The “Why” of Government Regulation

1. The “Why” of Government Regulation • 1. Some economists believe in an efficient market and would like the role of government to be making sure that competition can exist. • 2. Other economists have less confidence in the market, and believe that direct intervention (i.e., regulation) is needed to correct market failures.

2. Approaches to Government Control • 1. Antitrust concentrates on maintaining competition. The principal thrust of antitrust is to curtail monopoly power. • 2. Regulation direct intervention in the decisions of firms, forcing them to behave in a way that will produce results as near as possible to those that would occur in a competitive market.

3. Economic Theories of Regulation • 1. Market Failure Theory • 2. Capture Theory • 3. Public Choice Theory

4. Rationale for Regulation of Insurance • 1. Vested in the Public Interest Rationale • failures in this field can affect persons other than those directly involved in the transaction • fiduciary nature of insurance and extensive influence requires regulation • 2. Destructive Competition Rationale • competition, if left unregulated, can become excessive

5. Goals of Insurance Regulation • 1. Originally: solvency and equity • 2. Emerging goals: • availability and affordability

6. History of Insurance Regulation • 1869 Paul vs. Virginia • 1905 Armstrong Committee Investigation • 1910 Merritt Committee Investigation • 1944 South-Eastern Underwriters Association case • 1945 Public Law 15 (McCarran-Ferguson Act)

7. Regulation Today • 1. Legislative branch • 2. Judicial branch • 3. Executive branch: the Commissioner of Insurance • 4. the NAIC

8. NAIC State Accreditation Program • In 1989, in an effort to address deficiencies in state regulation, the NAIC established a solvency-policing agenda. • 1. Provides for NAIC certification of states that meet requirements of the program. • 2. Measures that must be adopted by states include enactment of NAIC model laws. • 3. By August 1998, 48 states had been accredited.

9. Areas Regulated • 1. Licensing of companies • domestic companies • foreign companies • alien insurers • 2. Examination of companies • state examinations • zone examination

10. Areas Regulated • 3. Insurer insolvencies • state insolvency funds • early detection of potential insolvencies • Insurance Regulatory Information System (IRIS) • Risk Based Capital requirements

11. Areas Regulated • 4. Rates • General Requirements are that rates must be • reasonable • adequate • not unfairly discriminatory • Life insurance rates only regulated indirectly

12. Areas Regulated • 5. Rates • Approaches to regulation of property and liability rates: • prior approval • open competition • file-and-use • use-and-file • flex rating

13. Areas Regulated • 6. Reserves • 7. Investments • 8. Policy forms • 9. Competence of agents • 10. Unfair practices • rebating • twisting

14. State Versus Federal Regulation • 1. Preeminence of state regulation depends on a single act of Congress: Public Law 15. • 2. Bills to repeal or modify Public Law 15 have been introduced in virtually every session of Congress since 1977. • 3. Repeal of modification is less likely today than at any time in the past 30 years.

15. Arguments Favoring Federal Regulation • 1. Past state regulation has been inadequate. • 2. Federal regulation would bring a desired uniformity. • 3. Insurance is interstate in nature, so regulation should be.

16. Consequence of Repeal of Public Law 15 • 1. Federal regulation would be superimposed on state regulation, which would still exist. • 2. Federal oversight could follow anti-trust approach or it could take the form of strict regulation.

17. Arguments Favoring State Regulation • 1. State authorities more familiar with local problems • 2. State authorities more responsive to local needs • 3. NAIC already provides uniformity to extent desirable • 4. Federal system would be superimposed on state system

18. Repeal of McCarran-Ferguson as a States-Rights Issue • Two issues relating to the regulation of insurance • 1. The first is whether it should depend on market forces or should take the form of market intervention. • 2. The second is whether the decision should be made at the federal or state level. • Currently, the states are free to choose between an antitrust, free-market approach or rigid regulation.

19. The Availability - Affordability Debate • Although there are many products that some members of society cannot afford, it has been argued that insurance is fundamentally different and that the industry has an obligation to make insurance “available” at “affordable” rates. • The debate over “availability” and “affordability” is whether availability and affordability problems represent market failures that should be addressed by regulation.

20. Essence of the Debate • “Availability” and “affordability” are concepts economists know as “supply” and “demand” • 1. Insurers will supply (make available) insurance when the price at which it can be sold will cover the cost of production. • 2. “Affordability” measures premium against the consumer’s ability to pay, not in terms of the cost of production. • 3. There is an inevitable conflict between goals of “availability” and “affordability.”

21. Conflict Between Availability and Affordability • 1. When the cost of losses for a group is low, insurance will be available and affordable. • 2. When the cost of losses for a group is high, insurers will offer the coverage only at a high premium. • 3. The high premium may not be affordable, absent some form of subsidy. • 4. The debate over availability and affordability is a demand for subsidies in insurance.

22. Existing Subsidies in the Insurance Market • 1. Shared Markets • 2. Mandated underwriting losses • 3. Government Insurance Programs • 4. Social pricing

23. Income Redistribution Effects of Subsidies • 1. When insurance is written and sold at a price that is less than the amount required to cover costs, losses are passed on to other parties (e.g., other insurance buyers). • 2. This involves a redistribution of income from one group to another group.

24. Income Redistribution Effects of Subsidy • 3. Distinction among various approaches to the subsidy is artificial. It makes little difference how the income is redistributed. • 4. Some argue that the question should not be how will we provide the subsidy, but rather whether we should provide it at all.

25. Causes of Availability Problems • Availability problems arise for three reasons • 1. Absolute supply of insurance is limited by regulatory standards that dictate relation-ship between insurer surplus and written premiums. • 2. Availability problems arise when the price at which insurance may be sold is less than the cost of production. • 3. The cyclical nature of insurance creates periodic shortages.

26. Causes of Affordability Problems • 1. “Affordability” depends on (1) the cost of the insurance, or (2) the income of the buyer. • 2. A premium may be high in an absolute sense, or relative to the consumer’s income.

27. Causes of Affordability Problems • 3. Premiums that are high relative to the consumer’s income are an income distribution problem, not a flaw in the insurance market. • 4. Premiums that are high in an absolute sense reflect a high hazard; they serve a beneficial function in identifying activities with a greater hazard than society is willing to pay.