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The main function of a market, whether highly competitive or highly regulated, is to facilitate the most efficient exchange of goods and services. This is true of insurance markets as well. According to economic theory, a market-driven insurance industry should provide “an efficient allocation of society’s scarce resources” while maximizing consumer choice and value.1 If significant imperfections do not exist, a competitive market will require no governmental intervention or oversight. Market forces themselves are a form of regulation in that they instill price, market conduct and other disciplinary forces upon industry participants.

Though markets often “self-regulate,” there can also be undesirable side-effects within markets. Policymakers sometimes enact regulations in an attempt to lessen the effect of any undesirable outcomes from market operations. Inefficiencies within markets often lead to governments taking regulatory actions in order to address market instability and uncertainty. Inefficiencies may include extreme situations where firms attempt to eliminate competitors and control the market or less dire situations where markets exhibit failures or imperfections.2 It is these situations, where markets do not provide the most efficient allocation of resources, which lead to regulation of industries.

When consumers hear the term “regulation” their natural thought process often brings them to think of some sort of government agency overseeing certain aspects of industry. The actions most typically thought of by consumers are price (rate) regulation and consumer protection (market conduct) regulation. Economic regulation can involve government-imposed restrictions on price, quantity, and entry and exit.3 Government interaction affects market behavior in an attempt to improve market functionalities but market forces continue to play a significant role.

Regulatory frameworks based heavily or solely upon a reliance on competition (e.g., anti-trust laws) will take direct steps to assure that no one competitor is allowed to obtain too much market share, at least not through the acquisition of competitors, agreements to allocate markets or pricing below cost to drive competitors from the market. While insurance regulation recognizes these possibilities to a certain extent, the original justification for insurance rate regulation was developed in large part from a desire to allow cooperative action among entities that were otherwise competitors, which is something that traditional anti-trust frameworks also prohibit. In fact, while there is still a desire by regulators to allow certain specific, limited forms of cooperative action (e.g., data collection and certain residual market activities) -- and allowance of these activities necessitates at least a certain degree of regulatory oversight -- rate regulation today is more reasonably justified because markets fall short of "perfect competition" in ways other than collusion or excessive concentration. While insurance-related examples of excessive market concentration exist and have existed in some commercial lines (e.g., medical professional liability), they have not been observed for homeowners or private passenger automobile on a statewide basis, and free entry appears to make such unhealthy concentrations unlikely even for niches of these markets.  As such, in present personal lines markets, while excessive market concentration is generally not viewed as a material impediment to competition, laws to deal with a monopoly or oligopoly are something that should be available to regulators in case such situations should ever threaten.

Most, if not all, industries throughout modern history have experienced governmental regulation to some degree. All businesses are subject to numerous regulations concerning product safety laws, employment laws, community zoning regulations, and accounting practices and procedures that ultimately have an impact on the cost of goods and services. For instance, while the production of food is thought of as a competitive market, producers and suppliers are bound by numerous safety regulations designed to keep the food supply safe. In addition, the government has created numerous agricultural subsidy schemes, in some cases, to cap food prices and, in others, to create a price floor. The utility, telecommunication, and transportation industries have experienced the highest degree of governmental regulation in the United States, particularly as a result of their importance to trade and commerce. Many other industries have been left, more or less, to competitive market forces with minimal government intervention.

In any case, governmental involvement occurs in all industries with its function, in most cases, to provide a market structure for all competitors – creating a rule book for competitors to play by. Typically regulation is seen as providing a structure or framework to encourage competition, rather than enacting strict control of prices or inputs that could impede competitive forces even further. Economists agree that governments should attempt to “craft laws and enforce regulations that promote more transparent markets supported by fair competition unfettered by government direction, favoritism, and unwarranted interference.”4  The regulator should not typically oversee price and input decisions but “establish policies that assure that the

1 Skipper, Harold and Klein, Robert. (2000) “Insurance Regulation in the Public Interest: The Path Towards Solvent, Competitive Markets,” The Geneva Papers on Risk and Insurance, vol 25, no 4, p. 488.

2 McDowell, Banks. (1989) Deregulation and Competition in the Insurance Industry. New York: Quorum Books, p. 95.

3 Viscusi, W., Vernon, J., and Harrington, J. (1995) The Economics of Regulation and Antitrust. Cambridge: MIT Press, p. 807.

4 Skipper and Klein (2000, p. 504).

© 2009 National Association of Insurance Commissioners 5

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