Insurance Regulation: Preliminary Views on States' Oversight of Insurers' Market Behavior
Published: 2003-05-06T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: This testimony provides information on two important tools state insurance regulators use to oversee the market activities of insurance companies--market analysis and market conduct examinations. Market analysis is generallly done in the state insurance departments. It consists of gathering and integrating information about insurance companies' operations in order to monitor market behavior and identify potential problems at an early stage. Market conduct examinations, which are generally done on site, are a review of an insurer's marketplace practices. The examination is an opportunity to verify data provided to the department by the insurer and to confirm that companies' internal controls and operational processes result in compliance with state laws and regulations. Specifically, this testimony focuses on (1) the states' use of market analysis and examinations in market regulation, and (2) the effectiveness of the National Association of Insurance Commissioners' (NAIC) efforts to improve these oversight tools and encourage the states to use them.
section_title: What GAO Found
paragraphs: We found that while all states do some level of market analysis, few states have established formal market analysis programs to maintain a systematic and rigorous overview of companies' market behavior and to more effectively identify problem companies for more detailed review. The way state insurance regulators approach and perform market conduct examinations also varied widely across the states. While NAIC has developed a handbook for market conduct examiners, states are not required to use it, and we found that it is not consistently applied across states. Moreover, the handbook is not intended to provide guidance for some important aspects of market conduct examinations--for example, how often examinations should be performed or what criteria states should use to select companies to examine. We also found that the number of market conduct examiners differed widely among states and that there were no generally accepted standards for training and certifying examiners. These differences make it difficult for states to depend on other states' oversight of market activities. Most of the states that we visited told us that they felt responsible for regulating the behavior of all companies that sold insurance in their state. With anywhere from 900 to 2,000 companies operating within each state, the pool of companies is simply too large for any one insurance department to handle. Attempts to do so are neither efficient nor effective. Moreover, since many states do not coordinate their examinations with other states, some large multistate insurance companies reported being examined by multiple states, while other companies were examined infrequently or never. We also found that since the mid 1970s, NAIC has taken a variety of steps to improve the consistency and quality of market conduct examinations. However, despite the NAIC's long-standing efforts and some limited successes, progress toward a more effective process has been slow. Recently, NAIC has increased the emphasis it places on market analysis and market conduct examinations as regulatory tools that could improve states' ability to oversee market conduct. With more consistent implementation of routine market analysis, states should be better able to use the resources they already have available to target companies requiring immediate attention. Also, by consistently applying common standards for market conduct examinations, states should be able to rely on regulators in other states for assessments of an insurance company's operations. These improvements should in turn increase the efficiency of the examination process and improve consumer protection by reducing existing overlaps and gaps in regulatory oversight. However, if NAIC cannot convince the various states to adopt and implement common standards for market analysis and examinations, current efforts to strengthen these consumer protection tools are unlikely to result in any fundamental improvement. While we focus on the states' use of market analysis and market conduct examinations, market regulation includes several other important regulatory tools, including complaint handling and investigation, policy rate and form review, agent and company licensing, and consumer education. Most states have functioning programs addressing each of these four regulatory areas. Ideally, all regulatory tools, including market analysis and market conduct examinations, should work together in an integrated and interrelated way.

section_title: Letter
paragraphs: I appreciate the opportunity to provide you with preliminary observations  from our work on state insurance regulators’ oversight of market activities  in the insurance industry. As you know, Chairman Oxley requested that we  review the market conduct activities of state insurance regulators. We are  nearing completion of this work, and we plan to issue a report on this  subject in the near future.
As you requested, this testimony provides information on two important  tools state insurance regulators use to oversee the market activities of  insurance companies—market analysis and market conduct examinations.  Market analysis is generally done in the state insurance departments. It  consists of gathering and integrating information about insurance  companies’ operations in order to monitor market behavior and identify  potential problems at an early stage. Market conduct examinations, which  are generally done on site, are a review of an insurer’s marketplace  practices. The examination is an opportunity to verify data provided to the  department by the insurer and to confirm that companies’ internal  controls and operational processes result in compliance with state laws  and regulations. My focus today is on (1) the states’ use of market analysis  and examinations in market regulation, and (2) the effectiveness of the  National Association of Insurance Commissioners’ (NAIC) efforts to  improve these oversight tools and encourage the states to use them.
To address these objectives, we collected data and interviewed officials  from nine state insurance departments—Arkansas, California, Indiana,  Maryland, Michigan, Missouri, New Mexico, Ohio, and Oregon, and at  NAIC’s Kansas City Headquarters. We also reviewed NAIC’s past and  current efforts to improve the market regulation program. We collected  and analyzed data from NAIC on all states, including the number of  licensed companies in each state, the number and types of examinations  conducted, and the resources allocated to these activities. We also asked  40 companies, 20 each from among the largest 300 property and casualty  firms (based on direct written premiums) and the largest 300 life  companies (based on asset size) about their market conduct examination  experiences between 1999 and 2001. Most of these companies are national  companies, selling in most or all of the states. However, because our  sample was not statistically valid, our results cannot be projected to all  insurers.
In summary, we found that while all states do some level of market  analysis, few states have established formal market analysis programs to  maintain a systematic and rigorous overview of companies’ market  behavior and to more effectively identify problem companies for more  detailed review. The way state insurance regulators approach and perform  market conduct examinations also varied widely across the states. While  NAIC has developed a handbook for market conduct examiners, states are  not required to use it, and we found that it is not consistently applied  across states. Moreover, the handbook is not intended to provide guidance  for some important aspects of market conduct examinations—for  example, how often examinations should be performed or what criteria  states should use to select companies to examine. We also found that the  number of market conduct examiners differed widely among states and  that there were no generally accepted standards for training and certifying  examiners. These differences make it difficult for states to depend on  other states’ oversight of market activities. Most of the states that we  visited told us that they felt responsible for regulating the behavior of all  companies that sold insurance in their state. With anywhere from 900 to  2,000 companies operating within each state, the pool of companies is  simply too large for any one insurance department to handle. Attempts to  do so are neither efficient nor effective. Moreover, since many states do  not coordinate their examinations with other states, some large multistate  insurance companies reported being examined by multiple states, while  other companies were examined infrequently or never.
We also found that since the mid 1970s, NAIC has taken a variety of steps  to improve the consistency and quality of market conduct examinations.  However, despite the NAIC’s long-standing efforts and some limited  successes, progress toward a more effective process has been slow.  Recently, NAIC has increased the emphasis it places on market analysis  and market conduct examinations as regulatory tools that could improve  states’ ability to oversee market conduct. With more consistent  implementation of routine market analysis, states should be better able to  use the resources they already have available to target companies  requiring immediate attention. Also, by consistently applying common  standards for market conduct examinations, states should be able to rely  on regulators in other states for assessments of an insurance company’s  operations. These improvements should in turn increase the efficiency of  the examination process and improve consumer protection by reducing  existing overlaps and gaps in regulatory oversight. However, if NAIC  cannot convince the various states to adopt and implement common  standards for market analysis and examinations, current efforts to  strengthen these consumer protection tools are unlikely to result in any  fundamental improvement.
While we focus on the states’ use of market analysis and market conduct  examinations, market regulation includes several other important  regulatory tools, including complaint handling and investigation, policy  rate and form review, agent and company licensing, and consumer  education. Most states have functioning programs addressing each of  these four regulatory areas. Ideally, all regulatory tools, including market  analysis and market conduct examinations, should work together in an  integrated and interrelated way.
subsections: section_title: Lack of General Agreement on Standards for Market Analysis and Market Conduct Examinations Results in Wide Variations Among States
paragraphs: In the absence of generally accepted standards, individual states decide  how they will do market analysis and perform market conduct  examinations. While all states do market analysis in some form, few have  established formal programs that look at companies in a consistent and  routine manner. States also have no generally agreed upon standards for  how many examinations to perform, which companies to examine and  how often, and what the scope of the examination should be. As a result of  the lack of common standards for market analysis and the lack of  consistency in the application of the guidelines for examinations, states  find it difficult to depend on other states’ oversight of companies’ market  behavior.
subsections: section_title: Few States Do Systematic and Routine Market Analysis
paragraphs: NAIC and some states have a growing awareness that better market  analysis can be a significant tool for monitoring the marketplace behavior  of insurance companies and deciding which insurers to examine. All states  perform some type of market analysis. In many states, however, it consists  largely of monitoring complaints and complaint trends; and reacting to  significant issues that arise. Three states that we visited—Missouri, Ohio,  and Oregon—have established a proactive market analysis program. These  programs for market analysis have established processes for monitoring  company behavior to identify trends, companies that vary from the norm  (outliers), and potential market conduct problems. In general, an  established program would have dedicated staff and protocols for  gathering data and conducting analysis at the department offices.
Each of the three states with an analysis process that we visited  approached market analysis in a different way. Ohio’s program consisted  of special data calls to obtain extensive information from selected  company files, and using computerized audit tools to analyze specific  aspects of companies’ operations relative to norms identified by peer  analysis and to state law. For example, Ohio did 184 “desk audits” in 2001  using data requested from companies doing business in the state. Missouri  relied on routinely collecting market data from all licensed companies.  Missouri has developed a market data report that companies submit as a  supplement to their annual financial reports. This data is then used to  evaluate market trends and conditions, as well as to identify individual  companies that were outliers. Oregon’s newly established program  involved maintaining files on companies in which all available data was  collected to facilitate a broad and ongoing review of company behavior.  Both Ohio and Oregon told us that their market analysis programs were  still in an experimental stage of development.
When properly done, market analysis can allow states to focus attention  on the high-risk companies rather than selecting companies for  examination based primarily on criteria such as market share, which does  not directly correlate to market behavior problems. Missouri officials  added that market analysis is not a substitute for market conduct  examinations but should interact and be integrated with the examination  process.
section_title: We Found Variations in the Way States We Visited Performed Examinations
paragraphs: Each state has between 900 and 2,000 licensed insurance companies.  Because in general states do not currently depend upon other states’  regulation of companies’ market behavior, most states feel a responsibility  for overseeing all the companies selling in their state. The impossibility of  examining so many companies requires regulators to identify and  prioritize which companies they will examine. The states we visited used a  variety of factors to choose companies for a market conduct examination.  The most commonly used factors for choosing from among the companies  deemed eligible for a market conduct examination were complaints,  market share, and time since the last examination.
Some states chose to do market conduct exams for only a subset of  licensed companies, even though other companies could comprise a  majority of the insurers selling in the state. For example, of the states we  visited, Arkansas focused primarily on domestic companies—that is, on  companies chartered in their state. In Arkansas, 245 of 1,668 licensed  companies in 2001 were domestic. As a consequence, 1,423 non-domestic  companies, or 85 percent of all the companies licensed in Arkansas in  2001, were not examined in Arkansas in spite of the fact that they may or  may not have been examined by some other state.
All the states we visited limited the scope of their examinations to  customers from within their particular state. That is, examiners looked  only at files of state residents. Moreover, most states further limited the  scope of their examinations by focusing on only one or a few of a  company’s area of operations. While some states still do comprehensive  market conduct examinations, the trend is to conduct targeted  examinations of limited scope and in a specific area of concern. State  officials we interviewed indicated that targeted examinations are being  used more often because these examinations do not take as long as  comprehensive examinations, allowing states to conduct more. Of the 9  states we visited, Arkansas, Missouri, and New Mexico continued to  conduct some comprehensive examinations as well as targeted  examinations.
Arkansas officials told us that they believed comprehensive examinations  were important because such examinations provided the greatest  assurance that companies were complying with insurance laws and  regulations. According to NAIC, 49 states and the District of Columbia  reported performing some market conduct activities in 2001. Of these, 15  completed only targeted examinations, 4 did only comprehensive  examinations, and 22 completed some of both types of examination. The  remaining nine did not complete any market conduct examinations in  2001.
The requirements for and level of training for examiners also varied widely  among the states. Each of the states we visited provided some type of  training for their examiners. However, there are no generally accepted  standards for what constitutes adequate training for a market conduct  examiner across the states. Several levels of certifications for market  conduct examiners are available, but only 2 of the states we visited,  Oregon and New Mexico, required their examiners to certify or become  certified in a specified period.
section_title: States Vary in the Emphasis Given to Market Conduct Examinations
paragraphs: As can be seen in table 1, there is considerable variation in the number of  examinations completed in 2001 by the states we visited. Variation in the  number of examinations consistent with the size of the insurance market  would be expected. However, as shown in the table, the number of  examinations completed bore little relationship to the size of the  insurance market in each state. This comparison should not necessarily be  taken as an indicator of the relative regulatory performance of the nine  states we visited, because during another year the ranking of the states  could be different. However, together with the variations in how states  select companies for examinations and how they do them, this added  variability helps further explain why the states may be reluctant to depend  on other states to examine companies selling insurance to their citizens.  plans, efforts, and results could improve regulation and, at the same time,  reduce the regulatory burden on companies. Many insurance companies,  particularly the largest ones, report that they undergo frequent, sometimes  simultaneous, market conduct examinations. We asked 40 of the largest  national insurance companies to provide information about their market  conduct examination experience for the years 1999 to 2001. Of the 25  companies that responded, 19 were examined a total of 130 times by  multiple insurance regulators during the 3-year period. Six were examined  once or twice during the period, and just over half the responding  companies were examined between one and five times. However, three  companies were each examined 17 or more times during the 3 years, with  one company receiving 20 examinations—an average of seven nearly every  year.
These results appear to be consistent with concerns expressed by the  insurance industry about excessively frequent and possibly duplicative  market conduct examinations. One of the most common complaints from  the 25 insurers that responded to our questionnaire was that states did not  coordinate their examinations with other states. Some companies reported  that, on occasion, multiple states had conducted on-site examinations at  the same time. The companies told us that such examinations create  difficulties for them and limited the resources they had available to assist  the examiners. For example, one insurer wrote, “It takes an insurer a  tremendous amount of effort to prepare for and deal with individual state  insurance department’s exams (every one is different, plus states generally  do not accept others exams in place of another similar exam being done).  The duplication of effort is wasteful by the states.”
In contrast, six companies, or nearly one-quarter of those responding, had  not been examined by any state during the period. Of these six companies,  two were last examined in 1997 and the other four did not report having  any market conduct examinations. These companies—like others that  reported—are large multi-state insurance companies. Since in many states  a primary criterion for selecting a company for examination is market  share, these responses suggest that the proportion of medium-size and  small insurers that rarely, if ever, receive a market conduct examination  may be much higher.
Groups of states, as well as NAIC, have taken actions to improve the  coordination and efficiency of the market conduct examination process.  One effort involves improving the sharing of examination information by  providing notice of upcoming examinations and sharing results through  NAIC’s Examination Tracking System. However, the Examination  Tracking System is incomplete and often ignored by the state regulators, in  part, because it has been inconvenient and difficult to use for scheduling  and reporting the results of market conduct examinations. As a result,  states are not fully utilizing the system. NAIC’s survey of states’ use of the  Examination Tracking System concluded that no more than 66 percent of  the states, or 36 states, consistently reported their market conduct or  combined market conduct/financial examination schedules to NAIC.  Moreover, only 31 percent of the states reported back to NAIC when the  examination had been completed.
Another avenue of coordination being pursued by NAIC and some states is  joint, or collaborative, examinations. Based on our review of nine states  and of NAIC information, some states do conduct collaborative  examinations. For example, Ohio officials told us that they had started to  conduct collaborative examinations with Illinois, Nebraska, and Oregon.  Indiana officials indicated that they had recently completed an  examination of a large insurer jointly with another state. Such efforts,  however, have not been consistent among states, nor is there a policy or  standard procedure about when or how such examinations should occur.  Furthermore, while collaborative examinations could reduce the total  number of duplicative exams and may result in somewhat more efficient  use of regulatory resources, they still require that each state send  examiners into the company. In effect, collaborative examinations are a  way for multiple states to do a market conduct examination of a company  at the same time. Such an examination may be to the benefit of the  company. However, if each state’s examiners still ask for samples of files  for only their own state’s insurance consumers, the benefit may be  reduced.
section_title: NAIC Has Identified Market Analysis and Examinations as Areas Needing Significant Improvement
paragraphs: The NAIC identified the need for uniformity in market conduct regulation  as early as the 1970s. Since then NAIC has launched a number of market  conduct efforts intended to identify and address the issues and concerns  caused by the lack of uniformity in states’ market conduct examination  processes, and more recently in the market analysis area. Although  progress has been slow in establishing more uniformity in market conduct  regulation, NAIC has had some successes. One of the earliest was the  development of the market conduct examination handbook containing  guidance on conducting and reporting examination results. In general,  most states use the handbook as an examination guide, but they can still  choose not to follow the handbook in an examination or to modify it. For  example, although the handbook lays out the steps for conducting an  exam, such as notice of an exam, use of sampling techniques, and  preparation of an examination report, each state can go about those steps  differently. Moreover, the handbook in not intended to cover some aspects  of examinations, including examination frequency and company selection  criteria.
One challenge to establishing voluntary uniform national standards for  examinations and examination processes is that states are free to adopt  the NAIC’s model laws, regulations, and procedures; to modify them to  meet their perceived needs and conditions; or even to ignore them  entirely. Once NAIC as an organization agrees on recommendations that  would create more uniform regulatory statutes, two additional challenges  to uniformity remain. First, when proposed changes affect state law, state  legislatures must approve the recommendations without significant  changes. Second, each state insurance department must successfully  implement the recommendations. These challenges to establishing  voluntary uniform national standards for examinations can clearly be seen  in the number of states adopting the model laws and regulation that NAIC  identified in 1995 as the essential elements for a market conduct  examination program. By 2003, only nine models had been adopted by  more than half the states, while two models had been adopted by five or  fewer states.
Achieving uniformity in market regulation will be a difficult process for  NAIC and the states. However, a similar problem that existed in solvency  regulation over a decade ago was solved by creating the Financial  Regulation Standards and Accreditation Program. The program’s overall  goal was to achieve a consistent, state-based system of solvency regulation  throughout the country. The program was designed to make monitoring  and regulating the solvency of multistate insurance companies more  consistent by ensuring that states adopt and adhere to agreed-upon  standards, which establish the basic recommended practices for an  effective regulatory department. To be accredited, states had to show that  they had adopted specific solvency laws and regulations that protected  insurance consumers, established defined financial analysis and  examination processes, and used appropriate organizational and  personnel practices. While the quality of regulation is still not consistent,  the Accreditation Program has improved financial regulation across the  states. As a result, states are now willing, in most cases, to depend on the  solvency regulation of other states.
While the process used by state insurance regulators to oversee solvency  could provide a model for oversight of market conduct as well, there are  structural differences in market regulation that will undoubtedly affect the  ultimate design of an improved market conduct oversight system. These  differences will have to be addressed by NAIC and the states in order to  move forward. First, market conduct oversight involves many different  activities and operations of insurance companies. This fact has broad  implications for regulatory consistency and mutual dependence, including  requirements for the necessary training of market conduct examiners and  analysts.
Second, regulators told us that life insurers tend to use a company-wide  business plan and organizational structure. That is, a life company’s  operations tend to be relatively consistent across the entire company.  Property-casualty insurers, on the other hand, tend to use a regional  business model and organizational structure. As a result, a property- casualty insurer’s operations could differ, perhaps substantially, from  region to region. Clearly, the life insurer model is more directly amenable  to domiciliary-state oversight than the property-casualty model. However,  any regional or state-by-state variances in a company’s operations and  procedures would reduce the effectiveness of domiciliary-state oversight.  Some aspects of market conduct oversight will always be state (or region)  specific because of the differences between life and property-casualty  insurers, but also because there will always be differences between some  of the specific laws and requirements of individual states. As a result, even  when greater uniformity of regulatory oversight is achieved, it is likely that  states will always have to devote some attention to the activities of  insurers not domiciled in their state. Nevertheless, if a state insurance  department knew that the domiciliary state was doing consistent market  oversight on the company with agreed-upon processes, appropriate scope,  and well-trained examiners and analysts, the level of attention needed,  even for a property-casualty company, could be substantially lessened.  Finally, even to the extent that properly designed and competently  performed market conduct oversight can effectively monitor and regulate  insurance company practices, it will extend to the sales practices of  insurance agents only to the extent that the company takes responsibility  for and exercises control of the behavior of the agents that sell its  products.
section_title: Preliminary Observations
paragraphs: In the current environment of market regulation, most insurance  regulators believe they need to oversee the market behavior of all  companies selling insurance in their state because they cannot depend on  the oversight of the other states. State regulators think this way in part  because important elements of market regulation are characterized by a  lack of even the most fundamental consistency. Formal and rigorous  market analysis is in its infancy among state regulators, and whether,  when, and how states do market conduct examinations vary widely. As a  result, state regulators are now using the resources that they have in the  area of market analysis and examinations inefficiently. Regulators from  different states examine some insurers often, while other insurers are  examined infrequently or not at all. More importantly, because market  analysis is weak, regulators may not be finding and focusing on the  companies that most need to have an examination.
We support the goal of increasing the effectiveness of market conduct  regulation through the development and implementation of consistent,  nationwide standards for market analysis and market conduct  examinations across the states in order to better protect insurance  consumers. The emphasis placed on these issues by NAIC has increased  substantially over the last 3 years. We believe that NAIC has taken a first  step in the right direction. Much work, however, remains, as NAIC and the  states have not yet identified or reached agreement on appropriate laws,  regulations, processes, and resource requirements that will support the  goal of an effective, uniform market oversight program. Such a program,  consisting of strong market analysis and effective market conduct  examinations, will facilitate the development of an atmosphere of  increasing trust among the states. However, at present it remains  uncertain whether the NAIC and the states can agree on and implement a  program that will accomplish this goal.
Madam Chairwoman, this concludes my statement. I would be pleased to  answer any questions you or other members of the subcommittee may  have at this time.
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