Martin Sheffield reports on the latest on the US deregulation front.
The nationwide push for commercial lines deregulation has intensified during 1999 as more states have approved or proposed legislation to relax or eliminate rate and form filing requirements for certain sophisticated or large policyholders.
Deregulation is intended to remove unnecessary or ineffective regulation from transactions that are deemed to be self-regulated. However, complications in defining, implementing, standardising and protecting this level of freedom have fuelled opposition.
New Hampshire, in August 1998, became the first state to approve commercial lines deregulation. As of September 1999, legislation had been passed in 20 states and was pending in two additional states. Three states - Connecticut, North Dakota and Texas - have defeated deregulation legislation.
The National Association of Insurance Commissioners initially considered deregulating commercial lines insurance four years ago, largely in response to the exodus of large commercial risks from the admitted US markets in favour of offshore, self-insurance or other alternative markets. Deregulation proponents believe the burdensome regulatory environment and excessive costs associated with commercial insurance were partly responsible for driving these risks from the traditional US markets.
The NAIC's 1997 “White Paper on Regulatory Re-engineering of Commercial Lines Insurance” estimated that complying with rate and form filing requirements added $1 billion to industry budgets and $40 million to $55 million to state budgets annually. In addition to regulatory constraints, another force encouraging commercial policyholders to procure coverage through alternative means was a lack of capacity from admitted carriers. As a result, premium rates for certain risks became too costly to place onshore with traditional carriers.
The exempt commercial policyholder
For insureds to engage in a deregulated insurance transaction, they need to meet the definition of a large commercial buyer, which varies by state. The NAIC, in its 1997 White Paper, proposed the establishment of a new class of sophisticated commercial insureds. Such insureds, referred to as exempt commercial policyholders (ECPs), would be exempt from rate and form filing requirements if any two of the following requirements are met:• Having a net worth of more than $50 million.
• Having net revenues/sales of more than $100 million.
• Employing more than 500 people, or having 1,000 employees per holding company aggregate.
• Employing or retaining a risk manager.
• Having aggregate premiums of over $500,000.
• Being a nonprofit or public entity with an annual budget or assets of at least $45 million.
• Being a municipality with a population over 50,000.
Support for deregulation is strong throughout the property/casualty insurance industry, particularly among multi-line commercial carriers. State insurance regulators also favour deregulation efforts. However, some market participants - namely, the excess and surplus lines community - are less enthusiastic, particularly since E&S carriers believe their market segments are not being included in many deregulation efforts.
The property/casualty industry contends that deregulation is needed to enable commercial lines insurers to respond efficiently to their customers' ever-changing needs. Deregulation is considered crucial to maintaining a level playing field with banks and securities firms if Depression-era regulations keeping banks out of most insurance activities are eventually repealed.
The excess and surplus lines writers, however, contend that an efficient, deregulated national market already exists through non-admitted mechanisms. The E&S companies are concerned about increased competition from admitted carriers that compete for a limited number of business risks.
The surplus lines community also is concerned that commercial deregulation will lead to a regulatory backlash if a third exempt admitted market is created to join the existing admitted and non-admitted markets. Non-admitted carriers - specifically, companies that operate exclusively on a surplus lines basis - are concerned that easier access to surplus markets in the current environment of cheap reinsurance and soft pricing will significantly diminish available risks. The fear is that premium-starved admitted markets will begin writing risks that traditionally have been placed in the surplus lines markets.
Many state regulators - New York, in particular - view deregulation as an opportunity to better use limited regulatory resources. Some regulators acknowledge that they add minimal value to insurance transactions between sophisticated commercial policyholders - which have vast risk management resources - and their insurance carriers. In fact, regulation hinders their ability to procure specialised coverage as the unique forms and related rates wait to be approved. Products designed to meet the specialized needs of customers are slowed - or, worse, derailed - by the regulatory approval process.
By supporting a deregulated environment, regulators also hope to improve their oversight of smaller, less sophisticated commercial insureds and individuals. They also hope to improve their oversight of market-conduct issues and make their triennial exams more efficient and effective.
States with deregulation in place
With the exception of New Hampshire, which mirrors the NAIC's White Paper, guidelines established or targeted by individual states vary. The varying guidelines suggest that states are approaching deregulation in a manner that will best meet their own needs.
Total annual premium dollars spent by an insured has surfaced as a decisive attribute in defining a large commercial policyholder. Premium thresholds among states vary and range from a zero threshold as proposed in New York to New Hampshire's more stringent level of $500,000.
States have been creative in pursuing commercial lines deregulation, as evidenced by Georgia's two-tiered system, which establishes an annual premium threshold of $100,000 for in-state operations and $500,000 for multi-state locations. Georgia's commercial lines legislation took effect in January 1999. Some states established varying premium levels for different lines of business. For example, Kansas approved a $50,000 minimum for property or general liability policies, but enacted a minimum limit of $100,000 for multiple line policies.
A.M. Best's perspective
How companies prepare to take advantage of the opportunity and the impact a deregulated market will have on already depressed commercial prices - and, ultimately, balance-sheet strength - will be of primary importance from a rating perspective.
Excess and surplus writers that have much of their business allocated to large risks are most susceptible to losing market share, especially if they remain precluded from bidding on admitted risks. Large E&S accounts are seen as ripe candidates for standard carriers in a deregulated environment. Of concern is that standard companies that lack specialised underwriting skills could begin writing risks they normally would not accept in the current regulated environment. This becomes more problematic, considering the lower minimum capital requirements of traditional standard companies relative to the E&S writers.
The different state requirements and the lack of uniformity regarding exempt commercial policyholders concern A.M. Best. Specifically, A.M. Best is concerned too much emphasis is being placed on premium size in determining a sophisticated buyer. Different premium thresholds are tied to varied exempt market sizes in different states, which could be a function of local market conditions, not sophistication.
Lack of uniform qualification requirements - especially regarding premium thresholds - raise additional issues for insureds that maintain multi-state operations. Additionally, administration and oversight of these risks may be more complicated for regulators, leaving companies vulnerable to ex-post regulation. Policyholders operating in multiple states could be subject to varying regulations, based on individual state thresholds. Under this scenario, it is unclear which state's regulations would be in effect. The handling of audit premiums and deductible levels also needs to be addressed.
A.M. Best is encouraged by deregulatory initiatives designed to promote a healthy, efficient market. The flexibility these initiatives are intended to provide to insurers - which, consequently benefits policyholders - is viewed positively. However, A.M. Best does not believe this movement should overly disadvantage any of the current markets and encourages legislation that fairly addresses all affected parties.
Martin Sheffield is vice president of the property/casualty division at A.M. Best Co., the Oldwick, N.J.-based insurance rating and information company.