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Federal vs. State Regulation of Insurance: Why It Matters

Posted by WSRB on September 10, 2012

One of the least-reported-on but crucial-to-the-insurance-industry lobbying efforts relates to increased federal regulation of insurance.

In 1945, Congress expressly acknowledged that regulation of “the business of insurance” was best left to the individual states. Since that time, the argument is regularly made that state regulation is “inefficient, costly and burdensome.” It is asserted that the 50+ individual jurisdictions a nationwide carrier has to work with represent a “patchwork” of rules and standards. This patchwork is an agonizingly difficult and redundant regulatory system, one that adds costs and denies consumers the creativity of the free market to quickly develop and market innovative insurance products.

A man stands in front of a board with the words "regulation," "procedure" and other terms on it.


The cure for these supposed impediments to a vibrant industry is always the same: federal regulation (or its close cousin, Optional Federal Charter). A single regulator for the entire country, we are told, will streamline the introduction of new products and result in more competition and a better world for agents, carriers and consumers.

There is logic to these ideas. Certainly, it would be easier to introduce a product if you only had to get it approved by one insurance department rather than 50. However, like most things in life, there’s more to the story.

First, let’s understand what the purpose of insurance regulation is. First and foremost, it is about consumer protection. Insurance protects our most valuable assets: our homes, our businesses, our financial well-being, our personal property and our lives.

Insurance regulation is intended to assure the purchasers of insurance contracts that those contracts can be relied on. A debate over the role of regulation in our society is appropriate, but the purpose of regulation is not to improve the efficiency of product development or promote innovation; it is to ensure that the contractual obligations to the insured are fulfilled.

Happily, innovation and efficiency have coexisted quite well with state regulation. Contrary to what some seem to believe, the industry has always responded to changing needs by expanding product and service offerings to meet those needs, as well as working cooperatively with regulators to improve regulatory efficiency. Effective regulation of financial services, whether banking or insurance, ultimately does grease the wheels of commerce because when an industry is well-regulated, consumers have a higher level of trust that the company they are dealing with is solvent, and their assets are secure.

Notice the term well-regulated. That’s the key. Some regulators have done a better job than others. If you compare the record of state-based insurance regulation to federal banking regulation over any time period, you will see a stark difference.

There have been numerous banking crises that have resulted in recessions, depressions and high-profile congressional hearings. I challenge you to name one insurance crisis that the average citizen remembers, or has even heard about. The only one most people can come up with is the 2008 AIG implosion, but it was actually AIG’s investment services division, not the state-regulated insurance division, that was responsible. In fact, we know of none of AIG’s state-regulated companies that needed bailouts or went under in that crisis. State regulators acted quickly to ensure that AIG’s regulated surpluses were maintained to pay for future losses as soon as the crisis became known.

Compare those results to federal financial regulation then and in all prior crises. Which has a better demonstrated record of effectiveness, state or federal regulation? How important is federal regulatory efficiency (even supposing that can be achieved) when it is so woefully ineffective?

State regulation has been such a success, in part, because insurance is a local and regional matter, one that is effectively regulated by those familiar with the risks. The Gulf and Atlantic states have regulations in place that deal with wind, flood and storm surge. In the Midwest, tornadoes and hail are concerns. The West must deal with earthquakes. Regulators in each state know what matters to the insurance consumers in their states. This is knowledge that Congress and the interested federal agencies acknowledge they don’t have, and what could be more crucial to effective regulation than this sort of knowledge?

Finally, the insurance market is robust and competitive. There are thousands of insurance carriers. The vast majority are financially sound, profitable and developing innovative new products on a regular basis. The occasional failures are wound down by their state regulators with little or no harm to the consumer. State regulators have made and continue to make progress on establishing reciprocity and consistency where it makes sense, and these changes are contributing to better market efficiencies. Federal regulation of insurance is a solution in search of a problem.

While most businesses would appreciate less regulation, insurance professionals recognize that some regulation is both necessary and good for the industry. The regulation that has worked best for over 100 years is state-based regulation. It’s worth holding on to, and that’s why it matters.