UCONN 3620 FOUNDATIONS OF
ACTUARIAL SCIENCE EXAM 2
QUESTIONS AND VERIFIED
ANSWERS|100% CORRECT|GRADE A+
Why is insurance regulated? - ANSWER Maintain insurer solvency, compensate for inadequate consumer
knowledge (not too complicated language), ensure reasonable rates (fair premiums), make insurance
available (help spread cost across society).
History of Regulation:
1. Commerce Clause of US Constitution
2. Paul v Virginia - Supreme Court
3. US v South-Eastern Underwriters - Supreme Court
4. McCarran-Ferguson Act - ANSWER 1. Commerce Clause of US Constitution: federal government has
authority to regulate interstate commerce (everything else left to states), powers not explicitly given to
the federal government are reserved for the states. Initially few regulatory controls and insurance was
generally conducted locally, state legislators granted charters to new insurers; first insurance
commissions created in 1851 (New Hampshire)
2. Paul V Virginia (1868): Supreme Court ruled insurance was not interstate commerce, and that the
states (not federal government) had right to regulate the insurance. Development of rating bureaus in
1870s, set rates to be charged by companies, response to many companies insolvencies arising out of
Boston and Chicago fires. Story: Paul sold insurance in VA, told needed license in VA, he said no, he did
have to pay for the license bc supreme court said to.
3. US V South-Eastern Underwriters (1944): The court ruled that insurance was interstate commerce
when conducted across state lines and was subject to federal antitrust laws. Ruling led to considerable
uncertainty about allowable practices and the role of state regulation.
4. McCarran-Ferguson Act (1945): states that continued regulation and taxation of the insurance industry
by the states are in public interest. Federal antitrust laws apply to insurance only to the extent that the
insurance industry is not regulated by state law. Stated that insurance is commerce, however
insurers/rating bureaus are exempt from federal antitrust laws, provided activities are subject to state
law, and do not involve boycott, coercion, or intimidation. Response of many states: formal codification
of regulation, encouraged insurers to use rating bureaus, prior approval rate regulation.
,Federal government could regulate insurance, but won't as long as states are doing their jo
National Association of Insurance Commissioners (NAIC) - ANSWER voluntary participation by state
insurance departments. goal is to encourage greater uniformity, cooperation, coordination of laws and
regulations. model laws and regulations.
8 Areas are Regulated by the States - ANSWER Finally Some Real Policy Sales Totally Rad Cool
1. Formation & Licensing of Insurers: licensing includes minimum capital and surplus requirements. a
domestic insurer is domiciled in the state. a foreign insurer is an out-of-state insurer that is chartered by
another state, but licensed to operate in the state. an alien insurer is an insurer that is chartered by a
foreign country, but is licensed to operate in the state.
2. Solvency - Reserves, Surplus, Risk Based Capital: must be around to pay claims. Assets must be
sufficient to offset liabilities. Admitted assets are assets that an insurer can show on its statutory balance
sheet in determining its financial condition. States have regulations that address the calculation of
reserves. An insurer's surplus position is carefully monitored by state regulators. Life and health insurers
must meet certain risk-based capital (RBC) standards, Insurers must hold a certain amount of capital,
depending on the riskiness of their investments and insurance operations. The purpose of investment
regulations is to prevent insurers from making unsound investments that could threaten the company's
solvency and harm the policy owners. Laws generally place a limit on the proportion of assets in a
specific asset category, such as real estate. Many states limit the amount of surplus a participating life
insurer can accumulate, rather than pay as dividends. Each insurer must file an annual report with the
state insurance department in the states where it does business. The state insurance department
assumes control of insurance companies that they determine to be financially impaired, all states have
guaranty funds, guaranty laws and guaranty associations that pay the claims of policy owners of
insolvent insurers, the assessment method is the major method used to raise the necessary funds
State versus Federal Regulation (Pros and Cons) - ANSWER Arguments for Federal Regulation: would
provide uniformity in state regulations, more effective for international insurance agreements, more
effective in the handling systemic risk, would enable insurers to become more efficient, cost savings with
one regulator versus 50 states,
Shortcomings of State Regulation: inconsistency across states, weak regulation in one state can hurt
people and insurers in other states, some states get a "free ride" on other states, inadequate protection
of consumers, inadequate market conduct examinations, insurance availability
, Arguments for State Regulation: more responsive to local insurance needs, federal regulation could lead
to a dual system of regulation and increase costs, poor quality of federal regulation, e.g., in the banking
industry, reasonable uniformity of laws can be achieved by the model laws of the NAIC, facilitates
experimentation and innovation
Unknown Consequences of Federal Regulation: already understand state regulation, political impacts?
Market Conduct Regulation - ANSWER Refers to the various interactions an insurance company has with
its customers whether they be consumers, customers or claimants.
Practices include: Sales of insurance policies, advertising of insurance products, underwriting and rating,
collection of premiums, Policy renewals, termination, and changes, Claims settlement.
Regulators are concerned that certain industry practices may have an adverse effect on policyholders,
beneficiaries, claimants and insurance consumers.
Concerns include: Sale of unsuitable insurance products, misrepresentation of coverage, excessive sales
pressure, rates that are excessive or unfairly discriminatory, denial of legitimate claims, improper
termination of policies.
What are rating agencies? - ANSWER Develop criteria upon which to base ratings, collect information
and meet with company management. Private company assessing financial strength of insurance
companies.
Risk Based Capital - Purpose, Definition, Calculation & Interpretation - ANSWER Purpose: insolvency risk
is reduced by insurer capital, capital provides a cushion to loss volatility, greater capital reduces the
likelihood of insolvency (all else equal). (Two key objectives: 1. RBC formula quantifies a "minimum" (or
benchmark) level of surplus reflective of an insurance company's risks, and which is compared to actual
surplus 2. Series of actions required of the company and regulators based on ratio of surplus to the RBC
calculated surplus). Other benefits: Provides a safety net for insurers (to allow for regulatory actions
before insolvency). Uniform among the states.
Definition: A certain amount of capital that insurance companies must have on hand in order to hedge
against their risks.
