Sources of Insurance Regulation

Insurance companies and their products are mostly regulated by the states, but the federal government also provide some regulations. The insurance market is also regulated to some extent by court rulings that have modified existing regulations. Although most insurance companies operate across state lines, and many have argued that federal regulation would be simpler and more economical, the federal government has allowed the states to maintain their primacy in regulating insurance markets.

States Regulate Insurance

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It would seem that, because most insurance companies sell in many states, insurance sales is interstate commerce, and, therefore, subject to the jurisdiction of the federal government.

In 1868, the Supreme Court first found, in the case of Paul v. Virginia, that insurance was not interstate commerce, and, thus, the states had the right to regulate insurance. Then in 1944, the Supreme Court reversed itself in the case of South-Eastern Underwriters Association (SEUA), a cooperative rating bureau that was found guilty of price-fixing and other violations of the Sherman Antitrust Act, and ruled that insurance was interstate commerce when conducted across state lines—hence, subject to federal regulation.

However, changing the entire industry was not that easy. Bureaucracies and insurance companies had developed an understanding—some would say cozy relationship. The states already had many rules and regulations governing insurance, whereas the federal government had virtually none. Furthermore, it raised the possibility that the states did not have the right to tax insurance.

In response to the SEUA decision, the federal government passed the McCarran-Ferguson Act (Public Law 15) in 1945 that stipulated that it was in the public interest to have the states regulate insurance, and that the insurance industry would not be subject to federal antitrust laws if it was regulated by state law.

Arguments Favoring Federal Regulation

Although there is some consistency in state laws through the adoption of model regulations, differences are numerous enough that many think federal regulation would be more efficient. For instance, to change rates, insurance companies must comply with the laws of each state in which they do business. Federal regulation would allow insurance companies to respond faster and more effectively to changing market conditions. Many also argue that the limited antitrust protection under the McCarran-Ferguson Act is unnecessary and anticompetitive.

Primary Sources of Regulation

There are 3 primary sources of regulations for insurance companies: legislation, court rulings, and regulations and rulings issued by state insurance departments.

Legislation

Legislation lays the foundation of insurance regulation. Generally, state statutes regulate the following:

There is also some federal regulation of the insurance industry. For example, the Securities and Exchange Commission treats variable annuities and variable life insurance as securities, and is, therefore, subject to its regulations.

Court Decisions

Court decisions mainly modify insurance regulations, whether by legislatures or by insurance departments, by making ambiguous rulings explicit or they may add to the law by filling in voids. Sometimes a law or rule is declared unconstitutional, and, thus, voided.

State Insurance Departments

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State insurance departments handle the day-to-day affairs of the insurance industry, and promulgate more specialized administrative rules for the industry that has the force of law. The head of the insurance department is the insurance commissioner. The insurance commissioner can enforce compliance by conducting investigations, issue orders, and suspend or revoke an insurer's license to do business in the state.

The insurance commissioners of every state belong to the National Association of Insurance Commissioners (NAIC), founded in 1871, that reviews industry regulations and drafts model laws and policy forms for the states. Although the NAIC has no legal authority, the states generally adopt their suggestions.

One of the duties of the state's insurance commissioner is to handle customer complaints. The commissioner usually has a staff to handle the many complaints that it receives. Typically, the commissioner's office will relay the complaint to the insurer, requesting a response by a certain date. If the insurer's response is unsatisfactory, the commissioner may direct a course of action.

Additionally, the NAIC also maintains a Consumer Information Source (CIS) website with information about insurance companies, and their claim history, states in which they are licensed, and other basic financial information. However, the best source of financial information and creditworthiness of insurance companies can be obtained from AM Best, which is the largest credit rater of insurance companies. Additionally, consumers can file complaints online at CIS about specific insurers.    

One of the major complaints about insurance commissioners is that they are usually hired from insurance companies, and most return to the industry after serving as a commissioner. Thus, a common perception is that they generally side with the insurers in disputes.

NAIC State Accreditation Program

In the 1980s, several large insurance companies became insolvent, demonstrating that the laws of many states were inadequate to prevent insolvency. In response, many have argued that the federal government should regulate insurance companies. To maintain state sovereignty over insurance, the NAIC created, in 1990,  the Financial Regulation Standards and Accreditation Program that certifies state insurance departments that have adopted effective measures regulating insurance holding companies, reinsurance intermediaries, general agents, credit for reinsurance, examination processes, in liquidation proceedings. State insurance departments are reviewed annually and must be recertified every 5 years.

Financial Modernization Act of 1999

Previously, federal law restricted banks, insurers, and security firms to their respective businesses. The Financial Modernization Act of 1999 (aka Gramm-Leach-Bliley Act, GLBA) removed this restriction. The main purpose of the GLBA was to remove the barriers between selling insurance, securities, and banking products that existed since the Great Depression, so insurance companies, brokerages, and banks could sell each other's products.

Now banks, insurers, and investment firms can sell banking and investment services, and insurance, promoting more competition, thus allowing 1-stop shops. However, the GLB Act has not had the results expected, because the financial services industry is very competitive, and it is difficult for most companies to compete in areas outside of their core business. The GLB Act also required that states standardize their licensing requirements so that agents and brokers can do business more easily in multiple states.

To give people greater control over the information that was being collected through improving information technology, the GLBA also provided new privacy protections: consumers must be notified about company privacy policies and they must be given the opportunity to prohibit the sharing the information with unaffiliated 3rd parties. But there is no restriction on the sharing of personal information with affiliated parties.

Additional privacy safeguards were also adopted for health records. The NAIC adopted the Privacy of Consumer Financial and Health Information Model Regulation in 2000. Health records protected under the regulation, include those held by health insurers and HMOs, healthcare providers, and healthcare clearinghouses. The regulations issued by the United States Department of Health and Human Services (HHS) in 2001 allow patients to access their medical records. Additionally, healthcare providers must disclose their privacy policy and obtain consumer consent before sharing the information with others.

The Dodd-Frank Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (DFA) was created after the financial crisis of 2007 to 2009 to reduce systemic risk and the too-big-to-fail hazard of big financial institutions. With the exception of AIG, most insurance companies did not pose a risk to the economy. Nonetheless, the Financial Stability Oversight Council (FSOC) was created, composed of federal regulators whose objective is to identify financial institutions that pose a systemic risk to the economy, otherwise known as systemically important financial institutions (SIFIs), that are subject to higher capital requirements and greater supervision by the Federal Reserve.

The DFA also created a new regulatory agency within the Treasury Department specifically for insurance companies, called the Federal Insurance Office (FIO), who works with state regulators on international insurance transactions. The FIO will also assist the Treasury Secretary to negotiate international insurance agreements. State laws that interfere with these international agreements may be preempted.

To increase efficiency, the DFA also regulates surplus line and reinsurance, which was often complicated by multistate regulation.

Global Insurance Regulation

The International Association of Insurance Supervisors (IAIS) was established in 1994, representing regulators from more than 200 jurisdictions in almost 140 countries that develops standards for insurance and publishes guidance papers on insurance principles and provides training and support for insurance supervision. (Insurance regulators are known as supervisors in many countries.) Because insurance companies hold much of the wealth of the world, effective global regulation of insurance companies will also promote global financial stability.

New Developments

Do State Insurance Departments Really Help Consumers?

Evidently, not too much, according to the Bloomberg article hyperlinked below. It's to be expected, I suppose, when you consider that the state insurance commissioners generally come from the insurance industry, and return to good jobs there. Furthermore, the National Association of Insurance Commissioners helps the states in writing the insurance laws. And since, according to the article, insurance companies sometimes pay for the foreign travel of state insurance commissioners, the insurance companies must be getting favors in return. That's generally how these things work: I'll rub your back, you rub mine. One may also wonder why state insurance commissioners would need to travel to other countries? A few "reasons" given in this article were that insurance companies need to expand overseas, and that the commissioners were trying to help some foreign governments to set up their own regulatory authority. There is no explanation as to how a state commissioner is going to be able help insurance companies expand overseas, or why the foreign governments who want help in setting up a regulatory authority for insurance in their countries do not pay the travel expenses of the people who are helping them? The other unknown about all of this is why doesn't the federal government regulate insurance companies, since most of the them conduct interstate commerce? A tremendous benefit to federal regulation would be the elimination of a lot of red tape and legal expenses that are no doubt generated by a patchwork of 50 state laws? The United States Supreme Court did rule, in 1944, that insurance was interstate commerce and was within federal jurisdiction. Then the following year, Congress passed the McCarran-Ferguson Act, which returned regulation to the states, with some federal oversight to monitor whether it is all working properly. Now, some members of Congress are, again, contemplating federal rule, but whether it will go anywhere or be any better remains to be seen.