Finance 341
Insurance Regulation
Lessons from Illinois
Overview
• Historical Development
– Insurance Regulation
– Industry Structure
– Antitrust Legislation
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Insurance Regulation in Illinois
Analysis of the Illinois Auto Experience
Generalization to Other Lines
Conclusion
History of Insurance Regulation - 1
• Objectives
– Protection of the Public
– Taxation
• Regulation by Legislation
– Charters
– Financial disclosure requirements
• Statutory Reporting Requirements
– Massachusetts 1807
– New York 1827
• Taxation of Insurers
– Massachusetts stamp tax 1785
– New York premium tax 1824
– Differential premium taxes 1827
Why Were States Regulating
Insurance?
• Commerce Clause of the U. S. Constitution
“Congress shall have the power ... to regulate commerce ... among
the several states”
– Limits power of states to regulate interstate business
• Paul v. Virginia 1869
– Insurance is not interstate commerce
• Insurance contracts are not commerce
• Policies do not take effect until delivered, so not interstate in nature
– States could regulate (and tax) insurance
Early Structure of the Property
Insurance Industry
• Primarily Fire Insurance
• Adverse Effects of Competition
• Rating Associations
– Local
– National Board of Fire Underwriters 1866
• Catastrophic Fires
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New York City 1835
Chicago 1871
Boston 1872
San Francisco 1906
• Insurance Bankruptcies
History of Insurance Regulation - 2
• Response to “Ruinous Competition”
– Merritt Committee 1910
– National Convention of Insurance Commissioners 1914
• Rating Laws Allowed Joint Ratemaking
Federal Antitrust Legislation
• Sherman Act 1890
– Section 1 - restraint of trade, including joint pricing
– Section 2 - monopoly
• Clayton Act 1914
– Strengthened Sherman Act with specific provisions
– Banned price discrimination (with many exceptions)
• Federal Trade Commission Act 1914
• Robinson-Patman Act 1936
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Amended Clayton Act
Strong restrictions on price discrimination
Required justification for any price differentials
Goal to protect small stores from lower prices of chain stores
Watershed in Insurance Regulation
• Southeastern Underwriters Association Case 1944
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Regional rating bureau with restrictions on rates
Legal actions began in 1922
Settlement provided payments to state officials
Result challenged by Missouri Attorney General, joined
by U. S. Department of Justice
– U. S. Supreme Court ruled insurance was commerce
• McCarran-Ferguson Act 1945
– States could continue to regulate insurance
– Federal antitrust laws would be superceded by state
regulation (except boycott, coercion and intimidation)
– No federal law applies to insurance unless specifically
stated in legislation
Insurance Rate Regulation
Post-SEUA
• All states adopted rate regulatory laws to
supercede federal antitrust laws
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State made rates
Mandatory bureau rates
Prior approval
File-and-use
Use-and-file
Open competition
• Rates are not to be inadequate, excessive or
unfairly discriminatory
Illinois Rate Regulation
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Adopted Prior Approval law 1947
Enacted Open Competition Law effective 1970
Open Competition Law expired in August 1971
Illinois has no rate regulatory law for most lines
of business
Illinois Statistics
• Population
12,419,293 as of 4/1/2000
Fifth largest state
• Size
– 55,593 sq. mi. (25th largest)
• Urban Population - 84.6%
• Per capita income $31,278 (8th)
How Is Illinois Faring without
Auto Insurance Rate Regulation?
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Loss ratio - Less variable
Rate levels - Less variable
Number of insurers - Highest in nation
Premium levels - Lower than comparable areas
Uninsured drivers - Lower
Residual market size - Lower
Cost of regulation - Lower
Conclusion
No need to regulate auto insurance rates
Figure 2
Percent of Automobiles in Residual Market
5
Percent
4
3
Illinois
National
2
1
0
1994
1995
1996
1997
1998
Figure 3
Standard Deviation Versus Loss Ratio
Annual Statement Page 14 Data
(1980-1998)
0.14
0.12
Standard Deviation
0.1
0.08
0.06
0.04
0.02
0
0.6
0.62
0.64
0.66
0.68
0.7
Loss Ratio
0.72
0.74
0.76
0.78
0.8
Figure 4
Standard Deviation Versus Loss Ratio
Fast Track Quarterly Data
(1990-2000)
0.35
0.3
Standard Deviation
0.25
0.2
0.15
0.1
0.05
0
0.7
0.75
0.8
Loss Ratio
0.85
0.9
Figure 5
Company 1 Year End Rate Levels
(12/31/89=1.000)
1.5
CA
CO
CT
FL
GA
IL
1.25
KY
Rate Level
MA
MI
MN
MO
NJ
1
NC
OH
OR
PA
SC
TX
VI
0.75
1989
1990
1991
1992
1993
1994
Year
1995
1996
1997
1998
1999
WI
Insurance Department Budgets as Percent of Premium Volume
Selected States
1999
0.25%
0.20%
0.15%
0.10%
0.05%
0.00%
California
Illinois
Massachusetts
New Jersey
South Carolina
Countryw ide
Insurance Industry Shift
• Auto Insurance is the primary line of business
– Not subject to same risk of catastrophe
– Rating information needs reduced
• More competitive environment
• Fire risk controlled
– Building codes
– Advances in fire protection
• New catastrophe risks
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Hurricane
Earthquake
Flood
Terrorism
Generalization to Other Lines
• Rate regulation is not needed for any line of
business with competitive markets and minimal
catastrophe risk
• Regulation could be beneficial for particular lines
that are not competitive
– Title insurance
• Regulation could be beneficial for coverages
exposed to catastrophe risk to prevent insolvencies
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Hurricanes
Earthquake
Flood
Terrorism