Today’s Lecture - #26
Insurance Regulation
Introduction to Insurance Regulation
Rationale
History
What Regulation Involves
State vs. Federal Regulation
Insurance Insolvency
Current Problems with Insurance Regulation
Insurance companies are one of the
most heavily regulated industries.
What is the most important reason to
regulate insurers?
A)
B)
C)
D)
E)
To prevent deceptive sales practices
To make sure they stay solvent
To make sure they don’t set rates too high
To make sure they don’t discriminate unfairly
Some other reason
Why Regulate Insurance?
Market Power
Imperfect Information
Public Policy
Advance Nature of Contract
Insurer gets your money before fulfilling the
contract
Brief History of Insurance
Regulation
Paul v Virginia - 1869
US v Southeast Underwriters Association
(SEUA) - 1944
McCarran Ferguson Act - 1946
You be the Supreme Court Judge
How would you rule in the SEUA case?
A) Uphold Paul v. Virginia:
Insurance is not commerce
B) Overrule Paul v. Virginia:
Insurance is commerce and subject to
Federal laws
C) Compromise:
Insurance is commerce but should not be
subject to Federal laws
What is Regulated
Licensing Requirements
Solvency
Investments
Reserves
Guaranty Funds
Policy Forms
Rates
Trade Practices
Rate Regulation
General Requirements
Rates must be adequate, not excessive and
not unfairly discriminatory
Methods
Prior approval
File and use
Open competition
Classification issues
What type of rating law applies in
Illinois for automobile insurance?
A)
B)
C)
D)
E)
Prior approval
File and use
Open competition
No rating law applies
None of the above
Regulation of Trade Practices
Agents must be licensed
Prohibited activities for agents
Twisting
Rebating
Allowed in Florida and California
Effect of agents’ interests
Claim practices
Underwriting practices
General Advice
If you are having a problem with an insurance company
(billing, claims, unjustified cancellation, unfair
treatment), contact the insurance department in the state
where you live.
In Illinois, contact:
Illinois Division of Insurance
320 West Washington Street
Springfield, IL 62767
217-782-4515
1-866-445-5364 (toll free)
or online at:
http://www.idfpr.com/DOI/Complaints/Complaints.asp
State vs. Federal Regulation
States Currently Regulate Insurance
Only Major Industry Regulated at State Level
Why?
Tradition
Paul v. Virginia
US v. SEUA - during W.W.II
Led to McCarran-Ferguson Act
Recent Proposals
Repeal of McCarran-Ferguson Act
Would lead to
Federal regulation instead of state
or Dual regulation
State regulation of small insurers
Federal regulation of major insurers
Claimed Advantages of State
Regulation
Have Current Knowledge
Recognizes Local Conditions
Encourages Experimentation
Effects of Mistakes are Localized
Claimed Advantages of Federal
Regulation
Uniformity
Could get the best regulators
Would be able to deal with large,
multinational insurers
Federal Government in Action on
Insurance Related Issues
Social Security
Bankrupt by 2040 or earlier
Political environment prevents informed
discussions and solutions
Federal Savings and Loans Insurance Corporation
(FSLIC) 1934-1989
Inadequate regulation
Political pressure to keep insolvent S&Ls open
Taxpayer cost of about $200 billion
Federal Government in Action on
Insurance Related Issues - Cont.
Pension Benefit Guaranty Corporation (PBGC)
12/31/04 financial position: negative $23.5 billion
United Airlines termination in May, 2005: $9 billion
Covered defined benefit pension plans
Underfunded by $600 billion (termination basis)
National Flood Insurance Program
Expected cost from Katrina and Rita $22 billion
Need to borrow from Federal government
Cannot repay these loans from future premium income
What Happens When Your
Insurer Goes Insolvent
State guaranty funds apply
Limits on coverage
Deductible on premium refunds
Delays in payment
Types of Guaranty Funds
New York
Pre-assessment fund
1982 Legislature “appropriated” $87
million
Recently found illegal and forced to return
funds
All Other States
Post-assessment basis
Longer delays
Limits on assessments
Lessons from Executive Life and
Mutual Benefit
Executive Life
Taken over by California regulators in
April, 1991
Company was sold
Policyholders received 70-80% of their
benefits
Mutual Benefit
Taken over by New Jersey regulators in July,
1991
Withdrawals restricted until 1999
Significant penalties applied to withdrawals
Credited interest rates lowered below contract
level
Basic Lessons
If a company is too big, then regulators will
intervene and re-write the contracts rather
than declare insolvency.
Current Problem Areas in
Insurance
Complex product
Insolvencies
Rising costs of liability insurance
Lack of availability of property coverage in
coastal areas
Irresponsible regulation
California - Proposition 103
New Jersey - Residual Auto Market ($3
billion in debt)
Current Problem Areas in
Insurance
Crooked regulators – Louisiana
Sherman Bernard - Commissioner 1972-1988
Convicted of taking payoffs – sentenced to
41 months in prison
Douglas Green - Commissioner 1988-91
Convicted of fraud, money laundering and
bribery - served 12 years in federal prison
Jim Brown – Commissioner 1991-2002
Convicted of lying to the FBI – sentenced to
6 months in prison
Conclusions
Insurance does need to be regulated
Current regulation is excessive and misdirected
Focus of regulation should be on solvency
Challenges presented by new financial instruments
Understanding derivatives
Dealing with international transactions
Hedging interest rate and similar risks
Expanding use of modeling
Need for competent, ethical regulators