Why is U.S. Insurance Regulated by the States? Why Should You Care?

The United States has always had a state-based insurance regulatory system. This means that every insurance company wishing to sell insurance in the U.S. must satisfy the different rules of EACH and EVERY state in which it would like to sell policies. As you can imagine, this causes a lot of extra expense and headaches, both for state governments and the insurers. Following more than 50 different regulatory schemes (don’t forget the territories) seems increasingly more ridiculous as the rest of the economic world gets smaller due to cheaper travel, deregulation of industries, and large migrating populations.

What is particularly shocking about state-based regulation is how much it costs in comparison to the systems in other countries – A U.S.-based insurer spends 6.8 TIMES MORE (per premium dollar) on operations than a U.K.-based insurer. U.S. life insurers pay an extra $5.7 billion annually, and U.S. property and casualty (P/C) insurers spend an extra $7.2 billion. I don’t need to tell you this adds up to a LOT of money, even after you average it across the industry.

Why Hasn’t Regulation Been Streamlined? Because that Would Cut into Profits.

With our state-based system causing such exorbitant excess costs, why don’t we see insurance companies pushing to have all regulation shifted to one uniform body, such as the federal government? Inexplicably, despite paying 6.8 times more for operations than their U.K. counterparts, American insurers still assert that the state-by-state regulation is better. They cite long lists of reasons, from the vague “we’ve always done it this way and it works” (works for WHOM?) to “insurance is local in nature and does not lend itself to uniform national regulation,” to “states are better positioned to respond to consumer complaints” (haven’t seen that, myself, and California is notoriously consumer-friendly). They even claim that states already have “mechanisms to achieve uniformity” (despite that they absolutely DON’T achieve any noticeable uniformity – and I know, I’ve researched each state) and that a “state-based system provides better opportunities for experimentation with ideas” (again, for WHOM? and to whose benefit?).

Their laundry list of grasping ideas leads me to believe the REAL motivation is simple – insurers believe they make more money under state regulation. Insurance companies are profit-motivated corporations like every other, so the bottom line is always profitability. This tells me that despite having costs 6.8 times higher than in the U.K., American insurance companies are recouping that money and MORE because state regulations are weak, lack uniformity, and are hardly enforced. In other words, insurers make so much money off of unprotected consumers that they prefer the state system.

The Federal Insurance Office:  A Step Toward Uniformity

Enter the FIO. After the financial crisis in 2008, when AIG demonstrated that insurers are not only VERY global in reach but also have the ability to bring down our entire economy (see the arguments about insurers and “systemic importance”), Congress passed the Dodd-Frank Act to reform Wall Street and increase consumer protections. In 2010, Dodd-Frank established the first federal regulatory body with the power to regulate the insurance industry – the Federal Insurance office. Given that insurers hold half of all U.S. bank held-assets, the complete lack of federal oversight over insurance companies until 2010 was more than a little frightening. Even the most adamant free market capitalist will begrudgingly admit that some uniform and effective regulation is necessary to keep the markets healthy.

Goodbye, Bad Behavior?

In case you haven’t been on the receiving end of an insurance company’s unfair claims handling procedures yet, let me point out an interesting and little-known fact. Insurance is the only industry which has given rise to a legal specialization dedicated solely to fighting the extreme bad behaviors of JUST THAT industry. Insurance company behavior has been so bad, for such a long time, that an entire field of law emerged in response: insurance bad faith. I truly hope that the FIO will be able to put a stop to most of the bad faith of insurers, for the benefit of us all.