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Regulation and Compliance

Insurance Is Regulated by States, Right?

Aaron Lunt | November 3, 2017

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Since the McCarran-Ferguson Act of 1945, Congress has delegated regulating the "business of insurance" to the states. By congressional act, Congress could rescind its delegation and create a federal regulatory framework, similar to what we see in the banking industry. That is highly unlikely for a variety of political and practical reasons.

The federal government does continue to play a role in regulating the business of insurance. Let's explore a few examples.

Affordable Care Act (A.K.A. "Obamacare")

Since the passage of Obamacare in 2010, there have been very few periods of time in the media where this law hasn't been mentioned. It has been a hot political topic for many years and was a significant issue in the 2016 US presidential election, and it remains red hot to this day!

Furthermore, in the summer and fall of 2017, there have been several legislative attempts to repeal, replace, and/or reform the law. The legislation is vast and complex, but it basically created certain standards of coverage on healthcare providers and certain requirements on employers as well as certain requirements on individuals (namely the mandate to have health coverage in certain situations). Since the law's enactment, the government has provided federal cost-sharing subsidies to insurers to cover certain costs for servicing low-income individuals, but the Trump administration has canceled these payments by executive order. As legislation continues to percolate on Capitol Hill, many changes could be on the horizon.

One of the by-products of the Act was the creation of insurance "exchanges," which are essentially online marketplaces where an individual can purchase health coverage that complies with federal law. Each state has either created its own exchange or subscribed to the federal one. One interesting piece of information is that, despite federal involvement in this area of insurance, states still maintain a large portion of their regulatory authority.

For example, state insurance regulators still review and approve (subject to certain state law exceptions and exclusions) rates prior to use. This has been a significant issue demanding media attention due to the political uncertainty and volatility of the law and whether the federal government will pass legislation to resume federal cost-sharing payments to insurers. The cost-sharing subsidies have a direct impact on the rates insurers must charge, whereby the latter is dictated by state regulators. Without the subsidies, insurers would need to dramatically increase rates.

This issue will remain a political hot-potato for months, and possibly years, to come.

The Terrorism Risk Insurance Act

Following the tragic events of September 11, 2001, there were significant insurance concerns that plagued the marketplace. First and foremost, the commercial insurance market retreated due to the uncertainty and unpredictability of terrorism exposures. This further stressed the US economy.

To illustrate, large, metropolitan construction projects were stalled due to the inability to secure builders risk, property, and workers compensation insurance. Furthermore, "high-value" targets—such as sporting venues, landmarks, governmental buildings, and consequential places of economic commerce—were finding it increasingly difficult to secure property, liability, and workers compensation insurance.

Terrorism was, and remains, a unique exposure that shares certain characteristics of natural catastrophes (e.g., hurricanes and tornadoes), but the following are two distinct differences.

  • Severity: Prior to September 11, 2001, there was a lack of terrorism loss data that enabled insurers to predict the severity of loss(es), especially to this magnitude. In our post-9/11 world, our understanding of the impact and cost (in human lives and to insurance coverage) has been drastically altered.
  • Frequency: The frequency of natural disasters can be predicted with greater accuracy than terrorism events based on a variety of factors—including climate, time-of-year, and other predictors. Terrorism, a human created catastrophe, is much less predictable. Theoretically, the frequency of terrorism events could happen monthly, weekly, or even daily—depending on a concert of human considerations. As Jason M. Schupp says in his book The Terrorism Risk Insurance Act—A Practitioner's Guide, "… the factors that drive the probability of a terrorist attack are in a constant state of change. For example, a relaxation of airport security procedures, the fall of a foreign government, an escalation of US troop levels abroad, the illegal release of classified intelligence information—among countless other factors driven by human decisions and behaviors—could influence the security of the United States and its exposure to the terrorist threat" (page 13, published in 2016 by Northloop Books).

The Terrorism Risk Insurance Act was signed into law by President George W. Bush in 2002 and has been extended three times with modifications over the duration of the program. The Act is scheduled to expire at the end of 2020, which means the current Trump administration will entertain another extension (President Donald Trump remains in office until January 20, 2021, unless reelected) and will remain relevant in the reauthorization discussion.

The National Flood Insurance Program (NFIP)

The NFIP was enacted in 1968 and remains in force today. Interestingly, the NFIP was scheduled to expire on September 30, 2017, but was reauthorized until December 8, 2017. The program has newfound focus due to Hurricanes Harvey and Irma wreaking havoc on Houston and southern Florida, respectively.

Much like terrorism insurance, the NFIP was created in response to a paucity of private coverage options for home owners and small business owners. The Federal Emergency Management Administration administers the program, and the NFIP has had many well-publicized deficiencies over the years. Namely, the NFIP has historically charged inadequate rates to cover its exposure(s), and the flood maps are constantly being redrawn. In addition, in some situations, the cost to insure flood risks is incredibly high—prohibiting many home owners and small business owners from buying coverage, unless required by a lender.

Later this year, Congress will be forced to continue the program and identify changes to it. The active hurricane season will continue to make the emotions around reauthorization a hot topic in the media.

The Wall Street Reform and Consumer Protection Act (A.K.A. "Dodd-Frank Act")

Another landmark piece of legislation that President Obama signed in 2010 was the Dodd-Frank Act. On the heels of the "Great Recession," this massive piece of legislation was enacted to help stabilize the financial markets and ensure financial firms were financially healthy enough to absorb future market shocks, reducing the chances of another financial meltdown.

The insurance industry was affected by the legislation (a few highlights below) because a large insurer—American Insurance Group (AIG)—had a financial product's division that was not regulated by insurance regulators. This led to AIG having obligations to pay out when certain financial instruments, such as collateralized debt obligations, began to sour due to the subprime mortgage lending industry. AIG received federal bailout money (under the Troubled Asset Relief Program), which has since been paid back, plus some, but it was much maligned by the media.

Due to AIG's involvement in the events described above, "insurance" is relevant in several areas of the Dodd-Frank Act. The following are a few areas that merely scratch the surface.

  • Creation of the Federal Insurance Office: Intended to help administer the Terrorism Risk Insurance Program, this department represents the US insurance market internationally and performs analysis over certain aspects of the insurance industry.
  • Nonadmitted and Reinsurance Reform Act: This Act helped streamline the compliance and reporting of surplus lines taxes, among other things, in the United States.
  • Creation of the Financial Stability Oversight Council: This group identifies and designates systemically important institutions for Federal Reserve oversight (AIG and Met-Life have been designated but subsequently undesignated, and Prudential remains the only designated insurance company).

Final Thoughts

Although states retain primary authority to regulate insurers and the business of insurance, the federal government has been involved in certain areas for a long time, with its involvement only seeming to intensify. In looking at the dichotomy between the federal and state regulation of insurance, there is oftentimes "dual" regulation (federal and state, as we see with health insurance) and "duel" regulation (gray areas where it is unclear whether the federal government or state controls). Insurers, agents, brokers, and other industry professionals must continue to navigate these complex waters and pay careful attention to the political environment. 

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