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Regulation of Insurance

Although some federal regulations affect insurance directly, such as the Fair Credit Reporting Act and a few programs that make coverage for catastrophic losses available, such as FEMA's (Federal Emergency Management Agency) National Flood Insurance Program, insurance is regulated primarily at the state level.

State Insurance Regulation

Insurance is closely regulated for the good of the insurance industry and the general public. Each state has its own laws and regulations to regulate the insurance business conducted within its boundaries.

Each state has an insurance department headed by an official charged with the responsibility for controlling insurance matters within that state. These officials are called directors, superintendents, or commissioners of insurance, depending on the state where they hold office, but they all perform similar duties. The term "commissioner" applies in most states.

Collectively, the commissioners of all states form a body known as the National Association of Insurance Commissioners (NAIC), which meets at regular intervals to exchange information and provide coordination of the regulatory measures of each state. Through its recommendations, much of the nation's insurance laws take shape. Although nonbinding on individual states, the NAIC's recommendations are generally followed.

Regulation of Companies

State regulation of insurance companies affects numerous aspects of their formation and operations, ranging from capital and surplus requirements to investment and marketing practices. State laws require the reporting of financial data and payment of premium taxes, and specifically prohibit a number of unfair or deceptive practices.

Admitted and Nonadmitted Companies

One of the duties of an insurance department is to determine which insurance companies will be allowed to do business in the state. A company that meets the insurance department's standards and is authorized to do business in a state is called an admitted or authorized insurer. An insurance company that is not authorized to do business in a state is a nonadmitted or unauthorized insurer. A nonadmitted insurer can only do business in the state under special circumstances.

Domestic, Foreign, and Alien Companies

Although a company can conduct business in several states, it is formed and incorporated in only one state. Within its home state, an insurance company is known as a domestic company. Within states other than the state in which it is incorporated, an insurance company is a foreign company. A company that is incorporated in a country other than the United States, but doing business in the states, is known as an alien company.


In many areas, state laws specifically differentiate between domestic companies and foreign and alien companies. Many of these differences focus on financial and reporting requirements as well as provisions for resolving legal disputes. These requirements are designed to protect the public. Although foreign and alien companies are permitted to do business within a state, special regulatory provisions that do not apply to domestic companies are necessary because the insurers are based outside of the state's jurisdiction.

Financial Regulation

In addition to examining and authorizing companies to conduct business within the state, the state insurance department keeps close watch over the financial health of all companies doing business within its boundaries.

Various regulations are designed to preserve insurance company solvency, to detect financial problems, and to protect insureds in the event that insolvency occurs. State laws impose capital and surplus requirements on insurers, require the preparation of annual financial statements, and require periodic examinations of insurers. These laws establish initial financial requirements and help in the early detection of financial problems. If an insurer falls into a hazardous financial condition, the insurance department attempts to rehabilitate the company. If an insurer becomes insolvent, the insurance department will handle the liquidation.

In many states, the public is also protected by one or more insurance guaranty associations that provide funds for payment of unpaid claims when an insurer becomes insolvent.

Company Ratings

There are several organizations that rate the financial strength of insurance carriers, based on an analysis of a company's claims experience, investment performance, management, and other factors. These organizations include A.M. Best, Standard & Poor, and Moody's. These ratings are one of the most widely used indicators of financial health (or the lack of it) in the insurance industry.

Regulation of Agents

Many insurance regulations are directed toward governing the qualification and behavior of insurance agents. As the primary source of contact between insurance companies and members of the general public, it is important that agents be properly educated and act in an ethical and professional manner.


The state insurance department devotes much of its time to working with insurance agents. One of its most important duties with regard to agents is licensing. It is illegal for someone to sell insurance without first obtaining a license from the state to do so.

To make sure that agents will be prepared to undertake their substantial responsibilities, each state requires its agents to pass a licensing exam to receive a license. This exam is administered by the state insurance department.

An agent may only offer insurance in the states where he or she holds the proper license. For example, an agent who is licensed to sell insurance only in his or her resident state of Indiana could not provide insurance on an Indiana customer's lake home located in Michigan. However, the Indiana agent could obtain a nonresident agent license from Michigan, and in that case he or she could sell coverage on property located in that other state.

Codes Regulating Agents

In addition to licensing, the state is responsible for the way agents conduct business within the state. State insurance codes are very specific about the standards agents must meet.

A fiduciary is a person who stands in a special relationship of trust to another person. Agents have fiduciary duties toward their clients, especially regarding the handling of premiums.

Agents cannot misrepresent or falsely advertise the terms or benefits of a policy or the financial condition of the company. Agents must make complete, accurate statements about the product being sold.

Twisting is a form of misrepresentation in which the agent convinces the client to cancel already existing insurance and buy another policy from the agent, to the detriment of the insured. Twisting is illegal.

Rebating is giving or offering some benefit other than those specified in the policy—such as cash, gifts, or securities—to induce a customer to buy insurance. For example, an agent might kick back part of a commission to the customer, thus lowering the price of the insurance in return for the business. Rebating is illegal in all but two states.

Agents can be in violation of the law if they unfairly discriminate against insured people. This means that an insured cannot be given a lower or higher rate than another insured in identical circumstances. It also means that the agent cannot accept a bribe from a client to provide insurance or lower the premium.

Form and Rate Filings

Another important function performed by state insurance departments is approval, or ratification, of the policy forms, endorsements, and rates used by companies doing business in their states. Rates are the basic charges an insurance company sets for various types of insurance.

In some states, called prior approval states, the insurance company must obtain official approval before using new forms and rates.

In file and use states, a company can begin using forms and rates as soon as they have been filed. The state eventually reviews the filing and officially accepts or rejects it. With use and file states, insurers must file rates and forms within a certain period of time after they are first used.

In open competition states, the state allows the companies to compete openly with the forms and rates they select, subject only to requirements of adequacy and nondiscrimination.

In some states, for some lines of insurance, the use of unique state forms or rates can be mandatory for any company doing business in the state.

Rating Organizations

Some states establish their own rates for certain types of insurance and require all companies to use these mandatory rates. For most types of insurance, however, the company must establish the rates and submit them to the state.

Rate-making involves collecting extensive and accurate financial, operational, premium, and loss records. To assist the insurance company in collecting these statistics, certain central service bureaus have been established. These organizations—made up of numerous individual insurance companies—gather, pool, and analyze statistics from all the member companies. The bureau then establishes loss costs based on these combined figures and files them with individual states. Loss costs represent the key component of an insurance rate—how much an insurance company needs to collect to cover expected losses.

Member companies can use these loss costs combined with factors covering their own expenses and profit margins to establish finished rates. Companies must file rates with the state but can do this by referencing the service bureau's loss costs and filing their own individual factors reflecting expenses and profit. Some companies do not belong to a service organization and collect their own statistics and file independently.

Companies that use bureau filings sometimes deviate from the published rates by charging something either higher or lower than the recommended rate. Deviations are usually permitted within a specified range, provided that the insurer is consistent in applying the same deviation to all similar risks.

One of the largest services bureaus is the Insurance Services Office, commonly referred to as ISO, which files both loss costs and standardized forms on behalf of its member companies. The National Council on Compensation Insurance, Inc. (NCCI) is a rating bureau that has jurisdiction over the workers compensation field. The Surety Association Of America functions as a rating bureau for surety bonds. There are numerous other rating bureaus.


An important area of regulatory responsibility for the state insurance departments is enforcement of the many laws and rules that apply to the conduct of the companies, agents, and types of insurance transacted within the state. The department is responsible for seeing that the insurance business within its jurisdiction operates in compliance with these codes and standards. Reported violations must be investigated, and appropriate penalties assessed. Violations can result in fines, license suspension or revocation, suspension or revocation of a company's authority to do business in the state, and, in some cases, imprisonment.

Federal Regulation

Although most insurance operations are regulated by the states, there are some areas where the federal government has exercised its regulatory authority. For example, federal law imposes penalties for fraud and false statements made in connection with insurance transactions. Anyone engaged in the insurance business who makes a false material statement or report or willfully and materially overvalues any land, property, or security in connection with financial reports or documents presented to an insurance regulatory official or agency for the purpose of influencing their actions can be subject to punishment. Any insurance officer, director, or agent who willfully embezzles, abstracts, purloins, or misappropriates any of the moneys, funds, premiums, credits, or other property of an insurer can be punished accordingly. Punishments can consist of substantial fines and/or periods of imprisonment for up to 10 years.

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