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The Political Economy of Regulation: The Case of Insurance.

The Political Economy of Regulation: The Case of Insurance

Regulation attracts the interest of many different groups, not the least of which is political economists. This book describes the evolution of insurance regulation from the political economist's point of view. The book is divided into eight chapters. An overview of the role of insurance as a financial intermediary and risk bearing mechanism is briefly introduced in the first chapter. The second chapter contains a general theory of regulation. Subsequent chapters (3 through 6) analyze the chronological development of insurance regulation in a case-study style; the concepts and terminology developed in Chapter 2 are applied to insurance. Empirical tests of the regulatory theory are conducted also. The final chapter summarizes the main points and makes specific policy recommendations concerning insurance regulation.

The regulatory model described by Meier revolves partly around the groups potentially interested in a regulatory change; these include industry groups, consumers, the regulatory agency, and political elites. (The latter consists of members of the judicial, legislative and executive branches of government.) The amount of pressure exerted by these groups in a particular situation varies as to whether the issue is salient and/or complex. A salient issue is "characterized by intense conflict of broad scope" (e.g., hazardous waste disposal) while a complex issue requires detailed technical information and skill to be resolved (e.g., utility regulation). Salient, non-complex issues are ideal material for political elites and consumer groups. Bureaucrats are likely to be most influential in non-salient, complex issues. The regulated industry is an important player no matter how the issue is characterized; the power wielded by the regulated industry typically diminishes as the number of interested groups grows.

For the most part, insurance regulatory issues are considered as complex and non-salient. However, important exceptions do arise over time. Issues such as use of unisex rates, no-fault automobile insurance; and readability of policy forms have become salient issues at the state level. As saliency increases, intervention by the federal government becomes more likely. Salient issues addressed at the federal level include social insurance programs (e.g., Social Security, unemployment insurance, and flood insurance), and passage of the McCarran-Ferguson Act. Recent proposals to repeal McCarran-Ferguson are partly motivated by the saliency of an apparent "conspiracy" among property-liability insurers.

Insurance is regulated in many different ways and at different levels. Each state has its own regulations which vary by type of insurance (life vs. nonlife), line of insurance (e.g., workers' compensation vs. homeowners multiple peril) and type of regulation (price vs. nonprice issues such as contract standardization and licensing requirements.) Hence a cohesive theory of regulation which addresses all of these issues is most welcome.

The shortcomings of regulatory theories contained in the business economic literature are exposed. Stigler, in particular, is singled our for special treatment. A capture theory, which hypothesizes that the regulators actually serve the regulated industry, was proposed as early as 1936 in the political science literature, but was subsequently abandoned because numerous empirical examples were inconsistent with the theory. Stigler's capture theory is re-examined as a special case of the multi-interest group regulatory model advocated by Meier. That is, cases where the dominant pressure group is the regulated industry (due to non-saliency of the issue and its complexity) may result in regulations favoring the regulated industry.

In addition to the analysis of the evolution of insurance regulation, Meier presents financial data and empirical tests of various regulatory theories including Stigler's. Many of these tests are inconclusive, if not downright naive. For example, Meier analyzes the financial performance of a P-L insurer from a cash flow perspective:

a successful [short-tail lines] insurance company could technically operate without any capital because yearly income would exceed yearly expenses (pp.88-89)

Meier does recognize that long-tail lines require a capital base and reserves, but does not appreciate the significance of these. For example, Meier analyzes the liability crisis in medical malpractice insurance by estimating a cash flow statement for this line. Total income is defined by Meier as the sum of premiums earned and investment income. Total expenses are defined as the sum of claims paid and underwriting and settlement expenses. The difference between these amounts

is the net operating profit without considering loss reserves. These calculations reveal that medical malpractice insurance had a positive net cash flow for every year in this [crisis] period. (p. 105)

Meier notes that contributions to loss reserves roughly correspond to this cash profit. Hence Meier concludes there is no capacity crunch or liability crisis. Instead, insurers may have been evading taxes by making contributions to loss reserves.

Meier's analysis relies on a pay-as-you-go method of financing losses. However, financial theory indicates that potential projects should be evaluated on the basis of all cash flows from the project. (Cash flows occurring in the future must be discounted to the present.) By comparing premiums earned with claims paid, Meier is mismatching cash flows from income producing projects (i.e., insurance policies). Meier should have concentrated on the difference in reporting of reserves (at full face value) and their present value. The pay-as-you-go method used by Meier is not unknown in insurance, but it is associated with social goals and re-distribution of wealth (e.g., Social Security).

Most of the other empirical results are contained in Chapter 7. Meier attempts to quantify the relative resources of the multi-interest groups to measure, via regression, their impact on regulatory policy. A variety of regulatory policies are considered--e.g., premium taxation of domestic vs. foreign insurers, guaranty fund assessments, and competitive rating laws, among others. Many of the regression results are inconclusive, but given the difficulty of the task, this is not surprising. As a mitigating factor, the reader may glean some insight in ways to quantify interest group pressure variables across states. For example, political party competition in a state may affect the consumer orientation of the state, since political elites might strengthen their position by responding to consumer concerns.

The data analysis suffers from other drawbacks. Little information is provided on the sample used in these regressions. For example, in many cases it is impossible to determine whether panel, cross-section, or time series data is used. In addition, the reader is left to wonder about the direction of causality in some models.

In summary, Meier provides a logical framework for understanding the development of insurance regulation and details very concisely how different pressure groups have interacted over time. This material is highly recommended for student and researcher alike. Empirical testing of this theory is still a wide open field for researchers.
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Author:Weiss, Mary A.
Publication:Journal of Risk and Insurance
Article Type:Book Review
Date:Jun 1, 1989
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