Revising Insurance Regulation: Policy Considerations

CRS Report for Congress
Revising Insurance Regulation:
Policy Considerations
Updated February 11, 2005
Baird Webel
Analyst in Economics
Government and Finance Division
Carolyn Cobb
Insurance Consultant
Government and Finance Division

Congressional Research Service ˜ The Library of Congress

Revising Insurance Regulation:
Policy Considerations
Summary
All insurers are now regulated by the 50 states. Since the 107^th Congress,
committees in both houses of Congress have considered whether that framework of
insurance regulation meets the demands of the marketplace and the needs of
businesses and individuals.
A key issue is the relative merit of federal regulation of the insurance industry
compared to the current state-based regulation. Less emphasized but also significant
are the differences that arguably exist among kinds of insurance, for the industry is
hardly monolithic. There are also fundamental policy issues concerning why and
how each kind of insurance might be regulated, and about what national interests may
be involved in resolving these questions.
This report discusses federal regulation of insurers — whether optional or
mandatory — in that broader context. To assist that discussion, it traces the evolving
rationale for regulation generally, explains insurers’ roles as risk managers and
financial intermediaries, and reviews briefly important aspects of the major lines of
insurance.
Many economists and scholars now generally agree that competitive markets
can allocate resources — including capital — more effectively than regulation.
Empirical studies have cast some doubt on a common rationale for insurance
regulation (i.e., that insurance is a public utility and that regulators can achieve
socially optimal pricing and socially desirable pricing). Studies have also shown that
the insurance market is competitive; courts have so narrowed its antitrust exemption
that it functions competitively.
Managing risk of financial loss is fundamental to the U.S. economy. Insurance
is one way to manage risk; for businesses, there are economic substitutes for
insurance. Insurers serve the U.S. economy as financial intermediaries, like banks,
and their investment portfolios are significant.
Different kinds of insurance can be classified in several ways. One option,
when considering why or how to regulate, is to classify by whether the purchaser is
a business or an individual. Businesses may not need the same level of regulatory
protection that individuals might.
This report will be updated in the event of major legislative activity.

Contents
In troduction ......................................................1
The Debate Over Optional Federal Regulation...........................1
Why Regulate?....................................................2
Conventional Theories..........................................2
Current Theory of Regulation....................................4
Insurers’ Role In Society?...........................................5
Insurers Are Subset of Risk Management Marketplace.................5
Insurers Are Financial Intermediaries..............................6
Kinds of Insurance.................................................8
Direct Insurance...............................................8
Property-Casualty Lines.....................................8
Life Insurance............................................11
Health Insurance.........................................13
Reinsurance .................................................13
Conclusion ......................................................16

Revising Insurance Regulation:
Policy Considerations
Introduction
The power to regulate insurance currently rests primarily with the individual
states. This primacy, however, has been slowly decreasing over time. Congress has
become increasingly involved in regulating insurance and in overseeing states’
regulation of insurance, and the corporate National Association of Insurance
Commissioners (NAIC) has assumed a national role.¹ Insurers and state insurance
regulators are now discussing whether to modify the current federalism balance and
if so, how. Resolving the question — intellectually or politically — involves
reviewing the risk management market generally and the insurance market
specifically, deciding on purposes for regulating, and crafting a federalism
framework that can accomplish those goals.
The Debate Over Optional Federal Regulation
Insurance is one way to finance risk of loss. Large U.S. insurers — both life and
property-casualty — are competing with other providers of risk-financing, nationally
and internationally, such as banks and the capital markets. They believe that they
have less efficient regulation than those cross-sectoral competitors. In their view,²
that imposes adverse macroeconomic and microeconomic consequences because it
steers capital away from insurers. They believe that having a single federal regulator
might provide more efficient regulation, which would enhance their competitive
position, attract capital, and reduce macroeconomic distortions.
State insurance regulators, smaller insurers, and consumer groups have a
different view of insurance. State insurance regulators view their purpose as
consumer protection, not macroeconomic or microeconomic capital allocations.
Smaller insurers do not view themselves as competing for capital with other types of

¹ CRS Report RL31982, Insurance Regulation: History, Background, and Recent
Congressional Oversight, by Baird Webel and Carolyn Cobb traces the development of the
current balance of power between the national and state governments with respect to
insurance regulation.
² Macroeconomics studies aggregate markets, and microeconomics studies individual
economic units — such as investors, businesses, and consumers. These distinctions can be
arbitrary, as aggregate markets are the collective decisions of individual economic units in
that market. Robert S. Pindyck and Daniel L. Rubenfeld, Microeconomics (Macmillan,
New York: 1989), pp. 3-5.

financial intermediaries. Consumer representatives view insurance as vested with a
public interest that market competition is ill equipped to meet. Collectively, these
interests believe that current state insurance regulation provides the best form of
consumer protection and that, though states’ regulation is not uniform, it can be made
efficient enough to serve the public interest.³
The debate gets into the purpose or purposes of insurance regulation. Some
might argue, for example, that insurers should be regulated to assure availability and
affordability of insurance for consumers and businesses. Others might argue that
insurers should be regulated to assure a competitive market in financial services —
an argument that presupposes consensus on what “the market” is.⁴ These arguments
— though heated within the insurance industry and between it and its state regulators
— generally do not incorporate broader public policy issues.
This report examines what regulation, if any, would be appropriate in subsets
of a private sector that is competitive and not monolithic. What might be the goal of
regulation of each basic kind of insurance? Why regulate each line at all? Should
commercial policies, for example, be regulated just like individual consumers’ auto
policies? If so, why? If not, why not? What is the cost of regulation — for
businesses? For consumers? Should life insurers be regulated like property-casualty
insurers? Should reinsurers be regulated? Why regulate the market at all? What is
“the market?”
Why Regulate?
Conventional Theories
Early theories about why government does or should regulate insurance
companies persist, even though many scholars and economists no longer find them
useful. One persistent perception has been that the insurance industry has captured
its regulators, and that state-level regulation therefore benefits insurers rather than
consumers.⁵ Empirical study has cast serious doubt on that theory, however, finding
that capture does not occur because the insurance industry is too diverse.⁶

³ For an overview of this viewpoint, see U.S. Congress, Senate Committee on Commerce,
Science and Transportation, Federal Involvement in Regulation of the Insurance Industry,
hearing statement of the Independent Insurance Agents and Brokers of America by Mr. Tom^th^st
Ahart, 108 Cong., 1 sess., Oct. 22, 2003, available at [http://commerce.senate.gov/pdf/
ahart102203.doc].
⁴ CRS Report RL30516, Mergers and Consolidation Between Banking and Financial
Services Firms: Trends and Prospects, by William D. Jackson. This report provides an
overview of the participants’ view of the marketplace.
⁵ The theory of regulatory capture originated in George J. Stigler, “The Theory of Economic
Regulation,” Bell Journal of Economics and Management Science, vol. 2, spring 1971, pp.

3-21.

⁶ Kenneth J. Meier, The Political Economy of Regulation: The Case of Insurance (Albany:
(continued...)

Another theory has been that insurance resembles a public utility, that is,
insurers provided such a basic service to the public (like airlines or telephone
companies) and that it should be regulated by the government in the best interest of
consumers. Proponents thought regulators should — and could — achieve socially
optimal pricing and socially desirable access.⁷ Experience disproved that theory also,
and regulatory reform began — and continues — in many sectors of the U.S.
economy.⁸
A third persistent but controversial view is that insurers have a complete
exemption from antitrust laws and so must be regulated to control anti-competitive
behavior. Regulation and later the insurance exemption in the McCarran-Ferguson
Act⁹ did keep some insurance rates artificially high.¹⁰ As courts have increasingly
narrowed the exemption over the last 50 years,¹¹ however, competition has
increased.¹² McCarran-Ferguson is now understood to allow insurers to share only
historical information about the timing and scope of their losses, which actually
promotes competition, since it gives new market entrants access to that historical
information.¹³

⁶ (...continued)
State University of New York Press, 1988).
⁷ See Richard E. Stewart, “The Social Responsibility of Insurance Regulation,” in Insurance
and Insurance Regulation: Speeches and Papers 1968-1992, pp. 1-5, available at
[http://www.stewarteconomics.com/Book020500.PDF], pp. 4-8. In 1968, at the time Mr.
Stewart gave this speech, he was Superintendent of Insurance in New York and president
of the National Association of Insurance Commissioners.
⁸ See Clifford Winston, “Economic Deregulation: Days of Reckoning for Microeconomists,”
Journal of Economic Literature, vol. 31, Sept. 1993, pp. 1263-1289. See also Alfred E.
Kahn, The Economics of Regulation: Principles and Institutions (Cambridge MA: MIT
Press, 1998), pp. xv-xxxvii.
⁹ 15 U.S.C. §1012(b).
¹⁰ Chao-chun Leng, Michael R. Powers, and Emilio C. Venezian, “Did Regulation Change
Competitiveness in Property-Liability Insurance? Evidence from Underwriting Profit and
Investment Income,” in Journal of Insurance Regulation, vol. 21, winter 2002, pp.57-78.^th
See also Scott E. Harrington, “Insurance Rate Regulation in the 20 Century,” in Journal
of Insurance Regulation, vol.19, winter 2000, pp. 204-218.
¹¹ See CRS Report RL31982, Insurance Regulation: History and Background, by Baird
Webel and Carolyn Cobb.
¹² See Tim Wagner, “Insurance Rating Bureaus,” in Journal of Insurance Regulation, vol.
19, winter 2000, pp. 189-203. See also U.S. Congress, House Committee on Financial
Services Committee, Subcommittee on Capital Markets, Insurance and Government
Sponsored Enterprises, The Effectiveness of State Regulation: Why Some Consumers Can’t^th^st
Get Insurance, House Committee on Financial Services, hearing, 108 Cong., 1 sess., Apr.

10, 2003.

¹³ Wagner, “Insurance Rating Bureaus,” p. 201; Meir Kohn, Financial Institutions and
Markets (New York: McGraw-Hill, 1994), p. 401.

Current Theory of Regulation
Experience and research generally support the current theory that competitive
markets can allocate resources more effectively than regulation,¹⁴ although consumer
representatives often disagree.¹⁵ On the other hand, economists generally recognize
that markets are not always perfectly competitive, and that they can fail to capture the
full benefits or costs of some activities or inactions. That is why some economists
suggest that government intervene in private markets only to
^!prevent systemic risk;
^!promote market efficiency; or
^!accomplish a social policy.¹⁶
Systemic risk is the risk that a single institution’s default will trigger a chain
reaction of defaults, leading to loss of confidence that undermines an entire financial
system.¹⁷ The term has generally been used in the banking context, referring to
concerns about consolidations creating more banks “too big to fail.”
Promoting market efficiencies is another rationale for government intervention,
since insurance markets — like other markets — can be imperfectly competitive.
Parties to an insurance contract might have less than complete information about
each other, for example; economists call that potential “informational asymmetry.”
U.S. securities laws have addressed informational asymmetry by requiring
prospectuses, for example; insurance regulators have required insurers to submit their
contracts, and often their rates, for prior approval. The U.S. antitrust laws — to
which the insurance industry is subject — are another example of government
intervention to promote market efficiency.
Accomplishing a social policy is a third rationale for government intervention.
Congress has, for example, created the flood insurance program¹⁸ and the terrorism
backstop.¹⁹ State legislatures have mandated certain health insurance coverages and
created pools for those unable to obtain insurance in the private market. These are
examples of intervention with a social or public policy purpose; it is analytically

¹⁴ Kohn, Financial Institutions and Markets, pp. 398-400. See also, e.g., Scott E. Harrington,
Insurance Deregulation and the Public Interest (Washington : AEI-Brookings Joint Center
for Regulatory Studies, 2000), at [http://aei-brookings.org/admin/pdffiles/harrington.pdf].
¹⁵ See U.S. Congress, Senate Committee on Commerce, Science and Transportation, Federal
Involvement in Regulation of the Insurance Industry, hearing statement of the Consumer^th^st
Federation of America by Mr. J. Robert Hunter, 108 Cong., 1 sess., Oct. 22, 2003,
available at [http://commerce.senate.gov/pdf/hunter102203.doc].
¹⁶ Kohn, Financial Institutions and Markets, pp. 398-400.
¹⁷ See Eugene Ludwig, “Systemic Risk: A Regulator’s Perspective,” Fannie Mae Papers,
vol. 1, no. 1, Feb. 2003, p. 1, at [http://www.fanniemae.com/commentary/pdf/fmpv2i1.pdf].
¹⁸ 42 U.S.C. §4001 et seq.
¹⁹ P.L. 107-297, 116 Stat. 2322; see CRS Report RS21444, The Terrorism Risk Insurance
Act of 2002, by Baird Webel.

useful to consider them for purposes of this report as social choices rather than as
market failures.
Insurers’ Role In Society?
Insurers Are Subset of Risk Management Marketplace
Managing risk is fundamental to our economy and our society. Individuals and
businesses have choices about how to manage risks, depending on whether they
perceive any uncertainty and on how risk-averse they are. They can mitigate by
controlling the risk — as in wearing seatbelts or hard-hats — and they can finance
them — as in setting aside reserve funds for contingencies (“self-insuring”) or buying
insurance. Any risk of financial loss can be financed if the financing entity has
enough reliable, objective information about the probability of that loss.²⁰
Risk of financial loss can be financed by retaining it, which means that
individuals or businesses can self-insure. Corporations, for example, form their own
downstream, or “captive,” insurers.²¹ Risks can also be financed by transferring
them, which means exchanging an uncertain future financial exposure for a stated
current fee. Individuals, for example, can buy insurance. Corporations can buy
insurance or options or hedges to shift risk. Risks can also be financed by sharing
them. Individuals share risks through insurers as intermediaries. Corporations can
buy insurance, too, but they can also — or instead — buy or sell a derivative.²²
There are economic substitutes, in other words, for insurance. This is
particularly true for entities with access to the capital markets. Insurers are
competing with the suppliers of those substitutes. Insurers’ competition includes
banks, securities firms, and capital markets — inside the United States and
internationally. Presently, these economic substitutes are disparately regulated, so
that similar risks are subjected to different capital requirements in different financial

²⁰ C. Arthur Williams, Jr., Michael L. Smith, and Peter C. Young, Risk Management and
Insurance (New York: McGraw-Hill, 1995), pp. 196-237.
²¹ See Elizabeth R. Costle and Kathleen A. Schauer, “The Captive Alternative: A Regulatory
Perspective,” Journal of Insurance Regulation, vol. 19, winter 2000, pp. 304-323. The
authors define a captive as a closely held insurance company owned by one or more
organizations to insure some or all of the risks of shareholders or affiliated organizations.
Captives are subject to substantially less regulation than other insurers. Ibid.
²² Emmett J. Vaughan and Therese M. Vaughan, Fundamentals of Risk and Insurance (New
York: John Wiley & Sons, 1996), pp. 9-12. A derivative is formally defined as “a zero net
supply, bilateral contract that derives most of its value from some underlying asset,
reference rate, or index.” Christopher L. Culp, The ART of Risk Management: Alternative
Risk Transfer, Capital Structure, and the Convergence of Insurance and Capital Markets
(New York: John Wiley & Sons, 2002), p. 264. See also CRS Report RL31045, Financial
Risk: An Overview of Market and Policy Considerations, by Mark Jickling.

sectors, even inside the United States.²³ Entities with access to less capital intensive
risk financing mechanisms will choose them;²⁴ individuals may not have access to
those choices.
Insurers’ share of the commercial risk-transfer marketplace has been
diminishing. Experts expect that by the end of 2003 about half of all U.S.
commercial market risks will be transferred out of the conventional regulated
insurers, up from a third in 1996.²⁵ The global premium for alternative risk transfer
is estimated at $88 billion in 2001, compared to $370 billion in commercial premium
paid to traditional insurers.²⁶ The trend is expected to escalate as traditional insurers’
capital remains tight and their capacity small and as corporations create captives to
cover their employee benefits.²⁷ The number of U.S. risk retention groups and
purchasing groups is rising rapidly.²⁸
Insurers Are Financial Intermediaries
Insurers serve as financial intermediaries, accumulating savings (premiums) and
investing them in order to pay future claims. They compete for those savings and
investments with other financial intermediaries, such as banks, mutual funds, and the
capital markets. Life insurers issuing annuities and underwriting pension funds
invest for a longer horizon than do property-casualty insurers, holding primarily
corporate bonds and mortgages. Property-casualty insurers, in contrast, do not hold
large portfolios of mortgages or real estate, holding instead more liquid government
and special revenue bonds as well as some common stock.²⁹
Insurers’ investment portfolios are significant in the U.S. economy. Life
insurers in 2003 held $3.80 trillion in assets, of which $1.01 trillion was in corporate

²³ The Joint Forum, Risk Management Practices and Regulatory Capital: Cross-Sectoral
Comparison (Basel, Switzerland: Bank for International Settlements, 2001), available at
[http://www.bis.org/ publ/j oint04.htm] .
²⁴ Some of these alternate risk-financing methods use captives and risk-retention groups.
Others use finite risk reinsurance, securitizations, or structured finance contracts. See Swiss
Re, Sigma 1-2003, The Picture of ART (Swiss Re: Dec. 9, 2002), available at
[ h t t p : / / www.swissre.com/INTERNET /pwsfilpr.nsf/vwFilebyIDK E YLu/ SHOR-5 J 3 K E N/
$FILE/sigma1_2003_e.pdf].
²⁵ Insurance Information Institute, “Captives and Other Risk-Financing Options,” June 2003,
available at [http://www.iii.org/media/hottopics/insurance/test3/].
²⁶ Swiss Re, supra note 23, p. 4.
²⁷ See David Pilla, “Maximum Exposure: Rocked by the combination punch of corporate
accounting scandals and the bear market following the major hit from Sept. 11, reinsurers
face a new world of being scrutinized by trading partners while scrambling for capital,”
Best’s Review, August 2003, pp. 38-46; Joel S. Chansky and Charles M. Waldron,
“Employee Benefits in Captives - $50 Million of Savings?”, available at
[http://www.milliman.com/pc/publications/captives/dol_article_f.pdf]; David Pilla,
“Employee Benefits: The Next Big Captive Market?,” BestWire, Aug. 9, 2001.
²⁸ See statistics from The Risk Retention Reporter, available at [http://www.rrr.com/].
²⁹ Vaughan and Vaughan, Fundamentals of Risk and Insurance, pp. 35-36.

equities and $2.12 trillion in corporate and government bonds.³⁰ Property-casualty
insurers — because they write short-term insurance — have smaller investment
portfolios. In 2003, they held $1.05 trillion in assets, of which $182 billion was in
corporate equities and $621.9 billion in corporate and government bonds.³¹ The
aggregate insurance sector in 2003 held 11% of the total assets held in the financial
services sector.³²
Insurers, particularly life insurers, are also significant net lenders in U.S. credit
markets. In 2002, they lent 9.1% of the total available in the U.S. credit market; by
comparison, U.S.-chartered commercial banks lent 16.9% of the total. In 2002,
property-casualty insurers lent about 1.5% of the total funds available.³³
A significant portion of U.S. insurers and the U.S. insurance market are now
foreign-controlled. In 2003, for example, $745 billion or 19% of U.S. life insurers’
assets were foreign-controlled and 120 U.S. life insurers were foreign-owned, up
from 69 in 1995. The proportion of foreign ownership has grown from 4% in 1995
to 11% in 2003, though it is actually down from 12% in 2001.³⁴ Among the world’s
10 largest life insurance companies in 2003, only the ninth largest was domiciled in
the U.S.³⁵ In 2002, at least 16% of U.S. property-casualty insurers’ assets were
foreign-controlled.³⁶ From 1992 to 2000, “sales of property/casualty insurance by
foreign-owned companies doing business in the United States grew 64.0 percent.”³⁷

³⁰ American Council of Life Insurers (ACLI), Life Insurers Fact Book 2004, p. 17, see
[ h t t p : / / www.a c l i . c o m/ A C L I/ A bout+ACLI+ nonmember/Industry+Facts/2004+Life+Insur
ers+Fact+Book.htm] .
³¹ Insurance Information Institute and the Financial Services Roundtable, The Financial
Services Fact Book 2005 (New York: Insurance Information Institute, 2005), available at
[ h t t p : / / www.f i na nc i a l s e r vi c e s f a c t s .or g/ f i na nc i a l 2 / i n s u r a nc e / pc f i na nc i a l / ] .
³² Ibid, see [http://www.financialservicesfacts.org/financial2/today/assets].
³³ Board of Governors of the Federal Reserve System, Flow of Funds Accounts of the United
States: Annual Flows and Outstandings, 1995-2002 (Washington: Board of Governors of
the Federal Reserve System, 2003), available at [http://www.federalreserve.gov/Releases/
z1/current/annuals/a1995-2002.pdf], p. 1, entitled “Total Net Borrowing and Lending in
Credit Markets.” This flow-of-funds excludes corporate equities and mutual fund shares.
³⁴ Life Insurers Fact Book 2004, pp. 30 and 6.
³⁵ International Insurance Institute, “World’s Largest Life Insurance Companies (2003),”
International Facts, at [http://www.internationalinsurance.org/international/rankings/].
³⁶ Davin D. Cermak, Economist, National Association of Insurance Commissioners, Kansas
City, MO, electronic mail to author, June 26, 2003. This estimate is based on infomration
that insurers file with the National Association of Insurance Commissioners (NAIC); it
likely underestimates the percentage that is foreign-controlled, since insurers with less than

10% foreign ownership need not report it.

³⁷ Insurance Information Institute, The Fact Book 2004 (New York: Insurance Information
Institute, 2004), p. 6.

Four U.S. insurers are among the world’s 10 largest property-casualty insurers by

2003 revenue.³⁸

Kinds of Insurance
Direct Insurance
Insurance covering mortality and morbidity risks is known collectively as “life
insurance.” Insurance covering property and liability risks is known collectively as
“property-casualty insurance.” Health insurance may be classified as either,
depending on the type of insurer issuing the contract. The term “direct insurance”
means any and all insurance coverages that persons or businesses purchase from
insurers. It excludes “reinsurance,” which refers to insurance purchased by insurers.
Property-Casualty Lines. The property-casualty insurance industry earned
a 4.4% return on equity in 2002 — while risk-free 10-year U.S. Treasuries earned
a 4.6% return.³⁹ The property-casualty insurance sector underperformed the Fortune⁴⁰

500 by 5.3% on average from 1988 through 2002. That record impairs insurers’

ability to attract and retain capital, which shrinks its capacity to finance risk. That,
in turn, makes insurance less available and less affordable — while other forms of
risk financing become more attractive to purchasers with alternatives.⁴¹
Property-casualty insurance can finance a risk that one’s property will be
destroyed by disaster or accident, a risk that one will be sued, or a risk that someone
else will fail to perform as they promised. These coverages are called, respectively,
property insurance, liability insurance, and surety insurance. They are “personal
lines” coverages if they are purchased to mitigate risk at home or in the family, and
“commercial lines” if purchased to mitigate risk in a trade or business.
Personal Lines. The National Association of Insurance Commissioners has
estimated that the average family “can easily spend” about $4,500 annually on
insurance.⁴² In the aggregate, about half of the net property-casualty insurance

³⁸ Ibid., p. 2; also at [http://www.internationalinsurance.org/international/rankings/].
³⁹ Testimony of Senior Vice President and Chief Economist Robert P. Hartwig, Insurance
Information Institute, in U.S. Congress, House Financial Services Committee, Subcommittee
on Capital Markets, Insurance and Government Sponsored Enterprises, The Effectiveness^th^st
of State Regulation: Why Some Consumers Can’t Get Insurance, hearing,108 Cong., 1
sess., Apr. 10, 2003, Serial No. 108-22 (Washington: GPO, 2003), p. 1, available at
[http://financialservices.house.gov/ hearings .asp?formmode=detail&hearing=205].
⁴⁰ Ibid.
⁴¹ Ibid. See also Scott E. Harrington, Insurance Deregulation and the Public Interest
(Washington: AEI Press, 2000).
⁴² U.S. Congress, House Committee on Financial Service, Subcommittee on Capital
Markets, Insurance and Government sponsored Enterprises, Insurance Regulation and^st
Competition for the 21 Century, testimony of the National Association of Insurance
(continued...)

premiums written in the United States in 2003 were spent on homeowners’ multiple
peril and private passenger auto,⁴³ which are the major personal lines. In most cases,
these coverages are mandatory — that is, lenders require homeowners’ insurance as
a precondition to a mortgage, and states require automobiles to be insured as a
precondition of driving.
Historically, states regulated both the terms and price of both homeowners and
automobile insurance.⁴⁴ The purpose was to protect the consumer, in several ways.
Contract terms were subject to prior approval and regulation because the consumer,
it was thought, had no bargaining power. Prices were regulated to keep insurers from
charging too little — thereby risking insolvency — or too much — thereby obtaining
excessive profits because the coverage was compulsory.⁴⁵
More recent theory and experience have belied those purposes for regulating
terms and prices.⁴⁶ Economists observe that the personal lines property-casualty
insurance market is easy to enter, heterogeneous, not concentrated, and prices are
relatively easy to compare. They generally conclude that the market is competitive
in structure and therefore — absent rate regulation — likely to be efficient.⁴⁷
Experience, as related in testimony to the 108^th Congress, demonstrates that
competitive markets serve purchasers of auto and homeowners’ insurance better than
heavily regulated markets.⁴⁸
Commercial Lines. The term “commercial lines” means property and
liability insurance coverages for various business risks. The risks include direct
property loss by fire or other perils, indirect property loss by interruption of business

⁴² (...continued)
Commissioners, presented by Terri M. Vaughan, Iowa Commissioner of Insurance, 107^th^nd
Cong., 2 sess., June 18, 2002, p. 4, available at
[http://financialservices.house.gov/ media/pdf/061802tv.pdf].
⁴³ Insurance Information Institute and the Financial Services Roundtable, “Insurance: Direct
Premiums Written by Line, Property/Casualty Insurance, 2003,” available at
[ h t t p : / / www.f i na nc i a l s e r vi c e s f a c t s .or g/ f i na nc i a l 2 / i n s u r a nc e / pc pbl ] .
⁴⁴ For an overview of state-by-state regulation of rates, see Insurance Information Institute,
“Rates and Regulation,” in Hot Topics & Insurance Issues, available at
[http://www.iii.org/ me di a/hottopics/insurance/ratereg/ ].
⁴⁵ Kenneth J. Meier, The Political Economy of Regulation: The Case of Insurance, pp. 51-

54, 59-60, 64-79.

⁴⁶ Rate regulation may have been necessary historically, when insurers’ rate-setting cartels
were thought immune to federal antitrust laws. That is no longer true. CRS Report
RL31982, Insurance Regulation: History and Background, by Carolyn Cobb and Baird
Webel, summarizes that history.
⁴⁷ Harrington, Insurance Deregulation and the Public Interest, pp. 25-30.
⁴⁸ U.S. Congress, House Committee on Financial Services Committee, Subcommittee on
Capital Markets, Insurance and Government Sponsored Enterprises, The Effectiveness of
State Regulation: Why Some Consumers Can’t Get Insurance, opening statement of^th^st
Chairman Mike Oxley, House Committee on Financial Services, 108 Cong., 1 sess., Apr.

10, 2003, [http://financialservices.house.gov/hearings.asp?formmode=detail&hearing=205].

or by employee misdeeds, risks of liability for products or employee actions, and
risks of losses caused by someone’s default or failure to perform. Accidents of
history and convention subdivide these and other commercial lines coverages and
give them often arcane names.⁴⁹ So, for example, the term “inland marine” refers to
insurance covering risks to domestic shipments, jewelers’ inventories, and accounts
receivable, among other things.⁵⁰ The total net direct premium in the commercial
lines market was about $197.6 billion in 2002.⁵¹
In general, states do not regulate prices for commercial lines of insurance, other
than workers’ compensation insurance.⁵² Most states do regulate contract language
for most types of commercial coverages,⁵³ although a few states exempt very large
commercial risks from their prior approval requirements.⁵⁴ This close supervision
of contracts between commercial entities has become controversial, as insurers lose
market share in the risk financing marketplace, and as academics, insurers, and
commercial entities discuss it as an “approval tax.”⁵⁵ Some observers support
continued regulation of commercial policy contract language because it protects less
sophisticated businesses against fraud; others oppose it because its costs to all
businesses — in terms of less innovation and greater delay — exceed its benefits to
the few.⁵⁶
Workers’ Compensation Insurance. Workers’ compensation (workers’
comp) has generally been considered a social program established to pass the costs
of industrial accidents to society generally.⁵⁷ All states require employers to purchase
workers’ compensation insurance, providing benefits to workers injured on-the-job
in substitution of tort liability. Some states have created residual markets for

⁴⁹ Vaughan and Vaughan, Fundamentals of Risk and Insurance, pp. 552-615.
⁵⁰ Ibid., pp. 569-571.
⁵¹ Insurance Information Institute, The I.I.I. Fact Book 2004 (Insurance Information Institute:
New York, 2004), p. 33.
⁵² J. David Cummins, “Property-Liability Insurance Price Deregulation: The Last Bastion?,”
in J. David Cummins, ed., Deregulating Property-Liability Insurance: Restoring
Competition and Increasing Market Efficiency (Washington: Brookings Institution Press,

2002), pp. 1-24.

⁵³ Ann F. Lavie, Assistant Vice President, Insurance Services Office, Inc., conversation with
the author, Oct 9, 2003. See also Richard J. Butler, “Form Regulation in Commercial
Insurance,” in Cummins, ed., Deregulating Property-Liability Insurance: Restoring
Competition and Increasing Market Efficiency, pp. 321-360.
⁵⁴ See, e.g., Maine Department of Professional and Financial Regulation, Bureau of
Insurance, table of prior filing requirements for commercial general liability policies,
available at [http://www.state.me.us/pfr/ins/Rate_filing_Comm_gen_liab.htm].
⁵⁵ Butler, “Form Regulation in Commercial Insurance,” in Cummins, Deregulating
Property-Liability Insurance: Restoring Competition and Increasing Market Efficiency, pp.

321-322.

⁵⁶ Ibid.,pp. 346-357.
⁵⁷ Vaughan and Vaughan, Fundamentals of Risk and Insurance, p.213.

employers unable to purchase workers’ comp in their private markets.⁵⁸ A state’s
residual market is administered privately, by an insurer reimbursed for its
administration, and its deficits are funded by proportional assessments on workers’
comp insurers doing business in that state.⁵⁹
Workers’ compensation insurance is the largest commercial line. In 2002, net
workers’ comp premiums were $36.5 billion, or about 18.5% of the total commercial
insurance market.⁶⁰ Unlike other commercial lines, most state insurance regulators
generally set the rates as well as establish contract terms in both their private and
residual markets for workers’ compensation insurance. Workers’ comp costs are
rising again after dropping in the 1990s following some market reforms, including
larger deductibles to improve incentives for safety.⁶¹ This has increased pressure for
further reforms.⁶²
Life Insurance. Life insurers underwrite⁶³ mortality and morbidity risks of
individual persons. This includes risk of financial loss by dying prematurely, by⁶⁴
outliving one’s savings, or by becoming unable to work or to care for oneself. The
insurance products to finance those risks are life insurance, annuity contracts,
disability insurance, and long-term care insurance, respectively. In general, these are
all considered personal lines coverages.
Life insurers estimate risk using a national mortality table. Though prices and
terms vary insurer-to-insurer, a single life insurer doing business in 50 states wants
to sell the same policy or contract everywhere. Also, unlike property-casualty
insurance, states do not directly regulate the prices that life insurers charge for life

⁵⁸ Ibid., pp. 213-218.
⁵⁹ National Council on Compensation Insurance [now NCCI Holdings, Inc.], Introduction
to the Residual Market, available at [http://www.ncci.com/ncci/web/news/infostop/residual/
overview.htm].
⁶⁰ Insurance Information Institute, The I.I.I. Insurance Fact Book 2004, p. 33.
⁶¹ Ibid., p. 72. See also Joseph Shields, Xiachua Lu, and Gaylon Oswalt, “Workers’
Compensation Deductibles and Employers’ Costs,” The Journal of Risk and Insurance, vol.

66, June 1999, pp. 207-218.

⁶² See Marla Dickerson, “Work-Injury Cost Savings in Doubt; An Insurance Rating Group
Sees Far Less Reduction Than What Reform Legislation Backers Project,” Los Angeles
Times, Sept. 30, 2003, part 3, p. 1; Ed Mendel, “Davis Signs Workers’ Comp Bill Amid
Soaring Costs,” San Diego Union Tribune, Oct. 1, 2003, p. A-3.
⁶³ The term “underwriting” means the process of selecting and classifying risk exposures.
Vaughan and Vaughan, Fundamentals of Risk and Insurance, p. 130. Underwriting can be
analogized to a manufacturing process and should be distinguished from a selling or
distribution process.
⁶⁴ Classically, it also includes medical and surgical indemnity insurance or what we call
“health insurance.” Both life insurers and property-casualty insurers may legally underwrite
health insurance; for this and other reasons, health insurance will be treated separately.

insurance or annuities.⁶⁵ States do, however, require the policy and contract forms
to be filed and approved. Each state reviews the terms of each new type of policy or
contract, checks how intelligible and readable it is, and otherwise assures itself that
each conforms to the state’s standards. It can take up to two years to get a life
insurance policy form or an annuity contract form approved in all states.
The purpose of regulating individual policy forms is to protect individual
consumers. A life insurance policy or annuity contract is considered “a contract of
adhesion,” meaning that the purchaser is considered unable to bargain with the seller
over its terms. This imbalance in bargaining power and knowledge has historically
justified state regulation of life and annuity policy forms. Since each state insurance
regulator is charged with protecting the consumers of his or her own state, no state
has been willing or able to cede its form review to another state’s authority.
State insurance regulators do realize that life insurers are now competing against
entities that are not subject to such a 50-state approval process.⁶⁶ Life insurers are
competing with banks and with securities firms — “each industry is offering similar
products, and each is marketing nationally to the same customers.”⁶⁷ The NAIC has
undertaken to streamline state regulation of life insurers to accommodate that
reality,⁶⁸ although opinions differ about whether the NAIC and its autonomous
members can make the changes necessary to adapt to that reality.⁶⁹ Unlike
commercial lines, however, no overt controversy has developed about the purpose
of regulating life insurance and annuities.

⁶⁵ States do mandate, however, how life insurers calculate their liabilities for life insurance
and annuity contracts they issue. See Vaughan and Vaughan, Fundamentals of Risk and
Insurance, pp. 241-252.
⁶⁶ NAIC, “Interstate Insurance Regulation Compact,” available at [http://www.naic.org/
compact/index.htm] .
⁶⁷ Peter J. Wallison, “Optional Federal Chartering for Life Insurance Companies,” in
Optional Federal Chartering and Regulation of Insurance, Peter J. Wallison, ed.
(Washington: AEI Press, 2000), p. 52.
⁶⁸ See NAIC, “A Reinforced Commitment: Insurance Regulatory Modernization Action
Plan,” dated Sept. 14, 2003, available at
[http://www.naic.org/ docs/regulatory_modernization_action_plan.doc].
⁶⁹ See U.S. General Accounting Office, Insurance Regulation: Common Standards and
Improved Coordination Needed to Strengthen Market Regulation, GAO Report 03-433,
(Washington: GPO, Sept. 2003), available at [http://www.gao.gov/new.items/d03433.pdf].
Compare with Chris Grier, “Mutual Insurer Group Wants Optional Federal Charter Off
Congressional Agenda,” BestWire, Oct. 8, 2003.

Health Insurance.⁷⁰ Individuals can finance their morbidity risk by
purchasing disability income insurance and health insurance. Disability insurance⁷¹
payments replace some portion of an ill or injured insured person’s income. About
80% of all disability insurance is group coverage sold by insurers.⁷² Disability
insurance is regulated as health insurance, which means that all individual policies
and rates must be filed with each state insurance department for prior approval.
Group disability income insurance is regulated under ERISA, or under state group
accident and sickness laws, as applicable.⁷³
Private insurance financed only about a third of national health expenses in

2000. About 45% of all medical expenses were publicly funded, and about 16%

were paid out-of-pocket.⁷⁴ These figures — as well as enactments by Congress and
the state legislatures — arguably demonstrate that our society regulates health
insurance as a social program.⁷⁵
Reinsurance
Reinsurance is insurance purchased by insurance companies. Insurers buy
reinsurance to limit their own losses on specific risks, to enhance their own
underwriting ability, to spread losses, and to finance their own risks and growth. The
insurer purchasing reinsurance is called the ceding company because it is ceding risks
to the reinsurer. The reinsurer is called the assuming company because it is
indemnifying — or assuming — risks from the ceding insurer. Reinsurers also buy⁷⁶
reinsurance, which is known as “retroceding.” Reinsurers operate globally, spread

⁷⁰ For details about how health insurance is regulated, see U.S. General Accounting Office,
Private Health Insurance: Federal and State Requirements Affecting Coverage Offered by
Small Businesses, GAO Report 03-1133 (Washington: GPO, Sept. 2003), available at
[http://cms.hhs.gov/charts/series/sec1.pdf];CRS Report RS20315, ERISA Regulation of
Health Plans: Fact Sheet, by Hinda Ripps Chaikind; CRS Report RL31634, The Health
Insurance Portability and Accountability Act (HIPAA) of 1996: Overview and Guidance on
Frequently Asked Questions, by Hinda R. Chaikind, Jean Hearne, Bob Lyke, Stephen
Redhead, and Julie Stone.
⁷¹ Vaughan and Vaughan, Fundamentals of Risk and Insurance, pp. 348-351.
⁷² Ibid., p. 349.
⁷³ David Brenerman, Assistant Vice President of Government and Public Affairs,
UnumProvident, telephone conversation with the author, Oct. 10, 2003.
⁷⁴ Centers for Medicare and Medicaid Services, U.S. Department of Health and Human
Services, The CMS Chart Series: The Nation’s Health Dollar, CY 2000, available at
[http://cms.hhs.gov/charts/series/sec1.pdf], p. 6.
⁷⁵ See CRS Report RL31982, Insurance Regulation: History and Background, by Baird
Webel and Carolyn Cobb; National Association of Insurance Commissioners, Model Laws,
Regulations, and Guidelines (NAIC: Kansas City MO, 2003), vol. I, pp. 10-1 through 120-

50 and vol. II, pp. 130-1 through 185-6.

⁷⁶ See Vaughan and Vaughan, Fundamentals of Risk and Insurance, pp. 150-152.

risk internationally, and access capital markets worldwide. In 2002 the world’s 40
largest reinsurers took in total premiums of $138.6 billion.⁷⁷
In the United States, state insurance regulators do not supervise reinsurance
rates or forms. State insurance regulators do supervise the quality of each insurer’s
reinsurance portfolio indirectly by setting standards for when and how a ceding
insurer may take credit on its statutory financial statements for reinsurance ceded.
Statutory financial statements employ fixed formulas and a liquidation-type
accounting basis; state regulators require them to assess U.S. insurers’ solvency. If
both the reinsurer and the reinsurance contract — known as a treaty — meet
minimum standards that vary slightly from state to state,⁷⁸ then that reinsurance may
be reported as an asset or a reduction from statutory liabilities.⁷⁹
Under these standards, a non-U.S. reinsurer that chooses not to become licensed
in the United States — and thereby subject to 50-state regulation — is considered
solvent only if it establishes in the U.S. a non-working trust fund equal to the gross
amount of its U.S. liabilities plus at least $20 million.⁸⁰ A trust with multiple
beneficiaries must be funded in the U.S. with an amount equal to its gross U.S.
liabilities plus $100 million. The trusteed assets must be cash-equivalent, and may
include letters of credit.⁸¹
This state regulatory requirement applicable to non-U.S. reinsurers has become
controversial. Non-U.S. reinsurers view it as discriminatory and a trade barrier, as
well as an inefficient use of capital.⁸² They have proposed instead a single point-of-
entry through the NAIC, which would have discretion to set the funding requirement
appropriate to the financial strength of each applying insurer.⁸³ State insurance
regulators and many U.S. ceding insurers seem inclined to retain the current funding
requirement in their states, which they see as protecting U.S. insurers against the

⁷⁷ Charles Fleming, “European Business News: Reinsurers Get Cold Shoulder,” The Wall
Street Journal Online, Sept. 16, 2003.
⁷⁸ See National Association of Insurance Commissioners, Model Laws, Regulations, and
Guidelines (Kansas City MO: NAIC, 2003), vol V, pp. 785-1 through 803-26 (compiling
states’ laws and rules on credit for reinsurance).
⁷⁹ See, e.g., Sholom Feldblum, “Reinsurance Accounting: Schedule F,” Journal of Insurance
Regulation, vol. 21, spring 2003, pp. 53-115.
⁸⁰ National Association of Insurance Commissioners, “Credit for Reinsurance Model Law,”
Model Laws, Regulations, and Guidelines, supra note 81, sec. 2.D.(3), vol. 5, pp. 785-2 and

785-3.

⁸¹ National Association of Insurance Commissioners, “Credit for Reinsurance Model
Regulation,” Model Laws, Regulations, and Guidelines, supra note 81, sec. 7.E., pp. 786-6
through 786-11.
⁸² Comité Européen des Assurances, “Reinsurance in the US: CEA Lobbying For Improved
Access to US Market,” CEA Executive Update, no. 25, Sept. 8, 2003, p. 3, available at
[ ht t p: / / www.cea.assur .or g/ cea/ v1.1/ act u/ pdf / uk/ act u117.pdf ] .
⁸³ Richard Banks, “Lloyds to Press the Collateralisation Argument Again at NAIC
Conference,” Insurance Day, Oct. 14, 2003.

insolvencies of non-U.S. insurers.⁸⁴ The controversy is likely to continue, since in
2002 about 46% of all U.S. property-casualty reinsurance premiums were written by
non-U.S. reinsurers unaffiliated with their U.S. cedant. The U.S. market share of
non-U.S. reinsurers and their U.S. property-casualty insurance affiliates grew to 77%
in 2002.⁸⁵
The September 11, 2001, terrorist attacks brought reinsurance to the attention
of Congress. Once the world’s reinsurers advised their cedants that new treaties
would include coverage for terrorism only at an additional cost, if at all, insurers
advised their policyholders similarly — and new commercial coverage for terrorism
became unavailable or unaffordable. The 107^th Congress responded by enacting the
Terrorism Risk Insurance Act of 2002 to provide some short-term capacity and
stability in the reinsurance market.⁸⁶ The act expressly preserved state regulation of
i n surance.⁸⁷
The September 11 terrorist attacks exacerbated concerns of the developed
countries’ central bankers about reinsurers’ resiliency, and about the instability that
their counterparty credit risks could impose on the international banking system.
International-level banking, securities, and insurance supervisors had formed working
groups after the Asian financial crisis in the late 1990s to consider how to promote
financial market stability. Building on an informal consensus that market discipline
would promote market stability, an international multi-disciplinary regulatory group
had concluded in April 2001 that financial intermediaries should provide additional
public information about their market, liquidity, credit, and insurance risks.⁸⁸
Subsequent to further review, the Financial Stability Forum⁸⁹ determined that lack

⁸⁴ See Reinsurance Association of America, “Reinsurance Collateral: Protecting US
Consumers with Reinsurance Collateral, in RAA Policy Update Materials, available at
[http://community.reinsurance.org/StaticContent/Policy/ ncoil.pdf].
⁸⁵ R.J. Lehmann, “Foreign Reinsurers Continue to Take More American Premium,”
BestWire, Sept. 2, 2003.
⁸⁶ P.L. 107-297, 116 Stat. 2322 (15 U.S.C. §6701 et seq.). See CRS Report RS21444, The
Terrorism Risk Insurance Act of 2002, by Baird Webel.
⁸⁷ P.L. 107-297, 116 Stat., pp. 2334-2335 (Sec. 106).
⁸⁸ Financial Stability Forum, “Press Release: Financial Stability Forum Reviews
Vulnerabilities and Efforts to Strengthen the International Financial System,” dated Sept.
4, 2002, available at [http://www.fsforum.org/press/PR_Toronto02.pdf]. For the Final
Report of the Multidisciplinary Working Group on Enhanced Disclosure, see
[http://www.bis.org/ publ/j oint01.pdf].
⁸⁹ The Financial Stability Forum “brings together senior representatives of national financial
authorities (e.g. central banks, supervisory authorities and treasury departments),
international financial institutions, international regulatory and supervisory groupings,
committees of central bank experts and the European Central Bank. Mr Roger W Ferguson
Jr, Vice Chairman of the Board of Governors of the Federal Reserve System, chairs the FSF
in a personal capacity. The FSF is serviced by a small secretariat housed at the Bank for
International Settlements in Basel, Switzerland.” Excerpted from
[ h t t p : / / www.f s f o r u m.or g/ about / who_we_ar e.ht ml ] .

of public information about reinsurers posed a systemic risk,⁹⁰ and it directed the
International Association of Insurance Supervisors (IAIS)⁹¹ to create a template for
a global database on aggregate risks in the reinsurance sector.⁹² The IAIS task force
on reinsurance is expected to complete a draft template by the end of 2003, test it
during early 2004, and present a final report to the Financial Stability Forum in 2004.
Conclusion
Regulation of insurers has accreted over 150 years, as courts and policymakers
have responded to needs in local economies, and later in aspects of the national
economy. State and national policymakers are now considering how to respond to
new economic demands on the financial intermediation that insurers perform. At
issue is the definition of those demands, as a preface to addressing the economic
policy issues emerging globally. Society, insurers, and consumers all have policy
needs, which Congress is working to address.

⁹⁰ Financial Stability Forum, press release dated September 4, 2002, available at
[ h t t p : / / www.f s f o r u m.or g/ pr ess/ PR_T or ont o02.pdf ] .
⁹¹ IAIS is a voluntary association of insurance supervisory officials from over 100 countries.
See [http://www.iaisweb.org/].
⁹² See Press Release, supra note 93, pp. 2-3.