Abstract
Insurance regulation has long been a subject of considerable interest to academics, policymakers, and other stakeholders in the insurance industry. Among the areas explored by academics over the years, there are three topics of particular importance that have significant implications for the regulation of insurance companies and markets: (1) catastrophe risk, (2) competition, and (3) systemic risk. This chapter provides an overview of insurance regulation and discusses key issues that it faces and how it has responded to these issues including the role of competition, increasing catastrophe risk, and the reemergence of systemic risk in financial markets and its implications for insurance regulation.
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
Saunders and Cornett (2003) discuss the rationale for the regulation of financial institutions. While their principal argument is based on externalities (discussed below), other arguments also contribute to the case for government oversight.
- 2.
The costs of determining financial soundness are much lower today than they were in the past as anyone with knowledge and access to the Internet can check an insurer’s claims paying ability provided by rating agencies. However, rating agencies cannot engage in enforcement actions (although they may pressure insurers to correct problems) and most countries do not accept the notion that they are an adequate substitute for government regulation.
- 3.
This view likely stems from the periodic price wars (and subsequent insurer failures) that afflicted property-casualty insurance markets in the USA during the 1800s and early 1900s.
- 4.
- 5.
It is true that consumers subject to unfair treatment might seek remedies through the courts and sometimes do so. However, legal remedies may not be feasible for consumers with limited resources and bills to pay. Also, it may be difficult to secure financial damages from some fraudulent insurers.
- 6.
If regulators believe that rate increases are warranted, they tend to prefer to see these increases phased in gradually over time rather than implemented in 1 year.
- 7.
Insights from Becker (1983) and related literature are helpful in understanding how interest group politics may play in government policies regarding insurance. Stigler (1971) and Peltzman (1976) also laid the foundation for an economic theory of regulatory behavior that considers the potential influence of the concentrated economic interests of regulated firms and other groups. Political scientists such as Meier (1988) have broadened this framework to include other factors that might influence regulatory behavior, such as ideology, bureaucracy, the role of political elites, and the complexity and saliency of regulatory issues.
- 8.
- 9.
See Scherer and Ross (1990) for a more detailed explanation of this framework and its application to various industries.
- 10.
Scherer and Ross (1990) list a set of basic conditions that determine market structure in their explanation of the SCP framework. One of the conditions they list is technology. One could reinterpret “technology” to include information pertinent to the production and sale of a good or service. Arguably, information is an especially valuable resource to buyers and seller of insurance and plays an important role in the functioning and regulation of insurance markets.
- 11.
- 12.
Cummins and Weiss (1991) analyze the structure and performance of the property-liability insurance industry in the USA, and Grace and Klein (2007) examine the structure and performance of the US life insurance industry. Several studies of the structure and performance of the insurance industries in other countries are provided in Cummins and Venard (2007).
- 13.
The Department of Justice (DOJ) has established merger guidelines, which consider markets with HHIs in excess of 2,000 to be highly concentrated. Mergers in such markets are subject to closer scrutiny by the DOJ.
- 14.
Information and expertise are arguably the most important resource to insurance companies as discussed above. To be successful in penetrating any market, insurers must have a good understanding of the risks they will underwrite and price.
- 15.
The number of insurance companies selling industrial life and health credit insurance is smaller, but these are small and declining markets.
- 16.
Many exits may represent mergers and acquisitions of life insurers into large holding companies.
- 17.
In 2004, New York Attorney General Eliot Spitzer filed a suit against the insurance broker Marsh-McLennan for steering its commercial clients to insurers which with which it had contingent commission arrangements. Several prominent insurers also were implicated in the suit.
- 18.
There were five insurance company insolvencies in Florida that could be attributed to the 2004/2005 storm seasons (three of these companies belonged to the Poe Group). The companies that became insolvent were “small” single-state companies that Florida regulators had allowed to take on too many exposures relative to their capacity to absorb the associated losses that would occur if severe hurricanes struck the state (Grace and Klein 2009b).
- 19.
Basel II is the second of the Basel accords which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. Basel II has been extended and superseded by Basel III which sets global regulatory standards on bank capital adequacy, stress testing, and market liquidity risk developed in response to perceived deficiencies in financial regulation revealed by the 2007–2009 financial crisis.
- 20.
An insurer is required to have capital that meets or exceeds the higher of the two standards.
- 21.
This is essentially equivalent to limiting an insurer’s probability of default to 0.5%.
- 22.
Regulators may seek to suppress overall rate levels and/or compress rate differentials between low- and high-risk insureds.
- 23.
It should be noted that these figures omit uninsured losses and that total economics losses from a catastrophic event can be much higher than insured losses.
- 24.
Insurers calculate various risk metrics of their potential losses from different catastrophic perils based on their exposures, reinsurance, and other financing arrangements. One of these metrics is an insurer’s Probable Maximum Loss (PML) which is similar in concept to Value-at-Risk (VaR) measurements. Typically, an insurer will structure its cat risk management program to ensure that it can meet specified PML targets and remain solvent.
- 25.
The NAIC publishes the Financial Condition Examiners Handbook as a basic reference tool to guide regulators in how to conduct financial examinations.
- 26.
When the US RBC system was first developed, regulators considered adding a capital charge for catastrophe risk but decided it would be too complicated and controversial at that time. As for the EU, the current approach for determining insurers’ capital standards is very simple and does not explicitly create capital charges for a number of specific risks so the inclusion of capital charge for catastrophe risk would not be consistent with this simplified approach.
- 27.
Under current projections, Solvency II is scheduled for full implementation beginning in 2014.
- 28.
Harrington and Niehaus (2003) estimated that the tax cost of holding additional capital to cover catastrophe losses could exceed 100% of the “expected cost of claims” at higher layers of an insurer’s catastrophe risk exposure.
- 29.
The discrimination against foreign reinsurers stems from US regulators’ concerns about their ability to access funds from a foreign reinsurer outside their regulatory jurisdiction. The laws in most states generally conform with the NAIC’s Credit for Reinsurance Model Law. Most recently, several states have modified their laws to provide more favorable treatment for reinsurance ceded to foreign reinsurers consistent with a reform proposal that was adopted but not implemented by the NAIC, as discussed further below.
- 30.
The term “unaffiliated” refers to the relationship between the primary insurer (i.e., ceding insurer) and the reinsurer (i.e., assuming insurer). A primary insurer may cede business to a reinsurer with which it is affiliated (i.e., they are owned by the same parent company) and/or reinsurers with which they are not affiliated.
- 31.
See Evans (2007).
- 32.
For example, a reinsurer that has an A rating from A.M. Best (and/or equivalent ratings from other rating agencies) would be required to post collateral equal to 20% of its obligations to US insurers. A reinsurer with an A rating from A.M. Best would be required to post collateral equal to 50% of its obligation to US insurers. Under the NAIC regulations, regulators are required to use the lowest financial strength rating received from an approved rating agency in determining the highest possible rating of a certified reinsurer.
- 33.
“Onshore” securitization refers to transactions that would be accomplished through a US-regulated entity or mechanism. “Offshore” securitizations refer to transactions that are conducted using non-US entities or mechanisms.
- 34.
- 35.
Of the total policies in force, 96.6% were for personal residential properties. Personal residential properties accounted for 75.3% of the total exposures in force. Commercial residential and nonresidential properties accounted for the other policies and exposures in force.
- 36.
Klein (2008) discusses and documents the nature of this interference in greater detail. For example, some states limit or prohibit the use of certain underwriting criteria, such as the age of a home and/or its market value, a history of prior claims, and the insured’s credit score. Also, some states issued moratoriums on policy cancellations/nonrenewals following major hurricanes. Further, some states have increased prior notice requirements for insurers electing to nonrenew policies in a specified area due to concerns about hurricane risk. Also, some states may limit the size of the wind deductible that an insurer can require as a condition for writing a new policy or renewing an existing policy.
- 37.
For example, Florida requires insurers to report data on their handling of hurricane claims and subjects insurers to claim audits. While these measures may not explicitly require insurers to pay claims more quickly or offer higher settlements, they can be used to apply implicit pressure. These requirements are specified in Rule 69O-142.015 Standardized Requirements Applicable to Insurers After Hurricanes or Natural Disasters issued on June 12, 2007. The Florida Office of Insurance Regulation (FLOIR) also performs targeted market conduct examinations of insurers’ handling of hurricane claims which can result in sanctions if regulators determine than an insurer has failed to adjust and settle claims in an appropriate manner. For example, the FLOIR accused Nationwide for underpaying 2004 hurricane claims and forced the company to review how it handled these claims. See “Nationwide Agrees to Review Hurricane Claims in Florida,” Columbus Dispatch, October 15, 2005. The Florida Governor also set deadlines for insurers’ settlements of 2004 hurricane claims. See “Deadline is Set for Insurers to Settle Storm Claims,” Palm Beach Post, October 27, 2004.
- 38.
For more information on the NFIP, see Michel-Kerjan (2010).
- 39.
Obtained from FEMA’s website on April 29, 2012 at http://www.fema.gov/business/nfip/statistics/stats.shtm
- 40.
For further discussion of proposals to reform the NFIP see Michel-Kerjan and Kunreuther (2011).
- 41.
See Zanjani (2008) for an analysis of the private and public provision of earthquake insurance in California.
- 42.
See Kunreuther and Michel-Kerjan (2004) for a discussion of the issues involved with terrorism risk insurance in the USA.
- 43.
Michel-Kerjan and Raschky (2011) found that this approach to funding the program (no upfront premiums, post-event recoupment charges) had a negative impact on insurers’ diversification when contrasted with wind and earthquake commercial insurance lines.
- 44.
FAIR plans exist in 32 states and supply full property coverage to insureds who cannot obtain coverage in the voluntary market. Wind/Beach plans provide wind only coverage for properties in designated coastal areas in the states of Alabama, Mississippi, North Carolina, South Carolina, and Texas. There are two state-run insurance corporations—the Florida Citizens Property Insurance Corporation and the Louisiana Citizens Property Insurance Corporation.
- 45.
This was demonstrated in the state case studies for auto insurance in Cummins (2002).
- 46.
Cummins et al. (2010) provide a comprehensive analysis of the federal government’s exposure to catastrophic risk.
- 47.
Historically, insurance regulators have viewed their role to supervise the insurance companies within holding company organizations, trusting other financial regulators to supervise the noninsurance activities of these groups. This is changing somewhat as insurance regulators are increasing their emphasis on group-wide supervision in which they will communicate with other financial regulators on the activities of noninsurance entities within a group.
References
Bajtelsmit VL, Bouzouita R (1998) Market structure and performance in private passenger automobile insurance. J Risk Insur 65(3):503–514
Baumol WJ, Panzar JC, Willig RD (1982) Contestable markets and the theory of industry structure. Harcourt Brace Jovanovich, San Diego
Becker GS (1983) A theory of competition among pressure groups for political influence. Q J Econ 98:371–400
Brown JR, Goolsbee A (2002) Does the internet make markets more competitive? Evidence from the life insurance industry. J Polit Econ 110(3):481–507
Caroll A (1993) Structure and performance of the private workers’ compensation market. J Risk Insur 60(2):185–2007
ChandraShekar P, Warrier SR (2007) Risk-based capital management: a “principles based approach” to insurer solvency management, Paper presented at the Asian-Pacific Risk and Insurance Association, Annual Conference, Taiwan, July 2007
Cummins JD (1988) Risk based premiums for insurance guaranty funds. J Finance 43:823–839
Cummins JD (ed) (2002) Deregulating property-liability insurance: restoring competition and increasing market efficiency. AEI-Brookings Joint Center for Regulatory Studies, Washington, DC
Cummins JD (2007) Reinsurance for natural and man-made catastrophes in the United States: current state of the market and regulatory reforms. Risk Manag Insur Rev 10:179–220
Cummins JD (2008) Cat bonds and other risk-linked securities: current state of the market and regulatory reforms. Risk Manag Insur Rev 11:23–47
Cummins JD, Phillips RD (2005) Estimating the cost of capital for property-liability insurers. J Risk Insur 72:441–478
Cummins JD, Phillips RD (2009) Capital adequacy and insurance risk based capital systems. J Insur Regul 28(1):25–72
Cummins JD, Venard B (eds) (2007) Handbook of international insurance: between global dynamics and local contingencies. Springer, Berlin
Cummins JD, Weiss MA (1991) The structure, conduct, and regulation of the property-liability insurance industry. The Financial Condition and Regulation of Insurance Companies R.E. Randfall and R.W. Kopcke, editors, Conference Series 35, Federal Reserve Bank of Boston, Boston, June 1991, pp. 117–164
Cummins JD, Weiss MA (2000) Analyzing firm performance in the insurance industry using frontier efficiency and productivity methods. In: Dionne G (ed) Handbook of insurance. Kluwer, Dordrecht
Cummins JD, Weiss MA (2010) Systemic risk and the insurance sector, Working paper, Temple University, September 14. http://ssrn.com/abstract=1725512
Cummins JD, Harrington SE, Klein RW (1995) Insolvency experience, risk-based capital, and prompt corrective action in property-liability insurance. J Bank Finance 19(3–4):511–527
Cummins JD, Suher M, Zanjani G (2010) Federal financial exposure to natural catastrophe risk. In: Lucas D (ed) Measuring and managing federal financial risk. University of Chicago Press, Chicago
Davidson RJ Jr (1996) Tax-deductible, pre-event catastrophe reserves. J Insur Regul 15(2):175–190
Dionne G (2001) Commitment and automobile insurance regulation in France, Quebec and Japan, Working Paper, HEC Montreal
Eling M, Luhnen M (2010) Efficiency in the international insurance industry: a cross-country comparison. J Bank Finance 34:1497–1509
Eling M, Klein R, Schmit JT (2009) Insurance regulation in the United States and the European union: a comparison, policy report. The Independent Institute, Oakland
European Insurance and Occupational Pensions Authority (2011) EIOPA report on the fifth quantitative impact study (QIS5) for solvency II, EIOPA-TFQISS-11/001, March 2011. https://eiopa.europa.eu/fileadmin/tx_dam/files/publications/reports/QIS5_Report_Final.pdf
Evans AM (2007) The EU reinsurance directive. The Geneva Papers on Risk and Insurance – Issues and Practice 32:95–104
Geneva Association (2010) Systemic risk in insurance – an analysis of insurance and financial stability. Special Report of the Geneva Association Systemic Risk Working Group, March. http://www.genevaassociation.org/PDF/BookandMonographs/Geneva_Association_Systemic_Risk_in_Insurance_Report_March2010.pdf
Grace MF (2010) The insurance industry and systemic risk: evidence and discussion. Networks Financial Institute Policy Brief 2010-PB-02, April
Grace MF, Klein RW (2007) The effects of an optional federal charter on competition in the life insurance industry. Report to the American Council of Life Insurance, Washington, DC
Grace MF, Klein RW (eds) (2009a) The future of insurance regulation in the United States. Brookings Institution Press, Washington, DC
Grace MF, Klein RW (2009b) A perfect storm: hurricanes, insurance markets and regulation. Risk Manag Insur Rev 12(1):81–124
Hanson JS, Dineen RE, Johnson MB (1974) Monitoring competition: a means of regulating the property and liability insurance business. NAIC, Milwaukee
Harrington SE (1992) Rate suppression. J Risk Insur 59:185–202
Harrington SE (2002) Effects of prior approval rate regulation of auto insurance. In: Cummins JD (ed) Deregulating property-liability insurance: restoring competition and increasing market efficiency. AEI-Brookings Joint Center for Regulatory Studies, Washington, DC
Harrington SE (2011) Insurance regulation and the Dodd-Frank act. Networks Financial Institute Policy Brief 2011-PB-01, March
Harrington SE, Niehaus G (2001) Government insurance, tax policy, and the affordability and availability of catastrophe insurance. J Insur Regul 19(4):591–612
Harrington SE, Niehaus G (2003) Capital, corporate income taxes, and catastrophe insurance. J Financial Intermediation 12:365–389
Helms RE (2001) The changing United States health care system: the effect of competition on structure and performance. Independent Institute Working Paper No. 29, April
Holzmuller I (2009) The United States RBC standards, solvency II and the Swiss solvency test: a comparative assessment. Geneva Papers on Risk and Insurance - Issues and Practice 34:56–77
Joskow PL (1973) Cartels, competition and regulation in the property-liability insurance industry. Bell J Econ Manag Sci 4(2):375–427
Klein RW (1995) Insurance regulation in transition. J Risk Insur 62:263–404
Klein RW (2005) A regulator’s introduction to the insurance industry, 2nd edn. National Association of Insurance Commissioners, Kansas City
Klein RW (2008) Catastrophe risk and the regulation of property insurance markets. Presented at the American risk and insurance meeting, Portland, OR, 4 August
Klein RW (2009) An overview of the insurance industry and its regulation. In: Grace MF, Klein RW (eds) The future of insurance regulation in the united states. Brookings Institution Press, Washington, DC
Klein RW (2012) The modernization of insurance company solvency regulation in the U.S.: issues and implications. Paper presented at the networks financial institute 8th annual insurance reform summit, Washington, DC, 21 March
Klein RW, Schacht J (2001) An assessment of insurance market conduct surveillance. J Insur Regul 20:51–93
Klein RW, Wang S (2009) Catastrophe risk financing in the United States and the European union: a comparison of alternative regulatory approaches. J Risk Insur 76(3):607–637
Kunreuther HC, Michel-Kerjan EO (2004) Policy watch: challenges for terrorism risk insurance in the United States. J Econ Perspect 18(4):201–214
Kunreuther HC, Michel-Kerjan EO (2009) At war with the weather: managing large-scale risks in a new era of catastrophes. MIT, Cambridge
Meier KJ (1988) The political economy of regulation: the case of insurance. SUNY Press, Albany
Michel-Kerjan E (2010) Catastrophe economics: the national flood insurance program. J Econ Perspect 24(4):165–186
Michel-Kerjan E, Kunreuther HC (2011) Redesigning flood insurance. Science 333:408–409
Michel-Kerjan E, Volkman-Wise J (2011) The risk of ever-growing disaster relief expectations. Paper presented at the annual NBER insurance group conference, Cambridge, MA, September. http://nber.org/confer/2011/INSf11/Michel-Kerjan_Volkman_Wise.pdf
MichelKerjan EO, Raschky PA (2011) The effects of government intervention on the market for corporate terrorism insurance. Eur J Polit Econ 27:S122–S132
Munch P, Smallwood DE (1981) Theory of solvency regulation in the property and casualty insurance industry. In: Fromm G (ed) Studies in public regulation. MIT, Cambridge
National Association of Insurance Commissioners (2010) Proposal for a risk-based capital charge for property catastrophe risk based on the results of catastrophe modeling, June. http://www.naic.org/documents/committees_ex_isftf_100623_capital_req.pdf
Peltzman S (1976) Toward a more general theory of regulation. J Law Econ 19:211–240
Saunders A, Cornett MM (2003) Financial institutions management: a risk management approach. McGraw-Hill, New York
Scherer FM, Ross DS (1990) Industrial market structure and economic performance. Houghton-Mifflin, Boston
Schwarz SL (2008) Systemic risk, duke law school, Research Paper No. 163, March. http://ssrn.com/abstract=1008326
Spulber DF (1989) Regulation and markets. MIT, Cambridge
Stigler GJ (1971) The theory of economic regulation. Bell J Econ Manag Sci 2:3–21
US Government Accountability Office (2005) Catastrophe risk: U.S. and European approaches to insure natural catastrophe and terrorism risks. GAO-15-199, Febraury, Washington, DC
Vaughan TM (2009) The implications of solvency II for U.S. Insurance regulation. Networks Financial Institute Policy Brief PB-2009–03, February
Viscusi WK, Harrington JE, Vernon JM (2000) Economics of regulation and antitrust, 3rd edn. MIT, Cambridge
Wang S, Klein RW, Ma G, Ulm ER, Wei X, Zanjani G (2009) The financial crisis and lessons for insurers. Report to the Society of Actuaries, Septembers
Zanjani G (2008) Public versus private underwriting of catastrophic risk: lessons from the California earthquake authority. In: Quigley JM, Rosenthal LA (eds) Risking house and home: disasters, cities, public policy. Berkeley Public Policy Press, Berkeley
Author information
Authors and Affiliations
Corresponding author
Editor information
Editors and Affiliations
Rights and permissions
Copyright information
© 2013 Springer Science + Business media, New York
About this chapter
Cite this chapter
Klein, R.W. (2013). Insurance Market Regulation: Catastrophe Risk, Competition, and Systemic Risk. In: Dionne, G. (eds) Handbook of Insurance. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-0155-1_31
Download citation
DOI: https://doi.org/10.1007/978-1-4614-0155-1_31
Published:
Publisher Name: Springer, New York, NY
Print ISBN: 978-1-4614-0154-4
Online ISBN: 978-1-4614-0155-1
eBook Packages: Business and EconomicsEconomics and Finance (R0)