agents

prohibits unfair trade policies: twisting, rebating

twisting

unfair trade policy involving the inducement of a policyholder to drop an existing policy and replace it with another that provides little to no benefit for them but which economically benefits the broker/agent

• ex: inducing a policyholder to switch policies because the broker/independent agent receives a commission

rebating

unfair trade policy involving giving an individual a premium reduction, portion of commission, or some other financial advantage not stated in a policy as an inducement to purchase the policy

McCarran-Ferguson Act of 1945

established that insurance should be regulated and taxed by the states and that federal antitrust laws do not apply to insurance (with some exceptions)

Financial Modernization Act of 1999 (gramm-leach-bailey)

eliminated barriers that formerly prevented banks and insurers from doing operations of the other industry

led to mergers and acquisitions but also created confusion as to who would regulate each division

cited as a contributor to the 2008 financial crisis

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

established federal oversight of the insurance industry by creating the Financial Stability Oversight Council (FSOC) in response to the great recession

authorized the FSOC to treat systemic risk and classify non-bank financial companies like insurance companies as systemically important financial institutions (SIFIs)

Arguments in favor of federal regulation

1. decrease compliance costs

2. increase innovation by establishing one single set of regulations as opposed to 50 for each state

3. increase competition

4. make negotiations for international insurance agreement and the treatment of systemic risk more effective

arguments in favor of state regulation

1. state needs are different

2. transition to federal regulation is costly and would require dual regulation temporarily

3. federal regulation has been historically inefficient

4. unknown consequences of federal regulation

market conduct

refers to the marketing and business practices of insurers and agents that involve interactions with insureds, claimants, and consumers

market conduct examinations

state departments of insurance conduct market conduct examinations of insurers to protect consumers from illegal acts by an insurance company