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Sarah Fisher is an associate editor at The Balance with two years of personal finance and business writing experience. She has written about personal finance for SmartAsset, and has held internships at the Consumer Financial Protection Bureau and Senator Kirsten Gillibrand's office.
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If you buy business insurance, you may have wondered who determines the rates you pay for commercial policies. Generally, insurance rates will be regulated by the state where you purchase insurance.
Insurance companies are regulated by the states. Each state has a regulatory body that oversees insurance matters. This body is often called the Department of Insurance, but some states use other names. Examples are the Office of the Insurance Commissioner (Washington) and the Division of Financial Regulation (Oregon). The insurance department is headed by a commissioner. Depending on the state, the insurance commissioner may be appointed or elected.
All states regulate the rates used in some types of insurance. The extent of regulation varies widely from state to state. Some states exert very tight control while others impose very little. Most states fall somewhere in the middle.
Many insurance companies conduct business across state lines. A few do business in virtually all states. Why aren't insurers regulated by the federal government?
In 1945, a law called the McCarran-Ferguson Act. This law gives states the authority to regulate insurers. The law was enacted in response to a decision by the U.S. Supreme Court the previous year. The court ruled that the business of insurance constituted interstate commerce. This meant that the federal government had the right to regulate insurance.
The Supreme Court's decision threatened to upend the insurance industry by eliminating state control. The McCarran-Ferguson Act restores power to the states. It gives states the right to tax and regulate insurers. However, the law contains three key exceptions:
In 2010 Congress passed the Dodd-Frank Act, which imposed many new regulations on financial institutions. The law established the Federal Insurance Office (FIO). This agency is part of the U.S. Department of Treasury. It was created to monitor the insurance industry to ensure it is financially stable. The FIO is an advisory body only. It has no regulatory authority over insurers.
There are several reasons why states regulate insurance rates. One is to ensure that rates aren't excessive. In the absence of regulation, insurers might charge rates that are too high and that generate too much profit. A second purpose is the opposite, to ensure that rates aren't too low. An insurer that charges excessively low rates might sell many policies but lack the funds to pay claims. Rates must be adequate so that insurers remain solvent.
The third goal of insurance regulation is to prevent unfair discrimination. Insurance underwriters are permitted to discriminate in favor of some insurance buyers over others, but the reasons must be valid. For instance, underwriters may charge a higher or lower rate based on a policyholder's claims history. A business that has incurred no prior auto claims may pay less for a commercial auto policy than a similar business that has sustained many auto losses. Underwriters may also discriminate based on the nature of the risk. An insurer may charge more to insure a building that has no fire sprinklers than a similar building with a full sprinkler system.
Insurers are barred from discriminating against policyholders based on factors unrelated to the risks insured. Examples are race, religion and national origin. Certain characteristics may be used to rate some types of insurance but not others. For instance, many states allow insurers to consider age, sex and marital status in the rating of personal auto coverage. These factors are not relevant to commercial auto rating.
All states exert some control over the rates used by insurers. However, insurance rate laws vary widely from state to state. Some states have strict laws that require pre-approval of all rates. Others have lenient laws that require no pre-approval. Many require prior-approval of some rates.
There are six basic types of insurance rate laws.
Many states use a combination of these laws. For instance, a state may require insurers to obtain prior approval of rates used in personal lines, but allow insurers to "file and use" rates used in commercial lines. Most rating laws permit state regulators to disallow rates that have already been filed. For instance, an insurance commissioner may bar an insurer from using rates filed under a "use and file" law on the basis that the rates are inadequate.
The six types of rating laws described above are often divided into two categories: prior-approval laws and competitive rating laws. Competitive rating laws is a term that includes all rating laws other than those that require rates to be pre-approved.
Currently, only a few states have prior approval laws that apply to all types of insurance. About a third of the states have no prior approval law at all. The remaining states have a mix of prior approval and competitive rating laws. Generally, rates used in business insurance are subject to less regulation than those used in personal insurance.
Prior approval laws are based on the concept that government intervention is necessary to ensure that rates are adequate but not excessive. In the past, many state lawmakers have supported this concept. Over the last few decades, however, legislators have discovered that prior approval laws can create serious problems.
For one thing, a rating system based on prior approval is costly. Both insurers and state regulators must employ staff to ensure that rates are submitted and reviewed in accordance with the law. Insurers that operate in multiple states have an added burden since the filing requirements vary from state to state. The costs incurred by insurers and state agencies are passed onto insurance buyers. Thus, rates are often higher in prior approval states than in those with competitive rating laws.
Secondly, prior approval laws create rates that are artificially low. Regulators often resist rate increases requested by insurers, causing increases to be delayed. When rates are too low, insurers suffer financial losses. When rates finally increase, insurers' financial condition rebounds. The result is seesawing profits and losses.
Prior approval laws can also create a shrinking insurance market. When rates are too low to cover insurers' losses and expenses, some insurers leave the state. Others are reluctant to enter. The result is reduced availability of insurance. Service and product choice may suffer as well. When rates are too low, insurers have little incentive to develop new products or improve service.
Finally, prior approval laws can lead to an influx of average-risk buyers into assigned risk plans. These plans are supposed to be a market of last resort. They are designed for high-risk buyers that can't obtain a policy from a standard insurer. Yet, when insurance is unavailable from "regular" insurers, average-risk buyers are forced into assigned risk plans.
Because of the problems associated with pre-approval laws, many states have modernized their regulatory process by instituting competitive rating. Competitive rating laws are based on the idea that competition will produce rates that are neither too high nor too low. These laws have been successful in many states because the insurance industry is highly varied. There are numerous insurance companies, and none is large enough to control the market. According to the Insurance Information Institute, there were over 2500 property/casualty insurers operating in the United States in 2015.
Competitive rating laws provide a number of benefits to insurance buyers. One is lower rates. Insurers are more likely to reduce their rates when they know they can quickly raise them later to compensate for losses. Secondly, insurers' financial performance is more consistent under a competitive rating system. When profits and losses are predictable, other insurers will enter the state. As the number of insurers increases, competition among insurers increases as well. This helps keeps prices low. Competitive pressures also encourage insurers to improve their service and diversify their products to attract customers.
Finally, competitive rating creates less demand for assigned risk plans. When insurers are seeking new customers, most insurance buyers are able to obtain coverage in the standard market. Assigned risk plans can operate as intended, and won't compete with standard insurers.
Insurance rates are what insurance companies use to determine insurance premiums. The insurer calculates the amount of money necessary to cover losses, expenses, and profits for the insurer. Then the insurer uses that calculation to determine what the customer will need to pay in order to be covered.
Yes, insurance companies are regulated by each state. This is due to the McCarran-Ferguson Act of 1945, which made state-by-state regulation and taxation the industry standard. Each state has its own set of insurance regulations.
