Insurers and the Consumer
While many types of industry are regulated, probably no other business has been subjected to the amount of government supervision, as has the insurance industry. There is certainly need of supervision at many levels, but much of it has resulted from a few who have conducted business in unprofessional ways. What began as accepted ways of doing business evolved into government mandates. Some regulation directly deals with important financial issues, such as insurer solvency. Some regulation deals with agents in the field. This type of regulation often came about when consumers were exposed to unprofessional conduct, uneducated agents, and sometimes even outright fraud.
Do We Need So Many Hoops?
Americans often think we need less government interference and that may sometimes be true. The insurance industry, however, has a “vested public interest” which makes regulation necessary. Although the courts do not actually define a “vested public interest”, the concept is legally applied to many industries, including insurance. It is the very nature of insurance that requires government regulation. Agents and insurers deal with the consumer’s immediate money and their future financial security. Policies are paid for in advance. Consumers pay for years on some types of policies before their need is likely to occur, such as nursing home policies and life insurance policies. The value of these types of contracts lies in their future performance. If the insurer were unable to financially fulfill their obligation, not only would the premium be lost but also the financial protection that was anticipated. In the case of a nursing home product, the premiums could be the least of the problem if the insurer could not meet its contractual obligation. A nursing home can cost upward of $4,000 per month. It is not unusual for such care to cost $8,000 to $10,000 monthly. Obviously, while the lost premium is important, the actual benefit purchased has an even greater value.
The insurer must meet even small expenses. If a policy-owner cancels their policy, the company must be able to refund premium, for example. Agents certainly want their commissions paid on a timely basis. All of these financial obligations must be met and federal and state governments often find themselves supervising to be sure they are. While the public may not be aware of it, the adequacy of the premiums collected has a direct effect on how financial obligations will be carried out by insurance companies. Of course, not just premiums determine that; so do liabilities and assets owned by the insurer and the investment of the assets.
Most of an insurer’s costs happen after the policy price is determined. An insurer that wants to capture business may consider underpricing a product to attract new clients. As a result, it is important that states examine policy pricing so that there are adequate funds to deliver that which was promised. Of course, rates must also be reasonable so that consumers can afford them. Some areas of insurance, lacking reliable statistics, have found themselves underpriced. Long-term care products (nursing home policies) found themselves in such a position. In the past year or two many of these products have doubled in price. This is a very unfortunate situation since people who have paid for years on such a policy now find themselves unable to continue paying for it. They may have paid on a long-term care product for as long as ten years or more (are now reaching the age when it will be needed) and can no longer afford the premiums.
Few people really understand insurance products. We tell them to read their contracts, but even those that do may not fully understand the scope of their policy. Let’s face it: contracts are complicated and filled with legalese. Policies need to contain legal language because they are contracts. All contracts are based on law and, therefore, the resulting legal language. Due to the difficulty of grasping the significance of the legal provisions, rates, and insurance company statements, most consumers depend upon their agents to steer them in the right direction.
Insurers have not always been financially stable. In the 1800’s and early 1900’s many companies ended up in financial failure. Some of the failures reflected the uncertainty of underwriting statistics, but many of them reflected the insurer’s desire to stay competitive (resulting in underpricing of risks). It became obvious that some type of supervision was essential to the industry. Most Americans want government supervision of the insurance industry (and others as well) even though we complain that government is too big. We realize that individually we probably have little power, but collectively we can control some of the factors in our lives through government regulation. Such is the case with insurance products. When enough people complain about a perceived injustice, the government (state or federal) may pass laws that require certain practices be either required or forbidden, depending upon the situation. Most often it is at the state level that insurance regulation is passed.
While the reasons for government regulation will vary with the situation, the most common reasons for regulation are:
· To maintain insurer solvency,
· To maintain ethical and competent insurance practices, and
· To make insurance available to those who need it.
Not everyone agrees with some of the legislation passed by the states. For example, when a state makes insurers accept greater risks, the cost of insurance is likely to increase affecting those who are least likely to use the benefits. This can cause a domino effect. Those who are least likely to use the benefits are most likely to drop the coverage as costs rise. That leaves those who are the highest risk and most likely to use the benefits. As increasingly more high risk people make up the group, costs continue to rise. This process is referred to as “adverse selection.”
It is not surprising that protection of the insuring public is the main objective of state legislation. However, there can be other objectives that include revenue and the fostering of a domestic insurance industry. One aspect of this is called “retaliation.” As an objective of regulatory activities, it is defensive in nature.[1] Retaliatory statutes have been enacted against foreign American insurance companies. In this context, a domestic company is one domiciled in the state whereas a foreign company is an American company domiciled in another state. A company that is domiciled outside of the United States would be called an alien company. This is an important point since many people confuse a foreign company with an alien company. This is not surprising since the term often used for an alien company is “one which is domiciled in a foreign country.”
Retaliatory statutes have been enacted against foreign insurance companies in an effort to protect those companies that are domiciled in the state from undue burdens and limitations that might be imposed by other states. In other words, if a state domiciled company wanted to do business in a neighboring state, but that neighboring state had imposed regulations that adversely affected the company, the state may enact retaliatory statutes to even the playing field. What would impose a financial burden? It can vary, of course, but usually it reflects tax laws of another state that create a greater burden on foreign companies than it does on domestic companies.
Revenue is also a commonly listed objective of regulation. Insurers and others involved in the insurance industry are subject to many types of license, charter, and statement filing fees at the state level. In some cases there may also be municipal licensing fees. Such fees seldom prevent ethical or moral problems such as unethical selling practices. Rather, fees are a means of revenue generation and have no other function besides that. The exception would be fees that are levied as fines for illegal or unethical business practices. Industry professionals often feel such fines do not really do much to curb such activity, however, since agents often get away with far more than they are fined for. While that may be true, the point of such fines is to curb unethical activity – not just to generate revenue. Of the revenue generated for license fees, chargers, and statement filing fees, only about 5 percent goes directly to support insurance regulation according to most sources. It is important to note that revenue generation is not a regulatory device since it usually has nothing to do with how or why insurance is sold. It is developed as a source of income although it often results in regulations.
The general consumer probably has no idea how many types of taxes that insurers are subject to. All states have a sales tax on the gross premiums (although it is not necessarily called a sales tax). The actual rate varies from state to state and from year to year. Some states also levy a tax on all or part of the insurer’s assets and some states tax the insurer’s net receipts. The states are not the only entities that levy a tax on insurance companies. The federal government collects an income tax as well from insurers, although the percentage of profits that insurers pay is lower than that of most industries because of their ability to finance growth through tax-exempt investment income.
It was not until 1944 that the federal government began to exercise control or restrictions over insurance companies. Prior to that time, it was exercised only by the individual state governments. Today there is both federal and state government regulatory authority. The historic South-Eastern Underwriters Association decision, which gave Congress nearly complete control over insurance, also changed how the state’s legal basis was granted. Since then, the state’s legal right to regulate the insurance industry has been based on the determination by Congress that the states, singularly and in cooperation with the federal government, need to regulate the industry and secondly, the states have the right to police industries within their borders.
Consumers often believe that they have no power over government, but in fact in the United States all sovereign power is legally vested in its people. When we elect representatives at all levels, the intent is for those elected to represent the population as a whole. Of course, we all realize that many representatives (politicians) loose sight of that fact. When we feel that is the case, theoretically we elect someone else to take his or her place.
The people have created governmental bodies to serve them and have granted these bodies vested powers. General powers were broadly granted to state governments. The federal government has been granted limited authority to act on matters affecting the entire nation (such as war, security, transportation, and so forth). Our constitution does not specifically restrict the states from legislating on matters that are typically handled by the federal government so both the state and federal government may pass legislation on the same issue. When this creates conflict, the federal legislation usually takes priority. The U.S. Constitution is so general that the powers delegated to the federal government can be interpreted in many different ways, with each interested party interpreting to meet their own agenda. Because of this, some areas are specifically reserved for the federal government. For example, no state laws are valid that contradict or contravene federal law regarding some matters, such as interstate commerce. Insurance has been traditionally regarded as beyond the Commerce Clause and has, therefore, been regulated by the states.
How Do These Traditions Come About?
In the case of the Commerce Clause, which gives Congress the exclusive power to regulate commerce with foreign powers and among states and Indian tribes, it came about as the result of a legal suit. In 1868, the case of Paul versus Virginia went to the U.S. Supreme Court, which held that an insurance contract was not an instrumentality of commerce. It held that each state had the right to prohibit foreign insurers (those domiciled outside of the state) from doing business within their limits.
Paul versus Virginia became the accepted standard for insurance business. It became accepted practice to regard the general supervision of all forms of insurance to be held by the individual states. Other cases brought before the Supreme Court followed the original decision made in 1868 with the case of Paul versus Virginia. Then on June 4th, 1944, the U.S. Supreme Court, in United States versus the South-Eastern Underwriters Association et al (332 U.S. 533 at 533) reversed the concept that insurance was not commerce. Once that concept was abandoned, insurance came under the regulation of the Commerce Clause of the U.S. Constitution. Once insurance became commerce (primarily interstate commerce) the court no longer accepted the premise that only the individual states could regulate it. Insurers became subject to all regulations that Congress had imposed on interstate commerce.
These changes led to Congress passing Public Law 15, 79th Congress, known as the McCarran-Ferguson Act. This law passed with the backing of state regulators and nearly the entire insurance industry. Under the McCarran-Ferguson Act, Congress took control over the regulation of the insurance industry, redefined the state’s authority, and established a plan for cooperative regulation among the states. Congress intended for primary responsibility remain with the states, but still be subject to antitrust laws regarding acts of boycott, coercion, or intimidation.
Under the McCarran-Ferguson Act, the federal government retains exclusive control over anything that should be uniform throughout the states. An example of this would be such things as employer-employee issues, including the National Labor Relations Act and the Fair Labor Standards and Equal Employment Opportunity Acts. Congress can expand the federal area of control if it chooses. Federal law would be applicable to the business of insurance excluding all state statutes that conflict with federal requirements. Currently federal law applies to crop insurance, flood insurance, crime insurance, and riot reinsurance.
The McCarran-Ferguson Act states that the continued regulation of insurance by the individual states is in the public’s best interest so acts of Congress should not be interpreted as superseding state regulatory laws unless they relate specifically to insurance. Therefore, this act was encouraged by the states and the insurance industry because it kept insurance under state jurisdiction in most cases.
Because states still primarily pass regulations (rather than the federal government), there remains the problem of lacking uniformity among states. This results in duplication, complexity, and sometimes inefficiency. Even so, few states express any desire to give up their right to legislate to the federal government. In addition, legal precedent firmly favors state regulation.
The states do desire to make some elements of insurance uniform, such as issues relating to the education that agents are required to complete. There is now the Midwest Zone Agreement, which uniformly approves courses for continuing education. Not all states are currently participating but more are expected to join in the future. Additionally, the National Association of Insurance Commissioners, together with representatives of the insurance industry, undertook the drafting of model legislation intended to place the individual regulation of states. It would allow states that participate to be uniform. Even so, the major amount of insurance regulation continues to vary by state.
One of the primary reasons federal regulation has been rejected is the fear that it would not necessarily make the states uniform, but rather would add federal regulation on top of existing state regulation. It would likely mean federal taxation on top of state taxation, costing the companies financially, which would be passed on to consumers.
How Does State Regulation Work?
As we have discussed, the individual states have the legal right to legislate the insurance industry and those involved in it (including agents). The legal basis for this right has to do with state policing powers as applied to private property and private business that is concerned in some way with the public interest. As we know, insurance has been determined to have a public interest. Why? Because insurance products are designed to benefit the consumer financially in some way. It might be a death benefit should the breadwinner die; it might be to protect one’s assets from a nursing home confinement; or it might be to financially protect one’s assets from a lawsuit. Whatever the intent, insurance is purchased for protection against a perceived risk.
There are three agencies that are involved in the state regulation of insurance and those involved with the industry:
It is primarily the state’s insurance regulators that police the insurance industry. They must do so according to legislative standards. In other words, the legislature passes a specific law, which the insurance commissioner’s office then enforces. The courts come into play when a specific piece of legislation is challenged in some way. The court determines the intent of the legislation when that happens. The National Association of Insurance Commissioners, called the NAIC, performs an important role as well. This group is made up of the individual insurance commissioners from each state. They contribute vital research and development of needed regulatory law as well as the coordination of activities of the legislatures. It is important to note that the NAIC is advisory only to the individual commissioners and has no actual legal authority.
The courts play more than one role in the regulation of the insurance industry. The most obvious role is the function of deciding cases when conflict occurs between insurers and policyowners. The resulting judicial decision is an interpretation of the law, which then acts as a parameter for other cases. This regulates the duties of the insurer relating to that particular class of policies. The courts also protect the consumer by enforcing criminal penalties when the law is violated (most often this would be a violation by either an insured or an agent).
Another role played by the courts is one that is often overlooked: insurers and their agents may use the courts to overturn arbitrary or perceived unconstitutional statutes or administrative regulations put in place by the state’s insurance department. When insurers or their agents feel the state insurance department has overstepped their authority, they turn to the courts to correct the situation. The courts role, however, seems to be diminishing as the legislature and the insurance commissioner take on an increasingly greater portion of the regulatory process. Even so, the importance of the courts cannot be overlooked since it plays a vital role for individuals and corporate rights.
The individual state legislatures have the ultimate power to make laws and amend them when necessary. Of course, this must b done within constitutional limitations. The legislatures establish the broad framework of the state agencies that govern insurance activity. They must consider the business of insurance to be very important to their states since, according to State Supervision and Regulation (December, 2001), 15 percent of the bills introduced by the legislature pertain to insurance in some way. Special interest groups are often the reason that insurance legislation is introduced to the legislature. Some states have mandated coverage for some very unusual things as a result of lobbyists for special interest groups. A special interest group can include lawyers, agents, consumer groups, product manufacture groups, or business entities. During the last twenty-five years many states have enacted comprehensive revisions of their insurance laws as a result from pressure from those representing specific groups. Often the newly developed codes have swept away decades of legislation. This may result in a uniform insurance code that is beneficial to most participants or it may result in a multitude of newly required (but seldom needed) benefits for policyholders that drive up the cost of their insurance. The job performed by the legislature affects nearly everyone since most of us purchase insurance in some form (more likely many forms – health, disability, car, home, liability, life, and business insurance).
Whether law has been updated or not, insurance regulation relates to the requirements, procedures and standards for:
Codes also deal for insurance contracts, specific standards for specific types of insurance (we often see this for long-term care insurance policies and increasingly other types of specialty products, such as annuities), standards for life and health policies, group life and group health products, and fire insurance. Each state may differ, but each state will address issues they feel are especially important. Each state legislate penalties for those who do not follow the requirements of the state.
Because the business of insurance is so widespread, each state legislature has established agencies or departments whose duties are limited to the supervision of insurance. It has been recognized that even our courts are not equipped to handle supervision of an industry that is highly specialized. Only experts are equipped to handle the questions and concerns that arise. If the court becomes involved they must rely on the experts. Therefore, it makes sense that issues and questions should go directly to those experts if possible rather than through the courts. The legislature realizes it would not be prudent to pass laws on issues they do not understand and are not experienced in. Therefore, it simply makes sense to form agencies or departments that are experienced in and do understand the mechanisms of insurance. Of course, this is also why problems can and do come up. The insurance commissioner is given broad discretionary powers. If he or she abuses those powers both the public and the industry can find themselves in an indefensible position. There may be few checks and balances to protect others from unfair restrictions or decisions.
The first state insurance department was formed in Massachusetts in 1852, so this is certainly not a new concept. The head of the department is not always called an insurance commissioner; he or she may also be called superintendent or director. He or she may have additional duties such as state auditor, comptroller, or treasurer. In some states the insurance department is associated with the state’s department of banking. The governor appoints most insurance commissioners with the appointment confirmed by the state senate. In some states, however, it is an elected position.
Agents may forget that the ability to conduct insurance business, represent an insurer, or sell insurance products is not automatic; it is considered legally to be a privilege. This privilege is only available to those who qualify and obtain the required education and licensing. As a result, the insurance commissioner or other appointed director controls and supervises the industry by means of the licensing function. He or she removes the right to be involved in the insurance industry by removing the license that permits it. Since it is the state that grants the insurance license, they have the right to require conditions and limitations for keeping the license effective and current. This is why the states have the legal ability to require periodic education for agents and others associated with the industry. This is not unique to the insurance industry. Other professionals that carry licenses must also meet specific requirements to maintain their licensing in their chosen professions.
Since it is a privilege to participate in the industry, not a right, the insurance commissioner is given numerous powers as well as duties. The commissioner’s primary powers include:
1. The power to make administrative regulations,
2. The power to grant or revoke a license,
3. The power to examine,
4. The power to require an annual statement of conditions,
5. The power to approve rates, policy forms, and so forth,
6. The power to investigate complaints from consumers,
7. The power to order liquidation or rehabilitation of companies, and
8. The power to initiate original investigations without receiving complaint.
Essentially, the duties involve enforcement of insurance laws and administration of the insurance department.
In 1871 the National Convention of Insurance Commissioners was formed. Today we know it as the National Association of Insurance Commissioners, or the NAIC. The objectives of the NAIC are to promote uniformity in legislation and administration among the states and to increase the efficiency of insurance officials. The NAIC also strives to protect the interest of all policyholders through education and legislation.
The NAIC has been successful in many ways. It has had a unifying effect among the states, since each state has the option of participating. As a result of the association’s work, all the states have adopted a nearly uniform blank for insurance companies’ annual financial reports (the insurer’s annual statement is known as the convention blank), eliminated much of the duplication and expense through use of a certificate of solvency by a company’s home state, agreement among the states that a deposit of securities should only be required in the company’s home state, adoption of uniform rules for valuation of securities, development of a zone system for the triennial examination of insurance companies, preparation of standard life insurance mortality tables, preparation of a standard life insurance liability valuation law, and a standard life insurance nonforfeiture law, a set of criteria to measure the financial strength of property and liability insurers, and the drafting of many other model laws in the insurance field. Few organizations can claim so many accomplishments as can the NAIC.
The National Association of Insurance Commissioners is continuing to add accomplishments to their list. Numerous model laws have been recommended for various things, including holding companies, variable contracts, guaranty funds, fronting companies and consumer advocate laws. Several research projects of major importance have been completed as well, which will supply new statistical reporting systems for both testing solvency of companies and measuring profitability. No state is required to follow any recommendation made by the NAIC, but generally the states find sufficient reason to at least consider them. As a result uniformity among states has greatly increased and this trend is expected to continue.
Many types of business experience government regulation but the insurance field is certainly one the most regulated among them. The insurance field is regulated by statute, meaning laws have been established to determine how the industry will operate. In fact, there is so much code relating to insurance in most states that there are separate codes used just for that industry. As agents, we certainly want to use only companies that are financially stable so they can fulfill the promises of the policies we write. As agents, we want the premium rates to be reasonable so our clients can afford to buy the policies. As agents, we also want the underwriters to be fair and avoid discrimination that would result in policy denials. We do not want any particular person, risk, or class of risk to be favored over another without sound scientific reasons for doing so. It is the job of each state to make sure that companies remain solvent and fulfill their financial obligations, to set premium rates that are fair yet enable the company to continue, and restrict unfair policy underwriting.
There is no way that this course could fully cover management and regulation of the insurance industry. States have lengthy volumes of code and that code varies among states. Even if this course could fully cover insurance codes no sane agent would want to read it. Therefore, we will simply highlight some areas. It is important to realize that our coverage here cannot be complete. Insurance laws are complex and relate to numerous areas of the industry.
As a protection for consumers, state statutes typically do not allow companies to make payment of dividends to stockholders, except from profits. Additionally states define the reserve liability, specify the deposit of certain securities in trust, outline the character of the annual financial reports that insurers must submit to the insurance departments of each state, authorize the examination of licensed insurers, and regulate the merger of companies and the procedure to be followed should an insurer become insolvent. State insurance departments have additional duties, but these are the ones that agents are most familiar with.
At one time the states limited the classes of insurance that a company could write policies for. The United States, at one time, adhered to the mono-line system. This contrasted with the multiple-line plans prevailing in England and most European countries. In other words, an insurer in the U.S. wrote only one type of insurance, such as casualty and surety, for example. The United States had three customary classifications:
Until the 1940s American companies were restricted by law in most states to writing only one of the three customary categories. British companies could write nearly any form they wished. Obviously, this made competition difficult for American insurers.
The American grouping of insurance types was not always strictly followed. There was overlapping by companies writing different classes of business. There were often subsidiaries created so they could sell multiple lines of business. Gradually, the states began to allow companies to sell multiple lines of business. By 1955 all the states had enacted legislation allowing insurers to sell multiple lines of insurance. This really did make sense since, first of all, companies were doing it anyway, and secondly there was no sound reason not to let them. There is one aspect that has been kept separate: life insurance. The delineation between life and property and liability insurance has been maintained uniformly even though the states have passed multiple-line legislation. That doesn’t mean that property and liability companies do not have links to selling life insurance. Many life insurers have purchased or formed property and liability insurers, and vice versa. The approach is either direct ownership or control through a common financial group.
Like other types of companies, insurers pay ordinary taxes, such as real and personal property taxes and federal and state income taxes. However, insurance companies also have some special taxes that are levied just on them. One of these is the “premium tax.” Most of the states subject property and liability companies to a tax on gross premiums, less return premiums. The actual amount will vary from state to state. The premium tax can become very complicated if we try to make a blanket statement since there is no uniform method of collecting it that applies to all states. The states apply different methods of taxation, and different rates to domestic companies. In some states the level of insurer taxation is reduced depending on the extent to which the insurance company invests its accumulated funds within that same state.[2]
Insurers are also subject to a variety of state license fees and special charges relating to their organization, annual licensing and the licensing of their agents, the filing of reports, the certification and publication of annual statements, and the maintenance of fire departments. In fact, some states even levy insurers to finance the reporting of completed agent education. This allows these states to have outside companies file and maintain agent records without cost to the state. Again, this is not uniform among the states so just because Georgia may collect funds a particular way does not mean that New York will be the same.
Insurance premiums tax is a major tax paid by insurance companies. It is paid by all life insurers, all stock insurers, all mutual insurers, and all captive insurers. It is assessed on premiums collected by insurance companies on all policies written in the preceding calendar year.
It is not possible to state in this course what rate the insurance companies are paying since it can vary by state. Whatever the rate, you can be sure it is passed on to consumers through the premiums and other charges they pay. Many states, suffering from too many bills and not enough income, are taking a hard look at insurer’s premium taxes. It is felt by many state regulators that insurers are not calculating them appropriately, thus paying less than they should be.
Insurer premium taxes affect all types of policies. The health reform law, for example, imposes a new sales tax on health insurance that increases the cost, which will (as always) be passed on to consumers. The amount of the tax is $8 billion beginning in 2014, increasing to $14.3 billion in 2018. It will increase based on premium trend thereafter. The Joint Committee on Taxation estimates that the health insurance tax will exceed $100 billion over the next ten years, according to the Center for Policy and Research.
The majority of the total tax revenue states collect from insurers is used for general state expenditures. Only a small amount of the tax was used to regulate the insurance industry. The balance was added to the general revenue of the state. These taxes are passed on to the policyholders, who have paid non-insurance taxes already. It is likely that, as states continue to need additional funding, they will turn to insurers for at least part of what they need to operate their state budgets.
Of course there is debate as to whether or not it is fair to policyholders to continue taxing insurers (who pass the costs on). Most agree that the premium tax should at least be uniform among the states. It is likely to continue to be a source of state funding since it is such an easy tax for them to collect. For example, if a state announces that they are going to raise the tax on gasoline, consumers have lots to say about it. However, if they announce they are raising the tax on insurers, consumers barely notice. Why? Because people do not realize how a premium tax affects them.
British taxation is levied on net profits, recognizing the fact that a written premium might result in a loss. In America, it is argued that taxation of premiums fails to make any allowance for loss payments and legitimate expenses of operation.
Another interesting feature of insurer taxation is the retaliatory laws that many states have on the books. Of course, they are not referred to as retaliatory laws; rather they are called reciprocal legislation. Most of these laws extend the retaliatory feature to cover any obligations, prohibitions, and restrictions, in addition to applying them to deposits of money or securities, and to taxes, fines, and fees. Under reciprocal laws, the state gives the same favorable (or unfavorable) treatment to admitted companies of a foreign state as that state imposes on the companies of the initial state. In other words, State A treats the companies originating out of State B exactly the same way that State B treats companies originating out of State A. If State A charges insurers originating out of other states a 2 percent tax, then State B will also charge insurers originating from State A that same 2 percent tax. That is why it is called a retaliatory law. State B is retaliating against the tax charged by State A on their insurers.
What happens if the tax is not uniform (as is often the case)? Since states are not uniform, it is likely that taxes are not uniform either. Consider the following example:
State #1 charges a 2 percent reciprocal tax (retaliatory tax).
State #2 also charges a 2 percent reciprocal tax.
State #3 charges a 3 percent reciprocal tax.
State #4 charges a 4 percent reciprocal tax.
If states 1 and 2 interact with their insurers it will be uniform. Both will charge the other the same amount.
If state #3 has insurers that wish to do business in states 1 and 2, both 1 and 2 will raise what they normally charge to 3 percent because that is the amount state #3 will charge their insurers.
State #4 charges foreign states 4 percent to do business within their borders. Therefore, other states, that normally charge less, will raise their fee to match that of state #4 (a retaliatory process). It is easy to see why critics of the system want to see states become uniform in their reciprocal legislation.
The regulation of those who sell insurance to consumers is a large portion of the regulatory insurance laws. State laws do several things:
In subcategories, other items will be described (such as requirements regarding continuing education for agents). Most states require agents to complete a test before they may obtain an insurance license. Most states also require that education be acquired periodically. These requirements are not uniform among the states. Some states have special requirements, such as education for a specific type of product. Usually, specialized education has been aimed at long-term care products and ethics. However, California recently enacted additional education for those who sell annuity products. It is expected that other states will follow suit with specialized requirements in addition to those already in place.
In most states, the initial examination to obtain the license is a one-time event unless the agent lets their license lapse. In that case, he or she may be required to retake the initial licensing exam.
Agents and brokers can lose their license under specific circumstances. One of those circumstances is the failure to acquire specified continuing education on a periodic basis. The exact type of education and the amount of education is not uniform among the states.
Agents and brokers are usually held personally liable on all contracts of insurance unlawfully made by them with companies or associations that are not licensed to do business within their state. Fines are likely, but they may also have their license suspended or revoked as a result.
Other activities that can affect an agent’s license include:
Many states require a resident agent or broker also sign a contract that is produced by a nonresident agent or broker. In those states that require this, it is also common for a requirement to exist regarding how commissions are split. This means that an individual may get a cut of the pie even though they did nothing to pursue the sale. Understandably there are those in the industry that feel this requirement should be eliminated.
After the passage of the McCarran-Ferguson Act, it was legally necessary to regulate premium rates. Of course, it could be argued that it has always been necessary to do so, but this Act made it legally necessary as well as morally necessary. Ratemaking is primarily based on the National Association of Insurance Commissioner’s model laws.
From a consumer standpoint, it is vitally necessary to regulate rates and rating bureaus since it so directly affects them. The purpose, from a legal standpoint, is to enforce the requirement that rates be adequate, reasonable, while preventing unfair discrimination. It must be noted that policy issue is fundamentally discriminatory since there is underwriting involved. However, it is important that segments of the population not be discriminated against merely because they belong to a particular segment. Each individual must be given the opportunity to apply and have fair underwriting based on the same standards applied to everyone.
Why would a company discriminate against a block of potential business? As we know, insurers are “fact gatherers.” As such, they are the first to see when specific features are more likely to bring about loss. For example, some areas have much higher rates of HIV than others. It would be easy for an insurer to decide that a particular locality, such as Seattle, Washington, has higher rates of HIV than other areas of the country. Therefore, the insurer might be inclined to refuse any male applicant living in Seattle. Obviously, this would be discriminatory since every male applicant from Seattle is not going to have the HIV virus.
Rating bureaus gather most of the essential loss and expense information that is necessary to develop premium rates. The rates generated by this information are advisory only. In most states the insurers, who are either bureau or non-bureau members, are not required to file and use these rates. The individual insurers are free to modify them if they wish, as long as the insurance commissioner accepts the modifications they make.
It is important to note that ratemaking is not necessarily uniform from state to state. For example, in North Carolina there is a State Rate Bureau that files automobile liability rates for all companies operating in that state. Companies may deviate from the approved amount only if they are able to convince the state that there is evidence to back up their position.
The rating bureaus are also subject to supervision and regulation by the various insurance commissioners of each state. Ocean marine insurance rates, aviation insurance rates, and rates for many inland marine lines are either exempt or less closely regulated under the rate regulatory laws than are other lines of insurance.
As we stated, the law requires rates to be adequate, reasonable and not unfairly discriminatory. Unfortunately, not all insurance lines have achieved this requirement. The automobile line has been the most significant producer of underwriting losses. Of course, there has been discussion regarding what might be a “best” model rating law. Bureau companies have found that competition from independent filings, deviated plans, dividend payments, and package plans has led to a loss of preferred business leaving them with substandard policyholders and consequently inadequate rates to cover their losses. Of course state authorities want to regulate in a way that covers these problems but state commissioners are often unsure themselves how to meet their obligations under the law.
As they relate to regulation of rates and rating bureaus, the state rating laws can be divided into four groups:
Under the Prior Approval states, the insurance department approves both rates and forms before any filing change can occur. When a change request is made, it has to be accompanies with documentation and statistical evidence to support the need for rate or form modification.
Under Modified Prior Approval states there is a rate-level adjustment based on experience data that can be filed and used immediately, whereas more fundamental changes, such as establishing a new classification system, for example, would be subject to prior approval.
When the File-and-Use method is used in states, the insurers are required to file their new or modified rates with the state’s commissioner prior to putting them into effect. The companies do not have to wait for approval, however. That is why it is called the file-and-use method: they file it, then use it right away. This is an important point since there are examples of commissioners who refused to accept or reject a filing for as long as three years. Most states do have a period of time during which the commissioner must act (typically sixty to ninety days following filing). If a filing is rejected the insurer would have to revert to the prior rate.
Open Competition states require neither the filing of rates nor their prior approval by the state’s insurance commissioner. The insurer may use the rates promulgated by the rating bureau or modified bureau rates, or it may generate rates of its own. This was the system used by California between 1947 and 1989. California now uses the Prior Approval method of ratemaking. Only one state used the Open Competition method initially, but now several states use it. There has been concern that there would be widespread insurer insolvencies and unethical practices as a result of the Open Competition method. However, that never did seem to happen. Since more states, including New York in 1969, went to this method, there has been increased awareness of the possibilities of company insolvencies and equity. Some say that is why there have not been problems.
Why would some industry watch-dogs worry about the Open Competition method? After all, isn’t competition good for the consumer? The worry is that competition will drive rates down too far in an effort to gain business from another insurer. The insurance company must be able to stay solvent in order to pay consumer claims. However, so far there has not been a problem that can be connected to this type of ratemaking. Again, it may be due to the watchful eye of the insurance commissioners that have prevented it, but many feel it has worked because insurers do not want to go under either. Companies want to stay solvent and they want to make a profit.
Another worry about the Open Competition method is the potential of collusion, which could result in an unreasonably high rate. This also has not seemed to happen. Most states have several hundred licensed and active property and liability insurers. Therefore, consumers have choice. Consumers are more likely today than ever before to shop around for their policies.
In a major study comparing automobile insurance rates in states with competitive rating laws versus those states with noncompetitive rating laws, Professors Robert Witt and Harry Miller found that “there is basically no relative-cost difference between the two classifications of rate regulatory laws. They concluded, following this study, that consumers in competitive rate states did as well or even better than they did in non-competitive states. Therefore, there may be no economic justification for the regulation of automobile rates by regulatory authorities. This might be especially true if the cost of regulating rates is taken into consideration since those costs might actually force up the rate charged for automobile insurance.
There has been a shift in regulatory emphasis. There has been a loss of importance for the rating bureaus. In the past, the bureaus occupied an important role making rates and determining policies, forms, and endorsements. Today they are more likely to be gathering statistical information necessary for ratemaking purposes and act as depositories and distributors of forms and endorsements. In addition, independent companies now dominate the personal lines market. They are capturing an increasing share of commercial lines. As a result of this, the regulatory emphasis has changed from bureau filing to claim and underwriting conduct.
As we know, it is important that insurers remain solvent so that claims may be covered. Obviously a policy is not efficient if it cannot pay covered claims when they arise. The laws of the individual states address this issue. Some of the states actually regulate the company’s investments. Domestic companies must typically invest an amount equal to the minimum capital requirement in (1) federal, state, or municipal bonds; or (2) bonds or notes secured by mortgages or deeds of trust on improved real estate. Some states allow specified classes of public utility or other high-trade bonds as investments. Assets equal in amount to a specified percentage of unearned premium and loss reserves must be invested in restricted securities of similar high quality. All of these requirements are aimed at keeping the insurer solvent and protecting consumer interests.
Foreign and alien companies are typically required, to the extent of the minimum amount of capital required of similar domestic corporations, to carry investments of the same class as previously stated for domestic companies. While states are not uniform in their requirements, usually assets standing behind reserve liabilities may be invested in any of the previously mentioned classes and in corporate bonds or preferred stocks that meet specific criteria as to net earnings and security.
Real estate holdings usually cannot exceed 10 percent of total assets but few property and liability companies invest in real estate anyway, except for their home office property. Some might invest in real estate through an affiliate company.
Some states have relaxed their investment restrictions on real estate to allow insurers to invest directly in income-producing real estate, although there are bound to be some restrictions. There are some states that place very little restriction on real estate investments, or any other type of investments. Companies are free to invest in whatever manner they desire.
Insurers file annual statements with the states regarding their financial solvency. Certain assets of insurers will not be recognized on these statements. Others investments must be carried at prescribed valuation bases. Assets that are not recognized are known as non-admitted assets. The most important example of a non-admitted asset is the reputation of a company that has been built as a result of dedicated salespeople and support staff. While such an asset cannot be displayed on a financial statement, it certainly exists. The more traditional examples of non-admitted assets includes premiums owed by agents if these are more than ninety days past due, furniture, fixtures, and certain types of supplies.
Admitted assets include those not prohibited by statute or regulation. They would include cash and bank deposits, real estate, mortgage loans, stocks, and bonds. Cash of the domestic type should not present a valuation problem. Bank deposits under most circumstances will be admitted at face value. Problems can arise if the currency is foreign or deposits are held in a failed bank. If it involves a failed bank, only amounts in excess of the FDIC limits would need adjustment. Amounts under that limit are guaranteed. Real estate held as an investment is typically carried at cost less related depreciation. Mortgage loans and collateral loans are carried at the amount loaned as long as they are properly secured. Stocks are valued at market, although certain sinking fund preferred stocks are carried at cost. Bonds not in default as to principal and interest are carried on an amortized basis. Their value gradually approaches par until they reach par at maturity. Bonds that are not in good standing are valued on the basis of whatever market or other related information is available. Other assets are usually valued at cost, with appropriate deductions for uncollectible assets.
As we know, the value of many assets is not stable. Therefore a special valuation reserve may be carried in the surplus account of some insurers in order to provide for possible decreases in value of their assets. This reserve should not be confused with the liability reserves. They simply represent an account for surplus rather than a true liability.
Thank you,
United Insurance Educators, Inc.
2014