Today’s Lecture - #26 Insurance RegulationInsurance companies are one of the most heavily regulated industries. What is the most important reason to regulate insurers?Why Regulate Insurance?Brief History of Insurance RegulationYou be the Supreme Court JudgeWhat is RegulatedRate RegulationWhat type of rating law applies in Illinois for automobile insurance?Regulation of Trade PracticesGeneral AdviceState vs. Federal RegulationRecent ProposalsClaimed Advantages of State RegulationClaimed Advantages of Federal RegulationFederal Government in Action on Insurance Related IssuesFederal Government in Action on Insurance Related Issues - Cont.What Happens When Your Insurer Goes InsolventTypes of Guaranty FundsLessons from Executive Life and Mutual BenefitMutual BenefitBasic LessonsCurrent Problem Areas in InsuranceSlide 23ConclusionsToday’s Lecture - #26Insurance RegulationIntroduction to Insurance RegulationRationaleHistoryWhat Regulation InvolvesState vs. Federal RegulationInsurance InsolvencyCurrent Problems with Insurance RegulationInsurance companies are one of the most heavily regulated industries. What is the most important reason to regulate insurers?A) To prevent deceptive sales practicesB) To make sure they stay solventC) To make sure they don’t set rates too highD) To make sure they don’t discriminate unfairlyE) Some other reasonWhy Regulate Insurance?Market PowerImperfect InformationPublic PolicyAdvance Nature of ContractInsurer gets your money before fulfilling the contractBrief History of Insurance RegulationPaul v Virginia - 1869US v Southeast Underwriters Association (SEUA) - 1944McCarran Ferguson Act - 1946You be the Supreme Court JudgeHow would you rule in the SEUA case?A) Uphold Paul v. Virginia:Insurance is not commerceB) Overrule Paul v. Virginia:Insurance is commerce and subject to Federal laws C) Compromise:Insurance is commerce but should not be subject to Federal lawsWhat is RegulatedLicensing RequirementsSolvency InvestmentsReservesGuaranty FundsPolicy FormsRatesTrade PracticesRate RegulationGeneral RequirementsRates must be adequate, not excessive and not unfairly discriminatoryMethodsPrior approvalFile and useOpen competitionClassification issuesWhat type of rating law applies in Illinois for automobile insurance?A ) Prior approvalB) File and useC) Open competitionD) No rating law appliesE) None of the aboveRegulation of Trade PracticesAgents must be licensedProhibited activities for agentsTwistingRebatingAllowed in Florida and CaliforniaEffect of agents’ interestsClaim practicesUnderwriting practicesGeneral AdviceIf you are having a problem with an insurance company (billing, claims, unjustified cancellation, unfair treatment), contact the insurance department in the state where you live.In Illinois, contact:Illinois Division of Insurance320 West Washington StreetSpringfield, IL 62767217-782-45151-866-445-5364 (toll free)or online at:http://www.idfpr.com/DOI/Complaints/Complaints.aspState vs. Federal RegulationStates Currently Regulate InsuranceOnly Major Industry Regulated at State LevelWhy?TraditionPaul v. VirginiaUS v. SEUA - during W.W.IILed to McCarran-Ferguson ActRecent ProposalsRepeal of McCarran-Ferguson ActWould lead toFederal regulation instead of stateor Dual regulation State regulation of small insurers Federal regulation of major insurersClaimed Advantages of State RegulationHave Current KnowledgeRecognizes Local ConditionsEncourages ExperimentationEffects of Mistakes are LocalizedClaimed Advantages of Federal RegulationUniformityCould get the best regulatorsWould be able to deal with large, multinational insurersFederal Government in Action on Insurance Related IssuesSocial SecurityBankrupt by 2040 or earlierPolitical environment prevents informeddiscussions and solutionsFederal Savings and Loans Insurance Corporation (FSLIC) 1934-1989Inadequate regulationPolitical pressure to keep insolvent S&Ls openTaxpayer cost of about $200 billionFederal Government in Action on Insurance Related Issues - Cont.Pension Benefit Guaranty Corporation (PBGC)12/31/04 financial position: negative $23.5 billionUnited Airlines termination in May, 2005: $9 billionCovered defined benefit pension plansUnderfunded by $600 billion (termination basis)National Flood Insurance ProgramExpected cost from Katrina and Rita $22 billionNeed to borrow from Federal governmentCannot repay these loans from future premium incomeWhat Happens When Your Insurer Goes InsolventState guaranty funds applyLimits on coverageDeductible on premium refundsDelays in paymentTypes of Guaranty FundsNew YorkPre-assessment fund1982 Legislature “appropriated” $87 millionRecently found illegal and forced to return fundsAll Other StatesPost-assessment basisLonger delaysLimits on assessmentsLessons from Executive Life and Mutual BenefitExecutive LifeTaken over by California regulators in April, 1991Company was soldPolicyholders received 70-80% of their benefitsMutual BenefitTaken over by New Jersey regulators in July, 1991Withdrawals restricted until 1999Significant penalties applied to withdrawalsCredited interest rates lowered below contract levelBasic LessonsIf a company is too big, then regulators will intervene and re-write the contracts rather than declare insolvency.Current Problem Areas in InsuranceComplex productInsolvenciesRising costs of liability insuranceLack of availability of property coverage in coastal areas Irresponsible regulationCalifornia - Proposition 103New Jersey - Residual Auto Market ($3 billion in debt)Current Problem Areas in InsuranceCrooked regulators – LouisianaSherman Bernard - Commissioner 1972-1988 Convicted of taking payoffs – sentenced to 41 months in prisonDouglas Green - Commissioner 1988-91Convicted of fraud, money laundering and bribery - served 12 years in federal prisonJim Brown – Commissioner 1991-2002Convicted of lying to the FBI – sentenced to 6 months in prisonConclusionsInsurance does need to be regulatedCurrent regulation is excessive and misdirectedFocus of regulation should be on solvencyChallenges presented by new financial instrumentsUnderstanding derivativesDealing with international transactionsHedging interest rate and similar risksExpanding use of modelingNeed for competent, ethical