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complementary good or service. Another wrinkle is added to this when – as is often the case with personal lines – insurance purchases are compulsory. Regulators must determine whether they should remain involved in an otherwise competitive market where consumers essentially have no alternative but to purchase a good or service. Additionally, if a large percentage of consumers fail to obtain or adequately comprehend information to identify and compare appropriate insurance products, then the question arises as to whether regulators should compensate for this by examining underwriting criteria, subjecting rates to filing and/or approval requirements, or by monitoring competitive activities of companies in the market. Thus, as minimizing the role of regulators is generally deemed to be desirable, the insurance industry should expect a less-intrusive regulatory approach to require insurers to share this information with consumers and other firms in the market in order to avoid market failures. Given the reluctance or inability of individual consumers to adequately digest detailed technical information, the challenge is to identify effective ways to communicate this information that require a minimum of government supervision and intrusion.

Regulators play an important role in balancing sound public policy with the interests of a profit-maximizing industry. Economists in general have recognized that, in imperfect markets, regulation can improve the overall welfare of consumers.19 Yet they also warn that regulators should not unnecessarily intervene in competitive markets and should recognize that economic theory states that a competitive market will lead to efficient outcomes, including low prices, reasonable profits and innovative products. However, within the insurance industry, there seem to be localized situations, particularly involving catastrophic situations and regions, where the market has not been well served. These specific instances, rather than the general idea of rate regulation, deserve the most research and attention.

Rate Regulation vs. Price Control

There has been much rhetoric about state regulators engaging in price control. This characterization appears in recent Congressional testimony and is contained in the comments of insurance industry representatives to this Working Group. The use of this characterization leaves the uninformed with the impression that most or all states set insurance rates for insurers. In recent years, all states have moved away from the strict setting of rates.  Rather, insurers develop the rates and rating systems that they intend to use and, in most states, file that information with the insurance regulator. Over time many states have moved away from prior approval regulatory frameworks toward those that place greater reliance on competitive forces. At the time this was written, there were 19 states that still operate under a prior approval framework.  One of the 19 prior approval states (Georgia) is prior approval for auto insurance while employing a file and use system for homeowners. Thus there are 31 jurisdictions that currently embrace some form of flexible or competitive rating for personal lines products.

However, a two- or three-word description of a state’s rating law (such as prior approval or file and use) does not always tell the whole story. In many jurisdictions the regulator has some measure of discretion as to how the regulatory framework is administered. For example, a file and use system can be administered – or treated by insurers - in a way that is not very different from a prior approval system.  In flex-rating states, prior approval may apply only if a rate request involves a relatively large increase.

Recommendations to the Property and Casualty Insurance Committee

The NAIC was formed to provide a forum for development of uniform policy when uniformity is appropriate. There is no single national auto insurance market or homeowners market in the United States. The Working Group recognizes that the unique characteristics of an individual state’s market may call for differences in regulatory frameworks. In recognition of the unique exposures to loss faced by different states, the unique legal frameworks (e.g. tort v. no-fault) and market conditions, this document contains some recommendations for actions by the NAIC and a set of principles that states can use in evaluating their current regulatory framework for personal lines insurance products. These principles can be used to help public policymakers evaluate current market performance and determine if changes are needed to the regulatory framework that either increase or decrease reliance on competitive forces. National uniformity is not necessary.

The Working Group recommends:

That model laws #775 and #780 and the 2000 draft model law and regulation be identified as guidelines and retained as a resource. The Working Group believes that the consistency of language for the various approaches to developing a regulatory framework for property and casualty insurance products would be beneficial to legislators as they develop statutory changes.

19 Viscusi, Vernon and Harrington (1995, p. 528).

© 2009 National Association of Insurance Commissioners 10

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