Chapter Outline

1
Chapter Outline

• 24.1 Scope and Operation of State Insurance
  Regulation
• Regulated Activities
• National Association of Insurance Commissioners
• 24.2 History and Efficacy of State Regulation
• History of State Regulation
• Paul v. Virginia
• South-Eastern Underwriters Association Case
• The McCarran-Ferguson Act
• Challenges to McCarran-Ferguson
• State vs. Federal Regulation

2
Chapter Outline

• 24.3 Objectives of Regulation The Public
  Interest View
• Serving the Public Interest by Mitigating
  Market Imperfections
• An Example of the Public Interest View Dealing
  with Costly and
• Imperfect Information
• Why Some Unregulated Markets May not Provide
  Adequate
• Information
• The Potential Role for Regulation
• Information Disclosure and Minimum Standards
• 24.4 Regulation and Political Pressure
• Regulators as Agents of the Public
• The Economic Theory of Regulation
• 24.5 Summary

3
State Regulation of Insurance

• State insurance department or commission
• State insurance commissioner
• elected
• appointed
• National Association of Insurance Commissioners
  (NAIC)
• Model laws
• State insurance code

4
Regulated Activities

• Licensing of insurers and agents/brokers
• Insurer solvency
• Rates
• Residual markets
• Content of policy forms
• Contract interpretation and enforcement
• Sales practices and information disclosure
• Compulsory insurance coverage

5
History of State Regulation

• State charters
• 1st state insurance department - NH, 1851
• Paul v. Virginia, 1868 - Insurance is not
  commerce
• Development of rating bureaus, 1870s
• Antitrust Acts, 1890s
• Southeastern Underwriters Association Case, 1942
• Insurance is commerce subject to antitrust laws
• McCarran -Ferguson Act, 1945

6
McCarran-Ferguson Act

• Regulation and taxation by states is in the
  public interest
• Exempt from federal antitrust law, provided
  activities are s.t. state law, and do not involve
  boycott, coercion, or intimidation
• Response of many states
• Encouraged insurers to use rating bureaus
• Prior approval rate regulation
• eliminated by many during 1960s

7
Challenges to McCarran-Ferguson

• Some argue it promotes collusion and increases
  prices
• Counter arguments
• Industry has a competitive structure
• Rating bureaus help smaller insurers compete
• Some argue federal solvency regulation would be
  better

8
Arguments in Favor of Federal Regulation

• Lack of uniformity across states increases
  insurers compliance costs
• Lower costs
• Economies in scale
• Avoids costly duplication
• Quality would be uniform
• Weak regulation in one state can hurt people and
  insurers in other states
• Some states free ride on other states

9
Arguments in Favor of State Regulation

• Can be tailored to local needs
• Facilitates experimentation
• NAIC coordination is sufficient to
• achieve economies of scale
• reduce costly duplication
• encourage uniformity
• reduce free riding
• Track record of federal regulation of financial
  institutions is not good

10
Public Interest View of Regulation

• Regulate if
• Industry conduct and performance deviates from
  what would occur in a competitive market
• Characteristics of a competitive market
• large number of sellers
• low entry costs
• low cost of information about prices and quality
• absence of spillovers (externalities)
• Costs and limitations of regulation are
  relatively low

11
Example Costly and Imperfect Information

• Costly for consumers to be informed about product
  quality
• Regulations that deal with this problem
• licensing
• solvency
• contract language
• sales practices
• Legal system also deals with the problem

12
Regulation and Political Pressure

• Difference between what regulation should do and
  what it actually does
• Alternative to public interest view
• Economic theory of regulation
• Legislators and regulators act in their own
  interest
• I.e., they maximize political support
• Regulations reflect this objective, not public
  interest

13
Economic Theory of Regulation

• General prediction
• Small groups (organization costs are low)
• with large per capita stakes (potentially large
  benefits)
• will benefit at the expense of large groups with
  low per capita stakes
• gt producers might be beneficiaries of
  regulation
• (capture theory)

14
Economic Theory of Regulation

• Application to insurance
• Insurers benefit at expense of consumers
• Some think this was true of prior approval rate
  regulation in 1950s and 1960s
• Certainly not true of rate regulation in past two
  decades
• rates often have been suppressed and compressed