Experts Explain Risk Management and Insurance
Through Emerging Issues
By Shawntaye Hopkins and Lisa McKinney, CSG communications associates
To many people, insurance legislation and regulation may not seem like the most interesting topics, said David T. Russell, a professor of insurance and finance at California State University Northridge, at the start of a recent eCademy webcast.
“On the other hand…this is an area that covers virtually every area of financial services and risk management for consumers and businesses,” Russell said. “And this is something state governments, since insurance is regulated at the state level, need to be aware of.”
The eCademy webcast titled, “Risk Management Insurance Fundamentals: Insurance Regulation and Legislation,” was one of four sessions in a webcast series presented by The Council of State Governments in collaboration with The Griffith Insurance Education Foundation.
All the eCademy sessions were designed to help state leaders better understand risk management and insurance in order to make policy decisions. The first session provided an overview of the impact of insurance policy. The second session focused on how catastrophes affect the property and casualty insurance industry. Presenters in the third session explained life and health insurance and, in the final webcast, Russell delved into legislation and regulation.
The eCademy webcast sessions are available in the CSG Knowledge Center; below are highlights from each.
Risk Management and Insurance Fundamentals
Well-functioning insurance markets are a critical component of a strong economy, according to Kevin Shaver, professor of economics at the University of Pittsburgh.
“If you look at the development of economies over time, innovation in insurance has been critical to their performance,” said Shaver.
Insurance is a contract that transfers the financial consequences of a potential loss from the insured to an insurance company. The benefits of insurance to the insured include paying for covered losses, reducing uncertainty and making planning easier, and encouraging efficient use of resources. Insurance also benefits business and society by supporting access to and availability of credit, providing sources of investment funds and reducing social burdens.
For example, when an individual applies for a home loan, banks require a homeowner’s insurance policy for the loan to go through. They are protecting their collateral in event of a situation, such as a house fire, that prevents the individual from repaying their loan in full, said Shaver.
“If we didn’t have insurance to protect the bank’s interest, it would be much harder to get home loans and credit would not flow as freely,” he said.
Insurance markets differ from traditional markets, in part because the product that is being sold is very different. The complexity involved in pricing insurance is part of what makes regulation of the industry necessary, Shaver said.
“When left to their own devices, insurance markets often don’t ensure efficient outcomes like other markets do,” he said.
When McDonald’s sells a hamburger, the cost of producing and serving that hamburger is known to the company and doesn’t depend on the customer. The restaurant has a lot of information about the expenses they will have on the front end and that helps them make better business decisions. That is not the case with insurers, said Shaver. The consumers to whom an insurer sells policies are critical in determining the cost of their business.
The company doesn’t know what the cost of insuring any individual will be because they are protecting people from potential incidents, Shaver added.
Consumer protection through regulating insurance policies and products, preventing unfair trade practices, and ensuring insurance is available and affordable are some of the regulatory issues policymakers have to contend with. In addition, for the market to work, they have to help ensure and insurer’s ability to pay claims and safeguard insurer-held funds.
Insurance Coverage—Property and Casualty
“The reason we purchase property and casualty insurance is so that we are able to innovate in society,” said David Pooser, assistant professor of risk management and insurance at St. John’s University, in the second webcast of the series. “Homeowners feel more confident about buying nicer homes, individuals are confident about driving to work every day (and) driving their families around because they know they have coverage if there is some kind of accident or loss. Businesses are willing to innovate and build new warehouses and manufacturing centers; businesses are willing to open themselves to the public and risk liability, risk property loss and business interruption.”
While many losses from catastrophes such as natural disasters and terrorism are borne by individuals and government, property and casualty insurance companies pay for a large portion.
After major catastrophe events, insurance companies will often either stop offering catastrophe insurance or drop out of particularly risky markets with high incidents of natural disasters, Pooser said.
“Florida is the clearest example,” he said. “Insurance companies just don’t want to write insurance there anymore. They see that potential costs of covering these catastrophes far outweigh any benefits that they make from writing insurance there.”
After Hurricane Andrew, a lot of insurance companies operating in Florida, Louisiana and Mississippi went bankrupt. The state of Florida has responded by providing state reinsurance protection at a reduced rate to insurance companies. Reinsurance, also known as insurance for insurers, transfers part of insurers’ risk to another party, the reinsurer, through an agreement that reduces the likelihood of having to pay an unmanageable amount on an insurance claim. Reinsurers have been instrumental in providing funding for major catastrophic events, including Hurricane Andrew, Hurricane Katrina and the 9/11 terrorist attacks.
Life and Health Insurance
In the next few decades, the population of people age 65 and older will increase from about 14 percent to 20 percent, said James Carson, an insurance professor at the University of Georgia, in the third webcast of the series. This population growth results in a number of challenges and issues, including funding programs such as Social Security and Medicare, and planning for death as it pertains to life insurance.
“As a country, we’re probably vastly underinsured,” Carson said. “Not that everybody needs life insurance but, of the people who do need life insurance, most studies would suggest that people are woefully underinsured.”
Term life insurance provides coverage for a specified period, is renewable, has no cash value—although it can be converted into a cash value policy—and is paid to a beneficiary.
Whole life insurance gets its name “from the idea that once you buy it you would literally hold this policy forever—so for as long as you live, for your whole life,” Carson said. Level premiums allow for a cash value, and it is possible to access money as a loan from the policy.
Universal life insurance came about because of the savings component of the whole life insurance policy.
“It was rather difficult for consumers to know or see the rate of return within their whole life policy,” Carson said.
Universal life insurance separates “where every penny of our premium goes within the life insurance policy,” he said. It is, therefore, more transparent.
“My perspective is that all three are good,” Carson said. “I wouldn’t recommend against any of those, but you really do have to shop around—or should shop around—and find a company that has a good track record of being competitive in terms or price and financial strength.”
In discussing health insurance, Carson said the vast majority of people in the United States get their health insurance through group plans.
“One of the reasons for that is our tax code,” he said. “Just like salaries are a deductible expense for companies, so are employer contributions for employee health insurance.”
But unlike salaries, group health insurance is not taxed at the individual level by the federal or state income tax. The Affordable Care Act’s “Cadillac” tax would impose a tax on some group benefits.
Insurance Regulation and Legislation
David T. Russell, the professor of insurance and finance at California State University Northridge, described the role of the National Association of Insurance Commissioners and insurance regulators. He noted that insurance companies have to comply with the regulations of 51 different jurisdictions.
“To keep insurance regulation fairly uniform, there is a governing body that gathers all insurance commissioners together called the NAIC—the National Association of Insurance Commissioners,” Russell said. “This gives each state the ability to take nuggets and knowledge from all of the other states and bring it back to their own state so that they don’t have to reinvent the wheel every time something needs to be done.”
Although it drafts model laws and regulations, NAIC does not make laws. States regulate insurer formation, financing, investment and taxation as well as insurance rates, producer licensing, and marketing and claims practices. Insurance regulators are given authority by state law and are responsible for enforcing the laws passed by legislators.
If there is a problem with a claims settlement, regulators can help make sure there are no unnecessary delays, that the policy provisions are clear, that the settlements are fair, not artificially low, and that everything is properly explained.
“Most claims people … want to pay no more and no less than what they owe,” Russell said. “However, it’s very helpful for consumers to have the regulatory, shall I say, threat to make sure things are paid quickly, fairly, and in full so that the consumer can feel good about the insurance mechanism and the insurance market is operating the way all of us expect it to.”
In addition, state governments provide or operate insurance programs for public policy reasons, Russell said.
“In addition to regulating the business of insurance, state legislatures have authorized the creation of state insurance programs,” he said. “These are programs that offer risk transfer mechanisms that, for public policy reasons, the legislature wants it to be available. Perhaps it’s not being provided by the private market or the private market needs competition that is not currently supplied.”
To view all four eCademy webcast sessions in entirety, visit the CSG Knowledge Center.