Principles of risk management and insurance 12th by rejde mcnamara chapter 08

Chapter 8
Government
Regulation of
Insurance


Agenda
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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
Credit-Based Insurance Scores

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Reasons for Insurance Regulation

• Maintain insurer solvency
• Compensate for inadequate consumer knowledge
• Ensure reasonable rates
• Make insurance available

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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.

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Historical Development of Insurance
Regulation
• 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

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Historical Development of Insurance
Regulation
• 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
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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

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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
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What Areas Are Regulated?
• 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

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What Areas Are Regulated?
• Life and health insurers must meet certain riskbased 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
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What Areas Are Regulated?
• 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

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What Areas Are Regulated?
• 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

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What Areas Are Regulated?
• Rate regulation takes a variety of forms across states
– Forms of rate regulation for property and casualty
insurance include:
• Prior approval law

• Flex-rating law

• Modified prior approval law

• State-made rates

• File-and-use law

• No filing required

• Use-and-file law

– Many states exempt insurers from filing rates for
large commercial accounts
– Life insurance rates are not directly regulated by
the states
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What Areas Are Regulated?
• 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

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What Areas Are Regulated?
• 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

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What Areas Are Regulated?
• 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

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What Areas Are Regulated?
• 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

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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

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State versus Federal Regulation
• 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

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State versus Federal Regulation
• Shortcomings of state regulation include:
– Inadequate protection of consumers
– Improvements needed in handling complaints
– Inadequate market conduct examinations
– Insurance availability

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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

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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)

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Modernizing Insurance Regulation

• The Federal Insurance Office 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.

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Modernizing Insurance Regulation
• 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

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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
– Problems with affiliates
– Overstatement of assets
– Alleged fraud
– Failure of reinsurers to pay claims
– Mismanagement
– Catastrophic losses

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