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I would hope that you would continue to consider this bill.
Senator BROOKE. Would you yield at that point, if I may ?
The CHAIRMAN. Yes.

Senator BROOKE. If larger companies were to leave the State guarantee funds system and I am not saying that they would, that is open to debate—that would no doubt reduce the size of the pool on which the State guarantee funds could draw to pay for an insolvency. But of course with the withdrawal of these large companies, if it occurred, it would also reduce the exposure of the State guarantee fund at that point, I think, has not been made.

The CHAIRMAN. What I am concerned about, of course, is you might have stronger companies, whose policies might be sounder, opting to get under the Federal jurisdiction, and leaving the weaker companies with less resources and greater risks possibly for the State to try to protect with inadequate funds.

Mr. HUNTER. That is what I meant by the expression "adverse selection.” It wouldn't be a one-to-one transfer. I am afraid the stronger companies would transfer out and in an absolute sense the State pool's strength would be lowered, but I don't believe it would be one-to-one.

Senator BROOKE. I don't think we know that.
Mr. HUNTER. No.
The CHAIRMAN. Mr. Sims.
Mr. Sims. I certainly don't know the answer to your question.
The CHAIRMAN. How do you stand on the preemption issue?

Mr. Sims. I don't think, at least based on what we know, there is a case for preemption at this point. There is the possibility of what the Federal Insurance Administration fears could happen.

On the other hand, to the extent that we have an analogous situation in the banking field, that has not proven to be a serious problem in that field. So I don't think at this stage of the game we can really make a precise determination as to what will happen in the event of a dual chartering system.

The CHAIRMAN. Thank you. Senator Brooke.

Senator BROOKE. Mr. Sims, I want to thank you for your very fine summary of the study done by the Justice Department on the pricing and marketing of insurance, and we are very privileged to have the principal author of that study here with us.

Mr. Sims, you state, and I quote: The long-run experience of at least one major insurance state that had an open competition system, in which the state has relied on market forces to control prices, suggests that unrestricted price competition can provide a most effective substitute for rate regulation, reasonable prices, maximum efficiency in the sale and distribution of insurance.

I take it that the State you are referring to is California, is that correct?

Mr. Sims. That is correct.

Senator BROOKE. Is it not true that even in California where open competition exists, the State regulators still retain the authority to set aside rates which are unfairly discriminatory?

Mr. Sims. That is correct.

Senator BROOKE. Does such authority go beyond preventing discrimination on the basis of race, sex, or religion?

Mr. Sims. Yes.

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Senator BROOKE. How far does it go?

Mr. Sims. My understanding, and Mr. Maseritz can correct me if I am wrong, is that the regulatory authority in California extends to the common kind of rate regulation language. I don't know what the precise language is.

Mr. MASERITZ. The language is essentially that rates can not be excessive, inadequate, or unfairly discriminatory.

Senator BROOKE. Mr. Sims, Mr. Hunter, in his statement—we have discussed this to some extent-mentions the problem of selection competition, the ability of an insurer to effect success not by price or quality of his product, but by selecting its customers in a fashion that will give it an advantage over its rival.

Selection competition is a feature of the insurance economy which seems to provide a ground for distinguishing insurance from other products and services, and for fashioning for insurance a series of specific rules, unique to its problems and circumstances.

How does the Justice Department study deal with the problems of selection competition !

Mr. Sims. First of all, I think to the extent that we understand what selection competition is, it appears to us to be as much a product of the regulatory system as it is of the nature of the product or service sold.

In an unfettered marketplace, you would anticipate that there would be competition for the better risks, to use the insurance term. But you would also expect that the less than superior risks would be served at a higher price commensurate with the difference in the anticipated risk.

In the insurance industry today there are severe restraints upon the pricing of the insurance product for those high risk customers. And where you have restraints on maximum pricing for the fellow who has an automobile accident once a month, you are undoubtedly going to have companies seeking to get away from that kind of fellow, and getting into the marketplace with preferred risks, which never have automobile accidents.

It doesn't follow from that experience in a highly regulated system, that you would have the same kind of problem in a relatively unregulated system.

Indeed, I would expect that problem would not be of the same magnitude. True, in an unregulated system, the guy who has an accident once a month is going to have to pay a real high premium for his automobile insurance. If that is seen to be a problem, the preferred way from our perspective to deal with that would be through a direct subsidy, some kind of direct payment to the individual, rather than the cross-subsidy which exists today by raising rates generally in order to pay for the increased loss experience that companies face with that type of individual.

Senator BROOKE. Thank you. Now you advocate early detection and swift removal of failing insurers, rather than keeping every insurer afloat.

Is that approach taken in those States in which open competition now exists?

Mr. Sims. I just don't know the answer to that question. There have been recommendations of various kinds, I think in New York, if I am

correct, that that approach should be utilized. But to my knowledge that recommendation has never been fully implemented.

Senator BROOKE. You don't know in how many States?

Mr. Sims. No; I simply don't know the answer to that. It is the system, by and large, which works in the banking field, administered by the Federal bank regulators, and works, based on our experience, very well.

Senator BROOKE. Now you state that the Justice Department's report did not examine in depth the potential impact of unrestricted price competition on smaller insurers.

Do you know if smaller insurers in California have been adversely affected by the existence of open competition?

Mr. Sims. Based on our information, the answer is no. I think there was a report by the California Insurance Department, which indicated there had not been a particularly abnormal exit rate for small insurers based on their experience in the open competition system.

There is always a problem when you face a move from a regulated system to an unregulated system. There are always fears and concerns of the unknown, no matter how attractive some of its features may be; it is always the unknown. You know what you are living with today.

Senator BROOKE. It is the devil you know rather than the devil you don't know.

Mr. Sims. That is right. You see that in the airline industry today, in various other industries, in which there is some talk about lessening regulation. That uncertainty would be with us in the insurance field as well.

But there is no reason, based on our knowledge, to believe efficient small insurers wouldn't be able to survive quite well in an unregulated environment.

Senator BROOKE. You have stated that it is important to permit regulation of rates by the States in cases where reverse competition exists. That is, where insurers compete for the agent's business rather than directly for the business of the ultimate consumer. Has State regulation been effective in protecting consumers in the case of credit life and health insurance or in the case of title insurance ?

Mr. SIMs. That is another question I simply don't know the answer to. I think the reverse competition problem needs more study, and more data needs to be collected.

I don't think, based on what we know right now, we can really say whether or not State regulation has worked.

Senator BROOKE. Would you elaborate briefly on your statement that the life insurance industry generally may be subject to reverse competition?

Mr. Sims. I would like Mr. Maseritz to respond to that.
Mr. MASERITZ. Could you ask the question again, Senator?

Senator BROOKE. Would you elaborate on your statement that the life insurance industry generally may be subject to reverse competition?

Mr. MASERITZ. The question arises because of the existence of the so-called expense limitation laws in three States, including New York. New York has indicated in various studies that there is need to control the expenses of agents because, in the case of whole life insurance, it

is a product that is sold, that is to say, it is a product in which the company has to go out to the consumer and make a case for the service in many instances.

Insurance companies want to provide an inducement to their agents and they do this through commissions.

Now at the same time there is the problem in life insurance of consumer information and consumer knowledge, because it is a highly complex service and product. It is this combination of factors—the incentive to sell and lack of information—that results in competition for the agents as opposed to competition for the ultimate consumer. We believe that is the basis for the expense limitation laws and the need to regulate the expense element of the premium.

Senator BROOKE. Thank you. I have one final question.
The CHAIRMAN. I believe Mr. Clark wanted to comment.
Senator BROOKE. I am sorry, yes, Mr. Clark.

Mr. CLARK. Senator, you have this problem: If the commission rate for the life insurers is 95 percent of the first annual premium for whole life, and the commission rate for term life is 35 percent, the chances are that there is going to be an awful lot of whole life sold and very little term life, even though the needs of many many people may be for term life. That is the concern.

Senator BROOKE. Thank you very much, Mr. Clark.

Now, Mr. Sims, one of the witnesses who will appear later in the week will state that S. 1710 works against the interests of smaller insurance companies, because, and I quote:

A host of opportunities will exist for Federally chartered insurers to exploit market and pricing opportunities and out-maneuver their State chartered competitors at every turn.

Would you care to comment on that?

Mr. Sims. That sounds like competition. You know, the great benefit of a competitive marketplace is that it forces people through a system of inexorable rewards and penalties to do their best. And doing their best means thinking about how they can beat the competition and provide a better service at a lower price, if possible.

That is not a concern that would particularly bother me.

Senator BROOKE. Thank you. Mr. Chairman, I want to again commend the panel, it has been an excellent panel, and very helpful. I am very grateful to each of you.

Again, Mr. Chairman, I thank you.

The CHAIRMAN. I agree, I think it has been a fine panel. All four of you gentlemen have been very helpful.

Here is one of the brightest, sunniest days of the year today, and we have pulled the shades to keep us from being flooded with too much light, yet we turn on the artificial lights, and we determined from an expert on the subject that we use about a gallon of oil by keeping these lights on all day.

It seems to me we could make one concrete specific contribution to energy conservation, probably the best the Congress will make all year, by turning the lights off when the sun is shining. From now on we will do that.

The committee will reconvene tomorrow morning at 9:30 to hear six experts on this subject.

[Thereupon, at 12 noon the hearing was recessed, to reconvene at 9:30 a.m. the following day.]

FEDERAL INSURANCE ACT OF 1977

TUESDAY, SEPTEMBER 13, 1977

U.S. SENATE,
COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS,

Washington, D.C. The committee met at 9:30 a.m., in room 5302, Dirksen Senate Office Building, Senator William Proxmire, chairman of the committee, presiding

Present: Senators Proxmire, Brooke, and Schmitt.
Senator BROOKE. The committee will come to order.

Chairman Proxmire will attend very shortly. He is unavoidably delayed but we will proceed with the testimony because we have many witnesses and much testimony this morning. The first panel will consist of the National Association of Insurance Commissioners, Mr. Wesley Kinder, insurance commissioner of the State of California; and from the Commonwealth of Massachusetts, James Stone, the insurance commissioner; and from the State of Illinois, Richard L. Mathias, director of insurance.

Will you come forward and, Deputy Commissioner Rodney, would you come forward with Mr. Stone. Director Mathias, will you identify your colleague?

Mr. Mathias. Senator Brooke, accompanying me on the right is Michael Hasten, who's our chief counsel.

Senator BROOKE. Welcome. We are pleased to have you.

Commissioner Kinder and Director Mathias, I don't have a résumé on you, but being from Massachusetts I am pleased to introduce Commissioner Stone.

I am particularly pleased to have you, Commissioner Stone. Mr. Stone is a graduate of Harvard College where he received a B.A. degree in 1969 with highest honors in economics. He also holds a Ph. D. in economics from Harvard and has served on the Harvard faculty.

From 1971 to 1975, Mr. Stone worked at Fairfield & Ellis, a prominent Boston-based insurance brokerage firm, and he served as vice president of that firm.

He has a number of publications to his credit, including a book titled "One Way for Wall Street."

He was appointed commissioner of insurance by Governor Dukakis on February 28, 1975.

Commissioner Stone is accompanied by Deputy Commissioner Keith Rodney, who has quite a record in his own right. He is a graduate of Syracuse University with a major in accounting and a concentration in economics. He is a certified public accountant, and before accepting

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