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State Regulation of Life Insurers: Implications for Economic Efficiency and Financial Strength http://acli.com/ACLI/Newsroom/News+Releases/NR07-052.htm
Steven Pottier, CLU, Ph.D.
Terry College of Business
University of Georgia
Athens, Georgia
ARIA 2007 Quebec
Introduction Does state regulation of multi-state life
insurers increase costs, reduce revenues, and reduce profits?
Supporters of Optional Federal Charter (OFC) for Life Insurers argue that substantial cost savings and efficiency gains will result for insurers opting for federal oversight
This study examines cost, revenue and profit efficiency measures to provide insight on potential benefits of OFC
Innovations Unit of analysis—consolidated groups
(affiliated insurers) and individual unaffiliated insurers
Number of regulatory jurisdictions measured at group-level States licensed and states domiciled
More extensive set of inputs and outputs than prior life insurer efficiency studies
Economic significance of results
Key findings
Cost efficiency scores decreases as the number of states licensed or domiciled increases, but increases with insurer size
Revenue and profit efficiency scores are not affected by multiple state regulation
Costs to benefits provided and revenues to benefits provided both increase with number of states licensed or domiciled, suggesting higher costs are offset or passed along to consumers
Overview of life insurer regulation Market regulation
Licensing, policy/contract provisions, rates, sales and claims practices
In general, life and annuity rates not regulated
Financial regulation Capital requirements, investment limitations,
reserve requirements, and guaranty funds Substantial compliance—deference to state of
domicile
Related literature Grace and Klein (2000)
Individual life insurers, 1997 Expense ratios increase with the number of states licensed Salary expense and license/fee expense ratios higher in
restrictive regulatory environments (total expense ratio not)
McShane and Cox (2006) Individual life insurers Expense ratio is not related to the number of states
licensed or to being a single-state insurer
Numerous studies using similar empirical method (i.e., I/O definitions, DEA)
Hypotheses and variables 1
Number of states licensed Number of states domiciled
Regulatory compliance costs are likely to increase when insurer group is licensed or domiciled in more states
Expansion into more states may present greater opportunity for revenue growth and consumer may place higher value on insurance from multi-state insurer
Binary variables multi-state and multi-dom also considered
Hypotheses and variables 2
Size—scale and scope economies Health insurance—financial and regulatory
differences from life and annuity business Ownership form—implications for activity
choices, different product characteristics, monitoring costs; used ultimate owner’s form
Publicly-traded—additional regulatory requirements, capital access
Multi-line—property/liability or health affiliates, scope economies or diseconomies
Hypotheses and variables 3
Line-of-business concentration—scope economies or diseconomies
New-York licensed—does not recognize substantial compliance, extraterritoriality
Capital/assets—relation to risk, capital costs Common stocks/invested assets—investment
risk and investment expenses Group member—economies in complying with
regulations, complexity of operations, broad services
Sample and data
2005 annual statement year blue-blank life insurers with positive assets, premiums and capital
Data—A.M. Best and NAIC Under 50 percent of gross premiums from
reinsurance assumed Single insurers—domiciled in U.S. Consolidated groups—one or more members
domiciled in U.S. Tables 2 and 3—summary financials Tables 4 and 5—summary statistics Table 6—correlations Main sample contains 284 life insurance entities
Inputs and outputs—quantities and unit prices Three main services of life insurers
Risk pooling, real services and financial intermediation 11 Outputs (benefits provided customers)
Net incurred claims (5 lines) Invested assets (5 lines) and deposit-type contracts
6 Inputs (costs) Agent and admin labor and business services—consists of
general insurance expenses, taxes, licenses and fees, commissions on direct business and reinsurance assumed
Capital—reserves, deposit-type funds, and equity Input prices—U.S. BLS, Ibbotson Associates, and
crediting rate deposit funds Output prices—revenues (investment and non-
investment) divided by output levels, truncated
Empirical results—main sample (284 firms) Table 7—states licensed and domiciled and
size Panel A—DEA efficiency scores Panel B—”traditional” efficiency measures
Table 8—table 7 panel A augmented by control variables
Table 9—DEA cost efficiency by size quartile
Financial strength and regulation (241 firms) Table 10—summary statistics categorical
variables Table 11—correlations Table 12—ratings, regulatory variables, and
other controls Table 13—ratings and efficiency measures Table 14—107 insurers not profit efficient Multiple-state regulation reduces financial
strength of profit inefficient insurers
Estimated cost savings of single regulator Table 15—based on parameters from table 9 Assumes that only actual costs, not optimal costs,
change due to single regulator Cost savings might not all be related to regulation—
inherent problem identifying what portion of costs are related to regulation and what portion is related to expansion to other states Partly address by not including commissions that are part
of inputs (costs) used to estimate regression parameters in Table 9
Reasonableness test—consider in relation to premium revenues and ACLI survey work
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