Insurer Regulation
States regulate insurance companies (insurers) throughout their existence—from formation through ongoing operations to dissolution if necessary.
Formation and Licensing of Insurers
Certificate of Authority
Before an insurer can do business in a state, it must obtain a Certificate of Authority (also called a license) from that state's insurance department.
| Requirement | Description |
|---|---|
| Articles of Incorporation | Legal documents forming the company |
| Bylaws | Internal governance rules |
| Minimum Capital and Surplus | Required initial funds |
| Business Plan | Description of intended operations |
| Officer/Director Information | Background of key personnel |
| Policy Forms | Sample policies to be issued |
| Rate Information | Proposed premium rates |
Insurer Classifications
| Classification | Definition |
|---|---|
| Domestic Insurer | Incorporated in the state |
| Foreign Insurer | Incorporated in another U.S. state |
| Alien Insurer | Incorporated outside the United States |
Exam Tip: A company can be "domestic" in its home state and "foreign" in all other states. "Alien" refers only to companies incorporated in other countries.
Types of Insurers by Ownership
| Type | Ownership | Profit Distribution |
|---|---|---|
| Stock Company | Shareholders | Dividends to shareholders |
| Mutual Company | Policyholders | Dividends to policyholders |
| Fraternal Benefit Society | Members (lodge system) | Benefits to members |
| Reciprocal Exchange | Subscribers | Returns to subscribers |
Solvency Regulation
The primary goal of insurance regulation is ensuring that insurers can pay claims—this is called solvency regulation.
Risk-Based Capital (RBC)
Risk-Based Capital is a method developed by the NAIC to determine the minimum amount of capital an insurer must hold based on its risk profile.
How RBC Works
- RBC considers both the size of the company and the riskiness of its operations
- Riskier investments and business require higher capital
- RBC is calculated using a formula that assigns risk factors to different assets and liabilities
RBC Ratio Levels and Actions
| RBC Ratio | Level | Regulatory Action |
|---|---|---|
| ≥200% | No Action Level | No regulatory intervention required |
| 150-199% | Company Action Level | Company must submit corrective action plan |
| 100-149% | Regulatory Action Level | Commissioner examines company's operations |
| 70-99% | Authorized Control Level | Commissioner may take control of company |
| <70% | Mandatory Control Level | Commissioner must take control of company |
Key Point: The RBC system is designed for early intervention to prevent insolvencies before they harm policyholders.
Reserve Requirements
Insurers must maintain reserves—funds set aside to pay future claims.
| Reserve Type | Purpose |
|---|---|
| Policy Reserves | Future claims under current policies |
| Claim Reserves | Known claims being processed |
| IBNR Reserves | Incurred But Not Reported claims |
| Unearned Premium Reserves | Premium collected but not yet earned |
Exam Tip: Reserves are liabilities on an insurer's balance sheet, not assets or surplus. They represent money owed to policyholders.
Rate Regulation
States regulate insurance rates to ensure they are:
- Adequate: Sufficient to pay claims and expenses
- Not Excessive: Not unreasonably high
- Not Unfairly Discriminatory: Based on actuarial justification
Types of Rate Regulation
| System | Description | Commissioner Action |
|---|---|---|
| Prior Approval | Rates must be approved before use | Approves or disapproves rates before effective |
| File-and-Use | Rates filed but can be used immediately | Can disapprove after use begins |
| Use-and-File | Rates used immediately, filed within specified period | Reviews after already in use |
| Flex Rating | No approval needed within a percentage band | Only reviews changes outside the band |
| No File (Open Competition) | No filing required | Intervenes only if problems arise |
Exam Tip: Prior approval is the most restrictive system, while no file/open competition is the least restrictive. Know the differences between these systems.
Rate Components
When reviewing rates, regulators examine:
- Pure Premium: Expected claims costs
- Loss Adjustment Expenses: Costs to investigate and settle claims
- Operating Expenses: Administrative costs
- Profit and Contingency: Reasonable return
- Trending Factors: Adjustments for future changes
Market Conduct Examinations
While financial examinations focus on solvency, market conduct examinations focus on how insurers treat customers.
Areas Examined in Market Conduct
| Area | Focus |
|---|---|
| Sales Practices | Are sales materials accurate and not misleading? |
| Underwriting | Are decisions made fairly and consistently? |
| Rating | Are proper rates being charged? |
| Claims Handling | Are claims processed promptly and fairly? |
| Policyholder Services | Are customers treated properly? |
| Complaints | How does the company handle complaints? |
Types of Examinations
| Type | Description |
|---|---|
| Routine Exam | Regularly scheduled comprehensive review |
| Targeted Exam | Focus on specific areas of concern |
| Complaint-Driven Exam | Triggered by consumer complaints |
| Multi-State Exam | Coordinated exam by multiple states |
Consumer Protection Mechanisms
Guaranty Associations
Every state has guaranty associations that protect policyholders if an insurer becomes insolvent:
| Feature | Description |
|---|---|
| Funding | Assessments on solvent insurers |
| Coverage Limits | Usually $300,000-$500,000 per policy |
| Covered Lines | Life, health, and property/casualty |
| Not Insurance | Guaranty funds are not insurance products |
Key Point: Guaranty associations provide a safety net but have coverage limits. They are funded by assessments on remaining solvent insurers after an insolvency.
Consumer Complaint Process
| Step | Description |
|---|---|
| 1. File Complaint | Consumer files with insurance department |
| 2. Investigation | Department investigates the complaint |
| 3. Response | Insurer must respond to the department |
| 4. Resolution | Department works toward resolution |
| 5. Action | Enforcement action if violation found |
An insurance company incorporated in State A that is selling insurance in State B would be classified in State B as a:
Under the NAIC Risk-Based Capital (RBC) system, at what ratio is the insurance commissioner required to take control of an insurer?
Under a prior approval rate regulation system, an insurer:
Insurance company reserves are classified on the balance sheet as:
State guaranty associations are funded by:
33.1 Licensing Requirements
Chapter 33: Producer Licensing and Conduct