Insurance in the United States
Insurance in the United States refers to the market for risk in the United States, the world's largest insurance market by premium volume. Of the $4.640 trillion of gross premiums written worldwide in 2013, $1.274 trillion (27%) were written in the United States.
Insurance, generally, is a contract in which the insurer (stock insurance company, mutual insurance company, reciprocal, or Lloyd's syndicate, for example), agrees to compensate or indemnify another party (the insured, the policyholder or a beneficiary) for specified loss or damage to a specified thing (e.g., an item, property or life) from certain perils or risks in exchange for a fee (the insurance premium). For example, a property insurance company may agree to bear the risk that a particular piece of property (e.g., a car or a house) may suffer a specific type or types of damage or loss during a certain period of time in exchange for a fee from the policyholder who would otherwise be responsible for that damage or loss. That agreement takes the form of an insurance policy.
|“||Insurance provides indemnification against loss or liability from specified events and circumstances that may occur or be discovered during a specified period.||”|
|— FASB Statement of Financial Accounting Standards No. 113, "Accounting for Reinsurance of Short-Duration and Long-Duration Contracts" December 1992|
The first insurance company in the United States underwrote fire insurance and was formed in Charleston, South Carolina, in 1735. In 1752, Benjamin Franklin helped form a mutual insurance company called the Philadelphia Contributionship, which is the nation's oldest insurance carrier still in operation. Franklin's company was the first to make contributions toward fire prevention. Not only did his company warn against certain fire hazards, it refused to insure certain buildings where the risk of fire was too great, such as all wooden houses.
The first stock insurance company formed in the United States was the Insurance Company of North America in 1792. Massachusetts enacted the first state law requiring insurance companies to maintain adequate reserves in 1837. Formal regulation of the insurance industry began in earnest when the first state commissioner of insurance was appointed in New Hampshire in 1851. In 1869, the State of New York appointed its own commissioner of insurance and created a state insurance department to move towards more comprehensive regulation of insurance at the state level.
Insurance and the insurance industry has grown, diversified and developed significantly ever since. Insurance companies were, in large part, prohibited from writing more than one line of insurance until laws began to permit multi-line charters in the 1950s. From an industry dominated by small, local, single-line mutual companies and member societies, the business of insurance has grown increasingly towards multi-line, multi-state and even multi-national insurance conglomerates and holding companies.
State-based insurance regulatory system
Historically, the insurance industry in the United States was regulated almost exclusively by the individual state governments. The first state commissioner of insurance was appointed in New Hampshire in 1851 and the state-based insurance regulatory system grew as quickly as the insurance industry itself. Prior to this period, insurance was primarily regulated by corporate charter, state statutory law and de facto regulation by the courts in judicial decisions.
Under the state-based insurance regulation system, each state operates independently to regulate their own insurance markets, typically through a state department of insurance. Stretching back as far as the Paul v. Virginia case in 1869, challenges to the state-based insurance regulatory system have risen from various groups, both within and without the insurance industry. The state regulatory system has been described as cumbersome, redundant, confusing and costly.
The United States Supreme Court found in the 1944 case of United States v. South-Eastern Underwriters Association that the business of insurance was subject to federal regulation under the Commerce Clause of the U.S. Constitution. The United States Congress, however, responded almost immediately with the McCarran-Ferguson Act in 1945. The McCarran-Ferguson Act specifically provides that the regulation of the business of insurance by the state governments is in the public interest. Further, the Act states that no federal law should be construed to invalidate, impair or supersede any law enacted by any state government for the purpose of regulating the business of insurance, unless the federal law specifically relates to the business of insurance.
A wave of insurance company insolvencies in the 1980s sparked a renewed interest in federal insurance regulation, including new legislation for a dual state and federal system of insurance solvency regulation. In response, the National Association of Insurance Commissioners (NAIC) adopted several model reforms for state insurance regulation, including risk-based capital requirements, financial regulation accreditation standards and an initiative to codify accounting principles. As more and more states enacted versions of these model reforms into law, the pressure for federal reform of insurance regulation waned. However, there are still significant differences between states in their systems of insurance regulation, and the cost of compliance with those systems is ultimately borne by insureds in the form of higher premiums. McKinsey & Company estimated in 2009 that the U.S. insurance industry incurs about $13 billion annually in unnecessary regulatory costs under the state-based regulatory system.
The NAIC acts as a forum for the creation of model laws and regulations. Each state decides whether to pass each NAIC model law or regulation, and each state may make changes in the enactment process, but the models are widely, albeit somewhat irregularly, adopted. The NAIC also acts at the national level to advance laws and policies supported by state insurance regulators. NAIC model acts and regulations provide some degree of uniformity between states, but these models do not have the force of law and have no effect unless they are adopted by a state. They are, however, used as guides by most states, and some states adopt them with little or no change.
Federal regulation of insurance
Nevertheless, federal regulation has continued to encroach upon the state regulatory system. The idea of an optional federal charter was first raised after a spate of solvency and capacity issues plagued property and casualty insurers in the 1970s. This OFC concept was to establish an elective federal regulatory scheme that insurers could opt into from the traditional state system, somewhat analogous to the dual-charter regulation of banks. Although the optional federal chartering proposal was defeated in the 1970s, it became the precursor for a modern debate over optional federal chartering in the last decade.
In 1979 and the early 1980s the Federal Trade Commission attempted to regulate the insurance industry, but the Senate Commerce Committee voted unanimously to prohibit the FTC's efforts. President Jimmy Carter attempted to create an "Office of Insurance Analysis" in the Treasury Department, but the idea was abandoned under industry pressure.
Over the past two decades, renewed calls for optional federal regulation of insurance companies have sounded, including the Gramm-Leach-Bliley Act in 1999, the proposed National Insurance Act in 2006 and the Patient Protection and Affordable Care Act ("Obamacare") in 2010.
In 2010, Congress passed the Dodd–Frank Wall Street Reform and Consumer Protection Act which is touted by some as the most sweeping financial regulation overhaul since the Great Depression. The Dodd-Frank Act has significant implications for the insurance industry. Significantly, Title V of created the Federal Insurance Office (FIO) in the Department of the Treasury. The FIO is authorized to monitor all aspects of the insurance industry and identify any gaps in the state-based regulatory system. The Dodd-Frank Act also establishes the Financial Stability Oversight Council (FSOC), which is charged with monitoring the financial services markets, including the insurance industry, to identify potential risks to the financial stability of the United States.
Admitted v. surplus
An important artifact of the state-based insurance regulation system in the United States is the dichotomy between admitted and surplus insurers. Insurers in the U.S. may be "admitted", meaning that they have been formally admitted to a state's insurance market by the state insurance commissioner, and are subject to various state laws governing organization, capitalization, policy forms, and claims handling. Or they may be "surplus", meaning that they are nonadmitted in a particular state but are willing to write coverage there. Surplus line insurers are supposed to underwrite only very unusual or difficult-to-insure risks. Although experienced insurance brokers are well aware of what risks an admitted insurer will not accept, they must document a ritual of actually shopping around a risk to several admitted insurers (who will reject it, of course) before applying for coverage with a surplus line insurer.
To relieve insurers and brokers of that tedious and time-consuming chore, many states (with the notable exception of Texas) now maintain "export lists" of risks that the state insurance commissioner has already identified as having no coverage available whatsoever from any admitted insurer in the state. In turn, brokers presented by clients with those risks can immediately "export" them to the out-of-state surplus market and apply directly to surplus line insurers without having to first document multiple attempts to present the risk to admitted insurers.
By their very nature, export lists illustrate what U.S. insurers consider to be hard-to-insure risks. For example, the California export list includes ambulance services, amusement parks, fireworks displays, moving a building, hot air balloons, product recalls, sawmills and security guards, as well as particular types of insurance like Employment Practices Liability and kidnap and ransom.
Although surplus line insurers are still regulated by the states in which they are actually admitted, the disadvantages of obtaining insurance from a surplus line insurer are that the policy will usually be written on a nonstandard form (that is, not from the Insurance Services Office), and if the insurer collapses, its insureds in states in which it is nonadmitted will not enjoy certain types of protection available to insureds in states in which the insurer is admitted. However, for persons trying to obtain coverage for unusual risks, the choice is usually between a surplus line insurer or no coverage at all.
Only the smallest insurers exist as a single corporation. Most major insurance companies actually exist as insurance groups. That is, they consist of holding companies which own several admitted and surplus insurers (and sometimes a few excess insurers and reinsurers as well). There are dramatic variations from one insurance group to the next in terms of how its various business functions are divided up among its subsidiaries or outsourced to third party corporations altogether. All major insurance groups in the U.S. that transact insurance in California maintain a publicly accessible list on their Web sites of the actual insurer entities within the group, as required by California Insurance Code Section 702.
An example of how insurance groups work is that when people call GEICO and ask for a rate quote, they are actually speaking to GEICO Insurance Agency, which may then write a policy from any one of GEICO's seven insurance companies. When the customer writes their check for the premium to "GEICO", the premium is actually deposited with one of those seven insurance companies (the one that actually wrote their policy). Similarly, any claims against the policy are charged to the issuing company. But as far as most layperson customers know, they are simply dealing with GEICO.
Obviously, it is more difficult to operate an insurance group than a single insurance company, since employees must be painstakingly trained to observe corporate formalities so that courts will not treat the entities in the group as alter egos of each other. For example, all insurance policies and all claim-related documents must consistently reference the relevant company within the group, and the flows of premiums and claim payments must be carefully recorded against the books of the correct company.
The advantage of the insurance group system is that a group has increased survivability over the long run than a single insurance company. If any one company in the group is hit with too many claims and fails, the company can be quietly placed into "runoff" (in which it continues to exist only to process remaining claims and no longer writes new coverage) but the rest of the group continues to operate.
By way of contrast, when small insurers fail, they tend to do so in a rather wild and spectacular fashion, as was often the case during the economic cycles of the 1970s and 1980s. Sometimes the result may be a state-supervised takeover by which a state agency may have to assume part of their residual liabilities.
- Life, Health
- Health (dental, vision, medications,others)
- Life (long-term care, accidental death and dismemberment, hospital indemnity)
- Annuities (securities)
- Life and Annuities
- Property and Casualty (P & C)
- Property (flood, earthquake, home, auto, fire, boiler, title, pet)
- Casualty (errors and omissions, workers' compensation, disability, liability)
Various associations, government agencies, and companies serve the insurance industry in the United States. The National Association of Insurance Commissioners provides models for standard state insurance law, and provides services for its members, which are the state insurance divisions. Many insurance providers use the Insurance Services Office, which produces standard policy forms and rating loss costs and then submits these documents on the behalf of member insurers to the state insurance divisions.
In recent years the operational definition of insurance presented at the beginning of this article proved inadequate as a result of contracts that had the form but not the substance of insurance. The essence of insurance is the transfer of risk from the insured to one or more insurers. How much risk a contract actually transfers proved to be at the heart of the controversy. This issue arose most clearly in reinsurance, where the use of Financial Reinsurance to reengineer insurer balance sheets under US GAAP became fashionable during the 1980s. The accounting profession raised serious concerns about the use of reinsurance in which little if any actual risk was transferred, and went on to address the issue in FAS 113, cited above. While on its face, FAS 113 is limited to accounting for reinsurance transactions, the guidance it contains is generally conceded to be equally applicable to US GAAP accounting for insurance transactions executed by commercial enterprises.
Risk transfer requirement
FAS 113 contains two tests, called the '9a and 9b tests,' that collectively require that a contract create a reasonable chance of a significant loss to the underwriter for it to be considered insurance.
9. Indemnification of the ceding enterprise against loss or liability relating to insurance risk in reinsurance of short-duration contracts requires both of the following, unless the condition in paragraph 11 is met:
a. The reinsurer assumes significant insurance risk under the reinsured portions of the underlying insurance contracts.
b. It is reasonably possible that the reinsurer may realize a significant loss from the transaction.
Paragraph 10 of FAS 113 makes clear that the 9a and 9b tests are based on comparing the present value of all costs to the PV of all income streams. FAS gives no guidance on the choice of a discount rate on which to base such a calculation, other than to say that all outcomes tested should use the same rate.
Statement of Statutory Accounting Principles ("SSAP") 62, issued by the National Association of Insurance Commissioners, applies to so-called 'statutory accounting' – the accounting for insurance enterprises to conform with regulation. Paragraph 12 of SSAP 62 is nearly identical to the FAS 113 test, while paragraph 14, which is otherwise very similar to paragraph 10 of FAS 113, additionally contains a justification for the use of a single fixed rate for discounting purposes. The choice of an "reasonable and appropriate" discount rate is left as a matter of judgment.
No brightline test
Neither FAS 113 nor SAP 62 defines the terms reasonable or significant. Ideally, one would like to be able to substitute values for both terms. It would be much simpler if one could apply a test of an X percent chance of a loss of Y percent or greater. Such tests have been proposed, including one famously attributed to an SEC official who is said to have opined in an after lunch talk that at least a 10 percent chance of at least a 10 percent loss was sufficient to establish both reasonableness and significance. Indeed, many insurers and reinsurers still apply this "10/10" test as a benchmark for risk transfer testing.
An attempt to use any numerical rule such as the 10/10 test will quickly run into problems. Suppose a contract has a 1 percent chance of a 10,000 percent loss? It should be reasonably self-evident that such a contract is insurance, but it fails one half of the 10/10 test.
Excess of loss contracts, like those commonly used for umbrella and general liability insurance, or to insure against property losses, will typically have a low ratio of premium paid to maximum loss recoverable. This ratio (expressed as a percentage), commonly called the "rate on line" for historical reasons related to underwriting practices at Lloyd's of London, will typically be low for contracts that contain reasonably self-evident risk transfer. As the ratio increases to approximate the present value of the limit of coverage, self-evidence decreases and disappears.
Contracts with low rates on line may survive modest features that limit the amount of risk transferred. As rates on line increase, such risk limiting features become increasingly important.
"Safe harbor" exemptions
The analysis of reasonableness and significance is an estimate of the probability of different gain or loss outcomes under different loss scenarios. It takes time and resources to perform the analysis, which constitutes a burden without value where risk transfer is reasonably self-evident.
Guidance exists for insurers and reinsurers, whose CEO's and CFO's attest annually as to the reinsurance agreements their firms undertake. The American Academy of Actuaries, for instance, identifies three categories of contract as outside the requirement of attestation:
- Inactive contracts. If there are no premiums due nor losses payable, and the insurer is not taking any credit for the reinsurance, determining risk transfer is irrelevant.
- Pre-1994 contracts. The attestation requirement only applies to contracts that were entered into, renewed or amended on or after 1 January 1994. Prior contracts need not be analyzed.
- Where risk transfer is "reasonably self-evident."
|“||Risk transfer is reasonably self-evident in most traditional per-risk or per-occurrence excess of loss reinsurance contracts. For these contracts, a predetermined amount of premium is paid and the reinsurer assumes nearly all or all of the potential variability in the underlying losses, and it is evident from reading the basic terms of the contract that the reinsurer can incur a significant loss. In many cases, there is no aggregate limit on the reinsurer's loss. The existence of certain experience-based contract terms, such as experience accounts, profit commissions, and additional premiums, generally reduce the amount of risk transfer and make it less likely that risk transfer is reasonably self-evident.||”|
|— American Academy of Actuaries|
Risk limiting features
An insurance policy should not contain provisions that allow one side or the other to unilaterally void the contract in exchange for benefit. Provisions that void the contract for failure to perform or for fraud or material misrepresentation are ordinary and acceptable.
The policy should have a term of not more than about three years. This is not a hard and fast rule. Contracts of over five years duration are classified as 'long-term,' which can impact the accounting treatment, and can obviously introduce the possibility that over the entire term of the contract, no actual risk will transfer. The coverage provided by the contract need not cease at the end of the term (e.g., the contract can cover occurrences as opposed to claims made or claims paid).
The contract should be considered to include any other agreements, written or oral, that confer rights, create obligations, or create benefits on the part of either or both parties. Ideally, the contract should contain an 'Entire Agreement' clause that assures there are no undisclosed written or oral side agreements that confer rights, create obligations, or create benefits on the part of either or both parties. If such rights, obligations or benefits exist, they must be factored into the tests of reasonableness and significance.
The contract should not contain arbitrary limitations on timing of payments. Provisions that assure both parties of time to properly present and consider claims are acceptable provided they are commercially reasonable and customary.
Provisions that expressly create actual or notional accounts that accrue actual or notional interest suggest that the contract contains, in fact, a deposit.
Provisions for additional or return premium do not, in and of themselves, render a contract something other than insurance. However, it should be unlikely that either a return or additional premium provision be triggered, and neither party should have discretion regarding the timing of such triggering.
All of the events that would give rise to claims under the contract cannot have materialized prior to the inception of the contract. If this "all events" test is not met, then the contract is considered to be a retroactive contract, for which the accounting treatment becomes complex.
Other US insurance topics:
- Health insurance in the United States
- Insurance Regulatory Information System
- McCarran-Ferguson Act
- National Association of Insurance Commissioners
General insurance topics:
Insurance systems in other countries:
U.S. Insurance Companies:
- Federal Insurance Office (2014). Annual Report on the Insurance Industry (PDF). Washington, D.C.: U.S. Department of the Treasury. p. 45.
- Black's Law Dictionary; Sixth Edition; Insurance; p. 802.
- Mayhall, Van, III, Insurance: Defined, Insurance Regulatory Law. Retrieved 2011-06-09.
- Insurance; The History of Insurance, Columbia Electronic Encyclopedia; 6th Ed.
- Insurance Handbook; Insurance Information Institute (2010).
- Company History; The Philadelphia Contributorship.
- Stempel, Jeffery W. (2007). Stemple on Insurance Contracts, Vol. 1, §2.07, 3rd Ed.
- Mayhall, Van, III, The Origins and History of Insurance, Part II: The History of Insurance in America , Insurance Regulatory Law. Retrieved 2011-06-10.
- Insurance Regulation in the United States: Regulatory Federalism and the National Association of Insurance Commissioners; Susan Randall; Florida State University Law Review, Vol. 26:625, 1999
- Stempel, Jeffrey W. (2007). Stemple on Insurance Contracts, Vol. 1, §2.07, 3rd Ed.
- Mayhall, Van, III, A Brief Chronicle of Insurance Regulation in the United States, Part I: From De Facto Judicial Regulation to South-Eastern Underwriters Ass'n, Insurance Regulatory Law. Retrieved 2011-06-09.
- See, for example: Brown, Elizabeth F. (2007). The Fatal Flaw of Proposals to Federalize Insurance Regulation, from the SelectedWorks of Elizabeth F. Brown, Georgia State University.
- United States v. South-Eastern Underwriters Association, 322 U.S. 533 (1944).
- The McCarran–Ferguson Act, 15 U.S.C. §§ 1011-1015.
- The McCarran–Ferguson Act, 15 U.S.C. §§ 1011-1012
- Mayhall, Van, III, A Brief Chronicle of Insurance Regulation in the United States, Part II: From McCarran-Ferguson to Dodd-Frank , Insurance Regulatory Law. Retrieved 2011-06-10.
- Brown, Elizabeth F. (2007). The Fatal Flaw of Proposals to Federalize Insurance Regulation, from the SelectedWorks of Elizabeth F. Brown, Georgia State University.
- Federal Insurance Office (2013). How To Modernize And Improve The System Of Insurance Regulation In The United States. Washington, D.C.: U.S. Department of the Treasury. pp. 5, 63.
- About the National Association of Insurance Commissioners. NAIC. Retrieved 2010-10-18.
- Berrington, Craig (2007). Federal Insurance Regulation Optional Federal Chartering Bills Come to the Big Top: The Substance and Politics of Act II
- Tobias A. (1982). The Invisible Bankers. Linden Press.
- The Dodd-Frank Act, Pub.L 111-203, H.R. 4173
- Insurance Industry Implications of the Dodd-Frank Act; Willkie, Farr & Gallagher, LLP; A Decent Start, Financial Reform in America, The Economist, July 2010.
- The Surplus Line Association of California, California Department of Insurance Export List (8 January 2013).
- "Reinsurance Attestation Supplement 20-1: Risk Transfer Testing Practice Note" November 2005