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The states regulate insurance by regulating the companies that develop the policies and sell the insurance.
States began regulating insurance companies by granting charters that authorized their formation and operation within the state, but there were few other requirements.
As the insurance industry grew, states started creating commissions that had oversight of the industry. New Hampshire created the 1st state insurance commission in 1851. In 1859, New York created a separate agency that could license insurers and their agents, and could also conduct investigations.
Nowadays, every state has an insurance department that monitors and regulates insurance within the state.
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 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.
The main purposes of insurance regulation is to maintain insurer solvency; to protect consumers; to make insurance available to people who, because they are poor risks, might otherwise be unable to get it; and to regulate rates.
The state has an interest in maintaining insurer solvency, because people can encounter financial difficulties if an insurer becomes insolvent and is unable to pay claims.
The main methods to protect consumers includes ensuring that insurance agents and brokers do not misrepresent their products, that contracts are readily comprehensible to most consumers, and that insurance policies have specific provisions; otherwise, it would be very difficult to compare different policies.
There are specific terms that denote the relationship of the state in which insurance is sold, the location of the insurance company, and where it is licensed to do business. Domestic insurance is insurance provided within a state by an insurer licensed in that state. Foreign insurance is insurance provided by an insurer licensed by a state other than where the policy is purchased or where the coverage is provided. Alien insurance is an insurer whose domicile is outside of the United States. Admitted insurance is licensed by the state in which it is purchased, and the insurer can be either domestic or foreign. Nonadmitted insurance is provided by an insurer who is not licensed to do business within the state. Surplus-lines insurance is nonadmitted insurance that is purchased through a surplus-lines broker.
Nonadmitted insurance can only be purchased through a surplus-lines broker, and the broker can only sell nonadmitted insurance if there are no admitted insurance policies that provide comparable coverage. A surplus-lines broker is required so that the state can regulate the broker, since it cannot regulate a nonadmitted insurer. However, many have argued that the need for a surplus-lines broker is unnecessary, since almost all nonadmitted insurance is purchased by large companies that have the legal and financial wherewithal to evaluate the insurers and their policies themselves; almost all consumer policies are admitted insurance.
There are 3 sources of regulations for insurance companies: legislation, court rulings, and regulations and rulings issued by state insurance departments.
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 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 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.
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.
One major concern of the states is the solvency of the insurer. If the insurer becomes insolvent, it could hurt its customers substantially, and since the states provide assistance to those whose claims are not paid because of an insolvent insurer, the states have a vested interest in maintaining insurer solvency, and, thus, it regularly reviews domestic insurers for signs of financial problems.
Every insurance company must file annual reports with the insurance department of each state that it does business, and the NAIC. About once every 3 years, each insurer is audited by the state in which it is domiciled, and there may be representatives from other states in which the insurer does business that may join the audit.
The NAIC Insurance Regulatory Information System (IRIS) monitors the solvency of insurers based on the annual reports submitted to it by calculating 12 ratios based on information in the reports. Ratios that are outside of normal ranges for most insurance companies may indicate financial problems. Companies with the highest number of abnormal ratios are flagged for greater scrutiny by state examiners.
Another method to help prevent the insolvency of life insurers is the risk-based capital (RBC) requirement developed by the NAIC. RBC rules changes the amount of capital and surplus that must be maintained, depending on the underwriting and investment risk of the insurer. For example, an insurer that invests in riskier assets will have a higher risk-based capital requirement than an insurer that invests conservatively.
All states have solvency laws and guaranty funds to help failing insurers, or, to at least maintain coverage and pay the claims of customers of insolvent insurers. When an insurer fails, the policyowners may be forced to give up some rights, such as access to their money for a specific amount of time, or, in the case of life insurance, the policyholders may receive less interest than the minimum that was guaranteed by the life insurance contract.
When the insurer’s surplus falls below the minimum level required by the state in which the insurer is domiciled, the state department will first try rehabilitation (aka conservatorship, receivership). If that fails, then the state will use liquidation, or, if it is a small insurer, the state may arrange to have another insurer take over the business.
Although some of the laws of most states are based on the 1989 NAIC Guaranty Fund Model Act, there are differences in who is eligible and their benefits. Most of the money for the guaranty funds comes from assessments on insurers.
To protect policyholders, states restrict the investment activities of insurers, generally requiring that most investments be in safe securities, such as Treasuries. Riskier assets are limited to a small specified percentage of admitted assets. Generally, the investment limitations are stricter for life insurers than for property and liability insurers, because life insurers hold much more of the policyowner’s money that will eventually have to be paid, whereas the premiums for property and liability insurance are used to cover losses within the covered period.
All states also regulate policy forms by requiring their approval by the state insurance department before they can be used in the state. The main purpose for regulating policy forms is that most insurance contracts are complex, and are difficult for most people to understand and to compare with other policies. Also, insurers could leave out important or expensive provisions to offer lower prices, which many people probably wouldn’t notice. Thus, states have minimum requirements for insurance policies that may include certain provisions, minimum guarantees, and cancellation rights.
All states have various methods to regulate insurance rates. Generally, rates must satisfy the broad objectives of being adequate enough to maintain the insurer’s solvency, but also be fairly priced, and not be unreasonably discriminating. Also, many states have deregulated rates for commercial lines of insurance, since businesses do not generally need the protection that is provided to consumers, and allows insurers to develop policies that satisfy the specialized needs of businesses.
The rates for life insurance are regulated by the requirement to have a minimum legal reserve to pay claims and benefits and by competition.
Rating laws apply to property and liability insurance, especially personal lines of insurance. The principal rating laws that allow an insurer to change their rates are
Different rating laws may apply to different lines of insurance within the same state.
Prior-approval laws are the most onerous for insurance companies. They are generally required to get approval for a rate change before they can change it, and, often, they are required to provide justification for the change in rate, particularly if it is for a big increase. In most states, the general procedure is that if a rate is not disapproved within a specific time, such as 30 or 60 days, then the rate is deemed approved.
Flex-rating laws only require prior approval if the rate change is substantial, such as 10% to 25%. This allows insurance companies to respond more rapidly to changing conditions.
The file-and-use law is like the prior-approval law, but allows the insurer to use the new rates immediately after filing, rather than waiting for approval. The insurance department retains the right to disapprove of the rate later, if it violates laws or is deemed to be not justified.
A slight variation of the file-and-use law is the use-and-file law, which allows the insurance company to change rates immediately, but must file the new rate with the insurance department within a specific time, typically 15 to 60 days.
Open-competition laws (aka no-filing laws) eliminate all filing requirements, but insurers may have to furnish rate schedules to the state insurance department, if requested. Rates under this law are naturally regulated by competition, as is the price of most items in a capitalist society.
All states require insurance agents and brokers to be licensed in the state in which they do business. The Financial Modernization Act required that states standardize their licensing requirements so that agents and brokers can sell in other states. Some states also require loss adjustors to be licensed. States may also require continuing education for agents and brokers.
States also regulate the conduct of agents and brokers, especially in regard to selling. Forbidden conduct includes misrepresentations of insurance contracts, false or incomplete comparisons of different policies sold by competitors, and twisting—duping the insured by false information or comparisons to change already owned policies to those that the agent or broker is selling.
There are anti-rebating laws, which prevent the agent or broker from sharing part of their commission with the customer.
Many states also have countersignature laws, which require that any non-life insurance policy be signed by a domestic agent, who is entitled to a commission, even if the agent did not solicit the business.
Most states charge premium taxes on insurance premiums, which average around 2% of the premium. The tax varies according to state, and sometimes according to the type of insurance. Premium taxes are almost never itemized on the customers’ bills, but are included in the premium. Originally, the purpose of the tax was for insurance regulation. Nowadays, states collect much more than they use for insurance regulation—thus, it is just another general tax.
Previously, federal law restricted banks, insurers, and security firms to their respective businesses. The Financial Modernization Act of 1999 (aka Gramm-Leach-Bliley Act, GLB) removed this restriction. Now banks, insurers, and investment firms can sell banking and investment services, and insurance, promoting more competition, and 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.
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