Chapter 8: Government Regulation of Insurers

What Areas are Regulated?  

• Formation and Licensing of Insurers  

• Solvency Regulation 

• Rate Regulation 

• Policy Forms 

• Sales Practices and Consumer Protection 

• Taxation of Insurers 

Formation and Licensing of Insurers  

• Minimum capital and surplus requirements (have to maintain a certain level of surplus/capital/money to pay losses; Surplus = Assets – Liabilities; Liabilities include: unearned premium and loss reserves (money set aside to pay claims); the greater the surplus, the greater their ability to pay claims) 

• Domestic Insurer  

  • Domiciled in the state. 

• Foreign Insurer  

  • Chartered (domiciled) in another state, but licensed to operate in the state. 

• Alien Insurer  

  • Chartered in a foreign country, but licensed to operate in the state. 

Solvency Regulation (regulators want to make sure insurance companies remain solvent) 

• Assets must be sufficient to offset liabilities   

• Calculation of reserves (responsible for calculating loss reserves) 

• Premium to Surplus Ratio (comparing two numbers; how much premium they have outstanding; premium: surplus; 1:1 is ideal/good ratio (ex: $200M to $200M); for every dollar in surplus, is every dollar I have in premium; 2:1 is OK (ex: $400M to $200M); bad is 3:1 ($600M to $200M); bringing in more premium meaning insuring too many people but not gaining any surplus from it) 

• Investment types and quality 

• Annual Statement must be filed (lists all their investments and provides all the information for regulators) 

• Guaranty Funds (money used on unpaid claims) 

 Rate Regulation  (have to get permission from regulators; approval) 

• Differs by state.  

• Prior-approval (file to regulators and send documentation; if regulators approve of rate increase then you can) 

  • Rates must be filed and approved by the state before being used. 

• File-and-use (do not need to wait for approval, but can file and use; however the regulators can review it, and the insurance companies may have to refund those who you may have charged with the increase in rates) 

  • Rates must be filed with the state, but can be used immediately. 

• Other Methods  

  • Modified-prior-approval, use-and-file, flex-rating, state-made rates, and no filing required. 

 Policy Forms (actual insurance contract; the language has to be approved by regulators; to protect consumers, the regulators are making sure the companies are not deceiving or taking advantage of the contract) 

• Policy forms and endorsements must be filed with the state department of insurance. 

• Purpose is to protect consumers from misleading, deceptive, or unfair provisions. 

 Sales Practices and Consumer Protection  

• All states require: 

  • Licensing of brokers and agents. 

  • Continuing education for brokers and agents 

• Prohibit unfair trade practices 

  • Twisting (insurers taking advantage of the situation; ex: make more commission even though it does not benefit the client whatsoever) 

    • Inducement of a policyholder to drop an existing policy and replace it with a new one that provides little or no economic benefit to the client. 

  • Rebating  

    • 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. 

 Taxation of Insurers (certain percentage of premium each year) 

• Insurers pay a state tax on gross premiums received from policyholders. 

 Important Regulations ( 

• McCarran-Ferguson Act (1945) 

• Financial Modernization Act (1999) 

• Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) 

 McCarran-Ferguson Act (1945) (resolved the confusion between interstate commercial lines and regulation within states; insurance is now regulated by the states) 

• Established that insurance should be regulated and taxed by the states. 

• Federal antitrust laws do not apply to insurance (with some exceptions). 

 Financial Modernization Act of 1999 (Gramm-Leach-Biley) (before federal laws stated you could not work outside your job; this regulation ended the barrier between that; ex: insurers can bank, banks could invest, etc.; banks and investing will be regulated at federal levels and insurance at state levels) 

• Eliminated barriers between insurers and banks. 

• Insurers can have banking operations and banks can have insurance operations. 

• Led to several mergers and acquisitions (Travelers and Citigroup). 

• Created some confusion as to who would regulate each division. 

• Frequently cited as a contributor to the financial crisis (2008) 

 Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) (The Big Short Movie =  mortgage back security may have a bunch of mortgage bonds; created the FSOC to treat systemic risk; Dodd-Frank is there to prevent it from happening again) 

• Established general federal oversight of the insurance industry. 

• Created the Financial Stability Oversight Council (FSOC) 

  • Has the authority to treat systemic risk (collapse of entire financial system due to the failure of a single entity or group of entities).  

  • Can classify non-bank financial companies (which includes insurance companies) as "systemically important financial institutions" (SIFIs). 

  • SIFIs receive tougher financial oversight and are regulated by the federal reserve. 

 Arguments for Federal Regulation 

• Decrease compliance costs. (do not have to pay as much costs since each state has different rules and do not have to spend time accommodating to a different states laws) 

• Increase competition. 

• Increase innovation. (launch across all insurance companies all at the same time) 

• More effective negotiations of international insurance agreements. 

• More effective treatment of systemic risk.  

 Arguments for State Regulation 

• Needs of each state are different. (easily regulates the states issues and problems; ex: hurricane may hit Florida, but not Michigan, less focus on it within certain states; allows those problems to be easily addressed) 

• Federal regulation in historically inefficient.  

• Transition to federal would be costly and require dual regulation for a short time. (take a lot of time and would be problematic because both would be running at the same time before swapping to one) 

• The National Association of Insurance Commissioners (NAIC) already advocates for uniformity. (agree to a Mono law and take it back to their own state, but some state commissioners will tweak it just to make it fit the state better; doing so still makes the laws different in each state) 

• Insurers can innovate by experimenting in different states. 

• Unknown consequences of federal regulation. (do not know what would happen if we switch to federal regulation) 

 Market Conduct 

• Refers to the marketing practices of insurers and agents that involve interactions with insureds, claimants, or consumers. (how they go about selling products; could have an adverse or negative effect) 

• Practices include:  

  • Sales of insurance policies 

  • Advertising of insurance products 

  • Underwriting and rating 

  • Collection and premiums 

  • Policy renewals, termination, and changes 

  • Claims settlement 

Market Conduct Examinations (could be periodic or the result of customer complaints) 

• State departments of insurance conduct market conduct examinations of insurers. 

• Goal is to protect consumers from: 

  • 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.