My Final Post: A Recipe for More Effective Consumer Protection in Insurance Regulation

Many thanks to Credit Slips for providing me with the opportunity to discuss some of the key consumer protection issues in insurance regulation.  As I hope I have shown over my short stint here, there is much that needs to be done in this important area, which often receives less attention from academics and the press than consumer protection in credit. 

I thought I would close by offering a simple set of recommendations for dramatically improving consumer protection in property/casualty insurance markets.  Here is my basic recipe, which would need to be separately implemented for each line of coverage:

(1) Promulgate a single policy that serves as a minimum baseline of coverage. 

(2) Develop "nutritional labels" geared towards providing consumers with a basic sense of the degree to which a carrier's policy provides greater coverage than the minimum baseline.

(3) Require prominent disclosure on the nutritional labels of several measures of claims paying quality, such as the percentage of claims denied, the average time within which claims are paid, and the frequency of non-renewal or cancellation within a year of a claim being submitted.

(4) Require full online disclosure of insurance policies, variables relating to claims payment, and data regarding the availability of coverage.  

(5) Carefully consider the need to regulate risk classifications that have a disparate impact on underserved communities.   

(6) Abandon all price regulation designed to suppress insurance rates, so long as a reasonable number of carriers exist in the marketplace.

(7) Promote the importance of independent insurance agents, but prohibit these agents from receiving different amounts of compensation based on the carrier with which they place consumers.

Homeowners Insurance Claims and the Foreclosure Crisis

Prompted by several comments to one of my earlier posts, I've been thinking about situations where a homeowner files an insurance claim for property damage to her home while she is in default on her mortgage.  The general practice, as I understand it, is for insurers to write claim settlement checks out to the mortgagee, rather than the policyholder, in such situations.   This practice is based on a clause in most homeowners policies that "If a mortgagee is named in this policy, any loss payable under Coverage A or B will be paid to the mortgagee and you, as interests appear." 

All of this makes sense.  But, it seems to me that the mortgagee ought to have an obligation to promptly use any insurance proceeds it receives in this manner to fix the underlying property damage.  Failing to do so, and holding on to the insurance proceeds as cash collateral, seems to me to potentially constitute a violation of the mortgagee's obligation of good faith.  Yet according to the commentators referenced above, this is apparently a common practice (though I would be curious about other readers' experiences).  

Relying on Disclosure When it is Least Likely to Matter

I’ve argued in my posts so far that transparency in property/casualty insurance markets is woefully inadequate.  Transparency, however, is not always a particularly good solution to a regulatory problem. The most visible controversy in the property/casualty insurance industry in the last decade illustrates this point nicely.  

That controversy involved the payment by insurers to independent insurance agents of “contingent commissions.”  These commissions are essentially year-end bonuses to agents based on the volume and/or profitability of the business sent to the insurer.  Such commissions create obvious conflicts of interest for ostensibly independent agents – the carrier who is best for the consumer may not be the carrier who maximizes an agent’s contingent compensation.  In response to this risk, numerous insurance jurisdictions, as well as the National Association of Insurance Commissioners, embraced disclosure requirements for insurance agents.  

Unfortunately, the regulatory problems created by contingent commissions are particularly resistant to disclosure-based responses.  To understand why, it is helpful to realize that contingent commissions are simply a specific example of a general phenomenon in which market intermediaries extract side payments from other professionals for steering business to them.  Yield-spread premiums – whereby lending institutions pay bonuses to mortgage originators depending on the rate of interest paid by the borrower – are another example. 

Such trilateral dilemmas, as Howell Jackson has dubbed them, are generally unresponsive to disclosure-based solutions.  Indeed, it is for this very reason that Dodd-Frank abandons a disclosure-based approach to yield-spread premiums in favor of an outright ban.  

Insurance Redlining and Transparency

Insurance nerds like to point out that insurance coverage is a pre-requisite to a wide range of activities, from starting a business to practicing medicine to driving a car.  In this sense, insurers often serve as gatekeepers to fundamental social privileges.  Nowhere is this more starkly illustrated than in the residential real estate context.  As one court succinctly put it: “No insurance, no loan; no loan, no house; lack of insurance thus makes housing unavailable.”  

Given the centrality of both credit and insurance to home ownership, one might expect that the rules in these two domains would similarly respond to the risk of redlining, which is the practice of denying or charging more for services in residential areas with large minority populations.  But as with coverage terms and claim handling, quite the opposite is true: whereas bank regulation has embraced transparency, insurance regulation has actively rejected it.  

Are You Really in Good Hands? How Do You Know If Your Insurer Will Pay a Large Claim?

Not surprisingly, one of the core consumer protection issues in insurance is ensuring that carriers pay claims fairly and expeditiously.  Unlike many contracts, insurance policies are sequential and contingent: whereas the policyholder performs routinely by paying premiums, the insurer performs by paying a claim if, and only if, a loss occurs.  This dynamic creates special risks of unfair business practices.  These risks are enhanced by the fact that many insurance policies (outside of the life insurance context) necessarily rely on abstract language to describe insurers’ coverage obligations.  For these reasons, much of insurance law – including the availability of bad faith lawsuits and state prohibitions on “unfair claims practices” – is devoted to ensuring carriers’ fair payment of claims.

Despite the centrality of claim-handling to consumer protection in insurance, regulators do essentially nothing to promote transparency in insurance markets with respect to this issue.  The reason is not that it would be particularly difficult to measure this variable:  useful metrics might include how often claims are paid within specified time periods, how often claims are denied, how often policies are non-renewed after a claim is filed, and how often policyholders sue for coverage.  In fact, state regulators already collect some of this data for their own use in policing the market place.   But none of this data is systematically made publicly available to consumers.  Rather, this information is generally treated as confidential on the basis that it could reveal proprietary company information or mislead insurance consumers.    

Purchasing Insurance as a Game of Chance: What Does Your Homeowners Policy Cover?

The core product that insurance consumers buy is a standard form contract.  Unlike virtually any other market, though, it is virtually impossible for purchasers of personal lines coverage (i.e. homeowners, renters, and auto insurance) to scrutinize this product before they purchase it.  Insurers only provide consumers with an actual insurance contract several weeks after they purchase coverage.  They generally do not make sample contracts available to consumers on the Internet or through insurance agents.  Marketing materials and other secondary literature from regulators and consumer organizations provide virtually no guidance about how different carriers’ policies differ.  And most states have essentially zero laws requiring insurers to provide any types of pre-sale disclosure to consumers regarding the scope of their coverage. 

How can this possibly be?  

Consumer Protection Strategies in Credit and Insurance: Why the Disconnect?

Many thanks to Credit Slips for inviting me to guest blog over the next week or so.  My hope during this time is to explore what I view as an important puzzle in consumer protection regulation: why it is that consumer protection strategies in insurance and credit are so different in the United States.  

From a consumer protection perspective, credit and insurance are intimately related.  At its core, consumer protection regulation in both domains is motivated by the fact that consumers routinely engage in complex financial transactions that they may not fully understand or appreciate.  And in both domains, firms or market intermediaries can exploit this fact to make additional profits in the short term, though such a strategy creates long-term legal and reputation risks.  Despite these similarities, consumer protection regulation in credit is predominantly concerned with disclosure and transparency whereas consumer protection regulation in insurance almost entirely ignores these tools in favor of more prescriptive regulatory approaches.