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Commercial insurance markets in the U.S. are very diverse in terms of sellers, buyers, products, and distribution systems. These markets continue to progress as commercial risk management needs evolve in response to a changing economy and greater global commerce. Domestic and international insurers compete aggressively to meet these needs with innovative products, services, and pricing options. Regulated insurers also face strong challenges from alternative risk management options.
However, the regulation of commercial insurance markets in the U.S. has not kept pace with changing nature of the insurance industry, as well as the capacities and needs of buyers. Regulation works best when it remedies significant market failures and protects consumers who warrant protection. Many states have lost sight of this principle with respect to commercial insurance. Archaic regulatory practices are overly restrictive and unnecessary given the competitiveness of commercial insurance markets and the ability of most businesses to protect their own interests in insurance transactions.
Concerns about this mismatch between regulation and markets prompted state insurance commissioners and the industry to develop a framework of recommended reforms of commercial insurance regulation. A principal thrust of this initiative was to deregulate to a great extent the insurance transactions of large businesses with operations in multiple states. It also envisioned a flexible and progressive approach to easing the regulation of all commercial insurance prices and products. The concept was to decrease the intensity of regulation as the size and sophistication of the buyer increases. The National Association of Insurance Commissioners (NAIC) affirmed its support of this platform with its adoption of a guiding white paper in 1998. While the white paper did not go as far as it should have in recommending progressive reforms, it still articulated a major change in regulatory philosophy that would substantially increase market efficiency. The hope was that the various states would enact and implement the recommended reforms to establish an efficient and harmonious regulatory framework for commercial insurance
Reality of Reform Falls Short
Unfortunately, the reality of regulatory reform has fallen far short of its vision. The shortfall has occurred at two levels. The NAIC model law and regulation constructed to implement deregulation have retreated from the already conservative reforms recommended in the white paper. Further, the changes enacted by the various states are uneven and inadequate, impeded by bureaucratic inertia and special interests that seek to insulate themselves from competition. Rather than a rationalized and harmonized system, insurers and insureds face a myriad of inconsistent regulations failing to deliver on the promise of commercial insurance reform.
The NAIC and the states must get back on track to bring commercial insurance regulation into the 21st century. This is a matter of urgent importance. Recent federal legislation is accelerating the convergence of financial services markets and institutions and raising serious questions about the efficiency of state insurance regulation. The failure to implement a rational and harmonious system of commercial insurance regulation will strike a severe blow to state-based regulation.
Realizing the Vision of Reform
To realize the vision of commercial insurance reform, the NAIC and the states should revamp and coordinate their regulations in several key areas.
The easing of regulatory restrictions should extend as far as possible in terms of commercial lines markets, buyers, insurers, and intermediaries. No segment should be regulated more heavily than is absolutely necessary and appropriate to protect the buyers in that market.
Rescind Prior Approval Requirements for Rates and Forms
Prior approval requirements for rates and policy forms should be rescinded and competitive regulatory systems instituted for all commercial insurance lines, regardless of the type of product and the size of the buyer. This is consistent with our Statement No. 2 on the deregulation of insurance prices, which advocated competitive rating for all major types of personal and commercial insurance. If individual consumers fare well under such systems for auto and home insurance, certainly businesses can do the same for the types of insurance they purchase.
The current versions of the NAIC model law and regulation do not meet this objective. The NAIC Property and Casualty Model Rate and Policy Form Law provides authority to the insurance commissioner to modify filing and prior approval requirements for commercial lines rates and forms. However, the model law effectively defaults to a "file and use" system for rates and a prior approval system for policy forms unless the insurance commissioner determines that exceptions are appropriate. Currently, 20 states still require prior approval of commercial lines rates, and the vast majority require prior approval of commercial policy forms.
Limit Filing Requirements
Requiring the filing of policy forms for standard products purchased by small businesses and compulsory coverages (e.g., workers’ compensation) is a matter for regulatory judgment. Regulators can judge whether they can use alternative means to ensure that forms comply with state laws. For other products, effective monitoring of the policy forms used by insurers should be sufficient to prompt regulatory action when necessary.
Establish Simple and Reasonable Criteria for Exempted Transactions
The transactions of "large" commercial buyers should be exempted from rate and form filing requirements and regulation. The thresholds used by the states to determine exempted transactions should be as simple and as low as possible. The states also should strive to make their criteria as consistent as possible to facilitate multi-state transactions by large buyers. Moreover, it would be desirable to explore the merits and practicability of allowing buyers that do not meet those thresholds to voluntarily choose not to have a particular transaction comport with rate and form requirements as long as it does not conflict with state laws.
While the NAIC’s intent to provide some flexibility in the exempted commercial policyholders criteria is laudable, the criteria are overly complex and restrictive. Some of the criteria enacted by states are unnecessarily stringent and inconsistent. They undermine the objective of facilitating efficient multi-state insurance transactions for large buyers. It would be preferable for states to use similar measures of buyer size and avoid high thresholds that would make it more difficult for a large number of commercial insureds to conduct multi-state transactions.
There also is an urgent need for more states to adopt large buyer exemptions. To date, only 18 states have enacted such legislation. An equivalent number of states may consider and enact similar legislation in the coming year, but this still would leave a large number of states without reforms.
Thus, while commercial lines deregulation represents a positive development, its implementation to date falls far short of what is needed to promote market efficiency. Prior approval rate and form regulation should be eliminated, filing requirements limited, and large buyers exempted based on reasonable and consistent criteria.