Insurance is an essential financial product intended to protect people and their property against significant financial loss. It is often required to gain access to or buy important products and services such as health care, a car, a home, and credit. In addition, the complexity of insurance contracts and the need to ensure the solvency of companies to meet future obligations has traditionally justified a substantial role for government regulation of the insurance industry.
Regulatory issues—many insurers are seeking parity with competing banks and securities firms to introduce new products into the marketplace and are pressing for more uniform standards and filing procedures to speed that process. Although a majority of states use some form of flexible or competitive rating system for property and casualty insurance, some industry groups and companies favor total rate deregulation. Further, various bills introduced in Congress have proposed establishing a dual regulatory and optional federal charter system for insurance. Like the federal preemption of state banking regulation, these proposals could weaken consumer protection currently afforded under state law.
States have responded with the Interstate Insurance Product Regulation Commission (IIPRC), a multistate system to develop uniform national standards for asset-protection insurance products such as annuities and life, disability, and long-term care insurance. The IIPRC held its first meeting in 2006. Its membership now includes 43 states and Puerto Rico, representing 70 percent of the value of insurance premiums nationwide. A major potential benefit for consumers is that pooling resources for product approvals and filings may free additional state resources to review market conduct and undertake other consumer protection measures.
The federal role in insurance regulation—the McCarran-Ferguson Act of 1945, which preserved the states’ traditional role as the primary regulator of the insurance business, also granted insurance companies a limited exemption from federal antitrust laws. The federal exemption covers the “business of insurance,” which among other things allows for joint underwriting, but it does not provide a blanket exemption from antitrust laws.
The activities that contributed to the near-collapse of insurance giant American International Group (AIG)—including massive sales of credit default swaps without appropriate collateral and capital reserves—highlighted the federal government’s lack of knowledge about the insurance industry, as well as the interconnectedness of many companies in the industry to the broader economy. As a result, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) authorized a more formal role in insurance regulation for the federal government. The act establishes the Federal Insurance Office (FIO) in the Department of the Treasury to monitor the insurance industry, including by identifying gaps in insurance regulation that could lead to systemic crises in the financial services industry.
The scope of FIO’s authority extends over all lines of insurance except health insurance, crop insurance, and long-term care insurance (unless long-term care insurance is included in life insurance or an annuity, in which case it is under the FIO’s authority). The FIO may preempt state insurance regulations that result in less favorable treatment of a non-US insurer. The preemptions do not apply to state insurance regulation of rates, premiums, underwriting, sales practices, coverage requirements, the application of antitrust law, or capital or solvency requirements (unless these requirements treat non-US insurers less favorably than US insurers). Only the insurance regulator in the state where the insured party resides has authority over nonadmitted insurers, sometimes called surplus lines.
Another important role of the FIO is monitoring the extent to which traditionally underserved communities and consumers—including people from racial and ethnic groups that have experienced discrimination and people with low or moderate incomes—have access to affordable insurance products. Recently, the FIO adopted a methodology to measure the affordability of automobile insurance. FIO will calculate an annual affordability index, providing a benchmark for understanding the affordability or lack of affordability of state-mandated automobile insurance in communities across the nation. According to FIO’s definition of affordability, average premiums exceeding 2 percent of the median income of lower-income communities and communities of racial and ethnic groups that have experienced discrimination, serves as an indicator that action is needed to improve affordability and accessibility so that drivers can comply with state insurance mandates.
Dodd-Frank authorized the Financial Stability Oversight Council (FSOC) to bring “systemically important” insurers under the solvency regulatory authority of the Federal Reserve Board (FRB). The act gave state insurance regulators a nonvoting seat on FSOC. The act also established a voting FSOC member with expertise in the business of insurance. In a related matter, the FRB issued a notice of proposed rulemaking on capital requirements for 14 insurance companies that Dodd-Frank placed within its jurisdiction. These include two that were designated by the FSOC as systemically important financial institutions. The other 12 are insurance companies that are organized as savings-and-loan holding companies. These 14 companies account for about one-quarter of the US insurance industry’s assets. A key rationale for capital requirements is that they give regulators a better view in what companies are doing and can help them to prevent a collapse that would precipitate a system-wide crisis, as occurred with insurance giant AIG in 2008. The FRB is expected to consider a number of approaches to setting capital standards tailored to insurance and will issue a proposed rule after reviewing public comments.
Insurer solvency—maintaining insurer solvency is a key function of state insurance regulation. Some say it is the most important consumer protection, because a solvent insurer will be around to pay when policyholders make a claim. All states have guaranty funds that pay claims in the event of insurer insolvency. Insurance regulators go to great lengths to avoid or mitigate claims against state guaranty funds, including facilitating takeovers of financially troubled insurers.
Each state has a separate guaranty fund for property and casualty insurers and for life and health insurers. The coverage amounts are set by state law. They vary by line of insurance and state. Coverage for annuities comes through the life and health guaranty funds. Generally, coverage for annuities has followed the account insurance limit of the Federal Deposit Insurance Corporation (FDIC). Although Congress increased the FDIC insurance coverage to $250,000, not all states have followed suit to increase their limits beyond $100,000.
Coping with major disasters—natural disasters and climate change have revealed major shortcomings in and put major strains on the country’s property insurance system (see Chapter 10, Utilities: Telecommunications, Energy and Other Services—Sustainable Energy and Climate Change). Along the Gulf Coast and in coastal areas along the eastern seaboard, homeowners continue to experience high insurance rates, sharp rate hikes, cutbacks in coverage, and nonrenewals. Households with low incomes and retirees living on fixed incomes are hit particularly hard. Some companies have enforced stricter underwriting standards to limit their exposure in high-risk areas. Others have limited the types of properties they insure. Some insurers have been forced to leave certain markets altogether. In some states, insurers of last resort have taken on market share far larger than their original intent. Further, as more people live near earthquake faults, floodplains, and coastlines, many areas of the country will face similar insurance cost increases and lack of coverage. States have taken a number of actions to improve the availability and affordability of insurance in coastal areas. Many have created state catastrophe funds to provide additional insurance capacity by allowing private insurance companies to set aside money tax-free for covered losses, and many have set up state-run “wind pools” as insurers-of-last-resort.
States have also taken steps to make buildings better able to withstand the impact of major storms by:
- adopting and enforcing risk-based building codes and strengthening land-use planning;
- providing home inspections to identify potential storm-resistance improvements;
- implementing programs to reinforce existing structures, including financial assistance for low-income owners; and
- mandating premium discounts for homeowners who implement approved mitigation measures.
Although such actions help reduce the effects of storms on the insurance market, the rising cost of reinsurance has put insurance out of reach for many former policyholders. One proposed measure to deal with this problem includes modifying the Internal Revenue Service code to allow insurance companies to defer taxes on reserves set aside for catastrophic losses while having the Treasury Department implement a reinsurance program for state catastrophe funds in the event of a major disaster. A Government Accountability Office (GAO) report notes that the efficacy of such approaches is uncertain. The National Flood Insurance Program (NFIP) is a key component of the federal government’s efforts to limit the damage and financial impact of floods. However, the program faces a number of challenges and is currently on GAO’s list of federal programs that pose a high risk of financial loss to the Treasury. Although it was intended to be funded with premiums from policyholders rather than tax dollars, as of 2014 NFIP owed the Treasury some $23 billion. Congress has made a number of efforts to strengthen the program, most recently the Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters Act) and the Homeowner Flood Insurance Affordability Act of 2014 (HFIAA). However, HFIAA, which was enacted to address the affordability concerns of certain property owners, amended the Biggert-Waters Act by lengthening the phase out of some premium subsidies and slowing down a number of premium increases that were intended to address NFIP’s solvency concerns. A 2015 GAO report notes that the NFIP is unlikely to generate sufficient revenue to cover any catastrophic losses resulting from future storms or repay the Treasury in the foreseeable future. Congress has considered legislation to facilitate development of a private flood insurance market that could conceivably lift some of the burden off the NFIP. But a proposal previously passed by the House of Representatives lacks a number of important protections for property owners who might purchase such products.
Insurance in the sharing economy—the sharing economy is a new economic model in which companies use online platforms to connect people wanting to exchange goods or services with people who need them (see also this chapter’s section on Innovation for All). Sharing economy companies maintain that they do not directly provide services or sell goods, but rather facilitate transactions between peers—a claim that continues to be challenged in the courts. A sharing economy company might connect someone looking for a ride with someone who is willing to provide a ride in his or her own vehicle; another such company might connect someone looking for accommodations with someone aiming to rent out a room. Challenges can arise, however, in cases where a customer is harmed and the individual providing the good or service does not have adequate insurance.
Congress should not pass legislation that creates federal standards as the ceiling rather than the floor for insurance regulation, thereby preempting state authority to strengthen consumer protections at the state level.
Congress should not pass legislation that creates conditions conducive to regulatory competition between the federal and state governments that would weaken government oversight and consumer protections for insurance customers.
Congress should not pass legislation that removes or weakens state laws guaranteeing consumer protections, given the long-term nature of insurance products.
- establish a full-time, independent insurance consumer advocate office funded by a nominal charge per insurance policy;
- consider statutory changes that would bring reinsurers under the scope of state regulatory authority and require documentation of their financial status; and
- set up and publicize a consumer appeals process.
Conflicts of interest
States should establish strong conflict-of-interest regulations for insurance commissioners, their staff, and any independent contractors hired by the insurance departments.
Commissioners and key staff should be restricted from obtaining employment with, or consulting for, regulated companies after leaving or retiring from public service, for a period long enough to ensure that conflicts of interest are avoided.
Maintaining solvency to cover claims
States should strengthen regulatory oversight of the safety and soundness of insurance companies, particularly as it relates to the protection of consumer funds held by insurers and the availability of coverage in the event of insurance company failure.
State guaranty funds should be created and should ensure adequate coverage in the event of insurance company insolvency.
State life insurance guaranty funds should cover, at a minimum, annuity losses of up to $250,000. Future coverage increases should follow the lead of bank account coverage by the Federal Deposit Insurance Corporation.
States should conduct studies of closed claims to establish how legal settlements and awards figure into insurance costs.
States should authorize their insurance commissioners to regulate insurance companies conducting business in the state, whether or not the companies have a physical presence within state borders.
States should increase the authority and resources of their insurance commissioners and departments in order to:
- establish (in appropriate lines of insurance) experience-based rates by type of business,
- require and analyze essential financial information,
- conduct studies and investigations of insurance problems,
- institute consumer protections, and
- publicize complaint procedures, with special efforts to reach diverse communities.
States should give their insurance commissioners the power to review insurance rates before they are implemented. Although prior approval should be the goal, states should, at a minimum, develop a system allowing rates to be set within specified ranges and approved by the state regulator.
Developing uniform state regulatory standards
The Interstate Insurance Product Regulation Commission (IIPRC) and the National Association of Insurance Commissioners (NAIC) should give priority to identifying a common set of standards (e.g., procedures for conducting market analysis and coordinating market conduct examinations) for a uniform market-oversight program.
The NAIC should create an information clearinghouse for insurance statistics and information, particularly with regard to claims and payouts; develop uniform reporting requirements; and provide technical assistance to state insurance departments.
The IIPRC and the NAIC should provide adequate resources for consumer representation.
Mitigating the impact of natural disasters
Congress should establish a national commission to examine and make recommendations on various approaches to mitigating the effects of natural disasters on insurance availability and affordability.
States should consider creating catastrophe funds to reduce the effects of natural disasters on insurance availability and costs. They should ensure fair claims handling by requiring insurers to itemize outstanding claims and requiring insurance departments to monitor progress toward their resolution.
Building codes in high-risk areas
To reduce the effect of natural disasters on insurance availability and costs, states and local governments should adopt and uniformly enforce strong, risk-based building codes, land-use planning, and programs designed to reinforce existing structures. Programs can include home inspections and financial assistance for low- and fixed-income owners and purchasers.
States should mandate and publicize insurance premium discounts for people who implement approved mitigation measures.
States should develop and implement storm-resistance labeling programs to encourage market demand for homes meeting higher construction standards.
State housing and housing credit programs should encourage the purchase of homes that meet stringent code standards, particularly in high-risk areas.