Insurance Regulation and Legal Principles

• Chapter 8 is about US government legislation of insurance
• Chapter 9 relates to The Fundamental Legal Principles

Major Reasons for Insurance Regulation

• Maintain insurer solvency
• Compensate for inadequate consumer knowledge
• Ensure reasonable rates
• Make insurance available

Landmark Legal Cases

• Paul v. Virginia (1868)
• McCarran-Ferguson Act (1945)
• Gramm-Leach-Bliley Act
• Dodd-Frank Wall Street Reform and Consumer Protection Act

Methods to regulate insurance companies

• Legislation
• Courts
• State Insurance Department

Legislation

• All states have insurance laws regulating six areas
• Formation of insurance companies
• Licensing of agents/brokers
• Financial requirements for maintaining solvency
• Insurance rates
• Marketing, sales, and claims practices
• Taxation
• Rehabilitation or liquidation of insurers

Courts

• Decisions concerning constitutionality of state laws
• Interpretation and legality of actions
• Courts can affect market conduct and operations of insurers

State Insurance Departments

• All states, DC, and US territories have separate insurance departments/bureaus
• Insurance commissioner is either elected or appointed by the state governor
• Insurance commissioner is responsible to administer state insurance laws
• NAIC – National Association of Insurance Commissioners discusses industry problems

Regulation Areas

• Formation and licensing of insurers
• Solvency regulation
• Rate regulation
• Policy forms
• Sales practices and consumer protection
• Taxation of insurers
• Miscellaneous

Formation of Licensing

• Domestic insurer is domiciled and licensed in the state they operate
• Foreign insurer is chartered in another state but licensed to do business in another state
• Alien insurer is chartered in a foreign country but licensed to do business in another country

Solvency Regulation

• Admitted assets
• Reserves
• Policyholder surplus
• Investments
• Reports and exams
• Liquidation of insurers

Rate Regulation

• Principals types include prior approval laws
• Modified prior approval laws
• If the rate change is based on loss experience then the insurer must file rates with state insurance dept; rates may be used immediately (file and use)
• For a change in rate classification or expense relationship, then prior approval of the rates is necessary (prior approval)
• File and use law, and use and file law are relevant
• Flex rating law
• State made rates
• No filing required

Regulation also impacts on

• Policy forms
• Sales practices and consumer protections
  • Regulation impacts on, agents/brokers licensing, and laws prohibiting twisting, rebating and unfair trade practices

Taxation of Insurers

• Insurers pay federal and state premium tax
• Premium tax is paid on gross premiums received, about 2%
• The purpose of taxation is to raise revenues for the states

Federal Regulation

• Advantages of federal regulations include
  • Uniform state laws and regulations
  • More effective negotiation of international insurance agreements designed rules for foreign insurers to follow in the US and speak with one voice for American regulators in international insurance agreements
  • More effective treatment of systemic risk and greater efficiency of insurers

State Regulations

• Claimed advantages of state regulations that include
  • Quicker response to local insurance problems
  • Increased costs from dual regulations
  • Poor quality of federal regulations
  • Promotion of uniform laws of NAIC
  • Greater opportunity for innovations
  • Unknown consequences of federal regulation
• Disadvantages of state regulations include
  • Inadequate protection of consumers
  • Improvements needed to handle complaints
  • Inadequate market conduct examinations
  • Insurance availability
  • Regulators overly responsive to the insurance industry

Insolvency of Insurers

• Regulatory problem, solvency is the ability of an insurer to meet its obligations
• Insolvency occurs for a variety of reasons
  • License revocation, cease-and-desist orders
  • If the insurer becomes insolvent, the policy can be sold to another insurer claims may be paid by the state's guaranty fund

Market Conduct Regulation

• Defined as marketing practices of insurers and agents that involve interaction with insureds, claimants, or consumers including:
  • Sale of policies
  • Advertising
  • Underwriting/rating
  • Premium collections
  • Policy renewals/terminations
  • Policy changes
  • Claims settlement and similar activities
  • Activities to modernize the insurance industry

Principles

• Indemnification states the insurer agrees to pay no more than the actual amount of the loss by preventing profit from loss
• Important component of P&C insurance contracts
• Deductibles, dollar limits, and contractual provisions may affect payout

Purpose

• Prevent the insured from profiting
• Reduce moral hazard
• No intentional acts may occur

Indemnification Exceptions

• Valued policy laws in some states
  • Requires payment of the face amount of insurance to the insured if a total loss to real property occurs from a peril specified in the law
• Replacement costs insurance
  • Replacement costs = ACV + Depreciation

Insurable Interest

• Principle stipulates that the insured must be in a position to lose financially if a covered loss occurs, with examples including mortgages, auto loans, etc
• Prevents gambling, and reduces moral hazard

Subrogation

• The insurance company can recover from a negligent third party any loss payment made to the insured
• Prevents the insured from collecting twice from the same loss
• Holds the negligent third party responsible for the loss
• Helps to hold down insurance rates
• Does not apply to life policies and cannot subrogate against its own insureds

Principal of Utmost Good Faith

• Higher degree of honesty is imposed on both parties to an insurance contract than is imposed on parties to other contracts
• Oral or written statements made by the applicant to induce the insurer to enter into an insurance contract
• Representation which is false is misrepresentation and makes the insurance contract is voidable
  • The insurer has the option if the misrepresentation is material, false, and relied on by the insurer
    • Material is meaning if the insurer knew the true fact, the policy would not be issued or issued on different terms
    • False means the statement is not true or misleading
    • Relied on relates to the insurer relies on the misrepresentation in issuing the policy at a specified premium
• Innocent misrepresentation of a material fact also makes the contract voidable and can be unintentional
• Also applies to fraudulent statements or proof of losses made after the loss occurs.

Concealment Defined

• Intentional failure of the applicant for insurance to reveal a material fact to the insurer essentially the same as non-disclosure
• The insurer must prove two things to deny a claim based on concealment:
  • The concealed fact was known by the insured to be material
  • Insured intended to defraud the insurer

Warranty

• Statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects reflects the principles of utmost good faith

Four Requirements of an Insurance Contract

• Offer and acceptance
• Exchange of consideration
• Competent parties
• Legal purpose

Legal characteristics of an insurance contract:

• Unilateral contract
• Conditional contract
• Contract of adhesion

Law of agency

• Waiver
• Estoppel