CHAPTER 10
Insurance Regulation
I. SUGGESTED CLASSROOM TIME: 110–130 MINUTES
II. CHAPTER OVERVIEW
This is the fourth and final chapter devoted to describing the participants in the insurance
politics. This material is particularly salient in light of the banking industry’s movement
toward insurance sales. One may also note that in some types of insurance activity, for
example, employment-based plans under ERISA, federal regulation takes precedent. The
influence of the Financial Modernization Act known as the Gramm-Leach-Bliley Act of
1999 is also addressed in this chapter.
III. LECTURE OUTLINE
A. Introduction—this chapter looks at how the federal government delegates regulatory
status to the states and how the various state governments regulate the insurance
transaction and the marketplace. One of the main thrusts of regulation is to protect
consumers, and insurance regulation is no exception.
B. Insurance Regulation
1. Definition of regulation—the rules of the insurance marketplace, as established by
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4. Public law is a federal law that gives states the most power to regulate, known as
Public Law 15, the McCarron-Ferguson Act.
C. Reasons for Regulation of the Insurance Transaction
1. Solvency: The most important reason for regulation. Consumers would suffer great
2. Unequal knowledge and bargaining power: In general, consumers do not
understand insurance contracts or financial statements. Thus, regulation is needed
3. Prices: Because prices are set before losses occur, the insurer has a difficult
problem. If prices are too high, the insurer will either make a lot of money or lose a
4. Promotion of Social Goals: In recent years some regulation has been directed at
making insurance more available and/or affordable for some groups. This basically
means that there is subsidization going on.
D. History of Regulation—State or Federal Regulation?
1. Paul v. Virginia: In 1869, the U.S. Supreme Court declared insurance not to be
interstate commerce; hence, it was the proper subject of state regulation (taxation).
3. South-Eastern Underwriters Association case (SEUA, 1944): The U.S. Supreme
Court found that certain practices of members of the SEUA violated federal
4. P.L.–15 (also known as the McCarran Act, or McCarran-Ferguson Act, 1945)
allowed the states to continue to regulate insurance if they regulated in the public
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5. Security and Exchange Commission v. Variable Annuity Life Insurance Company
(VALIC case, 1959). The court decided that the variable annuity prior to the
E. Gramm-Leach-Bliley Act of 1999 (GLB)
1. Purpose: To modernize the US financial services markets, formalize regulation and
make markets more competitive.
2. Important provisions of GLB (1999)
a. Title 1—repeals Glass-Steagall Act and allows for the creation of holding
companies
3. Provisions impacting the insurance transaction
a. Tying loans to the purchase of insurance is forbidden.
b. Misrepresentation of any aspect of products is forbidden.
F. Current Regulation by the States
1. Some uniformity comes from National Association of Insurance Commissioners
(NAIC) and New York’s Appleton Rule (which applies to all companies doing
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3. The role of the NAIC after Passage of GLB Act was modified because of several
initiatives.
a. Producer licensing reciprocity and uniformity
G. Regulated Activities
1. Investments limited to specified types and companies (Prudent-person rule type
restrictions)
2. Legal reserves and surplus
a. Purpose: an attempt to promote solvency
b. These rules force insurers to maintain a minimum amount of assets by causing
them to set up offsetting liabilities.
i. Unearned premium reserve: Nonlife insurers must set up a liability when
3. Regular audits and solvency testing
a. Insurance Regulatory Information System (IRIS) monitors key ratios of
insurers, which alerts regulators to any changes in financial condition.
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4. Risk-based capital (RBC) requirements
a. Life insurance and nonlife companies are subject to RBC requirements.
5. Guaranty funds
a. Designed to protect policy holders from losses due to insolvent insurance
companies.
6. Rate regulation
a. Some states require prior approval before rates are used; others allow for more
market-place competition using systems such as “prior approval,” “use and
file,” “file and use,” and “open rating.”
b. Rates are to be adequate, fair, and not unfairly discriminatory.
7. Antitrust concerns and rate making
a. If PL-15 were repealed, federal antitrust laws would apply to insurance rate
making.
8. Investment activities
a. Investments for life and nonlife companies are limited by regulation.
9. Policy form approval and expense limitations
a. New York’s section 4228
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10. Qualifications or licensing companies, agents, brokers, adjusters and company
officers
a. Admitted versus nonadmitted insurers
11. Consumer Complaints
12. Taxation
a. Premium tax
IV. ANSWERS TO REVIEW QUESTIONS
1. What does the term insurance regulation mean? Insurance regulation can be
viewed in simplistic terms or as a complex interaction of factors. A simple definition of
2. Why is the solvency of insurers of such great importance to regulators?
How do the regulators try to establish and maintain insurers’ solvency? One reason for
the purchase of insurance is to provide peace of mind in knowing that a loss will not
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3. What is meant by unequal knowledge and bargaining powers? Why do
regulators have to protect the purchasers of homeowners insurance more
than purchasers of large commercial insurance policies? Because insurance
contracts are difficult for the layperson to comprehend, due to the legal technicalities
4. How does the pricing of an insurance policy for the insurer differ from a
bologna manufacturer’s pricing its product? Why does the difference in
pricing problems require that insurance pricing be subject to regulation?
The bologna maker knows the costs of the majority, or all, of the inputs for his
products before he determines the price of his output. Even if the price of the inputs
fluctuates widely, the bologna producer can make equally rapid price adjustments. The
5. Why might the lowest-priced insurance policy be undesirable from the
consumer’s standpoint? The lowest priced insurance policy may come from a
financially weak, claims-resisting, no post-sale-service type of company. Any one of
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6. Describe the two approaches to rate regulation in insurance. The “prior-
approval” approach to rate regulation, which appears to be gaining favor, requires the
insurer to file proposed rates with the state insurance regulator and receive official
7. What was the outcome of the Paul v. Virginia case? The outcome of the Paul v.
Virginia case was that the Supreme Court agreed with the state’s interpretation. That
8. What effect did McCarran-Ferguson Act have on insurance regulation?
Why was it passed? The McCarran-Ferguson Act (P.L.-15) was passed one year after
the U.S. Supreme Court determined that the insurance transaction was one of
9. What is the role of the NAIC? What are its main functions? The National
Association of Insurance Commissioners (NAIC) has the responsibility of bringing a
10. How did the Gramm-Leach-Bliley Act (GLB) change the competitive
landscape of insurance? GLB was an attempt to level the playing field for all
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11. What are insurance company reserve requirements? How do they work to
protect the consumer? Reserve requirements determine the minimum liabilities of
an insurer. These liabilities include unearned premium reserve, claims reserves, and
12. Explain the nature of the risk-based capital ratio. Risk-based capital standards
were developed due to several large bankruptcies in the insurance business. Low
minimum capital amounts were the standard and did not reflect the risk associated
13. Describe the main methods for regulating the investment activities of
insurers. Insurance companies are restricted by regulation as to their investment
practices. High-risk or inferior investments may jeopardize insurer solvency; thus, the
14. Describe the differences between admitted insurers and nonadmitted
insurers. An admitted insurer is one that is licensed in the state where it plans to do
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15. Describe surplus-lines markets and explain their role in serving the needs
of insurance consumers. Surplus-lines markets are opportunities for insurance
consumers to acquire coverage, normally for hard-to-place business, from companies
V. ANSWERS TO OBJECTIVE QUESTIONS
1. All except which of the following are reasons to why the insurance transaction is so
carefully regulated?
2. The first insurance case dealing with the question of state versus federal insurance
regulations to reach the U.S. Supreme Court was
3. The two main regulatory approaches to supervising insurers’ prices are called
4. The federal law that allows the combination of banks and insurance companies is the
5. A ______ is created by insurance regulators to pay for the unpaid claims of the
policyholders of an insolvent insurance company.
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6. If an insurer’s liabilities exceed the value of its assets, it is
7. Assets that are readily available to pay claims are called
8. “Insurance provided by a licensed insurer within the state providing the license” is the
definition of
VI. IDEAS FOR INSTRUCTORS AND TEACHING METHODS
1. Have an extended discussion concerning the advantages and disadvantages of state
versus federal regulation of insurance. Who will regulate companies that merely exist
and operate within the boundaries of one state?
2. Discuss what possibly could happen if P.L.-15 were repealed to a) the ease of entry into
3. Have students discuss the following questions: Should rates charged by insurance
companies be as highly regulated as they are? Should government just focus on the
adequacy of rates? Should government be concerned and regulate how high rates are?
4. Have the students review the information on insurance company financial ratings. In