Insurance companies commonly use demographic factors to determine risk in setting rates, coverage, benefits, and eligibility. The effect on availability and affordability can be substantial. Furthermore, the use of a demographic factor can reflect or reinforce past or present patterns of discrimination. Nevertheless, there are signs that social values and civil rights may be starting to influence the equation. Discrimination based on race has been illegal for a number of years. Several states have also passed laws that ban or reduce the use of rate classifications based on age, gender, and marital status.
It is challenging to identify good risk predictors that do not rely on group or immutable characteristics. Such analysis requires the criteria to be reliable, verifiable, and administered efficiently and effectively. They must be as accurate as demographic factors in predicting losses, but with less prejudicial effect. For example, continued employment may be a more significant indicator of health than passing the traditional retirement age of 65. The number of miles driven and a person’s driving record may be better predictors than gender in determining auto insurance risks.
Because they are fast and relatively efficient to use, credit-based insurance scores are frequently being relied upon in setting premiums. There is debate about their fairness for individual policyholders, particularly for people of racial and ethnic groups that have experienced discrimination and those with lower incomes. However, several studies, including a 2007 report by the Federal Trade Commission (FTC), have found the use of credit-based insurance scores to be predictive of the propensity to file a claim. The FTC found little effect as a proxy for membership in racial or ethnic groups. Currently, three states—California, Massachusetts, and Hawaii—prohibit credit-based auto insurance pricing.
A 2016 Consumer Federation of America (CFA) study found that automobile insurance premiums often rise dramatically for good drivers as a result of insurance companies’ consideration of personal characteristics related to customers’ economic status. The study analyzed minimum limits liability premiums quoted to men and women in 15 cities by five of the nation’s largest auto insurers and found that premiums increased an average of 59 percent, or $681 annually, when the characteristics of the drivers were changed to reflect a lower economic status. CFA tested the impact of five factors that insurance companies frequently use to price auto insurance: level of education, occupation, homeownership status, ownership of a car during prior six months, and marital status. The report found that drivers with the same driving record and living at the same address pay higher premiums 92 percent of the time if they have a high school degree and a blue collar or hourly job, rent their home, have not owned a car for the past six months, and are unmarried. All of these factors are associated with lower economic status. This makes it important for state regulators to review the use of these factors in setting premiums to ensure adequate access to and affordability of insurance, particularly when states require consumers to buy insurance coverage.
Models that project losses from hurricanes and other natural disasters can also have a big impact on insurance rates. However third-party vendors, such as risk-modeling companies, that develop and sell information from such models are often not subject to state insurance department oversight.
After natural disasters homeowners and other policyholders are often subject to arbitrary and unfair policy cancellations or interpretations, which underscore the need for additional protections. For example, in 2006 a federal court ruled in Paul and Julie Leonard v. Nationwide Mutual Insurance Co. that a clause in the plaintiff’s homeowners insurance policy stating the insurer would not pay for losses from two simultaneous events (such as wind damage and water damage) was ambiguous and invalid. Such clauses, common in homeowners policies, have been used to deny coverage altogether if a small portion of damage can be attributed to a cause other than the covered peril.
The National Association of Insurance Commissioners (NAIC) has proposed the development of all-perils coverage backed by the National Flood Insurance Program to avoid conflicts between consumers and insurers regarding the cause of damage to their homes in a hurricane or other natural disaster.
Another area of growing concern involving older Americans is annuity sales because these products are sold as retirement investments. As sales have risen, consumers and regulators have reported instances of unfair and deceptive sales practices, particularly with respect to deferred annuities. According to the NAIC, most states have adopted some form of its model suitability regulation for annuity transactions. In some of those states, suitability requirements apply only to individuals of a specified age, generally 65 and older. In 2010, the NAIC revised its model suitability regulation for annuity transactions to be more consistent with the Financial Industry Regulatory Authority suitability rule that governs sales of variable annuities. The SEC is studying whether fiduciary duty is an appropriate standard of care in offering investment advice in the securities industry. The terms used in annuity contracts may also be confusing. Insurance companies often use different terms for similar benefits under the contracts, which can make product comparison difficult.
Yet another area of concern is with viatical settlement products, which were developed in the 1980s to enable people with terminal illnesses to obtain needed funds from their life insurance policies prior to death. A related practice involves healthy people who settle (or sell) their life insurance policies when they no longer need or want them. Some of the settled policies are bundled into securities or bonds and sold in global financial markets. Policies for which a market has developed are typically whole life with a cash surrender value. The policies are sold for more than their cash surrender value but less than the life insurance benefit.
These practices have the potential for fraud and misrepresentation for both the person who invests in the product and the person who provides the insurance policy. Policyholders involved in these transactions are often unaware that selling their policies can limit their ability to obtain subsequent life insurance and can cause them to incur an income tax liability. Insurance companies are concerned that healthy older people are being encouraged to allow strangers to buy (or originate) insurance policies on their lives with the intent to sell those policies. These transactions, known as stranger-originated life insurance (STOLI), may pose risks for the life insurance marketplace and generally violate state insurable interest laws. People encouraging STOLI transactions frequently give potential purchasers misleading information, including about how the premiums will be paid, to encourage them to consent to a policy.
The National Conference of Insurance Legislators (NCOIL) and the NAIC have each adopted a model law governing life and viatical settlements. Although the two models take different approaches, each addresses the STOLI issue. Twelve states have adopted the NCOIL approach, and eleven have utilized the NAIC model. Another seven states have enacted legislation to prohibit STOLI but do not follow either the NCOIL or NAIC models.
Insurers have new tools and technologies to manage claims and costs. These practices can benefit consumers by keeping down the cost of insurance. They also can lead to criticism when such practices are seemingly used unfairly. Life insurers have come under criticism lately for using the Social Security Administration’s death master file to end annuity payments when the annuitant has passed away, but failing to use the file or other means to expedite payment of life insurance benefits.
Another product that can expose consumers to fraud is prepaid, or “preneed,” funeral insurance, which people buy to ensure that their specific funeral arrangements are carried out. The policies can cover such things as coffins, memorial services, cemetery plots, and headstones. Although such policies can be beneficial, the potential for scam artists and abuse exists (see this chapter’s section on Consumer Products—Deathcare Industry.)
Unfair Acts and Practices in the Insurance Industry: Policy
Availability of coverage
Congress and the states should prohibit insurance companies from denying access to insurance coverage, particularly to people with disabilities, preexisting conditions, or chronic illnesses.
Legislation and regulation should prohibit companies from refusing to insure people, canceling or failing to renew policies, raising premiums, reducing death benefits, or limiting coverage based on age alone or in an arbitrary or unfair manner.
Redlining (the practice of refusing to insure), raising costs unfairly, or severely limiting service in certain geographic areas because of their racial or income composition must be outlawed.
New risk-classification systems
Research is needed to establish risk-classification systems that accurately and fairly reflect the risks associated with the individual characteristics of each insured person.
Information on risk-classification models used to set rates for homeowners and property insurance should be made available to the public, and states should establish appropriate oversight of the third-party vendors of such models.
States should require and enforce effective disclosures of life insurance premium costs, including costs of long-term care policies.
State departments of insurance should make credit-scoring models available to the public. Such disclosures are important if consumers are to make rational decisions in the marketplace.
In their review of insurance policy filings, state insurance departments should give particular attention to identifying and removing ambiguous and unfair wording and definitions.
Unfair or fraudulent marketing practices
- take swift, effective disciplinary action against unfair market practices and discriminatory pricing and service;
- impose a suitability requirement for life insurance sales; and
- require filing of replacement clauses to help prevent the practice of churning policies.
State licensing and regulatory boards should monitor industry compliance with laws that address the marketing and offering of prepaid funeral insurance by funeral directors, cemeterians, and third-party salespeople.
In the case of long-term care insurance, age-based practices should not result in exorbitant or unfair pricing.
States should require life insurers to use all reasonable means to locate the beneficiaries of life insurance policies.
States should strengthen prohibitions against unfair and deceptive practices in the sale of equity-indexed annuities and other annuity products, and should implement needs-based sales requirements for all insurance products.
States should adopt a fiduciary standard of care for sales of annuities, or at minimum, strong suitability requirements for annuity products that apply regardless of the purchaser’s age, as set out in the most recent version of the National Association of Insurance Commissioners model regulation.
Life and viatical settlements
States should pass laws regulating life and viatical settlements. Such laws should include requirements for licensing, record retention, and disclosures for both ends of the transaction. Such laws should not limit the authority of securities regulators over the secondary sale of life or viatical settlements as investments.