FIN: 3400 CH8 REVIEW
Explain the major arguments for federal regulation of the insurance industry.
Advocates of federal regulation present the following arguments in support of their position: (1) Uniform state laws and regulations (2) More effective negotiation of international insurance agreements (3) More effective treatment of systemic risk (4) Greater efficiency of insurers
Briefly explain the significance of the following legal cases and legislative acts with respect to insurance regulation: a. Paul v. Virginia b. South-Eastern Underwriters Association Case c. McCarran-Ferguson Act d. Financial Modernization Act of 1999
(a) In Paul V. Virginia, the court held that insurance was not interstate commerce and that the states rather than the federal government had the right to regulate the insurance industry. This decision stood for about 75 years until the Supreme Court reversed it in 1944. (b) In the South-Eastern Underwriters Association Case in 1944, the Supreme Court ruled that insurance was interstate commerce when conducted across state lines and was subject to federal regulation. (c) To resolve the confusion and doubt that existed after the South-Eastern Underwriters decision, Congress passed the McCarran-Ferguson Act (Public Law 15) in 1945. The McCarran Act states that continued regulation and taxation of the insurance industry by the states are in the public interest and that federal antitrust laws apply to insurance only to the extent that the insurance industry is not regulated by state law. (d) The Financial Modernization Act of 1999 (also called the Gramm-Leach-Bliley Act) had a significant impact on insurance regulation. The legislation changed federal law that earlier prevented banks, insurers, and investment firms from competing fully in other financial markets outside their core area. As a result, insurers can now buy banks, banks can underwrite insurance and sell securities, brokerage firms can sell insurance, and a company that wants to provide insurance, banking, and investment services through a single entity can form a new holding company for that purpose.
Although domiciled in Nebraska, Auto Insurance is licensed to sell auto insurance in 10 states. A different set of rates applies in each state. In five states, prior approval of rates is required. Two states have a file-and-use law, and the remaining three states have a flex-rating law. Auto Insurance has experienced poor underwriting results and needs to increase its rates. a. Explain how each of the above rating laws would apply to Auto Insurance. b. Describe some possible problems that Auto Insurance may experience in trying to get its rates increased in a prior-approval state.
(a) It will take Auto Insurance a substantially longer period to get the rates approved in a prior approval state, and the rate increase granted may be less than the rate increase requested. In a file-and-use state, the rates can be used immediately once they are filed. In a flex-rating state, if the rate increase is within the band or range allowed by law, the higher rates can go into effect without undue delay. (b) As noted earlier, there may be a substantial delay before the rate increase is granted by the state insurance department. The request for a rate increase may also be denied, or the increase granted is less than the amount requested. Additionally, the needed rate increase may be delayed or denied because some politicians believe that auto insurance premiums are too high, and that auto insurance is becoming unaffordable. Finally, if the rate increase is denied or is inadequate, Auto Insurance may decide to reduce the volume of new business written or may even withdraw from the state. If other insurers react in a similar manner there could be a market shortage of auto insurance in the state, which can result in market inefficiencies and distortions.
Opal, age 75, has a $60,000 ordinary life insurance policy that has a cash value of $35,000. Opal is concerned about the cost of long-term care in a nursing home. A new agent of a national life insurer persuaded her to transfer the $35,000 into a deferred annuity. The agent told Opal that the annuity pays lifetime income benefits and also allows her to withdraw the $35,000 without penalty if she should enter a nursing home. After the policy was issued, Opal had 10 days to change her mind. During the free-look period, a friend of Opal examined the policy. Analysis of the policy showed that only 10 percent of the cash value could be withdrawn each year without penalty. A 7 percent surrender charge would apply to any excess amounts withdrawn. In addition, the income payments were scheduled to start in 10 years when Opal attained age 85. Opal filed a complaint against the agent with the state insurance department. An investigation revealed that the agent had made similar misrepresentations to other clients. a. Based on the above facts, identify the illegal practice in which the agent engaged. b. What action can the state insurance department take against the dishonest agent? c. What action can the state insurance department take against the life insurer?
(a) The agent is guilty of twisting. Twisting is the inducement of a policyholder to drop an existing policy in another company because of misrepresentation or incomplete information by the agent. The agent gave false information about the amount of money that could be withdrawn without penalty the first year. Also, the agent told Opal the annuity pays lifetime benefits. However, Opal is 75, and the annuity payments are scheduled to start at age 85. Once again, Opal has been misled by the agent's misrepresentations. (b) The state insurance department can discipline the agent by a fine. The state insurance department can also revoke the agent's license. The insurer can be fined for improper supervision of agents. In addition, the state insurance department has the authority to revoke the insurer's license to do business in the state.
Explain the following actions by agents that are prohibited by state law: a. Twisting b. Rebating
(a) Twisting is the inducement of a policyholder to drop an existing policy in another company because of misrepresentation or incomplete information by the agent. Twisting laws apply primarily to life insurance policies. The objective is to prevent policyholders from being financially harmed by replacing one life insurance policy with another. (b) Rebating is giving a premium reduction or some other financial advantage not stated in the policy as an inducement to purchase the policy. An example is rebating part of the agent's commission to the policyholder. Rebating is illegal in the vast majority of states.
Briefly describe the major types of rating laws.
(a) Under prior-approval law, the rates must be filed and approved by the state insurance department before they can be used. In most states, if the rates are not disapproved within a certain period, such as 30 or 60 days, they are deemed to be approved. (b) Under a modified prior-approval law, if the rate change is based solely on loss experience, the insurer must file the rates with the state insurance department, and the rates can be used immediately (i.e., file and use). However, if the rate change is based on a change in rate classifications or expense relationships, then prior approval of the rates is necessary (i.e., prior approval). (c) Under a file-and-use law, insurers are only required to file the rates with the state insurance department, and the rates can be used immediately. (d) A variation of file and use is a use-and-file law. Under this law, insurers can put any rate changes into effect immediately, but the rates must be filed with the regulatory authorities within a certain period after first being used, such as 15 to 60 days. (e) Under a flex-rating law, prior approval of rates is required only if the rate increase or decrease exceeds a specific predetermined range. (f) A few states make rates that apply to specific lines of insurance, such as title insurance. (g) Finally, insurers may not be required to file their rates for certain lines with the state insurance department.
The Financial Services Company is a large life insurer that sells annuity products to retired people. Company actuaries have designed a new annuity contract that combines lifetime annuity benefits with long-term care in a skilled nursing home. Financial Services wants to market the new annuity nationally in all 50 states. The company faces competition from a national commercial bank that is trying to sell a similar product to Social Security beneficiaries. The CEO of Financial Services believes that the new annuity product could be marketed more efficiently if the company had a federal charter. Several members of the board of directors, however, believe that a federal charter would be undesirable. a. What major regulatory obstacle does Financial Services face in trying to market the new annuity product in each state under the present system of state regulation? b. Assume that Financial Services has the option of obtaining a federal charter. Explain the advantages, if any, of a federal charter to Financial Services in their efforts to market the new annuity product. c. Explain the major arguments against federal charters.
1. a) The major regulatory obstacle is getting each state to approve the new annuity product in a timely manner because of differences and inconsistencies in 50 state laws. It may take as long as two years to get the new product approved in all states. (b) The major advantage is that a federal charter would enable large life insurers to speed up the development of new products and get regulatory approval more quickly. As a result, large life insurers would be more competitive with other financial institutions at the national level. (c) There are several arguments against a federal charter. First, there will be a dual system of insurance regulation under the present system and a new federal system. The cost of regulation will increase because new federal employees must be hired, a mandatory federal charter could result in the loss of premium taxes to the states, and taxpayers will have to pay more because of an additional layer of federal regulation. Second, a new federal regulator would have the power to preempt state laws and may not agree with existing state laws that now affect policyholders and claimants under the present system. Dual regulation may result in regulatory overlaps and confusion among policyholders and insurers as to which laws should apply. Finally, some consumer advocates believe that greater regulation of cash value products is needed at the state level to protect consumers. A federal charter may result in lower consumer protection standards if an insurer is chartered at the federal level.
Describe the shortcomings of state regulation.
Critics claim that state regulation has several shortcomings, which include the following: (1) Inadequate protection of consumers (2) Improvements needed in handling complaints (3) Inadequate market conduct examinations (4) Insurance availability studies conducted only in a minority of states (5) Regulators overly responsive to the insurance industry
Explain why the insurance industry is regulated.
The insurance industry is regulated for the following reasons: (a) To maintain insurer solvency (b) To compensate for inadequate consumer knowledge (c) To ensure reasonable rates (d) To make insurance available
Explain the major arguments in support of state regulation of the insurance industry.
The major advantages claimed for state regulation are as follows: (1) Quicker response to local insurance problems; Greater responsiveness to local needs (2) Increased costs from dual regulation Uniformity of laws by NAIC (3) Poor quality of federal regulation (4) Promotion of uniform laws by NAIC (5) Greater opportunity for innovation
The principal areas that are regulated include the following:
The principal areas that are regulated include the following: (a) Formation and licensing of insurers (b) Solvency regulation (c) Rate regulation (d) Policy forms (e) Sales practices and consumer protection
Explain the principal methods for regulating insurance companies
Three principal methods are used to regulate the insurance industry: (a) Legislation (b) Courts (c) State insurance department