Trends in insurance regulation.
The pressures on global insurance markets generated by the September 11 terrorist attacks have set in motion some insurance regulatory actions whose end is not yet in sight. The implementation of the Terrorism Risk Insurance Act of 2002 (TRIA), (1) in combination with the Gramm-Leach-Bliley Financial Modernization Act of 1999 (GLBA), (2) has rekindled a long-smoldering debate between proponents of federal insurance regulation and the advocates of the status quo, state insurance regulation. Circumstances are now leading to debate among three choices: 1) modest changes to the current system of only states regulating insurance; 2) transfer of insurance regulation to the federal government; and 3) dual regulation by both the federal and state governments.
Alone among financial services in the U.S., insurance has remained the exclusive domain of state regulators. Two hundred years ago, the primary role of the states was to issue charters to insurers. As the industry grew, along with the nation's economy, the states developed taxation, rate, and solvency regulations. As it stands today, insurance regulation has become increasingly complex, involving an ever-expanding array of local, regional, and global issues, including financial solvency, securitization, risk-based capital, statutory accounting principles, technology, privacy, long-term care insurance, managed care, life and annuity issues, availability and affordability of various property/casualty lines, consumer information, credit scores as an underwriting and rating tool, international trade agreements, and agency issues. (3) The passage of GLBA added a new layer of complexity. The sudden apparition of catastrophic terrorism changed the perception of risk dramatically, and with it, insurance as we knew it.
The insurance regulation debate has a long history. In Paul v. Virginia (1868), the Supreme Court placed insurance regulation in the hands of the states. Despite a reversal in US. v. South-Eastern Underwriters Association (1944), the states retained their regulatory authority through the passage of the McCarran-Ferguson Act of 1945. Lack of uniformity in regulating an interstate and international industry challenges regulators and firms alike. Recognizing these difficulties early on, the states formed the National Association of Insurance Commissioners (NAIC) in 1871 to serve as their functional and symbolic "arm," sustaining state regulation by promoting uniformity and efficiency.
The continued viability of state regulation has reemerged as a question of immediate urgency. Reformers claim that the implementation of new federal laws, specifically GLBA and TRIA, have opened the door to federal regulation and to more urgent debate about Optional Federal Chartering of large and national/global insurers. Those in favor of some form of federal regulation appear to be gaining the support of insurance executives who, during the Congressional debate leading to the passage of TRIA, felt that neither the NAIC nor individual states regulators could adequately represent their interests. (4) The most recent survey of insurers reveals growing interest in federal regulation rather than state regulation alone. The majority, however, still are in favor of the status quo. (5)
In this paper we conduct a study of the two-century-long development of insurance regulation in the U.S, which we present in Exhibit 1, divided into four sections: (A) pre-1870, (B) 1870-1920, (C) 1920-1998, and (D) 1999-2003. The final section is intended to emphasize the importance of GLBA and September 11th and its subsequent legislation, TRIA. For each period, we look at the insurance markets, major events that affected the insurance markets and industry, the industry's reaction, and subsequent regulatory actions. As the industry matured and new lines of insurance were introduced, events and regulatory actions became more focused on specific lines. Therefore, Exhibit 1, sections A-D are divided into lines as appropriate to the period. For example, health insurance and social insurance were only developed in the second quarter of the 1900s, while fire, marine and life products are centuries-old.
A review of Exhibit 1, sections A-D leads to four main observations: 1) insurance is regulated by a multitude of non-uniform state systems; 2) local state insurance issues do exist and may require local solutions; 3) most insurance markets are national or global in scope and may demand a unified regulatory system; and 4) insurance regulatory change typically comes in the wake of one or more catastrophic events or crises of availability and affordability in insurance markets.
Each of these four conclusions tends to support the case for one of the three regulatory choices outlined above. Proponents of maintaining the state insurance regulatory system contend that the system is not broken, but requires realignment for better functionality and efficiency. In testimony given by the NAIC Secretary-Treasurer Joel Ario before the House Subcommittee on Over sight and Investigations/Committee on Financial Services of the 108th Congress, the position of the NAIC for preservation of state regulation was clear. (6) He pointed out that "market regulation is more difficult to harmonize than financial regulation where financial records do not change from state to state." However, in market regulation, "The market behaviors of insurers can be quite different from one state to another because the laws may be different and insurer compliance with the laws may vary by state. Market regulation is definitely not an area where 'one size fits all' across the country."
Proponents of the dual regulation proposed by the advocates of Optional Federal Chartering regard the need for federal regulation for some lines of insurance, for certain insurers and for financial issues as an important addition to supplement state regulation, as is the case in banking regulation. This proposal is an outcome of GLBA. Pointing out that the nature of their business is not regional, large insurers argue in favor of the option of choosing a federal charter, just as banks can do now with the Office of Comptroller of the Currency. A draft bill proposing Optional Federal Chartering was released in December 2001 by Sen. Charles Schumer (D-NY), and another was introduced in the House of Representatives in February 2002 by Rep. John LaFalce (D-NY). These bills merely opened the debate. A series of three hearings in June 2002 began "to explore the concept of federal insurance regulation and the potential to improve state supervision to offset the need for a federal regulatory agency." (7)
The proponents of exclusive federal regulation are in favor of uniformity and ending the "barrier to entry" that is created by the multitude of states insurance regulatory systems. While there is no proposal for exclusive federal insurance regulation at the present time, there has been an increased level of Congressional oversight over the NAIC and the insurance activities of the states. During the 108th Congressional session, insurance issues were a significant part of the agenda of the House Financial Services Committee. (8) While insurance regulation is the domain of the states, the committee has acted in an oversight capacity over the states with its decision to continue to examine the insurance solvency regulation program, including solvency accreditation of the NAIC (which began in the 1990s after a series of GAO reports about insurance insolvencies). The committee's agenda also included market conduct regulation, agent licensing reform as required under GBLA, insurance product approval, national insurance uniformity, terrorism insurance, workers' compensation, insurance marketing, insurance fraud, insurance consumer protection and seniors' retirement needs, risk retention acts, professional liability insurance and reforms aimed at resolving the crisis of availability and affordability in this line of coverage, insurance litigation reform to circumvent future insurance crises, holocaust claims, mold, natural disaster insurance, homeowner's insurance--price controls, underwriting criteria and availability, and corporate-owned life insurance. Standing out in this agenda is the "preemption of state insurance law" which reaffirms state regulation of insurance. The committee is charged to "review efforts by Federal agencies to preempt state laws governing insurance activities and will examine any controversial state insurance laws to ensure that they do not significantly interfere with federally authorized powers of financial institutions." (9)
While Congress exerts oversight, the states continue the business of insurance regulation including efforts to resolve major local problems of availability, affordability and insolvencies. An example is the resolution of file mold crisis in Texas and its impact on the homeowners' insurance market. In 2002, local regulators created the "Fair" plan giving homeowners access to insurance when the voluntary market failed to provide such coverage. (10) In June 2003 the Texas governor signed a bill to relieve the pressure on the homeowners' insurance market in Texas. As a result, the majority of homeowners' insurance in Texas is now subject to rate regulation. (11) In addition, mold remediation companies were brought under stringent regulation.
The medical malpractice insurance crisis provides another example of how states resolve local issues. (12) While Congress attempts to pass laws limiting awards in litigation, many state legislatures are also working on passing similar laws to relieve the pressure on medical malpractice insurance. Most recently, Pennsylvania Gov. Edward Rendell proposed that "the state would pay for three years the premiums of certain high-risk categories of physicians to the state's Medical Care Availability and Reduction of Error program." (13)
This article is structured as follows: Using the Exhibit format described above, we move through the 200-year history of insurance regulation in the U.S., including historical overviews of the most significant events in insurance regulation until 1998. Then we overview the current trends in insurance regulation, with emphasis mostly on GLBA and TRIA and their impact. The paper concludes with a summary.
Trends in Insurance Regulation Pre-1870
While already popular in Britain, insurance hardly existed in the United States prior to the 1790s. Marine insurance was the most developed fine, with fire insurance a distant second, mostly consisting of local mutual insurers, while life insurance was yet to emerge. As the nation grew and the economy developed, the insurance industry grew, making regulation necessary. Initially, insurance regulation only involved chartering and taxation. The New York Fire of 1835 led fire insurers to diversify into larger territories to mitigate their risk. To sell insurance on a regional or national scale, insurers developed the independent agency system.
Life insurance was affected by the financial panic of 1837, which reduced access to capital and made the mutual form popular. The Civil War further helped the growth of the life insurance industry.
By the 1870s, a number of states had separate insurance departments. Most followed the New York model and enacted separate statutes for fire and marine and life insurance. Minimum capitalization requirements were enacted, and forfeiture laws for life products were adopted.
The seminal legal case of Paul v. Virginia (1868) affirmed the power of the states over insurance regulation. Prior to the ruling, the insurance industry had campaigned for federal regulation. For both life and fire insurance firms, the variability of regulations in different states made doing business on a national scale increasingly complex. In its ruling, the Supreme Court declared insurance not to be interstate commerce, and thus not eligible for regulation by the federal government. As a result of Paul v. Virginia, insurance would not be subject to any federal regulations over the coming decades. (14)
Trends in Insurance Regulation 1870-1920
As noted in the introductory discussion, catastrophes act as catalysts to change insurance regulation. This was the case numerous times throughout history up to the September 11, 2001 catastrophic terrorist attack. During the 1870-1920 period, two of the most influential events were the Chicago and Boston fires of 1871 and 1872. The major insolvencies caused by these disasters brought the fire and marine industry into the realm of collective rate setting, first with the companies setting their rates cooperatively, and eventually with state regulators setting rates in conjunction with the insurance industry through its rating bureaus (progression in Exhibit 1. B).
In the field of life insurance, a few large insurers dominated a market characterized by fierce competition that led to rebating, twisting and other shady practices. Only after New York's Armstrong Committee investigation into the life insurance industry (1905-6) brought these practices and other misconduct to light did regulators begin to crack down on life insurers. In 1907 New York passed laws outlawing rebating and twisting and otherwise reforming the industry. Because of the so-called Appleton rule, requiring any insurer doing business in New York to follow that state's laws wherever they conducted business, New York's insurance laws became de facto national law.
Prior to 1920, other lines, beyond fire, marine and life, were just starting to emerge. The invention of the automobile spurred the growth of the casualty industry, with separate companies developing to handle this new line. During the 1910s, most states enacted workers' compensation laws to protect employees. Health insurance had yet to develop, however, as the industry. Private insurers, fearing adverse selection and moral hazard, did not perceive health coverage an appropriate exposure.
By 1920 life and property/casualty insurance regulation was essentially in its current form.
Trends in Insurance Regulation 1920-1998
Shortly after the Supreme Court's ruling in U.S v. Southeastern Uuderwriters Association (1944) overturning Paul v. Virginia and giving the federal government the power to regulate insurance, Congress reaffirmed state insurance regulation with the passage of the McCarran-Ferguson Act (1945). McCarran-Ferguson is the foundation of all current state insurance regulation.
State Regulation--General. The form and process of state insurance regulation is summarized in Exhibit 2. Today, most insurance departments have relatively few staff employees, with the exception of Texas, California, Illinois, Florida, and New York. (15) Despite the efforts of the NAIC to provide model laws for adoption by the states, the laws that are finally adopted may not be uniform across the states because of differing local interests. The resulting maze of regulations is considered a barrier to the entry of new insurers.
EXHIBIT 2. MAJOR PROCESSES AND DUTIES OF INSURANCE REGULATION IN THE STATES The state legislatures pass insurance laws that form the basis for insurance regulation. * To ensure the smooth operation of insurance markets and the solvency of Insurers, insurance laws are concerned with: * Licensing requirements for insurers, agents, brokers, and claim adjusters. * Rates and policy forms and consumer protection. * Methods of establishing reserves and the types of investments permitted. * Provisions for the liquidation or rehabilitation of any insurance company in severe financial difficulty. * Trade practices, including marketing and claims adjustment processes. * Availability of insurance and affordability during hard markets. Every slate has an insurance department to administer insurance laws. The state insurance commissioner is empowered to: * Grant, deny, or suspend licenses of both insurer and insurance agents. * Require an annual report from insurers (financial statements). * Examine insurers' business operations. * Act as a liquidator or rehabilitator of insolvent insurers. * Investigate complaints. * Originate investigations. * Decide whether to grant all, part, or none of an insurer's request for higher rates. * Propose new legislation to the legislature. * Approve or reject an insurer's proposed new or amended insurance contract. * Promulgate regulations that interpret insurance laws. Licensing Requirements * An insurer must tiara a license from each state in which it conducts business. * Holding a license implies that the insurer meets specified regulatory requirements designed to protect the consumer. It also implies that the insurer has greater business opportunities than nonlicensed insurers do. * A foreign insurer can conduct business by direct mail in a state without a license Item that state. The insurer is considered nonadmitted and is not subject to regulation. Nonadmitted or nonlicensed insurers are also called surplus lines or excess insurers. Financial Requirements * Risk hosed capital * Reserve requirements * Guaranty Funds Associations Policy and Rate Regulation Rates are regulated for auto, property and liability coverages. Methods include: * Promulgated rates * Prior approval * File-and-use * Open competition * Minimum rates for individual life insurance and annuity contracts are regulated indirectly retouch limits imposed on assumptions used in establishing reserves. Control of Agents' Activities * Insurance laws also prohibit certain activities on the part of agents and brokers, such as twisting, rebating, unfair practices, and misappropriation of funds belonging to insurers or insureds. * Unfair Practices is a catch-all term that can be applied to many undesirable activities of agents, claim adjusters, and insurers (including misleading advertisements). * Unfair practices may lead to fines, removal of licenses, and, in extreme cases, to punitive damage awards by the courts. Control of Claims Adjusting * Insurance commissioner's control claims adjusting practices primarily through policyholder complaints. * The commissioner's office investigates complaints. Control of Underwriting Practices * Over the years, insurers have used a variety of factors in their underwriting decisions. * A number Of these have become taboo from a public policy standpoint. Their use may be considered unfair discrimination. * Credit rating issues and privacy issues are under review and regulation. Providing Markets * Residual Markets for lines of business with availability issues to high risk insureds * Catastrophic pools for windstorm and earthquake risks Source: Baranoff, Etti. Risk Management and Insurance. John Wiley + Sons. 2003.
Major Issues in P/C Insurance Regulation 1920-1998. As noted in the introductory discussion and as shown in Exhibit 1. C, the underlying causes for actions by insurance regulators in the P/C markets are insolvencies, catastrophes and crises of availability and affordability. During the 1980s and 90s, crises and fraud led to many insolvencies, prompting regulators to strengthen their financial and market conduct regulation. Even before these waves of insolvencies, states had set up guaranty funds to protect insureds in cases of insolvency. (16) To ensure viable markets for all potential insureds, assigned risk pools were created for high-risk customers and catastrophe pools were developed for disaster prone areas.
The states continued the rate regulation system created prior to 1920 and used the advisory rates provided by the Insurance Services Office (ISO), which also filed policy form changes on behalf of member insurers with state regulators. Until the 1980s, when anti-trust fears led to its reorganization, ISO exerted great power as the industry's main advisory organization.
Major Issues in Health Insurance Regulation 1920-1998. Health insurance took off during the 1930s with the birth of the Blues-Blue Cross for hospitals and Blue Shield for doctors. While commercial insurers initially regarded health risk as uninsurable because of moral hazard and adverse selection, the success of the tax-exempt Blues led to interest by the commercial carriers. The Blues were required to use community rating by regulators, while the commercial writers could use experience rating. As a result, commercial insurers' share of the market grew. (17) HMOs, another prepaid health care system, had appeared earlier, hut it was only after the passage of the Health Maintenance Organization Act of 1973 requiring employers to offer HMOs to their employees that the HMOs' market share grew dramatically. (18)
With health insurance costs escalating due to aging population, third party payer and medical technology, modern managed care emerged in file late 1970s and early 1980s. As in HMOs, Preferred Provider Organization (PPOs) and other new health care plans limited access to providers. The limiting effects of managed care prompted passage of major healthcare legislation in various states to improve patients' rights. On the national level, various versions of "patient bill of rights" legislation failed to pass. However, various benefits became mandated by states and the federal government, such as a 48-hour stay in a hospital after delivery of a baby. (19)
Major federal legislation ensuring portability of health insurance when changing jobs was signed by President Clinton in 1996. The Health Insurance Portability and Accountability Act (HIPAA) also provided additional requirements including privacy laws.
Major Issues in Life Insurance and Pensions Regulation 1920-1998. As noted in Exhibit 1. C, life insurers were regulated for their solvency and reserves, but not rate regulated. Selling activities were also closely regulated. As new products emerged during the periods of high interest rates and interest in the stock market, such as universal life (1970s) and variable life (1980s), regulators on both the state and federal level (via the Securities and Exchange Commission) became more involved in regulating life insurance products.
The need for market conduct regulation became apparent during the 1980s when agents misrepresented the new interest-sensitive products as "vanishing premium" products, claiming they would be paid up after only a few years due to high interest rates and also could provide substantial retirement income. These misrepresentations cost many life insurers dearly in fines and led to the institution of market conduct examination and the creation of the new ethics officer position in many large life insurance companies.
In pensions, an area that has not been regulated by the states, ERISA passed in 1974 to protect the workers' retirement funds. As many insurers sell investment products such as annuity and life products to pension plans, life insurers regularly deal with this regulation.
As in the P/C area, guaranty funds were established for both life and health insurance in most states in the 1970s and early 1980s.
Social Insurance 1920-1998. The social insurance programs of the 1930s and 1960s represented a major step in federal government involvement in insurance. The risks covered under Social Security and Unemployment Compensation were considered too fundamental to be privately insured. Thus, the government provided a base floor of coverages for old age security, survivors, disability and medical coverage in the form of Medicare A and Medicare B.
Workers' Compensation is considered a social insurance program despite being provided in many states by the insurance industry. There are 25 states that operate state WC funds. Crises in availability during the 20th century led major reforms in the states' regulation of WC. (20)
Trends in Insurance Regulation 1999-2003
Around the beginning of the new millennium, two very different major events affected insurance regulation. After decades of debate, Congress passed the Gramm-Leach-Bliley Financial Services Modernization Act (GLBA) in 1999. Then, on September 11, 2001, America was attacked by terrorists. The horrific attacks on the World Trade Center wad the Pentagon led to the passage of the Terrorism Risk Insurance Act (TRIA) of 2002. The impact of both events on insurance regulation was discussed in the introductory comments. Here, we elaborate on more details.
The Gramm-Leach-Bliley Financial Services Modernization Act (GLBA) of 1999. Since the passage of GLBA on November 12, 1999, insurance regulators have been working to maintain state regulation (as opposed to moving insurance regulation under the federal umbrella) while complying with the new requirements under the Act as featured in Exhibit 3. State insurance regulators point out that they are committed to modernizing insurance regulations to meet the realities of an increasingly dynamic and internationally competitive financial services marketplace. NAIC's and the states' regulators' commitments to change are listed in Exhibit 4.
EXHIBIT 3. KEY FEATURES OF GLBA January 2002 * The Financial Services Modernization Act of 1999, known as the Gramm-Leach-Bliley Act or GLBA, became federal law November 12, 1999. * GLBA breaks down herders among the banking, insurance, and securities industries and establishes a framework to cover the responsibilities of federal and state regulators. * Traditional insurance providers will generally use the Act to offer their products through banks and other financial institutions and/or to become affiliated with a bank or other financial institution. * State insurance departments will be the functional regulators of the insurance business activities of all financial firms engaged in the business of insurance, including banks. * State licensing requirements for all insurers and agents remain in effect. * The Federal Reserve Board will supervise financial holding companies established under the Act, but generally must rely upon the examinations, reports, and decisions of the functional regulators. Source: California Department of insurance: http://www.insurance.ca.gov/ GLBA/MainPgs/Key%20Feature%20Dec%2001.html EXHIBIT 4. NAIC'S AND THE REGULATORS' COMMITMENTS TO GLBA * Amending state laws to include anti-affiliation statutes, licensure laws, demutualization statutes, and various essential consumer protections, including sales and privacy provisions. * Building on initiatives already underway concerning national companies, such as review of financial reporting, financial analysis and examination, and refining the risk-based approach to examining the insurance operations of financial holding companies. * Implementing functional regulation. * Speed to market concept of expediting the introduction of new insurance products into the marketplace. * Regulatory re-engineering, which promotes uniformity, and market conduct reform. * Streamlining and standardizing the licensing procedure for producers. As of February 2003, 48 states and Guam have passed the Producer Licensing Model Act (PLMA) or other licensing laws with the intent of satisfying the reciprocity licensing mandates of GLBA, 3 more legislatures are expected to consider PLMA in 2003. (32) Source: Baranoff, Etti. Risk Management and Insurance. John Wiley & Sons, 2003.
Terrorism Risk Insurance Act (TRIA) of 2002. The horrific attacks of September 11, 2001 affected the insurance industry and its regulation more fundamentally than any previous catastrophe. This was a man-made catastrophe. Neither the industry, nor state and federal regulators can foresee any possibility of truly predicting such future events. Underwriting, as the industry and regulators knew it before, changed its parameters. Initially, many states approved the terrorism exclusion endorsement proposed by ISO on behalf of the industry. However, fears that lack of coverage would curtail economic growth led to the signing of the Terrorism Risk Insurance Act by President Bush on November 26, 2002. The main features of the Act are contained in Exhibit 5.
EXHIBIT 5. MAJOR FEATURES OF THE TERRORISM RISK INSURANCE ACT OF 2002 * An event has to cause $5 million to be certified as an act of terrorism. * Each participating insurance company will be responsible for paying out a certain amount in claims--a deductible--before federal assistance becomes available This deductible is based on a percentage of direct earned premiums from calendar year 2002. The deductible is as follows: () 2002--1 percent (from enactment through the end of the year) () 2003--7 percent () 2004--10 percent () 2005--15 percent * For losses above a company's deductible, the federal government will cover 90%, while the company contributes 10%. * If the federal government pays for insured losses during the course of a year, the Treasury Secretary will be required to recoup the difference between total industry costs (individual insurers' losses up to their deductibles, plus the industry's 10 percent cast share above the deductibles) and the following fixed dollar amounts per year: () $10 billion for 2002 and 2003 () $12.5 billion for 2004 () $15 billion for 2005 * Even with federal support, the insurance industry's share of the risk substantial. For example, assuming that the baseline for the program is $125 billion in commercial insurance (direct premium written) and that the next terrorist attack amounts to $30 billion in commercial property and workers compensation loss, the total industry loss would be approximately: () $11 billion for the remainder of 2002 and 2003 () $14 billion in 2004 () $20 billion in 2005 * The recoupment will be accomplished through a surcharge on all policyholders. The surcharge cannot be more than 3% of the premium paid for a policy in a given year. * Losses covered by the program will he capped at $100 billion; above this amount, Congress is to determine the procedures for and the source of any payments. * The Insurance Information Institute estimates the total insured loss for the World Trade Center, Pentagon and Pennsylvania events is $40.2 billion. Source: Insurance Information Institute (III) http://www.iii.org/media/ hottopics/insurance/sept11/
As noted in the introductory discussion, both GLBA and TRIA open a wide door for federal insurance regulation. The implementation of TRIA is expected to give Treasury Department personnel expertise in insurance regulation. To date this expertise has been exclusively in file hands of the states' insurance regulators and the NAIC.
Additional Trends 1999-2003. Exhibit 1. D also features some less monumental regulatory changes. EGTRRA, 2001 and the new tax-favored Health Reimbursement Accounts are important steps to resolve the current issues of aging population, longer longevity and escalating health care cost. The major benefits of EGTRRA are increases in the tax-favored limits, increased flexibility and administrative simplification. EGTRRA is known to resolve some of ERISA's shortfalls. It is important to note that the changes in regulation described here are not part of state-based insurance regulation, but, are imperative for inclusion since they influence insurance products and innovation in insurance markets.
Summary and Conclusion
This paper's overview of the trends in insurance regulation over 200 years demonstrates that as risk changes, markets grow, and as the world becomes smaller, insurance regulation is no longer the sole domain of the states. Despite McCarran-Ferguson and the repeated affirmation that insurance regulation is under the domain of the states, as in GLBA 1999, we see the increasing involvement of the federal government in insurance issues. Risk, especially after September 11, has become central to every business. It is on the minds of executives and all types of regulators--state and federal alike. Thus, despite the affirmation of the power of the states in this unique financial arena, the federal government is deeply involved in insurance regulation. This involvement is in: 1) providing actual coverages such as the terrorism and flood coverages; 2) implementing of TRIA 2002; 3) forcing the states to create reciprocation laws for agents under GLBA; 4) providing social insurance such as Social Security, Medicare and unemployment compensation (administered
by the states); and 5) overseeing the actions of the states, as was the charge of the House Financial Services Committee during the 108th Congress.
EXHIBIT 1A. LOCAL TO GLOBAL: TWO CENTURIES OF INSURANCE REGULATION--PRE-1870 Line Insurance Markets Key Insurance Events Prior to Fire/ Local markets- Birth of a new 1830 Marine developing economy nation--need for economic growth (financial intermediation) Increased maritime ask. Napoleonic Wars, War of 1812, Embargo Act (18 month stoppage of marine business) Life Charity base 1830-1870 Fire/ Regional [??] national. 1835--A fire destroys Marine Competition in many New York's business markets and high district. Losses are failure rate. $15-$26 million, resulting in bankruptcy for 23 of the 26 local fire insurance companies. Life National Markets Panic of 1837-- financial crisis made Competition and high raising capital failure rate difficult. Civil war [??] growth in sales of life insurance Both Paul v. Virginia in 1868 keeps insurance under the jurisdiction of then states, not the federal government Regulatory Line Industry's Reaction Highlight/Reaction Prior to Fire/ Mutual fire insurers State legislatures 1830 Marine already in most cities, granted chairs to After 1790, joint-stock insurers. insurers begin to form. Fire insurers are State taxation of mostly limited to out-of-state insurers single markets. (encouragement of domestic business.) Marine insurers diversified into fire insurance. Life Churches and charitable State legislatures organizations granted charters to Insurers. 1830-1870 Fire/ Diversification into After 1835 states drop Marine other regional and discriminatory taxes of national markets. out-of-state companies. Development of independent agency By mid-century general system. incorporation laws make it easier in farm insurance companies. Life 1840s--most new life Incorporation and insurers take mutual taxation are main form. functions of regulation. Aggressive marketing 1850s, 60s--states Intense competition begin to establish separate insurance Variety of products. departments. Deferred dividend policies (tontines) Most states follow introduced in 1867. Massachusetts or New York regulatory models. Separate statutes enacted for life and fire & marine insurance. New York law (1849) requires life insurance companies to have minimum capital stock of $100,000 for consumer protection. Both MA (1861)--non- forfeiture law in life insurance EXHIBIT 1B. LOCAL TO GLOBAL: TWO CENTURIES OF INSURANCE REGULATION--1870-1920 Line Insurance Markets Key Insurance Events Fire/Marine Natural Markets 1871: The Chicago Fire, 1872: the Boston Fire. About 100 companies failed. 1906: San Francisco earthquake (direct quake losses of about $24 million and fire losses of about $500 million, according to the National Geophysical Data Center. That would be almost $10 billion in 2000 dollars.) (21) Populist movement leads to anti-compact movement, primarily in Midwestern states. 1911: The NY Merritt Committee: cooperation among insurers is in the public interest, Insurance boards should set rates. Requirement to submit uniform statistics on premiums and losses for the first time [??] national implications. 1914: German Alliance Insurance Co. v. Ike Lewis, Superintendent of Insurance. The Supreme Court declared insurance to be a public good, and thus subject to rate regulation. Casualty Casualty Industry develops New product--national [??] automobile insurance Labor movement and progressive reformers demand protection of workers. Life Few large firms dominate Economic downturn the industry. following Panic of 1873 Variety of new products. Competition leads to: rebating, twisting, and Growth of assessment and exaggerated claims of fraternal benefit future payments on societies tontine policies. Development of industrial 1905--Armstrong Committee life insurance, group Investigation reveals insurance misconduct by insurers including political Global market emerges kickbacks, nepotism, extremely high salaries No health insurance for top officials, and industry misuse of funds. "Commercial insurance companies did not believe that health was an insurable commodity because of the high potential for adverse selection and moral hazard. They felt that they lacked the information to accurately calculated risks and write premiums accordingly." (22) Regulatory Highlight/ Line Industry's Reaction Reaction Fire/Marine Collective rates: By Insurance departments in 1880s, rates are set by almost all states. boards of local agents. Regional organizations set NAIC National Association rates for smaller of Insurance communities. Commissioners) formed in 1871 (originally called Reacting to anti-compact the National Convention movement, rating bureaus of Insurance begin setting "advisory" Commissioners). Goal: more rates. uniformity among states. 1910s: Insurers fight Anti-compact laws passed state rate-regulation. in 20 states by 1908. After German Alliance 1910s: Anti-compact and decision, industry begins industry-based rate to cooperate with regulation replaced by regulators to set rates. state rate regulation and/or supervision. 1914: creation of an Actuarial Bureau within the National Board of Fire Underwriters establishes uniform classification standards. Casualty By 1910, 23 companies Regulators split sell liability policies. automobile insurance between fire & marine companies (property damage) and casualty companies (liability). 1910s: Workers' Compensation laws in most states. Life Many companies fail, The Armstrong Committee leaving industry dominated investigations leads to by few large finds. strict regulation of life insurance. Through the National Association of Life 1907--New York outlaws Underwriters (NALU), deferred-dividend formed in 1890, the life policies, rebating, and insurance industry twisting. New law also attempts to reform curtails lobbying itself. But unlike the activities, eliminates fire insurance industry. proxy voting, and mandates life underwriters standardized policy forms. did not succeed at self-regulation. New York Statute creates national standards because any company doing business in New York is required to follow its rules in all other states (Appleton Rule.) EXHIBIT 1C--LOCAL TO GLOBAL: TWO CENTURIES OF INSURANCE REGULATION--1920-1998 Line Insurance Markets Key Insurance Events P/C Multiple Lines US. v. South-Eastern Underwriters Association Global industry and issues (1944)--U.S. Supreme Court overturns Paul v. Virginia, Electronic: age determines that federal government can regulate insurance. Catastrophe losses--natural disasters: Hurricane Andrews (largest)--August, 1992 with $15.5 billion in insured losses, Northridge earthquake, 1-17-1994, most costly quake in U.S. history, causing an estimated $20 billion in total property damage including $12.5 billion in insured losses.) (23) 1970s--asbestos and pollution losses leading to liability crisis. Underwriting cycles leading to availability and affordability crises Since 1980--increase in number of insurers' insolvencies. (24) Since late 1980s--Redlining and credit scoring underwriting criteria issues Major Financial Institutions mergers-- Citicorp and Travelers (1990s) Stock market bubble from mid 1990s to early 2000 Health Growth of the health 1930-1940--The birth of insurance industry. Blue Cross and Blue Shield Aging population, longer HMOs vs. commercial health longevity of the baby insurers in an era of boom generation and spiraling health care medical technology costs. impacts. Portability and privacy issue for health insurance Life/ New financial products High interest rates in Pensions 1970s and 1980s and the Global Industry stock market bubble in the late 1990s Global issues of financial markets Corruption in pensions People live longer Ethical Issues--vanishing premiums in life insurance Social The Federal government Depression era Insurance enters the insurance area --Social Security and World War II Unemployment Compensation Acts. Worker s Compensation Creep in late 1980s and States are heavily involved 1990s. in WC insurance. Social Security deficits. Aging poli longer longevity of the baby Medicare deficits. boom generation and medical technology impacts. Regulatory Line Industry's Reaction Highlight/Reaction P/C P/C rating by rating McCarran-Ferguson Act bureaus. Industry seeks to (1945)--Congress allows protect the bureau system. states to continue Insurance Services Office regulating insurance as (ISO) provides advisory long as they meet certain policy forms and rates for federal requirements. adoption by the states. Industry granted limited exemption from anti-trust During periods of high laws. Law primarily affects returns on investment property/casualty insurers. income, the industry adopts "Cash flow" underwriting. Various types of rate regulation becoming Flood insurance is too predominant in the states: catastrophic for private Promulgated rates, file insurers and use, use and file and benchmark rates with When litigation resulted deviation. in high losses. ISO files policy forms with 1980s brought a governance exclusions with the state change in ISO to ensure "no regulators. Example: collusion" among insurers Pollution exclusion. in rate setting, Investment income is being considered in rate making by the states. The states adopt modified policy forms proposed by the industry via ISO. Example homeowners, automobile and commercial property and liability policy forms. Response to natural catastrophic events: 1. Hurricanes and weather related catastrophes led to Special Catastrophe Programs known as Beach and Windstorm Plans (i.e. Florida Hurricane Catastrophe Fund) that are designed to ensure the availability of windstorm insurance for properties close to the ocean. These pools are operated by property insurers doing business in those states with exposure. (25) 2. Earthquakes in California led to the creation of the California Earthquake Authority (CEA) in 1996. The CEA is a privately funded, publicly managed organization. Insurers can, participate in the CEA and offer CEA policies to their policyholders. To provide insurance markets during availability and affordability crises, each state adopts some form of involuntary market such as assigned risk pools or joint underwriting associations. All insurers are required to belong to these residual markets. (26) 1970s--Each state creates P/C guaranty fund to protect insureds when insurers become insolvent. (27) Congress passes the National Flood Insurance Act of 1968 & Flood Disaster Protection Act of 1973 (28) to protect residents of flood prone areas. NAIC creating an International Panel, Federal government shadows over NAIC (GAO). The NAIC efforts to bring uniformity among the states via model laws do not bring uniformity. NAIC creating data bases and developing model laws to handle market conduct and underwriting criteria issues. P/C Risk-Based capital laws are enacted in 1994. Issues on the agenda of the NAIC and the states grow in scope and complexity. Federal vs. state insurance regulation debate emerges Health Development of the health Tax incentive for group insurance industry which health insurance codified staves off government Under are 1954 Internal intervention of Revenue Code (IRC). Under nationalized health the code employer insurance. Community contributions to employee rating for the Blues and health plans were exempt experience rating by from employee taxable commercial insurers in income. Cafeteria plans early years. under Section 125 of the Internal Revenue Spiraling health care costs Code--expends tax lead to managed care incentives. solution and the creation of PPOs, POS, and other The 1973 Health Maintenance health plans. Blues, Organization Act commercial insurers and HMOs are more aligned Each states creates a in response to consumer life/health insurance needs. New Medical Saving guaranty fund to protect Accounts (MSAs) and Health insureds when insurers Reimbursement Accounts become insolvent. (HRAS) emerge. The states adopting Long-Term Care products "patients bill of rights" to protect health consumers. Congress too debates me issues. States also adopt mandate benefits requirements for health insurers and special programs to help small employers. The NAIC efforts to bring uniformity among the states via model laws do not bring uniformity. The NAIC and states are handling a wide and complex array of health insurance issues. 1996--Health Insurance Portability and Accountability Act (HIPAA) signed by president Clinton. Life/ Life insurance remained a Life insurance regulation Pensions competitive market. primarily concerned with solvency, adequate reserves Development of Universal and consumer protection Life Insurance products and other innovative life Each state creates a and annuity products life/heallh insurance incorporating investment guaranty fund to protect in the stock market. The insureds when insurers life industry is part of become insolvent. financial intermediation industry and competes Market conduct examinations accordingly. developed by the states to exert greater scrutiny over the conduct of agents and companies advertisements. 1974--ERISA--Employee Retirement Income Security Act--Federal protection of employee benefits and pensions. Creation of the Pension Benefits Guarantee Corporation (PBGC). TRA86--the tax reform of 1986 brought about more changes to pensions regulation by the Department of Labor and IRS. Insurers create new market The NAIC efforts to bring conduct departments and uniformity among the states the position of Ethics via model laws do not bring Officer in the 1980s and uniformity. The NAIC and 1990s. states are handling a wide and complex array of life insurance issues. Social Wage freeze during WW II 1930s-60s--creation of Insurance period leads to increase social insurance programs in employee benefits. including Social Security (1935, 39, 54). In states where WC Is sold Unemployment Compensation, by insurers, insurers fight Medicare and Medicaid. litigation and high medical cost to streamline rate States pass laws to help levels. mitigate the high cost of WC by reducing litigation. Most states regulate WC rates. WC residual markets are available in each state for high risk employers. 25 states run their own WC Funds. Some are exclusive and others are in competition with the industry. (29) EXHIBIT 1D. LOCAL TO GLOBAL: TWO CENTURIES OF INSURANCE REGULATION--1999-2003 Line Insurance Markets Key Insurance Events P/C Global The Gramm-Leech-13 Billey Hard markets Financial Services Modernization Act (GLBA) of 1999 September 11, 2001 terrorist attacks Mold crisis Availability and affordability issues of medical malpractice, (30) accounting scandals and tightness in D&O coverage Life/ Global markets and issue GLBA, 1999 Pensions Continued issues of the late 1990s. A drop in the Mock market and economic downturn. Health Tight markets Continued issues of the late 1990s. Medical inflation. Social Needs of reforms Social Security deficits. Insurance Medicare deficits Large September 11, 2001 WC Losses Regulatory Line Industry's Reaction Highlight/Reaction P/C No major mergers as a NAIC end states reacted to result of GLBA, 1999. ensure continuation of state Insurance regulation The horrific terrorist attacks caused tightness Terrorism Risk Insurance in the markets. Major Act (TRIA) of 2002, Federal changes in underwriting oversight intensifies and coverage. Terrorism while the NAIC develops exclusions until passage directives to implement of TRIA. the Act. The Treasury department also issues The mold issue in Texas directives for comments. leads to mold exclusion and reduction in homeowners Texas Department of coverage. Insurers try to Insurance creates a FAIR leave the Texas market and plan for homeowners do not write new business. insurance and the governor signs a bill to bring Texas Lloyds into the regulatory umbrella. Many States and Congress are working on legislation to lower limits of malpractice litigation. Life/ New innovative life 2001--Economic Growth Pensions insurance products Tax Reduction and Reconciliation Act (EGTRRA)--increase favorable tax treatment in qualified retirement plans and changes in pensions regulation. Health Insurers continue to 2002-Health Care tighten managed care and Reimbursement Accounts increase cost. Employers receive favorable tax shift cost to employees treatment. and look to creative products such as defined contribution health plans. Social Congressional discussion on No change yet--under debate Insurance various solutions in Social to provide prescription Security and Medicare drugs to Medicare recipients. The Sep. 11 Losses led to closer lock into terrorism exposure. Tightness in reinsurance market for WC (31)
(1.) An overview and the steps for implementation are at: http://www.ustreas. gov/offices/domestic-finance/ financial-institution/terrorism-insurance/. The Terrorism Risk Insurance Act of 2002 requires that the Treasury Department monitor the availability and affordability of terrorism insurance, thus placing a federal agency in a rate-monitoring capacity. See also Friedman, S. "Could Terror Law Spur Federal Charter?" National Underwriter Property & Casualty/Risk & Benefits, Management Edition. January 20, 2003.
(2.) See explanation in Section V of tiffs paper. Summary of Provisions of the Act are also at: http://www.senate.gov/~banking/ conf/grmleach.htm
(3.) "ISSUES 2003," National Association of Insurance Commissioners].
(4.) Friedman, S. "Could Terror Law Spur Federal Charter?" National Underwriter Property & Casualty/Risk & Benefits, Management Edition. January 20, 2003.
(5.) Hays, D. "More Insurers Favor Fed Regulation, Survey Finds." NU Online News Service, May 10, 2003. The concept of federal regulation for the insurance marketplace appears to be making some inroads judging by an instant poll taken ... at an industry conference here. The survey was done at the National Council on Compensation Insurance annual meeting, where participants were asked "Which do you favor--state regulation of insurance, federal regulation of insurance or some combination?"
(6.) "The NAIC Testifies on State Market Regulation and Consumer Protection Says Effective Consumer Protection Focused on Local Needs is Hallmark of State Regulation," Kansas City, Mo., May 6, 2003, at www.naic.org
(7.) Brostoff, S., Washington Editor. "Sen. Schumer Plugs U.S. Chartering." NU Online News Service, March 13; and "Issues 2003," Optional Federal Charter, NAIC, page 83.
(8.) Brostoff, S. "Insurance Weighs Heavily on Agenda of House Financial Services Panel." National Underwriter Edition, February 10, 2003.
(9.) See Oversight Plan of the Committee on Financial Services for the 108th Congress at: http://financialservices. house.gov/media/pdf/oplan108.pdf
(10.) January 8, 2003, Texas launches residual market for homeowners insurance, Texas FAIR Plan Association officially begins enrolling consumers at: http: //www.tdi.state.tx.us/commish/news/ nr01083a.html
(11.) Harmon, D. "Gov. Rick Perry signed three insurance bills into law Tuesday." Austin American-Statesman. Wednesday, June 11, 2003:
Insurance regulation: Senate Bill 14 puts all insurance companies operating in Texas under state regulation, giving the insurance commissioner the power to review and reject homeowners rates. All auto policies are now under state regulation. The law takes effect immediately.
Mold remediation: House Bill 329 requires mold assessors and remediators to be licensed by the state, imposing minimum standards on a previously unregulated industry. It takes effect Sept. 1.
Water damage claims: Senate Bill 127 requires insurance companies to respond more quickly to certain water damage claims--an effort to get water damage cleaned up before mold can form.
(12.) Ackerman, T. D. and Ayenew, T. "Beyond Tort Reform: Fixing The Economies Of Med Mal Litigation." National Underwriter Edition. April 28, 2003.
(13.) Prince, M. "Pennsylvania governor pro poses med mal changes." Business Insurance. Posted on June 11, 2003
(14.) Baranoff, D. "Shaped By Risk: Fire Insurance in America 1790-1920." Ph.D. dissertation. The Johns Hopkins University, 2003; Baranoff, D. "Insurance," in Northrup, C., ed. The History of U.S. Economic Policy, 1600s-2000. Santa Barbara, CA: ABC-Clio, 2003.
(15.) 2001 Insurance Department Resource Report, NAIC
(16.) Insurance Information Institute (III) "Insolvencies/Guaranty Funds" Hot Topic, April 2003 at: http://www. iii.org/media/hottopics/insurance/insolvencies/
(17.) See footnote 16.
(18.) History of HMOs, Health Alliance Plan at: https://www.hap.org/info/main/ history_hmo.php
(19.) "Clinton signs 48-hour hospital stay bill for new moms," September 26, 1996, CNN Web posted at: http://www. cnn.com/US/9609/26/new.mothers/
(20.) Insurance Information Institute (III) "Workers Compensation" Hot Topic, May 2003 at: http://www.iii.org/media/ hottopics/insurance/workerscomp/
(21.) Insurance Information Institute (III) Earthquakes: Risk and Insurance Issues, Hot Topic, May 2002 at: http://www.iii.org/media/hottopics/insurance/earthquake/
(22.) Thomasson, M. "Health Insurance in the United States." EH.Net Encyclopedia, Whaples, R., ed., April 18 2003 URL http://www.eh.net/encyclopedia/contents/ thomasson.insurance.health.us.php
(23.) See footnote 15.
(24.) See Insurance Information Institute (III), Hot Topics and Insurance Issues, Insolvencies/Guaranty Funds. April 2003 at: http://www.iii.org/media/hot topics/insurance/insolvencies/, Baranoff, E. G. "Causes of Insolvencies of Texas Insurers during the 1980s and 1990." ARIA meeting, Orlando, FL, 1990; and Baranoff, E. G., and Williams, N. "Texas' Early Warning System," ARIA meeting in Denver, CO, 1989 (unpublished).
(25.) Insurance Information Institute (III), Hot Topics and Insurance Issues, Catastrophic Insurance Issues, June 2003, at: http://www.iii.org/media/hottopics/ins urance/xxx/
(26.) Insurance Information Institute (III) "Residual Markets" Hot Topic, April 2003 at: http://www.iii.org/media/hot topics/insurance/residual/The first of the residual market mechanisms for automobile coverage was established in New Hampshire in 1938.
(27.) History of Guaranty Funds Management Services at: http://www.gfms.org/history.htm and the National Conference of Insurance Guaranty Funds at: http://www.ncigf.org/newbottomx.htm
(28.) The Federal Emergency Management Agency (FEMA) at: http://www.fema. gov/pdf/nfip/floodact.pdf
(29.) Insurance Information Institute (III) "Workers Compensation" Hot Topic, May 2003 at: http://www.iii.org/ media/hottopics/insurance/workerscomp/
(30.) Prince, M. "Cheney calls for medical malpractice reform." Business Insurance, June 13, 2003. WASHINGTON--Vice President Dick Cheney urged Congress to quickly pass medical malpractice liability reform. "The current medical liability system is "broken" and has driven up malpractice insurance rates, forcing some physicians to stop practicing medicine," Mr. Cheney said.
(31.) Insurance Information Institute (III) "Workers Compensation" Hot Topic, May 2003 at: http://www.iii.org/ media/hottopics/insurance/workerscomp/
(32.) Source: NAIC at: http://www.naic.org/ GLBA/narab.htm
1. Baranoff, D. "Shaped By Risk: Fire Insurance in America 1790-1920." Ph.D. dissertation, The Johns Hopkins University, 2003.
2. Baranoff, D. "Insurance," in Cynthia Northrup, ed. The History of U.S. Economic Policy, 1600s-2000. Santa Barbara, CA.: ABC-Clio, 2003.
3. Baranoff, E. Risk Management and Insurance. New York: John Wiley & Sons, Inc., 2003.
4. Baranoff, E.G., D. Baranoff and T. Sager. "Nonuniform Regulatory Treatment of Broker Distribution Systems: An Impact Analysis for Life Insurers," Journal of Insurance Regulations. September, 2000
5. Baranoff, E.G. and D. Gattis, "Shaping a Positive Insurance Regulatory Environment in the New Knowledge Millennium," Seminar, Proceedings of the International Insurance Society, Inc. Vol. 2000, July, 2000.
6. Baranoff, E.G. and D. Gattis. "Measuring Attitudes Toward Regulation," Best's Review, P/C and L/H Issues, September 1998.
7. Hartwig, R.P. "September 11, 2001: The First Year, One Hundred Minutes of Terror that Changed the Global Insurance Industry Forever." Insurance Information Institute at: http://www.iii.org/media/ hottopics/insurance/sept11/sept11paper/
8. Klein, R.W. "The Regulation of Catastrophe Insurance: An Initial Overview." Prepared for The Wharton Catastrophe Risk Project, December 7, 1998.
9. Thomasson, M. "Health Insurance in the United States." EH.Net Encyclopedia, edited by Robert Whaples, April 18, 2003 URL http://www.eh.net/encyclopedia/ contents/thomasson.insurance.health .us.php
Etti G. Baranoff, Virginia Commonwealth University
Dalit Baranoff, The Johns Hopkins University
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|Author:||Baranoff, Etti G.; Baranoff, Dalit|
|Publication:||Review of Business|
|Date:||Sep 22, 2003|
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