If you purchase business insurance, you may have pondered who determines the premiums you pay. Typically, insurance premiums are governed by the state in which you obtain coverage. States are able to tax and regulate insurance providers. Anti-discrimination laws only apply to non-risk-related criteria, such as race, religion, and national origin. Some states require all rates to be pre-approved, whilst others do not.
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State Regulation of Insurance Premiums
The states control the insurance industry. Each state has its own insurance regulatory authority. This organization is commonly referred to as the Department of Insurance, but some states use other terms. Washington's Office of the Insurance Commissioner and the Division of Financial Regulation are examples (Oregon). The department of insurance is led by a commissioner. The insurance commissioner may be appointed or elected, depending on the state.
Some forms of insurance rates are governed at the state level. State to state, the level of regulation varies significantly. Some states are extremely restrictive, while others are lax. The majority of states fall in the middle.
Insurance Premiums and Government Regulation
Many insurance companies do business in multiple states. Few conduct business in nearly every state. Why is the insurance industry not controlled by the federal government?
McCarran-Ferguson
In 1945, the McCarran-Ferguson Act was passed. This law grants states regulatory authority over insurers. The law was passed in reaction to a U.S. judgment. Supreme Court the year prior. The court determined that insurance business comprised interstate commerce. This meant the federal government had the authority to regulate the insurance industry.
The Supreme Court's decision to eliminate state regulation posed a danger to the insurance business. The McCarran-Ferguson Act reinstates state sovereignty. It authorizes states to tax and regulate insurers. However, there are three important exceptions to the law:
- Insuring companies are susceptible to federal antitrust laws to the extent that they are not governed by state law.
- The federal government may enact insurance regulations that trump state regulations.
- The federal government prohibits insurers from engaging in boycotts, coercion, or intimidation.
Dodd-Frank
The Dodd-Frank Act, passed by Congress in 2010, imposed numerous new requirements on financial firms. The statute created the Federal Insurance Office (FIO). This agency is part of the U.S. Treasury Department. It was established to ensure the financial stability of the insurance business. The FIO is strictly an advisory organization. It lacks regulatory oversight over insurance.
Purpose of Rate Regulation
States regulate insurance prices for a variety of reasons. One is to guarantee that rates aren't excessive. In the absence of regulation, insurers may charge excessively high rates and create excessive profits. A second objective is to guarantee that interest rates are not too low. An insurer who charges unreasonably low premiums may sell several policies, yet lack the financial resources to settle claims. Rates must be sufficient for insurers to remain solvent.
The third objective of insurance regulation is to eliminate prejudice. It is permissible for insurance underwriters to favor some insurance purchasers over others, but the reasons must be valid. Insurers may, for instance, charge a greater or lower premium based on a policyholder's claims history. A company with no prior vehicle claims may pay less for a commercial auto policy than a comparable company with numerous accident losses. Insurers can also make distinctions based on the nature of the risk. An insurance may charge a building without fire sprinklers a higher premium than a comparable structure with a sprinkler system.
It is prohibited for insurers to discriminate against policyholders on the basis of characteristics unrelated to the risks insured. Race, religion, and national origin are examples. Certain qualities may only be used to rate certain forms of insurance. For instance, several states permit insurers to factor in age, gender, and marital status when determining the cost of personal auto insurance. These criteria are irrelevant to the ranking of commercial vehicles.
Difficulties With Prior Approval
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The rationale underlying prior approval legislation is that government intervention is required to guarantee that rates are adequate but not excessive. Historically, numerous state legislators have endorsed this approach. Legislators have realized over the past few decades, however, that prior approval regulations can cause significant complications.
A rating system based on prior permission is expensive, for one thing. Both insurers and state regulators are required to hire personnel to guarantee that submitted rates are examined in conformity with the law. Since filing requirements vary from state to state, operating in numerous jurisdictions imposes an additional burden on insurers. Insurance purchasers bear the expenses imposed by insurers and government organizations. Thus, rates are typically higher in states with prior approval than in states with competitive rating legislation.
Artificially Low Rates
Secondly, prior approval laws produce rates that are artificially low. Regulators frequently oppose rate increases requested by insurers, delaying rate increases. When premiums are excessively low, insurers incur financial losses. When rates are eventually raised, insurers' financial status improves. The outcome is fluctuating gains and losses.
Shrinking Insurance Market
In addition to causing a declining insurance market, rules requiring prior approval can also result in a shrinking insurance market. When premiums are insufficient to cover losses and expenses, some insurance companies leave the state. Others are reluctant to enter. The outcome is diminished insurance availability. Service and product selection may also deteriorate. When rates are excessively low, there is little motivation for insurers to create new products or enhance service.
Assigned Risk Plans
In conclusion, prior permission laws can result in an influx of consumers with average risk into assigned risk plans. The purpose of these programs is to serve as a market of last resort. They are intended for high-risk buyers who cannot receive coverage from a conventional insurer. When "normal" insurers are unavailable, however, average-risk purchasers are obliged to purchase assigned risk plans.
Advantages of Competitive Ranking
Due to the challenges associated with pre-approval regulations, some jurisdictions have used competitive rating to modernize their regulatory processes. The concept underlying competitive rating legislation is that competition will create rates that are neither too high nor too low. Because the insurance sector is so diverse, these regulations have proven effective in a number of jurisdictions. There are various insurance providers, none of which are large enough to dominate the industry. In 2015, there were about 2500 property/casualty insurers operating in the United States, per the Insurance Information Institute.
Insurance Costs
Competitive rating regulations offer a number of advantages to insurance purchasers. One is rate reductions. Insurers are more willing to decrease their rates if they believe they can swiftly increase them to cover losses. The financial performance of insurers is also more constant under a competitive rating system. Other insurers will enter the state when profits and losses are predictable. As the number of insurers increases, so does competition between them. This helps to maintain cheap prices. Additionally, competitive pressures motivate insurers to enhance their service and vary their product offerings in order to attract clients.
Reduced interest in assigned risk plans
In conclusion, competitive rating reduces demand for assigned risk plans. When insurers seek new clients, the majority of insurance purchasers can receive coverage in the normal market. Assigned risk plans can function as designed and will not compete with conventional insurers.
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