INFORM+INSPIRE
Assembly Insurance Committee
Seminar
Business of Insurance, Regulation and
Public Policy Overview
Robert W. Peterson
Professor of Law
Director, Center for Insurance Law and Regulation
Santa Clara University School of Law
The Griffith Insurance Education Foundation
Brief History of the Regulation of
Insurance
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Paul v. Virginia (1869)
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Samuel Paul was a New York licensed agent who was
selling insurance in Virginia
Virginia claimed he needed a Virginia license and could
sell only from a Virginia company.
Paul argued insurance was “interstate commerce” and
should not by subject to intrastate restrictions. I.e., it could
not be regulated by the states.
The Supreme Court held that insurance was NOT
interstate commerce and could/should be regulated by the
states
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Brief History of the Regulation of
Insurance
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United States v. SEUA (1944)
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SEUA was an association of insurers accuse of
monopolistic pricing.
SEUA argued that they were not subject to Sherman
Clayton and other FEDERAL monopolistic pricing laws
because they were and could be regulated only by the
states
The U.S. Supreme court decided insurance IS interstate
commerce and could be regulated by the FEDERAL
GOVERNMENT
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Brief History of the Regulation of
Insurance
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States who had been regulating insurance in the meantime,
lobbied to keep their autonomy.
In 1945 Congress obliged by passing the McCarran-Ferguson
Act
This act reasserted the federal right to regulate insurance, BUT
Left regulation to the states so long as the states are doing an
adequate job.
The States joined in the NAIC (National Association of Insurance
Commissioners) to flex this delegated power and to show
Congress that they were, indeed, discharging their duty. --The
NAIC recommends model laws to help effect some uniformity
across the 50 states, but has no authority to enforce laws.
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Brief History of the Regulation of
Insurance
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All states passed rating laws providing that rates must be
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adequate
not excessive
not unfairly discriminatory
“No rate shall be approved or remain in effect which is
excessive, inadequate, unfairly discriminatory or
otherwise in violation of this chapter.”¹
¹ (CIC) sec. 1861.05(a).
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Why states regulate insurance:
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Consumers (insured) pay in advance for a service
of uncertain cost to be rendered in the future.
Some of these services are considered essential or
important.
Solvency of insurers is critical to the ability to
deliver this service.
Destructive competition or poor/dishonest
management impairs the ability to deliver the
service.
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Why states regulate insurance:
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Insurance is complex – perhaps the only product
where the consumer has no idea how much it
“should” cost or what it is really “worth”.
“Slow pay/No pay” insurers frustrate this public
purpose, so regulators regularly engage in “Market
Conduct” examinations of insurers to assess
whether they are delivering on their promise and
complying with applicable statutes and regulations.
Because of their complexity, policy forms are also
subject to regulation
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SOLVENCY
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To insure solvency, regulators require insurers to
maintain enough capital to service their obligations
Insurers use unique, conservative accounting rules
(Statutory Accounting Principals—SAP) rather than
Generally Accepted Account Principals (GAAP).¹
Regulators inspect financials yearly or more
frequently.
¹10 CCR sec. 2643.5
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INSOLVENCY
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Insolvent insurers will be seized by the regulator and be placed in
receivership, liquidated, or sold to another insurer.
To protect policyholders, all states have guarantee funds. These are
funded by assessments on the premiums of insurers in the state.
California Insurance Guarantee Fund (CIGA).¹
Capped at $500,000 per claim (100% for Workers Compensation).²
Funded on a post assessment basis – i.e., insurers are assessed to
cover insolvencies that have occurred. Generally 1% of written
premium.
After insolvency of a number of large Workers Comp. carriers, CIGA
issues bonds to fund coverage and assessed the premiums against
insurers. There is a worker comp. special bond “CIGA” surcharge to
service these bonds—generally 1%, but has been as high as 2% or
2.5%.
¹ CIC secs 1063-1063.77
² CIC sec. 1063.1(c)(7)
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CIGA PAYMENTS
1987-2011
Note the spike in worker compensation payments. $8,568,629 in 2000 to $405,132,579 in
2001! Total payouts for auto and homeowners from 1987 to 2011 was $522,668,055.
Total payout for worker compensation for the same period was $5,579,527,327!
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What happened?
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Two factors:
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the insolvency of a number of large
workers compensation carriers and
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there is no $500,000 cap on workers
compensation.
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Why did the W.C. Insurers Become Insolvent?
W.C. Insurers’ Premiums were inadequate.
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Individual discounting to Employers
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Not subject to prior approval by Department of
Insurance
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Could it happen again?
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Why Insurers Become Insolvent
 Note that Fraud outranks Catastrophe Losses.
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REGULATING INSURANCE
RATES
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4 general ways states regulate insurance rates. The first three
rely primarily on competition to set rates. They are:
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OPEN COMPETITION
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FILE AND USE.
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USE AND FILE
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The forth general method is:
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PRIOR APPROVAL
State systems are listed and compared at:
http://www.iii.org/issue_updates/regulationmodernization.html
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THE MAIN EVENT –
CALIFORNIA
SO YOU WANT TO INTRODUCE A BILL?
Let’s take a concrete example: to enhance competition
and lower costs, assume you want to allow a
policyholder’s new auto insurer to offer the same loyalty
(“persistency”) discount that a previous insurer is
offering. What is the political/regulatory matrix in which
you must operate?
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THE MAIN EVENT –
CALIFORNIA
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California’s current insurance regulatory scheme emerged
from the smoke of the “Tort Wars” of the late 1980s.
In 1988 there were 5 propositions on the California ballot
addressing torts or insurance. The only one to prevail (by
slightly less than 51% of the vote) was Proposition 103.
Prop. 103 completely altered insurance regulation in Calif.
It may be amended only by a 2/3 vote of the legislature, and
then only if the amendment “further[s] [the] purposes” of the
proposition.¹ (statute passed by 2/3 vote invalidated because
it did not “further” the purpose of Prop. 103).
¹ Foundation For Taxpayer and
Consumer Rights v. Garamendi, 132
Cal. App. 4th 1354, 1365-66 (2005)
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WHAT DID PROPOSITION 103 DO?
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20% rollback in insurance rates.¹
Established an elected Commissioner of Insurance.²
Moved California from an open competition state (no rate had
ever been found excessive) to a “prior approval” state for most
lines.³
Mandated some rating factors, and mandated the order of their
weighting (1st—Driving Record, 2nd—Miles driven annually,
3rd—Years driving experience).4
Mandated a good driver discount of 20%.5
¹ CIC sec. 1861.01
² CIC sec. 12900(a)
³ CIC sec. 1861.05(b). See CIC sec. 1851 for
excluded lines
4 CIC sec. 1861.05(a)
5 CIC secs. 1861.02(b), 1861.025.
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WHAT DID PROPOSITION 103 DO?
(CONTINUED)
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Invested the Commissioner with authority to adopt auto rating factors “that have
a substantial relationship to the risk of loss.”
Forbad the Commissioner from giving any consideration to the degree of
competition in setting rates.¹
Forbad insurers from considering the lack of previous auto insurance as a rating
factor.²
Provided that no rate may be CHANGED (note that this applies to raising OR
LOWERING rates) without the filing of “a complete rate application.” ³
Permits anyone to intervene in rate making or rule making proceedings.4
Interveners who qualify as representing “the interests of consumers” are entitled
to “reasonable advocacy and witness fees and expenses” if they made a
“substantial contribution.” If in a rate application, the award is paid by the
insurer—otherwise by the Department of Insurance (DOI).5
¹ CIC sec. 1861.05(a)
² CIC sec. 1861.02(c)
³ CIC sec. 1861.05(b)
4 CIC sec. 1961.10(a)
5 CIC sec. 1961.10(b).
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WHAT DID PROPOSITION 103 DO?
(CONTINUED)
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The 20% role back was invalidated by the
California Supreme Court on constitutional
grounds.¹ With a few exceptions, the
remainder of Prop. 103 was upheld,
including the provisions above.
¹Calfarm v. Deukmejian, 48 Cal.3d 805,
258 Cal.Rptr. 161 (1989)(insurers entitled
to a “just and fair return.”).
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THE CALIFORNIA DEPARTMENT OF
INSURANCE
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Approximately 1,200 employees.
Approximately 100 lawyers
Offices in San Francisco, Los Angeles and Sacramento
Budget of over $205,000,000
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Entirely supported by industry fees of various sorts. Nothing flows to the
Department from premium taxes.
If you are a glutton for information, here is the Department’s
annual report: http://www.insurance.ca.gov/0400-news/0200studies-reports/0700-commissionerreport/upload/2011CDIAnnualReportFinal.pdf
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THE CALIFORNIA DEPARTMENT OF
INSURANCE
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California is 6th largest insurance market IN THE WORLD
Regulates over 1,500 companies and over 340,000 brokers and
agents.
Gross premium taxes are the fourth largest source of General Fund
revenue for the state ($2,135,000,000 in 2009-10). Only personal
income tax, sales tax and bank and corporate tax contribute more.
This is over 4.5 times the tax revenue generated by California’s
alcohol and tobacco taxes combined.
Consumer Line for information and assistance (a handy referral for
your constituents). 1-(800-927-HELP (4357)(Calling from within
California); 213-897-8921(Outside California);1-(800)-482-4833(TDD
- Telecommunication Devices for the Deaf). See:
http://www.insurance.ca.gov/0100-consumers/0400-talk-to-us/
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BACK TO YOUR BILL
How do insurers make rates?
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First, they create a “rate plan” which calculates the total
premium needed to service the entire book of business in the
particular line (including profit and overhead).
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Next, they create a “class plan.” This plan divides the
premium among policyholders according to rating factors –
e.g., driving record, type of vehicle, age, location, gender of
driver, etc.
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AUTO RATING FACTORS IN CALIFORNIA
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All auto rating factors in California are either mandated by
Proposition 103 or are adopted through regulation by the
Commissioner of Insurance.¹
In addition to the Good Driver Discount, there are three
mandatory and 16 optional rating factors in California.
Three rating factors are MANDATORY, and must be weighted
in the following order
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Driving Record
Number of Miles Driven Annually
Number of Years of Driving Experience
All other rating factors approved by the Commissioner are
OPTIONAL RATING FACTORS.
¹CIC 1861.02
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AUTO RATING FACTORS IN CALIFORNIA
Here they are in California:
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Automobile Rating Factors
Mandatory Rating Factors (in order of “weight”)
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(1) Insured's driving safety record.
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(2) The number of miles he or she drives annually.
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(3) The number of years of driving experience the insured
has.
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Auto Optional Rating Factors (not in order of
weight except #15 and #16)
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(1) Type of vehicle;
(2) Vehicle performance capabilities, including alterations made subsequent to original
manufacture;
(3) Type of use of vehicle (pleasure only, commute, business, farm, commute mileage, etc.);
(4) Percentage use of the vehicle by the rated driver;
(5) Multi-vehicle households;
(6) Academic standing of the rated driver;
(7) Completion of driver training or defensive driving courses by the rated driver;
(8) Vehicle characteristics, including engine size, safety and protective devices, damageability,
reparability, and theft deterrent devices;
(9) Gender of the rated driver;
(10) Marital status of the rated driver;
(11) Persistency (but only if presently covered for automobile insurance “by the insurer or
affiliate”) ;
(12) Non-smoker;
(13) Secondary Driver Characteristics;
(14) Multi-policies with the same, or an affiliated, company;
(15) Relative claims frequency.
(16) Relative claims severity. [15 and 16 are usually referred to as the “territorial rating
factors.” Among optional rating factors, 15 and 16 must be weighted last]
Source: Cal. Admin. Code tit. 10, § 2632.5
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Auto Optional Rating Factors
Note rating factor #11-- Persistency (but only if presently covered for automobile
insurance “by the insurer or affiliate”).
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1. The Commissioner has not approved your rating factor. Optional rating
factors are arguably committed to the Commissioner.¹
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2. An insurer giving a discount to a migrant from another insurer must make
up the difference from others purchasing policies from the insurer who have
not been previously insured (i.e., they have no “persistency”). This would
violate the provision of proposition 103 that prohibits insurers from
considering the lack of previous insurance as a rating factor.² This raises
rates for first-time purchasers of insurance, so it would not “further” the
purposes of the Proposition.
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Therefore, your legislation, although adopted by a 2/3 vote, is invalid.³
¹ CIC 1861.02(4)
² CIC sec. 1861.02(c).
³ Foundation for Taxpayer and Consumer Rights v. Garamendi,
132 Cal.App.4th 1354, 34 Cal. Rptr.3d 354 (2005).
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Auto Optional Rating Factors
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This illustrates the necessity and possible consequences of “Pumping” and
“Tempering.”
Insurance is a zero-sum game. When a rating factor inaccurately reflects
the risk, it may be “unfairly discriminatory” because policyholders in one
category will pay too much, and those in another too little.
This also invites the twin terrors of insurers: Adverse Selection and Moral
Hazard.
To comply with Proposition 103’s mandatory rating factors, or to allocate
territorial rating below its actual significance, one must either “pump” a factor
to boost its weight, or “temper” another factor to reduce its weight.
Creates cross-subsidies between groups of policyholders.
For a case discussing pumping and tempering in the context of territorial
rating (currently factors #15 and 16), see Spanish Speaking Citizens’ Found.
v. Low 85 Cal.App.4th 1179 (2000).
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Auto Optional Rating Factors
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In discharging your legislative obligations, you work under the
brooding omnipresence of Proposition 103, which enjoys
nearly quasi-constitutional status.
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After the persistency legislation was invalidated, the issue of
“portable persistency” has spawned two ballot initiatives
aimed at authorizing it. Proposition 17, June 2010 and
Proposition 33, November 2012. Both failed (Prop. 33 – 55%
to 45%). For a discussion visit:
http://www.mcgeorge.edu/Documents/Publications/Measure1
495.pdf
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Two more controversial rating areas
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Territory (#15 and #16)
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Credit Rating (not among California’s
rating factors, but an important rating
factors in many other states).
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The Marriage Relationship—Your Statutes and
the Commissioner’s Regulations
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When crafting legislation, keep in might that the
Commissioner may, and likely will, use your legislation as a
basis for promulgating further implementing regulations.¹
Unclearly or ambiguously drafted legislation may spawn
disputes about the scope of the Commissioner’s authority to
adopt valid regulations.
Example: Fair Claims Practices Legislation and
implementing regulations.²
¹ CIC secs 790.10
² Globe Life dispute and CIC sec. 790.03.
See esp. Par. 81-125
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SOME REGULATORY ISSUES ON THE
HORIZON
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Delays in the rate approval process. Automobile
dealers may charge what they will. Automobile
insurers, however, MUST charge the approved rate.
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In California, they cannot raise or lower a rate without
filing a “complete rate application.” ¹
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Many states allow approved rates to “flex” within a
range (Often 5% to 15% depending on the state). State
rating systems are listed and compared at:
http://www.iii.org/issue_updates/regulationmodernization.html
¹CIC sec1861.05(b)
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SOME REGULATORY ISSUES ON THE
HORIZON
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Filing a rate application triggers a process that is costly, time
consuming, and delays “speed to market.”. The insurer has
the burden proof on all of the issues.¹
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If a consumer organization intervenes and the rate goes to a
hearing, more than a year may be required to bring the new
rate to market. By then, it may be old news.
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The Commissioner is aware of this and may propose some
changes in the process (trammeled, perhaps, by Proposition
103 which dictates much of the underlying procedure,
including timing and that “[d]iscovery . . . be liberally
construed.” ²
¹ CIC sec. 1861.05(b)
² CIC sec. 1861.08(e)
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SOME REGULATORY ISSUES ON THE
HORIZON
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Self-driving cars. How reconcile the
mandatory rating factors and the 20% Good
Driver Discount with cars that do not require
drivers?
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Who will be responsible for those accidents
that do occur? Owners? Manufacturers?
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Federal Incursion—Back to the Future—194546 again?
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Some Insurance has been largely “federalized.” ERISA, the
Affordable Care Act. There will be numerous bills designed to
reconcile California law with federal requirements.
Dodd/Frank and the Federal Insurance Office (FIO)—Long awaited
report. The Nose of the Camel? The Creeping Federal Octopus?
State Regulators are mustering their resources through the NAIC to
protect their turf and (not surprisingly) state revenue.
Prior Approval for Health Care Rates? A health care “Proposition
103” narrowly missed qualifying for Nov. 2012 and will likely return.
The Commissioner also supports prior approval for health insurance
rates (ask him about it). See his comments at:
http://www.insurance.ca.gov/0400-news/0100-pressreleases/2011/release002-11.cfm
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Questions?
Feel free to contact me:
Robert W. Peterson
Center for Insurance Law and Regulation
School of Law
Santa Clara University
Santa Clara, CA 95053
Tel: (408) 554-4141
Email: rpeterson@scu.edu
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