Insurance Regulation: Preliminary Views on States' Oversight of Insurers' Market Behavior

Published by the Government Accountability Office on 2003-05-06.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                            United States General Accounting Office

GAO                         Testimony
                            Before the Subcommittee on Oversight
                            and Investigations, Committee on
                            Financial Services, House of
For Release on Delivery
Expected at 3:00 p.m. EDT
Tuesday, May 6, 2003        INSURANCE REGULATION
                            Preliminary Views on
                            States’ Oversight of
                            Insurers’ Market Behavior
                            Statement of Richard J. Hillman
                            Director, Financial Markets and
                             Community Investment

Madam Chairwoman and Members of the Subcommittee:

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.1

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

 The National Association of Insurance Commissioners is comprised of the insurance
commissioners of the 50 states plus the District of Columbia, Puerto Rico, and the United
States Territories. The commissioners promulgate model (recommended) laws and
regulations for consideration by the states and provide support services for the state
insurance departments. NAIC meetings also provide a venue for discussion of issues that
are of interest to all.

Page 1                                                                       GAO-03-738T
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

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

Page 2                                                           GAO-03-738T
                           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.

                           In the absence of generally accepted standards, individual states decide
Lack of General            how they will do market analysis and perform market conduct
Agreement on               examinations. While all states do market analysis in some form, few have
                           established formal programs that look at companies in a consistent and
Standards for Market       routine manner. States also have no generally agreed upon standards for
Analysis and Market        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
Conduct                    the lack of common standards for market analysis and the lack of
Examinations Results       consistency in the application of the guidelines for examinations, states
in Wide Variations         find it difficult to depend on other states’ oversight of companies’ market
Among States

Few States Do Systematic   NAIC and some states have a growing awareness that better market
and Routine Market         analysis can be a significant tool for monitoring the marketplace behavior
Analysis                   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

                           Page 3                                                           GAO-03-738T
                             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.2 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

We Found Variations in the   Each state has between 900 and 2,000 licensed insurance companies.
Way States We Visited        Because in general states do not currently depend upon other states’
Performed Examinations       regulation of companies’ market behavior, most states feel a responsibility
                             for overseeing all the companies selling in their state.3 The impossibility of
                             examining so many companies requires regulators to identify and

                              A desk audit involves a review of company files at the department without physically going
                             to the company.
                              Not all licensed companies in a state are actively selling insurance. For example, some
                             companies with existing business may be going out of business although still servicing
                             existing customers (in run-off) or in liquidation. These companies may still have some
                             active policies in the state, but are not selling any new business.

                             Page 4                                                                        GAO-03-738T
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.4 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

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

 States generally have the authority to do a market conduct examination on any company
that sells insurance in the state.

Page 5                                                                    GAO-03-738T
                           remaining nine did not complete any market conduct examinations in

                           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.

States Vary in the         As can be seen in table 1, there is considerable variation in the number of
Emphasis Given to Market   examinations completed in 2001 by the states we visited. Variation in the
Conduct Examinations       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.

                           Page 6                                                         GAO-03-738T
Table 1: Market Conduct Examinations Completed in 2001 Relative to Various Measures of the Size of the Insurance Market in
Each State

                                                 Market conduct                                                    Total number of             Estimated state
                                                  examinations                Total premium volume            licensed agents and            population in 2001
 State                                         completed in 2001              in 2001 ($ in millions)              brokers in 2001              (In thousands)
 California                                                    80                             95,368                       220,506                       34,600
 Ohio                                                            5                            39,663                       154,100                       11,390
 Michigan                                                       0                             37,840                        86,739                       10,006
 Missouri                                                      29                             20,656                        91,695                        5,637
 Maryland                                                      26                             20,517                        72,039                        5,386
 Indiana                                                        43                            19,208                        83,277                        6,127
 Oregon                                                        15                             10,750                        46,573                        3,473
 Arkansas                                                     19                                6,919                       41,268                        2,695
 New Mexico                                                      8                              6,045                       28,910                        1,831
Sources: State Insurance Departments.
         NAIC’s 2001 Insurance Department Resources Report.
         U.S. Census.

                                                              Note: Does not include follow-up exams or desk audits.
                                                              Total premium volume for life, health, and property/casualty insurance.
                                                              Michigan did a limited review of market conduct issues as part of its 37 financial examinations.
                                                              Three of these were multistate examinations.
                                                              Arkansas also examined 65 funeral homes that sold prepaid funeral insurance.

                                                              In addition to the variation in examinations completed, some states have
                                                              dedicated very few resources to market analysis and market conduct
                                                              examinations. NAIC’s 2001 Insurance Department Resources Report does
                                                              not even break out department staff assigned to market analysis, although
                                                              financial analysts are separately identified. In addition, 14 states, or 27
                                                              percent, did not report having any market conduct examiners on staff,
                                                              although 4 of the 14 did report using full-time contract examiners. Ten
                                                              states, or nearly 20 percent of all states, did not report having any market
                                                              conduct examiners at all.

Interstate Coordination                                       Our review of the nine states indicated that the practice of sharing
and Communication Is                                          examination information with other states, when it occurred, varied
Inconsistent and                                              substantially from state to state. Some states coordinate their examination
                                                              plans with other states or review other states’ examination reports prior to
Infrequent                                                    going into a company, while other states do not. Even in states where
                                                              some coordination occurs, other states’ examination results do not
                                                              generally affect examination plans. Oregon officials told us that there is a
                                                              need for more interstate collaboration and reliance on examination results
                                                              from other states. More coordination of market conduct examination

                                                              Page 7                                                                                GAO-03-738T
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

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.

 We did not verify the companies’ responses with state regulators. Moreover, we have no
basis for evaluating the states’ reasons for selecting specific companies to examine.

Page 8                                                                     GAO-03-738T
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

Page 9                                                           GAO-03-738T
                      The NAIC identified the need for uniformity in market conduct regulation
NAIC Has Identified   as early as the 1970s. Since then NAIC has launched a number of market
Market Analysis and   conduct efforts intended to identify and address the issues and concerns
                      caused by the lack of uniformity in states’ market conduct examination
Examinations as       processes, and more recently in the market analysis area. Although
Areas Needing         progress has been slow in establishing more uniformity in market conduct
                      regulation, NAIC has had some successes. One of the earliest was the
Significant           development of the market conduct examination handbook containing
Improvement           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

                      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

                      Page 10                                                        GAO-03-738T
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

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

Page 11                                                          GAO-03-738T
               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

               In the current environment of market regulation, most insurance
Preliminary    regulators believe they need to oversee the market behavior of all
Observations   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.

               Page 12                                                        GAO-03-738T
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