Because insurers develop insurance rates that affects most people, the laws of nearly all states give the state insurance commissioner the power to enforce regulation of insurance rates
Ratemaking is the process insurer use to calculate the rates that determine the premium for insurance coverage.
A Rate is the price of insurance for each unit of exposure. The rate is multiplied by number of exposure units to arrive at the premium.
A Premium is the periodic payment by an insured to an insurance company in exchange for insurance coverage.
An Actuary analyzes data on past losses and expenses associated with losses and combining this with other information develops insurance rates. In other words, an actuary is a person who uses complex mathematical methods and technology to analyze loss data and other statistics to develop system for determining insurance rates.
Objectives of Rate Regulation
Rate regulation serves three general objectives: -
· To ensure that rates are adequate
· To ensure that rates are not excessive
· To ensure that rates are not unfairly discriminatory.
Ensuring that Rates are adequate
When rates are adequate, the prices charged for a given type of insurance coverage should be high enough to meet all anticipated losses and expenses associated with that coverage while generating a reasonable profit for the insurer.
It is virtually impossible to guarantee that premium paid by the insured will be adequate to cover insured losses. Even when a large group of similar exposure unit is covered, unexpected events, such as a natural disaster, might lead to losses significantly higher than those predicted when rates were originally set.
Ensuring that rates are not Excessive
To protect consumers, states also require that insurance rate not be excessive. Excessive rates could cause insurers to earn unreasonable profits. Determining whether rates are either excessive or inadequate is difficult, especially since insurers must price insurance policies long before the results of the pricing decision are known.
Ensuring that rates are not unfairly discriminatory
Since insurance is a system of sharing the costs of losses, each insured should pay a fair share of the insurer’s losses and expenses. Some disagreement exists as to how this fair share should be determined.
Actuarial equity is a ratemaking concept through which actuaries base rates on actuarially calculated loss experience and place insureds with similar characteristics in the same rating class.
Social equity is a rating concept that considers rates to be unfairly discriminatory if they penalize an insured for characteristics (such as age or gender) that are beyond the insured’s control.
Unfair discrimination would involve applying different standards or methods of treatment insureds who have the same characteristics and loss potential. This would include charging higher-than-normal rates for an auto insurance applicant based solely on the applicant’s race, religion, or ethnic background.
Insurance Rating Laws
In attempts to balance conflicting objectives, states have developed a variety of laws to regulate insurance rates.
· Prior approval law – Rate must be approved by the state insurance department (commissioner) before they can be used. The commissioner has certain period typically 30 to 90 days to approve or reject the filing. Some states have deemer provision (delayed effect clause) that causes the rates to be deemed approved if the commissioner does not respond to the rate filing within the specified time period.
· Flex Rating Law – Prior approval is required if the new rates are specified percentage and above or below previously filed rates.
· File and use Law – Rates must be filed but do not have to be approved before use.
· Use and File Law – Rates must be filed within a specified period after they are first used in the state.
· Open Competition (No File Law) – Rates do not have to be filed with the state regulatory authorities. This approach is called open competition, because it permits insurers to compete with one another by quickly changing rates without review by the state regulators. Market forces determine rates under this approach.
· State Mandated Rates – This system requires all insurers to adhere rates established by the state insurance department for particular type of insurance.
Who Provides Insurance
