REGULATION OF INSURANCE
The history of insurance regulation has its roots in 17th century England; however, the controversial and highly contested route of its development has resulted in a regulatory structure that is uniquely different than that found in other industries. There is no question, however, that the activities of American insurance companies are highly regulated, and few other businesses are guided by the strict controls and guidelines found in this industry.
To illustrate, an insurance company cannot establish operations without specific and regulated levels of operating funds. Other businesses do not have these start-of-business requirements. Similarly, insurance products must be sold by only state approved licensees, while other businesses may market their goods and services through whatever means they elect. Only the insurance industry must have its rates approved by the state in which it is operating, while other businesses are free to set their own prices and rates. Finally, regulations require insurance companies to maintain certain levels of funding (reserves) for the protection of their consumers.
Generally, in most other industries, the state regulatory focus becomes secondary to federal regulation as an industry matures, but the insurance industry in the United States has moved away from a centralized federal regulatory structure and the concentration of regulation has been passed to state governments.
Although the states exerted little control over insurance businesses prior to the Civil War, several states established statutes requiring charters for the insurers selling products within their boundaries. These charters and their provisions restricted insurance company activities and offerings, specified reserves, and established parameters regarding investments.
In some states, chartering bodies directed insurance companies to make their financial standings public, while others required insurers to publish annual reports. Companies in Massachusetts were mandated to make these reports public as early as 1818. Other states soon followed this lead, asking for annual reports from state-based insurance companies, and requiring insurers outside the state to make statements of their financial condition available. Other than these parameters, the insurance businesses of the time were allowed to operate as they chose.
While these chartering mechanisms provided regulatory guidelines for the industry, little was done to enforce these guidelines. The states were adept at issuing charters and often appointed various departments to tax their earnings from premiums, but the administrators assigned to regulate insurance businesses in certain states were not always effective in policing the industry in regards to legislation.
As a result, some companies made poor investment decisions and squandered their funds. Others simply went bankrupt. Still others used deceptive and unfair policy provisions. This roller coaster track record made it obvious that some type of regulation was necessary for the protection of the public. It also indicated a need for regulation to balance business activities and sustain the industry.
In an effort to more efficiently empower state regulatory offices, New Hampshire was the first state to establish a three-seat insurance commission in 1851. The board was later reorganized to include a single commissioner in 1869. Other states followed, and today, state insurance commissions continue to exercise substantial influence within the insurance industry.
In 1855, the state of Massachusetts established the first department of insurance and in 1858 appointed mathematics professor Elizur Wright as insurance commissioner. Wright would later be credited as the person who contributed most to the future of insurance supervision, due to his concept of regulation as a means to promote insurer solvency.
Shortly after New Hampshire created the first insurance commission, the U.S. House of Representatives proposed a bill to establish a national bureau of insurance as an adjunct of the Treasury Department. Two years later, the Senate proposed a similar bill. Both were defeated, however. The reason for the failure of the two bills, it was speculated, was because the country was not yet ready to embrace the idea of federal control of the insurance industry.
In the early 1900s, the effectiveness of the regulation of the insurance industry was studied by two separate committees. The New York legislature appointed a committee (the Armstrong Committee) for the purpose of studying the life insurance industry in 1905. The committee reported finding several areas of abuse regarding financial reporting and other wrongdoings resulting from the lack of effective regulation.
In 1910, the New York legislature appointed the Merritt Committee to investigate non-life insurance lines. This committee reported that price competition would result in rate wars that would be devastating to the industry. It noted that insurers that had only marginal operations would be forced to offer coverage at a slightly lower rate and that those insurers with stronger operations would respond to these decreases by lowering their rates. Eventually, this would create a problem for the margin insurers, which would result in bankruptcies. This study reported that cartel insurance pricing was acceptable for the public good as well as for the good of the industry.
In most states, the insurance department is part of the executive branch of state government, and it is under the direction of the insurance commissioner. In a few instances, this is an elected position. However, in other states, the governor appoints the commissioner. The commissioner�s main duty is to administer the insurance laws of the state, with the assistance of staff members. In most states, the insurance department is represented by a force of anywhere from 50 to 100 persons.
Paramount to the success of the state departments of insurance is the National Association of Insurance Commissioners (NAIC), a nongovernmental body developed to coordinate the activities of the individual state insurance departments. Founded by George W. Miller, the second superintendent of insurance for the state of New York, the early goals of the NAIC were those of uniformity of examination practices, annual reporting statements, and laws.
The first meeting of the body was in 1871 and included the insurance commissioners of each state. It became a voluntary organization, and through the guidance of the NAIC, the state departments began to avoid the confusion of uncoordinated operations. Today, the NAIC meets twice yearly, with regional meetings scheduled between meetings of the entire NAIC body. Various committees from the organization work throughout the year on specific topics. Many committees focus on standardization procedures and formats, but others have developed information included on policies and policy statements.
As a body, the group is committed to the development of legislative recommendations. Once the need for a new law is identified, a specific committee studies the situation and makes a recommendation to the larger group. If the group can pass the measure, it is submitted to the legislatures of the states involved in the form of a model bill for discussion. Although some states eventually reject some of these legislative proposals, the process has resulted in a growing uniformity of the industry�s regulation throughout the country.
The NAIC continues to study the problems and changes within the industry. Task force groups use advisory committees made up of insurers and the public-at-large to investigate issues and ideas to improve the industry as a whole. For example, one NAIC task force gave primary attention to the use of gender and marital status as classification factors used in automobile insurance ratings and comprehensive health insurance coverage. Another looked at the question of state versus federal insurance regulation and ways to detect insurer insolvency before it actually occurred.
The NAIC�s statement of intent highlights that the NAIC is committed to modernize insurance regulations to meet the realities of an increasingly dynamic and internationally competitive financial service market. Ultimately, the NAIC is committed to work cooperatively with governors, state legislators, federal officials, consumers, companies, agents, and other interested parties in order to facilitate and enhance this new evolving marketplace.
The Financial Services and Modernization Act of 1999, which is known as the Gramm-Leach-Bliley Act (GLBA), established a comprehensive framework to permit affiliations among banks, securities firms, and insurance companies. GLBA acknowledged that states should regulate the business of insurance. However, Congress also called for state reforms to allow insurance companies to compete more effectively in the newly integrated financial service marketplace and to respond with innovation and flexibility to increasingly demanding consumer needs.
Working with governors and state legislators, the NAIC has undertaken a thorough review of respective state laws to determine needed regulatory or statutory changes to achieve functional regulation as outlined by GLBA.
The NAIC is committed to uniformity in producer licensing and the creation of uniform licensing standards. As a necessary interim step, the NAIC has adopted the Producer Licensing Model Act for consideration by state legislatures. The model act provides specific multi-state reciprocity provisions to comply with the requirements of GLBA. Seeing reciprocity as only a short range solution, the NAIC has empowered the Insurance Regulatory Information Network to develop recommendations for a streamlined national producer licensing process that will reduce the cost and complexity of regulatory compliance related to the current multi-state process.
According to the NAIC, the model act creates uniformity in agent licensing procedures, defines the exceptions to licensing; simplifies the licensing process; promotes the Insurance Regulatory Network and Producer Database; creates reciprocity while preserving states� rights; eliminates the regulation of business relationships through key commission-sharing provisions; and eliminates retaliatory fees.
The NAIC is in the process of refining their risk-based approach to examining the insurance operations of financial holding companies to place greater emphasis on a company�s unique risk exposures and how it manages those risks.
The NAIC is committed to enhance communication and coordination among all functional regulators and is reviewing the role of NAIC resources in supporting such communication and coordination. The NAIC is committed to pursue development of a group wide approach to regulating insurer groups and enhancing coordination among states.
Historic legislation affecting the banking industry in the United States intended to keep banks out of businesses that would be risky and thereby put the depositors� funds at risk.
The National Banking Act of 1864 gave banks the power to carry out tasks directly necessary and incidental to banking business, however insurance was not considered incidental to the banking business and therefore a prohibited activity.
The stock market crash of 1929 caused the public to lose confidence in the banking system. Congress passed the Glass-Steagall Act of 1933 in an attempt to restore confidence in banks. The Glass-Steagall Act prevented a commercial bank from affiliating with any entity that was principally engaged in the sale of securities. However, banks were still allowed to operate holding companies. Through these holding companies and their affiliates banks were able to avoid some of these restrictions and became involved in the securities and insurance businesses.
Over the years decisions made by regulatory agencies that oversee banks (such as the Federal Reserve, the Office of the Controller of Currency, and the Office of Thrift Supervision) effectively allowed banks to enter into insurance and other financial businesses.
Additional legislation in 1985 and 1986 continued to eliminate the barriers intended to keep banks out of the insurance business. In 1985 the Controller of Currency declared insurance a general investment product, thereby allowing banks to become involved in the insurance business. Additionally, over the years if a bank was located in a town with a population of 5,000 people or less, the bank was allowed to sell insurance. In 1986 the Controller�s office expanded this loophole and permitted banks to sell insurance products in towns with populations over 5,000 so long as the transaction was conducted through a subsidiary of the bank or branch located in a town of under 5,000. The insurance industry challenged these decisions in court but the challenges were ineffective and banks were allowed to continue entering the insurance business.
When BankAmerica acquired Charles Schwab and Company in 1981 and Citicorp and Travelers Group merged in 1988 it became obvious banks were in the securities and insurance businesses to stay. Congress now realized that there was a need for legislation that recognized this change and which would provide necessary safeguards to protect the public�s interests.
Through the 1980s and 1990s Congress debated the deregulation of financial industries a number of times; however, each time there was an attempt to pass legislation removing the barriers or regulating the entry of banks into financial investment and insurance businesses, the legislation failed to pass. In 1999 Congress realized it was time to take action and passed the Financial Services and Modernization Act of 1999, also known as the Gramm-Leach-Bliley Act (GLBA), which was signed into law by President Clinton on November 12, 1999.
GLBA impacts the insurance industry in two key ways. First, GLBA brings federal regulation to insurance sales primarily through the regulation of insurance producers. This is to be accomplished first and foremost by creating uniformity in the regulation of producers throughout the nation. The second major impact is the protection of personal financial information.
In taking the steps to comply with GLBA most states found it necessary to update and amend existing legislation and pass some new laws. For example, Illinois amended both its license law and its administrative code provisions affecting insurance law.
Subtitle B of Title III of the GLBA sets forth the national standards required for insurance producer licensing. To insure swift action by the states to comply with the new regulations, GLBA actually set forth an ultimatum. If the requirements were not met within a specified time frame the NAIC was to oversee the creation of a group named the National Association of Registered Agents and Brokers (NARAB).
The purpose of the NARAB would be to provide a mechanism through which uniform licensing, appointment, continuing education, and other insurance producer sales qualification requirements and conditions would be adopted and applied on a multistate basis, while preserving the right of states to license, supervise, and discipline insurance producers and to prescribe and enforce laws and regulations with regard to insurance-related consumer protection and unfair trade practices.
The legislators that put these rules together felt so strongly about the need for uniformity and reciprocity to truly meet the goals of GLBA that the law even goes on to create steps that would be taken toward creation of NARAB if the NAIC did not take action on these issues.
The NAIC moved swiftly to take action and the creation of NARAB has not and will probably never be required. However, the text of this portion of GLBA appears here.
GRAMM-LEACH-BLILEY ACT
Subtitle C�National Association of Registered Agents and Brokers
SEC. 321. STATE FLEXIBILITY IN MULTISTATE LICENSING REFORMS.
(a) In General.‑‑The provisions of this subtitle shall take effect unless, not later than 3 years after the date of the enactment of this Act, at least a majority of the States�
(1) have enacted uniform laws and regulations governing the licensure of individuals and entities authorized to sell and solicit the purchase of insurance within the State; or
(2) have enacted reciprocity laws and regulations governing the licensure of nonresident individuals and entities authorized to sell and solicit insurance within those States.
(b) Uniformity Required.‑‑States shall be deemed to have established the uniformity necessary to satisfy subsection (a)(1) if the States�
(1) establish uniform criteria regarding the integrity, personal qualifications, education, training, and experience of licensed insurance producers, including the qualification and training of sales personnel in ascertaining the appropriateness of a particular insurance product for a prospective customer;
(2) establish uniform continuing education requirements for licensed insurance producers;
(3) establish uniform ethics course requirements for licensed insurance producers in conjunction with the continuing education requirements under paragraph (2);
(4) establish uniform criteria to ensure that an insurance product, including any annuity contract, sold to a consumer is suitable and appropriate for the consumer based on financial information disclosed by the consumer; and
(5) do not impose any requirement upon any insurance producer to be licensed or otherwise qualified to do business as a nonresident that has the effect of limiting or conditioning that producer�s activities because of its residence or place of operations, except that countersignature requirements imposed on nonresident producers shall not be deemed to have the effect of limiting or conditioning a producer�s activities because of its residence or place of operations under this section.
(c) Reciprocity Required.‑‑States shall be deemed to have established the reciprocity required to satisfy subsection (a) (2) if the following conditions are met:
(1) Administrative licensing procedures.‑‑At least a majority of the States permit a producer that has a resident license for selling or soliciting the purchase of insurance in its home State to receive a license to sell or solicit the purchase of insurance in such majority of States as a nonresident to the same extent that such producer is permitted to sell or solicit the purchase of insurance in its State, if the producer�s home State also awards such licenses on such a reciprocal basis, without satisfying any additional requirements other than submitting�
(A) a request for licensure;
(B) the application for licensure that the producer submitted to its home State;
(C) proof that the producer is licensed and in good standing in its home State; and
(D) the payment of any requisite fee to the appropriate authority.
(2) Continuing education requirements.‑‑A majority of the States accept an insurance producer�s satisfaction of its home State�s continuing education requirements for licensed insurance producers to satisfy the States� own continuing education requirements if the producer�s home State also recognizes the satisfaction of continuing education requirements on such a reciprocal basis.
(3) No limiting nonresident requirements.‑‑A majority of the States do not impose any requirement upon any insurance producer to be licensed or otherwise qualified to do business as a nonresident that has the effect of limiting or conditioning that producer�s activities because of its residence or place of operations, except that countersignature requirements imposed on nonresident producers shall not be deemed to have the effect of limiting or conditioning a producer�s activities because of its residence or place of operations under this section.
(4) Reciprocal reciprocity.‑‑Each of the States that satisfies paragraphs (1), (2), and (3) grants reciprocity to residents of all of the other States that satisfy such paragraphs.
(d) Determination.‑�
(1) NAIC determination.‑‑At the end of the 3‑year period beginning on the date of the enactment of this Act, the National Association of Insurance Commissioners (hereafter in this subtitle referred to as the ��NAIC��) shall determine, in consultation with the insurance commissioners or chief insurance regulatory officials of the States, whether the uniformity or reciprocity required by subsections (b) and (c) has been achieved.
(2) Judicial review.‑‑The appropriate United States district court shall have exclusive jurisdiction over any challenge to the NAIC�s determination under this section and such court shall apply the standards set forth in section 706 of title 5, United States Code, when reviewing any such challenge.
(e) Continued Application.‑‑If, at any time, the uniformity or reciprocity required by subsections (b) and (c) no longer exists the provisions of this subtitle shall take effect 2 years after the date on which such uniformity or reciprocity ceases to exist, unless the uniformity or reciprocity required by those provisions is satisfied before the expiration of that 2‑year period.
(f) Savings Provision.‑‑No provision of this section shall be construed as requiring that any law, regulation, provision, or action of any State which purports to regulate insurance producers, including any such law, regulation, provision, or action which purports to regulate unfair trade practices or establish consumer protections, including countersignature laws, be altered or amended in order to satisfy the uniformity or reciprocity required by subsections (b) and (c), unless any such law, regulation, provision, or action is inconsistent with a specific requirement of any such subsection and then only to the extent of such inconsistency.
(g) Uniform Licensing.‑‑Nothing in this section shall be construed to require any State to adopt new or additional licensing requirements to achieve the uniformity necessary to satisfy subsection
Sections 322 through 335 of GLBA go on to establish the alternative if the goals of section 321 are not met. The formation of the National Association of Registered Agents and Brokers would accomplish these goals.
SEC. 322. NATIONAL ASSOCIATION OF REGISTERED AGENTS AND BROKERS.
(a) Establishment.‑‑There is established the National Association of Registered Agents and Brokers (hereafter in this subtitle referred to as the ��Association��).
(b) Status.‑‑The Association shall-
(1) be a nonprofit corporation;
(2) have succession until dissolved by an Act of Congress;
(3) not be an agent or instrumentality of the United States Government; and
(4) except as otherwise provided in this Act, be subject to, and have all the powers conferred upon a nonprofit corporation by the District of Columbia Nonprofit Corporation Act (D.C. Code, sec. 29y‑1001 et seq.).
SEC. 323. PURPOSE.
The purpose of the Association shall be to provide a mechanism through which uniform licensing, appointment, continuing education, and other insurance producer sales qualification requirements and conditions can be adopted and applied on a multistate basis, while preserving the right of States to license, supervise, and discipline insurance producers and to prescribe and enforce laws and regulations with regard to insurance‑related consumer protection and unfair trade practices.
SEC. 324. RELATIONSHIP TO THE FEDERAL GOVERNMENT.
The Association shall be subject to the supervision and oversight of the NAIC.
The NAIC created the NARAB Working Group to help states implement the requirements of Section 321 of Subtitle C and avoid the formation of NARAB as called for in Sections 322 through 335.
William J. Kirven III, Co-Chair of the Working Group testified before a subcommittee of the United States House of Representatives stating �NAIC and State insurance regulators wholeheartedly support the licensing goals endorsed by Congress in NARAB. We (the insurance commissioners) do not, however, believe NARAB is necessary. Moreover, we believe the creation of NARAB as a separate organization would undermine the legal authority of State insurance departments to protect consumers throughout the United States. If NARAB were to prevent States from exercising their full range of powers to regulate insurance for the benefit of consumers, there would be nobody to perform this vital function.�
Subtitle C of the GLBA provides the states with two approaches to avoid creation of NARAB. The first is for states to recognize and accept the licensing procedures of other states on a reciprocal basis so agents will not be required to meet different standards in each state. In order to achieve reciprocity under the NARAB provisions, a majority of states and United States territories must have laws and regulations that guarantee reciprocal treatment for non-resident agents doing business in more than one state. The required reciprocity will be reached if a majority of states and territories do all of the following:
� Permit a producer licensed to sell insurance in his or her home state to sell in non-resident states after satisfying only minimum requirements such as submission of a licensing application and payment of all applicable fees.
� Accept the satisfaction by a producer of his or her home state�s continuing education requirements.
� Do not limit or condition producers� activities because of residence or place of operations (except that counter-signature requirements are still permitted).
� Grant reciprocity to all other states meeting reciprocity requirements.
Alternatively, the States can avoid the creation of NARAB by adopting uniform laws and regulations regarding non-resident agent licensing. Laws and regulations will be deemed to be uniform under the NARAB provisions if the states do each of the following:
� Establish uniform criteria for integrity, personal qualifications, education, training, and experience of licensed insurance producers.
� Establish uniform continuing education requirements.
� Establish uniform ethics course requirements.
� Establish uniform criteria regarding the suitability of insurance products for specific customers.
� Do not limit or condition producers� activities due to residency or place of operations.
Prior to passage of the GLBA, the NAIC was working on an improved Producer Licensing Model Act to promote uniformity and efficiency among the States. NAIC moved quickly to amend this model legislation to incorporate the NARAB reciprocity provisions required by the GLBA.
The NAIC�s Producer Licensing Model Act has been used as the primary vehicle for the States to implement the GLBA requirements for licensing reciprocity. Adoption of the Model Act by a majority of states assured that the NAIC and the industry would be in compliance with the NARAB reciprocity requirements. The NAIC further asserts that adoption and implementation of the Model Act does much more than simply satisfy the minimum requirements of the GLBA. The Model Act creates a foundation for achieving the ultimate goal of uniformity among the States for agent licensing.
As of August 2004, 49 states and Guam had passed the Producer Licensing Model Act (PLMA) or other licensing laws with the intent of satisfying the reciprocity licensing mandates of GLBA.
42 states have been certified by the NAIC as meeting the requirements for producer licensing reciprocity under GLBA.
The NAIC states that the only significant barriers to national reciprocity are fingerprinting and surplus lines bond requirements for nonresident producers, as these represent core consumer-protection issues to the states that have them in place. However, the NAIC indicates that a state that is reciprocal is not precluded from extending reciprocity to states that maintain these consumer protection requirements, which may further expand the scope of reciprocity.
30 states plus the District of Columbia are processing non-resident applications electronically through the National Insurance Producer Registry (NIPR) gateway.
The Uniform Non-Resident Application is now accepted in 49 states and the District of Columbia.
The states under the guidance of NAIC have made great progress in implementing the requirements of GLBA and thereby have seemingly made the creation of the NARAB unnecessary.
Illinois has been an active participant in the dialog and planning during this transitional period and has passed its own legislation to bring the state into compliance. Illinois adopted a new licensing act incorporating the necessary elements of the Producer Licensing Model Act on August 16, 2001.
When GLBA expressly allowed financial institutions that had operated as separate companies to be combined or owned by the same entity (for example, banks owning or operating as insurance brokers), it opened new opportunities for the use of information gained from operations in one business area to be used by other segments of the business.
To protect against the possibility of these intertwined business relationships intruding on individual privacy rights, GLBA includes provisions to protect consumers� personal financial information held by financial institutions. There are three principal parts to the privacy requirements:
� The Financial Privacy Rule.
� The Safeguards Rule.
� The Pretexting provisions.
The GLBA gives authority to eight federal agencies and the states to administer and enforce the Financial Privacy Rule and the Safeguards Rule. These two regulations apply to �financial institutions,� which include not only banks, securities firms, and insurance companies, but also companies providing many other types of financial products and services to consumers. Among these services are lending, brokering or servicing any type of consumer loan, transferring or safeguarding money, preparing individual tax returns, providing financial advice or credit counseling, providing residential real estate settlement services, collecting consumer debts, and an array of other activities. The previously unregulated non-traditional �financial institutions� are regulated by the Federal Trade Commission (FTC).
The Financial Privacy Rule governs the collection and disclosure of customers� personal financial information by financial institutions. It also applies to companies, whether or not they are financial institutions, who receive such information.
The Safeguards Rule requires all financial institutions to design, implement, and maintain safeguards to protect customer information. The Safeguards Rule applies not only to financial institutions that collect information from their own customers, but also to financial institutions, such as credit reporting agencies that receive customer information from other financial institutions.
The pretexting provisions of the GLBA protect consumers from individuals and companies that obtain their personal financial information under false pretenses, a practice known as �pretexting.� An example of pretexting would be a phone survey claiming to be gathering information to allow insurance companies the opportunity to create new policies that will be better for all insureds, when in truth the information will be used to better organize a presentation to sell insurance to the consumer being questioned, or in a worst scenario, to use the information to steal a person�s identity.
Protecting the privacy of consumer information held by �financial institutions� is at the heart of the financial privacy provisions of the GLBA. The GLBA requires companies to give consumers privacy notices that explain the institutions� information-sharing practices. In turn, consumers have the right to limit some, although not all, sharing of their information.
The GLBA applies to �financial institutions� that offer financial products or services to individuals. This of course includes insurance businesses. The law requires that financial institutions protect information collected about individuals; it does not apply to information collected in business or commercial activities.
A company�s obligations under the GLBA depend on whether the company has consumers or customers who obtain its services.
� A consumer is an individual who obtains or has obtained a financial product or service from a financial institution for personal, family, or household reasons.
� A customer is a consumer with a continuing relationship with a financial institution. Generally, if the relationship between the financial institution and the individual is significant and/or long-term, the individual is a customer of the institution.
For example, a person who purchases an insurance policy from an insurer is considered a customer of the company and the insurance producer that assisted in the purchase, while a person who makes application or discloses personal financial information during an interview is considered to have a consumer relationship with the company and producer.
The difference between consumers and customers is important because only customers are entitled to automatically receive a financial institution�s privacy notice. Although there are some exceptions, consumers are entitled to receive a privacy notice from a financial institution only if the company shares the consumers� information with companies not affiliated with it. Customers on the other hand, must receive a notice every year for as long as the customer relationship lasts.
The privacy notice must be delivered to individual customers or consumers by mail or in person; it may not be posted on a wall with the mere hope that the customer sees it. Reasonable methods to deliver a notice may depend on the institution�s business. For example, an insurance company taking applications at its website may post its privacy notice on its website and require online consumers to acknowledge receipt as a necessary part of an application.
The privacy notice must be a clear, conspicuous, and accurate statement of the company�s privacy practices; it should include each of the following:
� Information the company collects about its consumers and customers.
� The parties with whom it shares the information; and
� The manner in which it protects or safeguards the information.
The notice applies to the �nonpublic personal information� the company gathers and discloses about its consumers and customers. In practice, that may be most or all of the information a company has about consumers and its customers. For example, nonpublic personal information could be information that a consumer or customer puts on an application, information about the individual from another source, such as a credit bureau, or information about transactions between the individual and the company, such as an account balance. Indeed, even the fact that an individual is a consumer or customer of a particular financial institution is nonpublic personal information. But information that the company has reason to believe is lawfully public, such as mortgage loan information in a jurisdiction where that information is publicly recorded, is not restricted by the GLBA.
Consumers and customers have the right to opt out of or say no to allowing their information to be shared with certain third parties. The privacy notice must explain how and offer a reasonable way for the party to opt out. For example, providing a toll-free telephone number or a detachable form with a pre-printed address is a reasonable way for consumers or customers to opt out; requiring someone to write a letter as the only way to opt out is not acceptable.
The privacy notice also must explain that consumers have a right to say no to the sharing of certain information including credit report or credit application information, with a financial institution�s affiliates.
An affiliate is an entity that does one of the following:
� Controls the company.
� Is controlled by the company.
� Is under common control with the company.
The GLBA does not give consumers the right to opt out when the financial institution shares other information with its affiliates, and the GLBA provides no opt-out right in several other situations. For example, an individual cannot opt out if:
� A financial institution shares information with outside companies that provide essential services like data processing or servicing accounts.
� The disclosure is legally required.
� A financial institution shares customer data with outside service providers that market the financial company�s products or services.
The Safeguards Rule was adopted in May of 2000. These rules are written in an understandable and relatively brief format. Therefore we have included most of the actual rule below. We have removed some of the specific references to sections of law that will not affect your understanding of the rule, and we have also added some short clarifying remarks, although the rule is primarily self explanatory.
STANDARDS FOR SAFEGUARDING CUSTOMER INFORMATION
1. Purpose and scope
(a) Purpose. This part, which implements sections 501 and 505(b)(2) of the Gramm-Leach-Bliley Act, sets forth standards for developing, implementing, and maintaining reasonable administrative, technical, and physical safeguards to protect the security, confidentiality, and integrity of customer information.
(b) Scope. This part applies to the handling of customer information by all financial institutions over which the Federal Trade Commission (��FTC�� or ��Commission��) has jurisdiction. This part refers to such entities as ��you.�� This part applies to all customer information in your possession, regardless of whether such information pertains to individuals with whom you have a customer relationship, or pertains to the customers of other financial institutions that have provided such information to you.
2. Definitions
(a) In general except as modified by this part or unless the context otherwise requires, the terms used in this part have the same meaning as set forth in the Commission�s rule governing the Privacy of Consumer Financial Information.
(b) Customer information means any record containing nonpublic personal information � about a customer of a financial institution, whether in paper, electronic, or other form, that is handled or maintained by or on behalf of you or your affiliates.
(c) Information security program means the administrative, technical, or physical safeguards you use to access, collect, distribute, process, protect, store, use, transmit, dispose of, or otherwise handle customer information.
(d) Service provider means any person or entity that receives, maintains, processes, or otherwise is permitted access to customer information through its provision of services directly to a financial institution that is subject to this part.
3. Standards for safeguarding customer information
(a) Information security program. You shall develop, implement, and maintain a comprehensive information security program that is written in one or more readily accessible parts and contains administrative, technical, and physical safeguards that are appropriate to your size and complexity, the nature and scope of your activities, and the sensitivity of any customer information at issue. Such safeguards shall include the elements set forth in section 4 of this rule and shall be reasonably designed to achieve the objectives of this part, as set forth in paragraph (b) of this section.
(b) Objectives. The objectives of � the Act, and of this part, are to:
(1) Insure the security and confidentiality of customer information;
(2) Protect against any anticipated threats or hazards to the security or integrity of such information; and
(3) Protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.
4. Elements
In order to develop, implement, and maintain your information security program, you shall:
(a) Designate an employee or employees to coordinate your information security program.
(b) Identify reasonably foreseeable internal and external risks to the security, confidentiality, and integrity of customer information that could result in the unauthorized disclosure, misuse, alteration, destruction or other compromise of such information, and assess the sufficiency of any safeguards in place to control these risks. At a minimum, such a risk assessment should include consideration of risks in each relevant area of your operations, including:
(1) Employee training and management;
(2) Information systems, including network and software design, as well as information processing, storage, transmission and disposal; and
(3) Detecting, preventing and responding to attacks, intrusions, or other systems failures.
(c) Design and implement information safeguards to control the risks you identify through risk assessment, and regularly test or otherwise monitor the effectiveness of the safeguards� key controls, systems, and procedures.
(d) Oversee service providers, by:
(1) Taking reasonable steps to select and retain service providers that are capable of maintaining appropriate safeguards for the customer information at issue; and
(2) Requiring your service providers by contract to implement and maintain such safeguards.
(e) Evaluate and adjust your information security program in light of the results of the testing and monitoring required by paragraph (c) of this section; any material changes to your operations or business arrangements; or any other circumstances that you know or have reason to know may have a material impact on your information security program.
5. Effective dates
(a) Each financial institution subject to the Commission�s jurisdiction must implement an information security program pursuant to this part no later than May 23, 2003.
(b) Two-year grandfathering of service contracts. Until May 24, 2004, a contract you have entered into with a nonaffiliated third party to perform services for you or functions on your behalf satisfies the provisions of 4(d), even if the contract does not include a requirement that the service provider maintain appropriate safeguards, as long as you entered into the contract not later than June 24, 2002.
These rules are issued by the FTC specifically for those businesses that are under its jurisdictions regarding oversight of the provisions of the GLBA. Although the insurance business is not under the control of the FTC there is a potential that businesses that fall under these rules could be involved in an insurance transaction.
To recap, the GLBA includes as non-public personal financial information; names, addresses and phone numbers; bank and credit card account numbers; income and credit histories; and Social Security numbers.
The Safeguards Rule applies to businesses, regardless of size, that are �significantly engaged� in providing financial products or services to consumers. In addition to developing their own safeguards, financial institutions are responsible for taking steps to ensure that their affiliates and service providers safeguard customer information in their care. This is why it is good business to check out the practices of firms you do business with to see that they are in compliance with these rules.
Adequately securing customer information is not only the law, it makes good business sense. When you show customers that you care about the security of their personal information, you increase their level of confidence in your business. Poorly-managed customer data can lead to identity theft. Identity theft occurs when someone steals a consumer�s personal identifying information to open new charge accounts, order merchandise, or borrow money.
The Safeguards Rule requires financial institutions to develop a written information security plan that describes their program to protect customer information. The plan must be appropriate to the financial institution�s size and complexity, the nature and scope of its activities, and the sensitivity of the customer information it handles. As part of its plan, each financial institution must do each of the following:
� Designate one or more employees to coordinate the safeguards.
� Identify and assess the risks to customer information in each relevant area of the company�s operation and evaluate the effectiveness of the current safeguards for controlling these risks.
� Design and implement a safeguards program, and regularly monitor and test it.
� Select appropriate service providers and contract with them to implement safeguards.
� Evaluate and adjust the program in light of relevant circumstances, including changes in the firm�s business arrangements or operations, or the results of testing and monitoring of safeguards.
These requirements are designed to be flexible. Each financial institution should implement safeguards appropriate to its own circumstances. For example, some financial institutions may choose to describe their safeguards programs in a single document, while others may memorialize their plans in several different documents, such as one to cover an information technology division and another to describe the training program for employees. Similarly, a company may decide to designate a single employee to coordinate safeguards or may spread this responsibility among several employees who will work together. An insurance producer should be aware of how and where they fit into the safeguards of the companies with which they work.
In addition, a firm with a small staff may design and implement a more limited employee training program than a firm with a large number of employees. A financial institution that doesn�t receive or store any information online may take fewer steps to assess risks to its computers than a firm that routinely conducts business online.
When a firm implements safeguards, the Safeguards Rule requires it to consider all areas of its operation, including three areas that are particularly important to information security: employee management and training; information systems; and managing system failures. Firms should consider implementing the following practices in these areas:
Employee Management and Training
The success or failure of an information security plan depends largely on the employees who implement it. A company may want to:
� Check references prior to hiring employees who will have access to consumer or customer information.
� Ask every new employee to sign an agreement to follow the organization�s confidentiality and security standards for handling non-public financial information.
� Train employees to take basic steps to maintain the security, confidentiality and integrity of customer information, such as:
� Locking rooms and file cabinets where paper records are kept.
� Using password-activated screensavers.
� Using strong passwords.
� Changing passwords periodically, and not posting passwords near employees� computers.
� Encrypting sensitive customer information when it is transmitted electronically over networks or stored online.
� Referring calls or other requests for customer information to designated individuals who have had safeguards training.
� Recognizing any fraudulent attempt to obtain customer information and reporting it to appropriate law enforcement agencies.
� Instruct and regularly remind all employees of your organization�s policy - and the legal requirement - to keep customer information secure and confidential and post reminders about their responsibility for security in areas where such information is stored.
� Limit access to customer information to employees who have a business reason for seeing it. For example, grant access to customer information files to employees who respond to customer inquiries, but only to the extent they need it to do their job.
� Impose disciplinary measures for any breaches.
Information Systems
Information systems include network and software design, and information processing, storage, transmission, retrieval, and disposal. Here are some suggestions from the FTC on how to maintain security throughout the life cycle of customer information - that is, from data entry to data disposal:
� Store records in a secure area. Make sure only authorized employees have access to the area. For example:
� Store paper records in a room, cabinet, or other container that is locked when unattended.
� Ensure that storage areas are protected against destruction or potential damage from physical hazards, like fire or floods.
� Store electronic customer information on a secure server that is accessible only with a password - or has other security protections - and is kept in a physically-secure area.
� Don�t store sensitive customer data on a machine with an Internet connection.
� Maintain secure backup media and keep archived data secure, for example, by storing off-line or in a physically-secure area.
� Provide for secure data transmission (with clear instructions and simple security tools) when you collect or transmit customer information. Specifically:
� If you collect credit card information or other sensitive financial data, use a Secure Sockets Layer (SSL) or other secure connection so that the information is encrypted in transit.
� If you collect information directly from consumers, make secure transmission automatic. Caution consumers against transmitting sensitive data, like account numbers, via electronic mail.
� If you must transmit sensitive data by electronic mail, ensure that such messages are password protected so that only authorized employees have access.
� Dispose of customer information in a secure manner. For example:
� Hire or designate a records retention manager to supervise the disposal of records containing nonpublic personal information.
� Shred or recycle customer information recorded on paper and store it in a secure area until a recycling service picks it up.
� Erase all data when disposing of computers, diskettes, magnetic tapes, hard drives or any other electronic media that contain customer information.
� Effectively destroy the hardware.
� Promptly dispose of outdated customer information.
Managing System Failures
Effective security management includes the prevention, detection, and response to attacks, intrusions or other system failures. Consider the following suggestions:
� Maintain up-to-date and appropriate programs and controls by:
� Following a written contingency plan to address any breaches of your physical, administrative or technical safeguards;
� Checking with software vendors regularly to obtain and install patches that resolve software vulnerabilities;
� Using anti-virus software that updates automatically;
� Maintaining up-to-date firewalls, particularly if you use broadband Internet access or allow employees to connect to your network from home or other off-site locations; and
� Providing central management of security tools for your employees and passing along updates about any security risks or breaches.
� Take steps to preserve the security, confidentiality, and integrity of customer information in the event of a computer or other technological failure. For example, back up all customer data regularly.
� Maintain systems and procedures to ensure that access to nonpublic consumer information is granted only to legitimate and valid users. For example, use tools like passwords combined with personal identifiers to authenticate the identity of customers and others seeking to do business with the financial institution electronically.
� Notify customers promptly if their nonpublic personal information is subject to loss, damage, or unauthorized access.
The GLBA puts some limits on how anyone that receives nonpublic personal information from a financial institution can use or re-disclose the information. Take the case of an insurance company that discloses customer information to a service provider responsible for mailing premium notices, where the consumer has no right to opt out. The service provider may use the information for the limited purpose of mailing the notices. It may not sell the information to other organizations or use it for marketing.
However, it�s a different scenario when a company receives nonpublic personal information from a financial institution that provided an opt-out notice when the consumer didn�t opt out. In this case, the recipient steps into the shoes of the disclosing financial institution, and may use the information for its own purposes or re-disclose it to a third party, consistent with the financial institution�s privacy notice. That is, if the privacy notice of the financial institution allows for disclosure to other unaffiliated financial institutions � like insurance providers � the recipient may re-disclose the information to an unaffiliated insurance provider.
Other important provisions of the GLBA also impact how a company conducts business. For example, financial institutions are prohibited from disclosing their customers� account numbers to non-affiliated companies when it comes to telemarketing, direct mail marketing or other marketing through e-mail, even if the individuals have not opted out of sharing the information for marketing purposes.
As we mentioned above, another provision prohibits �pretexting.� Pretexting is the practice of obtaining customer information from financial institutions under false pretenses. The FTC has brought several cases against information brokers who engage in pretexting.
Under the GLBA it is illegal for anyone to:
� Use false, fictitious, or fraudulent statements or documents to get customer information from a financial institution or directly from a customer of a financial institution.
� Use forged, counterfeit, lost, or stolen documents to get customer information from a financial institution or directly from a customer of a financial institution.
� Ask another person to get someone else�s customer information using false, fictitious, or fraudulent statements or using false, fictitious, or fraudulent documents or forged, counterfeit, lost, or stolen documents.
Pretexting can lead to �identity theft.� Identity theft occurs when someone hijacks personal identifying information to open new charge accounts, order merchandise, or borrow money. Consumers targeted by identity thieves usually don�t know they�ve been victimized until the hijackers fail to pay the bills or repay the loans, and collection agencies begin dunning the consumers for payment of accounts they didn�t even know they had.
According to the FTC, the most common forms of identity theft are:
� Credit card fraud - a credit card account is opened in a consumer�s name or an existing credit card account is �taken over.�
� Communications services fraud - the identity thief opens telephone, cellular, or other utility service in the consumer�s name.
� Bank fraud - a checking or savings account is opened in the consumer�s name, and/or fraudulent checks are written.
� Fraudulent loans - the identity thief gets a loan, such as a car loan, in the consumer�s name.
The insurance industry will continue to feel the impact of the GLBA as the most important federal law affecting the insurance industry in recent years; the GLBA has already provided significant benefits with respect to multi-state coordination and reciprocity. The financial privacy and safeguards rules have also been widely implemented and provide significant additional information to the consumer which was not available just a few years ago.
Regulation of the insurance industry is ultimately triggered by the fact that the insurance industry is �affected with a public interest.� This concept was initially developed by the British jurist Lord Matthew Hale in 1676. The U.S. Supreme Court used Hale�s concept as a basis for writing its own decisions and determined that the insurance industry was deemed �affected with a public interest� because of its role in many other business and industry activities.
The case of Paul v. Virginia in 1869 determined the legal basis for state regulation of the insurance industry. Samuel Paul was a Virginia insurance agent for several New York fire insurance companies. In Virginia at that time, insurance agents representing out-of-state companies were required to provide certain information to the state controller�s office. Paul had not met these requirements. The result of his noncompliance was a $50 fine. When Paul appealed the fine, he argued that the insurance business was commerce, and in his case, interstate commerce. The U.S. Constitution, by his interpretation, controlled interstate commerce, and according to Paul, Virginia�s requirement�s of the insurance industry were highly unconstitutional.
The Supreme Court rejected Paul�s argument, ruling that selling insurance policies was not commerce. The court said these were personal contracts and did not fall into the same category as merchandise being shipped from one state to another. In their ruling on Paul v. Virginia, the Supreme Court upheld the Virginia laws and ruled that insurance companies were not to be regulated by the federal government, but by the states. Paul ultimately lost his fight and had to pay the $50 fine. This case is important to our discussion because it determined that it was the right of the government to regulate insurance companies, a ruling that was held intact for the next 75 years.
In part, the ruling stated:
�Issuing a policy of insurance is not a transaction of commerce. The policies are simple contracts of indemnity against loss by fire, entered into between the corporations and the insured, for a consideration paid by the latter. These contracts are not articles of commerce in any proper meaning of the word.
�They are not subjects of trade or barter offered in the market as something having an existence and value independent of the parties to them. They are not commodities to be shipped or forwarded from one state to another and then put up for sale. They are like other personal contracts between parties that are completed by their signature and the transfer of consideration. Such contracts are not interstate transactions, though the parties may be domiciled in different states. The policies do not take effect and are not executed contracts until delivered by the agent in Virginia. They are, then, local transactions, and are governed by the local law. They do not constitute a part of the commerce between the states any more than a contract for the purchase and sale of goods in Virginia by a citizen of New York whilst in Virginia would constitute a portion of such commerce.�
In 1877, in the case of Munn v. Illinois, the Supreme Court further determined that insurance companies were businesses affected by the public interest. In its ruling, the Court recognized the states� rights to regulate �properties� affected with the public interest, but protected these �properties� or businesses by further stating that the courts, not the legislature, would be responsible for determining �reasonableness.�
Munn v. Illinois became a landmark ruling because it specified that property was �clothed with a public interest when used in a manner to make it of public consequence and affects the community at large.� However, no specific consequences were delineated in the ruling, and in its final form, the public interest concept became a dynamic one that would vary with court opinions through the years.
In the early 1900s, it was proposed that certain aspects of the insurance industry be placed under federal regulation. However, the judiciary committee advised the U.S. Congress to refrain from passing such legislation, basing their arguments on the fact that Paul v. Virginia and other cases had determined that the federal government had no documented authority over the industry. It was not until 1944 that the Supreme Court reversed its Paul v. Virginia decision and ruled in the South-Eastern Underwriters Association case that the insurance industry was indeed commerce.
In 1945, however, the U.S. Congress passed the McCarran-Ferguson Act. This act stated that the states should continue to regulate the insurance industry because it was in the public interest, and further specified that federal antitrust laws only apply to the insurance industry in instances where state regulation is not effective. If the state regulatory body is strong and adequately regulates the industry in that state, federal antitrust laws would not be applicable.
The McCarran-Ferguson Act was accompanied by a report from the House Judiciary Committee, which stated:
�Nothing in this bill is to be so construed as indicating it to be the intent or desire of Congress to require or encourage the several states to enact legislation that would make it compulsory for any insurance company to become a member of rating bureaus or change uniform rates. It is the opinion of the Congress that competitive rates on a sound financial basis are in the public interest.�
In 1944, the Supreme Court ruled on a case involving the South-Eastern Underwriters Association (SEUA) and, in a surprise move, reversed the Paul v. Virginia decision. The SEUA was a rating bureau with approximately 200 members (representing about 90 percent of the fire insurance lines) and was located in Atlanta, Georgia. The SEUA had been charged with violating the Sherman Antitrust Act because it was believed that it was monopolizing the fire insurance business.
The indictments brought against the SEUA included those for restricting interstate commerce by fixing noncompetitive rates on fire and other related insurance lines and monopolizing commerce in insurance. The SEUA also had charges against it for fixing commissions, compelling consumers to buy only from SEUA members, and using boycotts.
Attorneys for the SEUA argued that, based on Paul v. Virginia insurance was not commerce and therefore not governed by the Sherman Antitrust Act. The court determined that insurance was indeed commerce and subject to control by the federal government. This ruling, in turn, subjected the insurance industry to the terms of the Sherman Antitrust Act, and the court determined that cooperative pricing by the 200 rating bureau members was illegal.
It is important to note that the Supreme Court received criticism for deciding a question about the U.S. Constitution without a majority vote by the nine justices; however, with a vote of 4-3, the decision stood. The insurance industry was now officially subject to federal regulation.
The opinion itself concluded:
�Our basic responsibility in interpreting the Commerce Clause is to make certain that the power to govern intercourse among the states remains where the Constitution placed it. That power, as held by this Court from the beginning, is vested in the Congress, available to be exercised for the national welfare as Congress shall deem necessary. No commercial enterprise of any kind that conducts its activities across state lines has been held to be wholly beyond the regulatory power of Congress under the Commerce Clause. We cannot make exception of the business of insurance.�
The confusion caused by the SEUA decision led to the belief that there was a penalty in disobeying state laws that require rate-making organizations, but going along with them would cause one to be in violation of the Sherman Antitrust Act. Nothing could be further from the truth, however. In fact, only state laws that did not run counter to federal legislation applied because the rest were nullified by the ruling of the SEUA. One fact was made clear: the states� rights to regulate insurance were never challenged by the SEUA ruling.
In his written opinion, Justice Black pointed out:
�Another reason advanced to support the result of the cases that follow Paul v. Virginia has been that, if any aspects of the business of insurance be treated as interstate commerce, �then all control over it is taken from the states and the legislative regulations that this Court has heretofore sustained must now be declared invalid.� Accepted without qualification, that broad statement is inconsistent with many decisions of this Court. It is settled that, for constitutional purposes, certain activities of a business may be intrastate and therefore subject to state control, while other activities of the same business may be interstate and therefore subject to federal regulation. And there is a wide range of business and other activities that, though subject to federal regulation, are so intimately related to local welfare that, in the absence of Congressional action, they may be regulated or taxed by the states.�
The states� authority to regulate the insurance industry was clarified through the SEUA decision, but while the opposing sides awaited the Court�s opinion, Congress introduced the Bailey-Van Nuys bill to establish their intentions for the states to continue to regulate insurance, making the industry exempt from the Sherman and Clayton Antitrust Laws. The members of the rating bureaus supported the bill because they did not want the antitrust laws to apply to their activities. Members of the NAIC and the �independents� (nonmembers of the rating bureaus) wanted to do away with the monopolistic activities they perceived in the industry, so they were against the bill. The bill did not make it past the Senate and ultimately failed, but later, other proposals followed that were eventually the McCarran-Ferguson Act, or �Public Law 15.�
This law stated that the states� regulation of the industry was, indeed, in the public interest, and for this reason, the industry was exempted from the provisions of the antitrust laws until July, 1948 � the date fair trade and antitrust laws were applicable to those parts of the industry not regulated by the states. However, according to Section 3(b) of Public Law 15, �... nothing in this act should render the Sherman Act inapplicable to any agreement to boycott, coerce or intimidate, or act of boycott, intimidation, or coercion.�
The report accompanying the act stated:
�Nothing in this bill is to be so construed as indicating it to be the intent or desire of Congress to require or encourage the several states to enact legislation that would make it compulsory for any insurance company to become a member of the rating bureaus or charge uniform rates. It is the opinion of Congress that competitive rates on a sound financial basis are in the public interest.�
Some interpreted this law to mean that only insurance companies volunteering to become part of a rating bureau in a state-regulated environment were sanctioned. However, the Allstate, et al. v. Lanier, et al. case ruled that the law requiring that all automobile insurance companies in the state of North Carolina become members of the North Carolina Rating Office was not in conflict with the McCarran-Ferguson Act. In this ruling, the U.S. District Court stated that the state was so �authorized� and could go into further depths of regulation if the legislature decided to do so. Therefore, the states were given the right to limit competition if they chose to do so. The Supreme Court declined to review the case.
Before the SEUA case, certain rules were locally enforced which would be illegal under the Sherman Act. These rules, which were introduced by stock agents� associations included boycott, coercion, and intimidation. Both insurers and agents were affected by these rules that effectually curbed competition. Among other limitations, insurance companies were allowed to have a certain number of agents in an area. Further, they were limited to reinsuring member insurers. Members were also not allowed to represent non-stock insurance companies, insurance companies that wrote policies directly (bypassing agents), companies selling established below-bureau rates and companies whose agents were not members of the association.
Although the National Association of Insurance Agents decided to refrain from reinforcing these rules, certain local associations continued to use the rules, causing challenges from the Justice Department. Such was the rationale behind The U.S. v. Insurance Board of Cleveland and a similar case pitting the Justice Department against the New Orleans Insurance Exchange.
The two boards said that the tenets of the McCarran Act had nullified the antitrust laws, but the court rebutted that nothing in the McCarran Act had suggested that the Sherman Act was not applicable, particularly in instances of boycott, coercion, or intimidation for the purposes of limiting competition.
In the objective examination of insurance regulation, the primary purpose is the protection of the consumer public.
In all areas of the insurance industry, public confidence in the established system is required to maintain success. If the public should lack confidence in the industry because of experiences with fraudulent and incompetent insurers, the system would eventually fail. This lack of confidence would occur if the insurer became unable to provide the coverage promised. In cases of insolvency, the consumer would not only forfeit the price of the policy, but also the expected reimbursement for loss of property, disabilities, medical expenses or the support of dependents.
To establish and maintain consumer confidence, certain regulatory goals have been developed to combat negative and unscrupulous business activities within the industry in order to:
� Prevent insurer insolvency.
� Prevent fraud.
� Assure reasonable pricing.
� Increase the availability of insurance.
Each of these goals is explained in more detail below.
� Insurer insolvency.
One of the primary goals of insurance regulation is to prevent insurance companies from going into bankruptcy.
To this end, controls have been established through government regulations unique to the insurance industry. These controls require insurance companies to maintain certain levels of operating capital, as well as specified reserves and surplus levels to underwrite �the future services� agreed upon in the policies issued by that company. The government requires insurance companies to meet these levels because of the far-reaching effects of an insurance company going bankrupt.
When any other business fails, investors in that business lose their money and people lose their jobs, but the bottom line of a business failure is something called competition � a major aspect of our free enterprise system. Sometimes a business goes bankrupt because it is not offering the goods and services at a reasonable price to the consumer. When a business folds, the competition absorbs its customers and may adjust goods and prices to remain within the good graces of the consumer public. In this scenario, both the competitor and the consumer benefit. When an insurance company fails, there are no similar beneficiaries.
The other major aspect to be considered in understanding regulations for the prevention of bankruptcy of insurance companies is that insurance premiums are based on the insurer�s estimate of the cost of future services. If the estimated costs of these services or losses are lower than the actual costs, the result is that rates are set too low and policies are under-priced.
Several decades ago, the industry underestimated the necessity of raising rates in liability claims for property and casualty policies. A few years later, this area of the industry experienced significant losses because of the under-pricing.
Because the industry must estimate future trends and activities, there is always the possibility that rates may be inadequate to cover losses. This fact, when coupled with the far-reaching impact of insurance company failure, forms the logic of regulation as a necessary means to protect the industry from insolvency.
� Prevention of fraud.
The prevention of fraud is also a primary goal of government regulation because it protects the consumer against being misled or misinformed by an insurer. As has often been pointed out by the industry, as well as public advocates, insurance policies are highly complex, technical documents that few laypeople actually understand. Without regulation, the possibility would exist that, at some time, an unscrupulous insurer could include certain phraseology that would mislead the insured and save the insurer from paying a particular claim.
The second aspect of regulation for the purpose of preventing fraud concerns an insurance company�s continuing solvency. Attempting to strengthen its consumer base, a struggling company will advertise itself as a strong and reliable firm, with well-invested funds. To provide the consumer with some protection against fraudulent claims of this type, states monitor a firm�s operations to assure that no false claims may be made.
� Reasonable pricing.
A third goal of regulation is to protect the insurance consumer against excessive rates.
Like regulations to protect the consumer from fraud, this type of regulation is also unique to the insurance industry. If an insurer decides to increase rates, it must first file its intentions to raise rates with the state commissioner. If there are objections, no rate increases may occur.
Since the insurance industry�s pricing is based on past experience and certain statistics, the assumption is that the future will be much like the past. Rates, therefore, are based on the past experiences of many insurers. These collective rates, of course, would be more reliable than the rates based on the past experiences of a single insurer.
In view of this assumption, the insurance industry is not required to comply with the anti-price fixing aspects of antitrust laws but, instead, may establish its prices based on its collective experience. With rates established through regulation, the resulting competition works to maintain reasonable pricing within each state�s industry.
� Insurance availability.
Making insurance available to all who need coverage is the final goal of regulation.
This pledge to the consumer public is the basis for the establishment of automobile insurance pools in states to make liability insurance available to those drivers considered to be high-risk and not otherwise able to obtain insurance from standard insurers.
Insurance is also made available to a broad-based market through federal programs reinsuring those companies that offer property and crime insurance in high-risk situations. And because increasing liability claims have raised the cost of professional malpractice insurance, government regulations have also been put into place to continue making this insurance available to all who require it.
As years go by more insurance is becoming necessary for individuals and families. There is an ongoing debate as to whether insurance companies should be regulated to the point that they have no choice as to whom they insure. Some argue that the government should underwrite protection, such as Medicare, particularly for those deemed to be too great a risk for a private insurance company to insure. The opposing view believes that insurance companies should be forced to make coverage available to all who require it. The debate continues.
From its beginnings, the insurance industry has had ample time and opportunity to diversify itself regarding products, services, and methods of marketing. Today, it provides various services to its patrons, delivering these in a variety of formats that respond to the various and emerging needs of the public it serves. All, however, are strictly regulated, and, within the industry today, the complexities of its business are divided into three major areas of regulation:
� Financial strength of the insurer.
� Products.
� Sales and sales practices.
In order to protect the solvency of the insurer, numerous regulations are required to control aspects of the business, such as rates, expenses, investments, surplus, dividends, organization, annual reports and liquidation of insurers. Specific levels of capital and surplus are required before insurers can open their doors for business. Once these requirements have been met, regulators have ongoing expectations of the insurer to maintain an adequate cushion of operating capital and surplus to respond to any unexpected declines in investments or burden of claims.
All insurers are regulated to prohibit investments that are highly speculative or that fall in the high-risk category. This type of regulation limits the percentage of any insurer�s assets that may be committed to investments in stock or real estate. This, in turn, may also limit the company�s ability to build capital at a rapid rate.
A company�s reserves are also regulated and must always be adequate to meet obligations that may arise in the future. Each state has its own formula for calculating reserves to cover each type of policy.
Financial regulatory laws affect not only the reserves and assets of the insurance companies across the country, but also the basic organization of the companies, their investments, valuation of assets and rate setting mechanisms.
Over the years, the insurance industry has become so complex that policies are often the subject of court interpretation. Because of these complexities, it is difficult for the average policyholder to understand even a basic policy, which allows for unscrupulous agents to write policies that may not be in the best interest of the insured. In some cases, even honest insurers may inadvertently include exclusions and special provisions that may be misleading or unfavorable to the policyholder.
Because of this situation, and because it is generally felt that most insurance policies are difficult to understand, there has been a movement in place for several years to simplify policy formats. One rate advisory bureau filed a homeowners policy reducing the narrative by about 40 percent and increasing the size of the type used in the policy by 25 percent. More white space was also allowed between the lines. More readable policy guidelines have also been instituted for automobile, business, personal, life, and health insurance policies.
Certain state insurance commissions have also instituted guidelines regarding insurance policy forms. In doing so, they are attempting to protect both the policyholder, as well as reputable insurers, against policies that are ambiguous, deceptive, or so difficult to understand they could be misleading. Certain formats of life and health insurance policies are prohibited from use, and commissions reserve the right to disapprove policies that contain unjust, inequitable, deceptive, or misrepresentative provisions.
The purpose of this type of regulation is, at first glance, to protect the consumer from unreliable services and disreputable agents. However, the regulation also serves to provide a balance of fair competition within the environment. In this area of regulation, the states regulate how insurers obtain new policyholders, the ethical standards within the industry and the standards required of insurance sales professionals.
Most of the states statutes regulate not only the qualifications for those that sell insurance but also prohibit misrepresentation of the facts about a policy and its coverage. Some statutes also cover the parameters of the relationship between the insured and the insurer.
In the insurance industry, the term �twisting� refers to the misrepresentation of the facts by an agent in order to manipulate the policyholder into substituting one contract for another. Twisting also includes failure to include all the facts when policies are represented.
Because of regulations against twisting, agents are discouraged from making recommendations that may include dropping one policy in favor of another. Some regulations provide that any insurer of a policy that could be replaced would have the ability to evaluate and rebut any comparative information received by the policyholder.
Rebating is another regulated sales activity. Rebating occurs when an agent refunds part of the premium to the policyholder. This practice is intended to skirt around the rate requirements established by a state. In most states, anti-rebating regulations have been established for the purpose of protecting the public interest. Rebating is difficult to prove and, therefore, few cases of rebating are ever heard in court.
Historically, self-regulation was the first type of formalized insurance regulation and continues to be the most powerful form of industry regulation in both the United States and Great Britain. This form of regulation has maintained its power because of the fear of more public reaction against individual insurers. Therefore, it has been advantageous for industry professionals to seek and obtain additional self-regulatory powers that support the public interest.
Under the current system, the insurance industry is also subject to three distinct types of regulation executed by the three branches of the democratic form of government � legislative, judicial, and executive. These three methods of regulation, plus the self-regulatory structures, oversee specific areas of operations within the industry and distribute regulatory powers between state and federal regulatory agencies. The following paragraphs will examine and explain the distinctions of each of the four categories.
State legislatures create insurance codes which govern the insurance industry within that state. Insurance codes address the licensing of insurance companies and producers in order to regulate the conduct of the companies and their agents and employees. The laws also focus upon the specific products permitted to be sold within a state. Each state may implement different variations upon the common themes which mold the regulation of the insurance industry.
Through their interpretation of legislation and other questions, the judicial branch of each state plays a major role in the legislation of the insurance industry. Although their involvement is often indirect in its nature, the courts are also employed to settle disputes between parties involved in insurance contracts. The written ruling of the court for each case, therefore, becomes a part of the body of regulation affecting insurance.
As the insurance industry became more diversified and complex, it became obvious, that the industry�s regulation should be supervised by knowledgeable and experienced individuals. No longer could lawmakers be charged with regulating this rapidly-growing business alone. To fill the administrative needs, each state has established an insurance department headed by a commissioner. Commissioners help to create and enforce rules, called administrative law, to assure the successful operation of the industry within their state.
The duties of state insurance commissioners are broad and varied, but each state insurance department has certain basic duties. These include licensing of insurance companies and agents working within the state, monitoring the activities of licensed agents, and screening these activities regarding good business practices. In some cases, the commission is required to mete out certain penalties for unscrupulous behavior, such as the revocation of licensure or the closing of businesses who fail to meet regulatory requirements regarding reserves, capital, and surplus.
Since 1818, when the Massachusetts insurance department required filing of the first annual financial reports, state commissions have required the filing of annual statements; furthermore, they act as a depository for securities in states with laws governing securities and require an evaluation of corporate assets on a regular basis.
The commissions also regulate trade practices and oversee and approve policy contracts. In its role as a regulatory body, the commission may also monitor rates to assure against discrimination.
Once regulations were in place from governmental sources, the instrument of self-regulation reemerged from a growing consciousness or awareness by special groups of the disadvantages of intrusive outside interpretation and regulation. In view of this, the insurance industry has continued to be a self-regulated industry to a certain degree. Through associations of insurers and agents, these self-regulatory groups have exerted some degree of control through strict codes of ethical conduct and other cooperative agreements. These groups continue to function, generally out of the fear that more public regulation would impair the industry and its purposes.
We now examine specific types of regulation which states may enforce in order to permit the prosperity of the insurance industry and protection of consumers.
The regulation of insurer expenses is a typical area of financial regulation. With the SEUA decision, organizations control commission rates, and if rate wars occur, it is within the jurisdiction of the state insurance commissioner to regulate the situation. Life insurance expenses are regulated in several states, with the New York law being the most complex. This law places caps on expenses and the cost of acquisitions, and affects approximately 70 percent of the life insurance sold in the United States. The New York law features:
� Restricted commission and fees on individual policies.
� Controls on awards or prizes for volume business.
� Complex limits on field expenses.
� Maximum caps placed on renewal commissions and service fees.
� Training allowances for new agents that are commission-approved.
The solvency of an insurance company is measured by the amount by which admitted assets surpass the company�s liabilities. This measurement is taken by state regulators. Valuations for the company are highly regulated, a feature unique to the insurance industry compared to most corporations.
In most situations, �admitted assets� are those assets held by the company that include legal portfolio investments. Admitted assets always include office buildings and real estate (some states also allow computer equipment), but do not include operational assets for the firm. Assets such as automobiles, supplies, furniture and other capital expenditures, or secured or unsecured loans and advances to agents are not included in calculating admitted assets.
It is often easier to value some admitted assets than others. For example, cash and bank accounts are valued at face amount, but there are other criteria for most other holdings.
Examples of these criteria include:
� Real estate � valued at book value or market value.
� Mortgage and collateral loan � valued at amount of outstanding debt.
� Bonds � amortized value if they are secured by earning power.
� Bonds in default � market value as instructed by the Committee on Valuation of Securities of the NAIC.
� Stocks � values prepared by the Committee on Valuation of Securities of the NAIC and equal actual market value as of December 31 of that year.
� Open accounts and premiums to be collected � valued at book value less an estimate of bad debts.
With these guidelines, it is not the insurer who is able to pay claims within a reasonable period that is deemed solvent, but rather the insurer whose admitted assets are equal or exceed their liabilities.
While the rates on individual life policies, most health policies, and ocean marine insurance are not regulated, there is a minimum rate level set for group life by several state insurance departments. Property and liability rates are controlled by model rating laws.
These regulations are based on historical records of prospective loss and expense, as well as the occurrence of catastrophic events and hazards within a certain area. When there is regulation of this sort, an insurance company must file premium rates, rating plans, coverage, and rules for approval by the commissioner or a special committee. In this filing, the company must also provide support of any calculations with documentation.
Some insurers will go through a licensed rating organization rather than filing directly with the state commissioner; however, the commissioner can also disapprove any filing, as long as he or she specifies reasons why the filing was disapproved.
Each state commission must also approve a rating organization, and each rating organization must allow any qualified insurance company to take advantage of its services, without any discrimination toward the company. There are technical requirements built into methods of recording and reporting loss and expense experience, exchange of rating plan data, and consultation with other states, and the state commissioner usually taps a rating organization to collect this data.
Unless a company files an application for deviation, each subscriber must follow the rating organization�s rates and policies; but, the commissioner may also disapprove these applications for deviation if there is a hint of inadequate, excessive, or discriminatory rates.
Observers of the insurance industry have often pointed out that the regulation of automobile insurance rates has taken on a political aspect, because state department commissioners are more focused on whether the standard is excessive as opposed to the standard being adequate. It was the suggestion of one such observer that the political careers of the regulators in one state were obviously more important than the financial solvency of insurers in that state.
The problem arises when the public pressure for lower auto insurance rates takes precedence over the required financial strength of the insurance companies, and therefore, some states continue to walk a tightrope between these two priorities. Notably, in one state, when a commissioner voted to increase automobile insurance rates, that person was quickly fired by the incumbent governor who was running for another term.
In the area of property-liability insurance, many states no longer favor direct regulation of these rates. This is because there is an abundance of data and research behind the rates of this coverage, and because of strong competition, there is no danger either of excessive or inadequate rating.
Because some insurance companies could charge inadequate rates in an effort to become more competitive, the state commissions are now sophisticated enough to detect those companies who could be bordering on insolvency. Because of these and other situations that are unique to property-liability rating, numerous proposals have been set forth to remove regulators from the pricing of this coverage.
These proposals have resulted in two types of rating laws:
� File-and-use rating laws.
� No-file rating laws.
With file-and-use rating laws, a company could request a rate change with the documentation to support it, and then use the new rate until it is disapproved by the state commission. Under the no-file laws, the insurer can request a new rate without statistical documentation and then use that rate before notifying the commissioner. In most states, there is a specified period in which the commission is notified regarding the no-file rates.
Valuation rules applying to the insurer�s reserve liability operate in lieu of regulation of life insurance rates, and the reserve requirements are not related directly to the premium structure of life insurers. An inadequate structure will cause inadequate assets to offset the required reserves. In this branch of insurance coverage, discriminatory prices are prohibited, just as they are in property-liability insurance, yet unit prices may vary with the policy size and the insurability of the policyholder.
In other branches of the industry, competition has been an effective tool for regulation; however, in the life and health insurance branches, competition is not regarded as a useful regulatory tool because purchasers have no basis for comparison of rates and no tools to technically analyze these comparisons.
Because of past abuses among life and health insurers, these rates are monitored by most state insurance departments. All states require that insurance companies file annual reports of loss ratios on health insurance because the public interest requires tracking of these statistics; however, the state insurance departments are not well-enough staffed to consistently check insurance company rates against the benefits offered.
This, too, is a controversial area of regulation and is probably discussed more than most of the other financial regulation categories. Those companies that write property and liability insurance should maintain both loss reserves and unearned premium reserves. The loss reserve is the liability for claims and settlement costs the insurer estimates. The unearned premium reserves are those which at the time of valuation represent all policies outstanding and their gross premiums.
Medical malpractice, automobile, and workers� compensation loss reserves use the formula or loss ratio method for computing the minimum reserve, based on the previous three years and the expected loss ratio, which is 60 percent for medical malpractice and auto, and 65 percent for workers� compensation.
The sticky point which most concerns regulators about loss reserves is that most insurance companies estimate loss reserves lower than practicable, and, in turn, this may lead to insolvency when the insurer is pressed for payment. Conversely, when insurers set reserves too high, they also increase their rates to excessive proportions. Because most state insurance departments do not have the trained personnel to �police� these areas of a firm�s operations some insolvencies have occurred as insurers have been able to hide the exact circumstances for setting their reserve percentages.
Life insurers have one principal reserve known as the policy reserve. This reserve is calculated to meet all policy obligations, as well as premiums and assumed interest. The valuation on this reserve may be different from premiums charged by an insurer because it does not include an allowance or expenses and in fact may be calculated based on a different set of interest and mortality assumptions.
The Modified Reserve Standard is used by some life insurers because the bulk of the expense a company incurs is during the first year the policy is in effect. These expenses include premium taxes, general expenses on the part of the insurer and mortality costs. This leaves little of the premium left for the insurer, and is definitely not enough to cover the reserve for the end of the first year.
The payment of dividends to policyholders is usually a matter of judgment on the part of the insurer. Still, some state insurance departments attempt to control this decision by limiting the surplus amount accumulated by the insurer; for example, not to exceed 10 percent of the policy reserve. By this type of limitation, the insurance departments effectively prevent the accumulation of a large surplus while dividends are lower or not paid at all. This type of regulation, according to insurance commissioners, also curbs inefficient use of a large store of assets.
The surplus of an insurance company will be made up of surplus that is paid-in and surplus that is earned. A capital stock insurer also has capital that is paid-in.
The capital-stock account of an insurance company is the dollar value that has been given to shares owned by stockholders. In most states, these shares are issued at a premium, or, in other words, the stock has a value that is less than the money paid by the stockholders. This creates the paid-in surplus.
Mutual insurance companies are required to have a paid-in fund minimum, but because there is no capital stock in a mutual insurance company, the fund is entirely made up of paid-in surplus.
If an insurance company writes new business at a fast pace, there is the possibility that this increase in business could exhaust the insurer�s surplus and lead to insolvency. At the end of World War II, for example, several insurance companies actually �sold out� their products because they wrote as much business as they could without bringing their surplus accounts down to below acceptable levels. Because they could not raise enough capital in a short period of time, the companies had to quit issuing new policies. Some insurers decided to become selective in who they insured, favoring the more profitable companies. The less profitable businesses were left without insurance. This �capacity problem� is particularly important in discussions of property-liability insurance.
Currently, the state insurance departments guard against this problem by using a rule of thumb that net premiums should not exceed twice the policy owners� surplus. In some circles, a ratio of 3-to-1 is used, and some states even allow ratios as high as 4-to-1.
The branch of the insurance industry that does not seem destined for �capacity problems� is life insurance. The need for a large surplus is not as immediate in life insurance, and many states limit the accumulation of surplus by those companies who sell participating policies.
With the exception of property-liability insurers, who experience a majority of problems in the area of underwriting, most other branches experience most of their financial problems as the result of problems with their investments. Because of this fact, most states regulate investment of the assets of insurance companies. These restrictions may be either quantitative or qualitative, dealing with the types of investment media, the amount of security required, the percentage of admitted assets to be invested, and the percentage of admitted assets dedicated to a single area of investment, among others.
Each state has insurance codes that guide the development of new companies in the insurance business.
These codes are in place to protect the public from being misled, from being the victims of unscrupulous business people and from people who want to profit from the sale of the insurance company�s stock.
State insurance commissions have the right to regulate the types of insurance to be offered by new insurance companies, as well as the types of coverage available from this insurance.
The states issue a license to write insurance for domestic, foreign, and alien insurers, and then establish strict guidelines by which all insurers must do business in that state. The licenses issued to domestic insurance companies are usually permanent, but foreign and alien licenses are subject to renewal each year.
The state insurance commissions believe that their licensing requirements are effective in controlling the activities of all insurance companies, assuming that they are complying with minimum statutory standards of financial solvency, and eliminating fraud or dishonesty among the insurers.
There are two laws that currently deal with unauthorized insurers (those who are unlicensed in a certain state or mail-order insurers). One of these is the Unauthorized Insurer Service of Process Act. In this act, the commissioner serves as the agent for foreign companies for service of process (the summons that brings a defendant to court for legal jurisdiction). The second act is the Uniform Reciprocal Licensing Act. Under the Uniform Reciprocal Licensing Act a domestic insurance company�s license may be taken away if it operates in another state that has a reciprocal licensing act without obtaining a license. A state may also control unauthorized insurers by limiting their business to that of licensed surplus lines or licensed brokers.
When an insurance company becomes technically insolvent, the state commission of insurance takes over the company for liquidation, rehabilitation, or conservation. The commissioner may take over operations at any time if the company is not being operated in the best interests of those holding policies with that company. An insurance company suspected of nearing insolvency has a right to a hearing by the commission, but when an order to liquidate is issued, the assets of the company become vested in the commission. At that point, if the need for a takeover is not sufficiently supported, the assets are returned to the company�s management.
The Uniform Insurers Liquidation Act provides a uniform procedure in liquidation cases where insurers have done business in more than one state. This gives equal rights to each adopting state in the handling of claims and the final distribution of the insolvent company�s remaining assets.
To maintain a certain amount of control over the policies offered by various insurers, each state commission must approve policy forms. This makes it difficult for companies to either mislead or deceive the consumer with statements that contain highly technical terminology or ambiguous descriptions of coverage. For certain types of insurance coverage, including fire and workers� compensation, a standard form is required. Other coverages, such as life and health, forbid the use of gimmickry in their forms and verbiage.
The commissioner, upon reviewing a new policy format, may overrule any type of wording in provisions that may be deceptive or misrepresent the �real� coverage. The unfortunate aspect of this particular type of regulation is that most state insurance departments have neither the funds nor the trained personnel to review every form that is used for insuring individuals in that state.
Like any other industry, insurance companies in America pay local, state, and federal taxes and fees. The bulk of these taxes are levied by the state; however, some communities and municipalities collect taxes as well. These mandatory payments include income taxes, property taxes, license and filing fees for annual financial statements, and fees for taking the insurance licensing exam. Companies also pay taxes on franchises (if they apply), premium taxes (although some states tax insurance companies as an alternative to premium taxes), and special taxes on workers� compensation and various other types of insurance.
While state taxation varies according to state requirements, federal income taxes are levied according to formulas found in the Internal Revenue Code, and taxation on real estate and property are the same as for any other taxpayer. In some states, taxes levied on fire insurance premiums go to support local fire departments. Likewise, the taxes on workers� compensation insurance are used to establish the system, security funds, and funds to underwrite programs for employing handicapped individuals.
One of the most unique and most controversial of taxes paid by insurance companies is the premium tax. At one time, the proceeds from this form of taxation were used to pay the costs of regulation; however, state insurance companies today receive only a small portion of the premium tax, with the greater part of the proceeds used to fund other services provided by the state. This particular tax has brought an outcry from the insurance industry, with objections centering around the seeming inequity in taxing one industry without taxing others. The bottom line of the premium tax is that it is ultimately paid by insurance subscribers, and no state has reported any problems in collecting the premium tax.
The truth of the matter is that the premium tax is a bone of contention within the industry. First of all, the states vary taxation rates between 1.7 percent and 4 percent, with 2 percent being the most widely used. In some states, U.S. companies are taxed at a lower rate than foreign companies, a situation that the NAIC has worked to eliminate.
To strike some type of balance, a large majority of the states charge what is called a retaliatory tax, which equalizes the domestic tax rate for companies operating outside the state. In some states, too, the premium tax varies according to the line of insurance, based on whether or not the insurance company may have some of its assets invested in that state. The states also vary their formulas for calculating the premium tax. In some cases, the insurance company is allowed to deduct its policy dividends from its tax base, but few states allow this deduction.
Today, some states are considering an income tax in place of a premium tax (or, in some instances, in addition to the premium tax). The difficulty in determining a company�s income is most often cited as a reason for not going forward with this idea. It is also important to know that formulas to measure income presently differ among the states.
Although most insurance rates are derived by extremely complicated formulas, a simplified explanation is that insurance rates are a determination of a policyholder�s percentage of responsibility for loss expenses. The premium to insure a home or automobile is the rate per unit of coverage multiplied by the number of units purchased.
Here are some examples: A customer wants to purchase a homeowners policy. A unit would be 100 square feet within the building. Depending on the particular circumstances, the unit may be $100 or $1,000 of coverage purchased.
Once the cost per unit is established, the insurer must look into the future to determine the percentage chance that the homeowner will suffer a loss, based on past experience and the rate of probability that a homeowner will file a claim. This historical experience plus the influence of new trends and developments, such as improved building materials, are also taken into consideration to determine the final rate to be paid.
Historically, insurers calculated each policy on a separate basis. But, as business increased, this system proved to be too cumbersome, and insurance companies also found some glaring deficiencies in their existing methods. Rate setting (sometimes referred to as rate making) soon became a group effort in order to make rates both profitable for the companies and fair to the policy buyers. These rates were published, and if variances were appropriate, the established rates became the basing point for these variations. The various lines of insurance began setting their own rates, and today, the industry trends suggest that independent rate making is the rule for all types of insurance coverage.
When a rate filing is submitted to the state insurance department by an insurance company, the data submitted is evaluated by the department, with three objectives in mind:
� To prohibit excessive rates for coverage.
� To maintain the financial solvency of the company.
� To avoid unfair discriminatory rates.
The strictness and meticulousness with which new rates are evaluated depends upon the state. In some states, for example, property and casualty rates require explicit approval by the insurance commission, prior to the use of new rates. In other states, the �open competition� condition exists, and it is assumed that the competition will regulate costs much more effectively than the insurance commission. In the �open competition� states, the commissioner of insurance may curtail the use of certain rates, particularly those violating rating standards, but rates do not have to be filed and approved, as is the practice in the more rigidly controlled states.
It is worth noting here that anyone having a grievance against an insurance agent or insurance company is invited to file a complaint and is entitled to a hearing. However, the burden of proof that rate filings actually comply with the law is on the shoulders of the insurance company or the rating bureau.
Life insurance rates are not regulated in the same manner that other rates are regulated. The control of these rates is indirect, or, in other words, based on supervision of mortality tables, dividends and interest rates used to compute the reserves of life insurers. When these controls are combined, the result is an indirect regulation of life insurance rates that are inadequate, excessive, or discriminatory.
Within the regulation of life insurance, there is one central controversy involving �cost disclosure.� Since life insurance rates do not reflect the true costs of the policy to the company, it is entirely possible that a policy having a low premium may be very costly to the issuing insurer, or the opposite may be true � a policy with a high premium may require very little from the insurer, cost-wise. To provide consumers with a better understanding of life insurance rates, and to give them a better tool with which to compare the costs of various policies and coverages, the industry has turned to the interest-adjusted method for computing policy costs. Indeed, the NAIC has recommended that the states require life insurance companies to provide detailed information to consumers about the costs of a policy. Some states have agreed to this suggestion. Others vehemently oppose this concept. Ultimately, some consumers have agreed, saying that the interest-adjusted computation is just as difficult to understand as other methods, and that they will rely on their agents for guidance in purchasing adequate coverage for their individual needs.
In terms of regulating rates, the state insurance commissioner decides whether or not to approve a rate. In some states, the commissioner is assisted by appointive rating organizations to collect and maintain data regarding rates. The commissioner also has access to rating laws that involve the technical requirements of methods for recording and reporting losses and expenses over certain periods, as well as exchange of rating plan data and the experience and advice of other states.
Rates for life insurance lines are regulated individually by guidelines applicable to the insurer�s reserves and the liability of these reserves. However, the reserve requirements do not relate to the premium charged. As an example, if the insurance company charges a premium on a life insurance policy that is inadequate to cover its exposure, the company�s assets will soon be smaller than the liability of the coverage it will have to eventually pay.
The thinking among insurance industry leadership and regulators alike has been that competition would ward off excessive rates, but because the consumer public has neither the technical knowledge nor general understanding of the industry, it is questionable that competition actually serves as an effective regulator of life insurance.
To serve as a guide for charging rates, the industry has developed price indexes based on formulas developed within the industry. The indexes are used by a large number of companies. The states have also entered into the educational area of the industry by publishing buyers� guides showing the prices of a number of life insurance lines.
In the case of health insurance lines, there are several states that require these lines to file a schedule of their rates with the insurance commissioner. Other states allow the commissioner the ability to disapprove health insurance forms, particularly if benefits and premiums are not proportionally balanced.
Some states require that insurers file a listing of expected losses associated with the claims filed on health insurance. In addition, all states require that insurance companies file reports of their loss ratios. While the public interest automatically requires close scrutiny of each case in point, the states cannot provide enough professionals to review or supervise every health insurance policy. In fact, so many different health insurance policies now exist that it is impossible to check their rates against benefits. This makes the agent�s role extremely important since the public is generally unable to fully understand the many variables between policies.
Although it may seem that most regulation applies to the insurance companies rather than the individual producer, it is the producer that the client sees and therefore the person most responsible for the image the public will have of our industry. Rules and regulations can only go so far to create the proper business environment. Ethical standards are also a necessary element in guiding a producer�s conduct. The next section of study will focus on ethics and ethical behavior for insurance producers.