Policy Documents

Ten Principles of Property and Casualty Insurance Regulation

Matthew Glans and Eli Lehrer –
October 1, 2009

Why do we need 10 principles of P&C insurance regulation?

We wrote this guide for three reasons: because insurance is an important economic activity; because it is regulated almost entirely at the state level and is thus of particular concern to state legislators; and because we hope a look at the principles behind insurance regulation will encourage state regulators to create freer marketplaces for consumers and insurers.

Insurance Is Vital to a Growing Economy

Insurance is one of the key institutions that make economic prosperity possible. Properly designed insurance makes the management of risk possible and, in so doing, makes long-term planning and investment more reliable. Insurance markets best accomplish their risk-management function when insurers are allowed to charge actuarially determined, risk-based rates that accurately reflect the risk their policyholders incur. When government regulation interferes with these price mechanisms, the result is either rate suppression or a redistribution of the cost burden, resulting in wealth redistribution from policyholders who behave prudently to those who take greater risks.

Political manipulation of insurance rates, regardless of its intentions, distorts the valuable competitive signals of the private market and reduces the range of products available for consumers. Price controls inevitably reduce the supply and lower the quality of insurance products.

Insurance Is Regulated at the State Level

Insurance is the largest and most important economic activity regulated almost entirely at the state level. In some cases, this regulation leads to inefficiency. Although federal and international entities oversee banking, trade, manufacturing, and many service industries, states alone have the power to oversee property and casualty insurance, under the federal McCarran-Ferguson Act of 1945. As a result, insurers and consumers must deal with a confusing and expensive maze of state regulations. International insurers have a difficult time entering the United States market because they must enter each state market separately.

State regulation makes insurance more expensive, on average, than it otherwise would be, because incumbent insurers often lobby political authorities for rules that limit competition and allow them to raise rates. Consumers use their political influence as voters to support rate caps and subsidies to socialize the cost of insuring against risks they face due to the choices they make, costs they should pay themselves. Both pressures lead to less consumer choice--major property and casualty insurers have not introduced a single major new product since modern homeowners insurance (the HO-3 and HO-8 policies, in industry parlance) became available in 1959.

Freedom Is Best

Government certainly has a role to play in regulating insurance. Enforcement of laws regarding reserve requirements to ensure solvency is needed in the insurance business, and that enforcement properly belongs in the hands of the state. Rules governing timely response to claims and the use of clear language in insurance contracts are also legitimate government functions that benefit consumers.

The current regulatory environment in many states, however, goes far beyond this limited role. It is characterized by heavy-handed regulation through processes that are generally unknown by the general public and dominated by special-interest groups and a small number of elected and unelected officials. These processes impose large, though undocumented, costs on businesses and individuals deprived of reliable and affordable insurance products, and they increasingly threaten to put U.S.-based financial services companies at a competitive disadvantage with those in Europe.

We believe most insurance decisions--especially the price charged for insurance products--should be determined by market forces and voluntary arrangements. The benefits of doing this are clear: States with more open and free regulatory environments provide more insurance choices to consumers and more insurance jobs. A free and open insurance environment makes sense. This guide describes how to build one.

Recommended reading: Eli Lehrer and Michelle Minton, Property and Casualty Insurance 2009 Report Card, The Heartland Institute, 2009.