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Reinsurance: The Silent Regulator?

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Aviva Abramovsky

Volume 15

Issue 2

PUBLISHED

Spring 2009

Abstract

This article argues that any discussion of insurance regulation should consider the impact reinsurance may have on insurer behavior. It reviews traditional types of reinsurance and examines how private reinsurance contracts can influence insurer actions. When reinsurance is excluded from a holistic analysis of the insurance system, its practical effects can misdirect regulatory assumptions. Moreover, reinsurance operates as a source of independent—and often unexamined—contractual influence on insurers, and as a potential source of interference with regulatory initiatives. Although reinsurance arrangements arise from private contracts, those contracts can exert regulatory effects significant enough to warrant answering this Essay’s central question affirmatively: reinsurance may indeed be correctly termed a “silent regulator.”

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Examining Current Proposals for Increasing the Federal Role in Dealing With Coastal Hurricane Risk

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Louis Cruz

Volume 16

Issue 1

PUBLISHED

Fall 2009

Abstract

This note distinguishes predatory lending from subprime lending while focusing on the insurance consequences of predatory lending. It examines how single premium credit insurance (SPCI) and private mortgage insurance (PMI), two mortgage-related insurance products, have contributed to the current predatory lending crisis. The note argues for reforms that would eliminate SPCI and make PMI a more feasible option for insureds, enabling subprime lenders to offer mortgages to qualified borrowers while reducing predatory lending and foreclosures. The introduction provides background on subprime and predatory lending; the second part analyzes several issues concerning the role of insurance in the subprime mortgage market; the third part discusses necessary reform measures to address problems with mortgage insurance; and the fourth part reviews recent Federal Reserve Board actions and evaluates whether they are likely to bring meaningful change. The note concludes that although the Fed’s new regulations are a step in the right direction, an outright ban on SPCI is necessary and predatory lending must be stopped completely.

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The 2008 Mental Health Parity and Addiction Equity Act: An Overview of the New Legislation and Why an Amendment Should be Passed to Specifically Define Mental Illness and Substance Use Disorders

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Sara Nadim

Volume 16

Issue 1

PUBLISHED

Fall 2009

Abstract

This note examines the 2008 Mental Health Parity and Addiction Equity Act and argues that although the Act represents a landmark improvement in mental illness parity coverage, it should be amended to define explicitly what constitutes a mental illness or substance use disorder. The first part explores the history of federal mental health parity efforts. The second part discusses the Act’s specific provisions, emphasizing that it does not provide explicit definitions of covered conditions. The third part reviews state definitions of mental illness, while the fourth highlights recent developments supporting the biological basis of mental illness. The fifth part evaluates the societal cost reductions that would result from expanding mental health insurance parity. The note concludes that certain severe biologically based mental illnesses should be expressly listed in the statutory definition and required, at minimum, to be covered by insurers. It supports this position by showing that the cost impact on employer group health plans would be minimal, whereas societal costs—such as homelessness and reduced workplace productivity—would decrease substantially when mental illness and substance use disorders receive adequate treatment.

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Predatory Lending and Its Insurance Consequences

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Erin O’Leary

Volume 16

Issue 1

PUBLISHED

Fall 2009

Abstract

This note distinguishes predatory lending from subprime lending while focusing on the insurance consequences of predatory lending. It examines how single premium credit insurance (SPCI) and private mortgage insurance (PMI), two mortgage-related insurance products, have contributed to the current predatory lending crisis. The note argues for reforms that would eliminate SPCI and make PMI a more feasible option for insureds—changes that would enable subprime lenders to offer mortgages to qualified borrowers while reducing predatory lending and foreclosures. The introduction provides background on subprime and predatory lending; the second part analyzes several issues concerning the role of insurance in the subprime mortgage market; the third part discusses necessary reform measures to mitigate problems associated with mortgage insurance; and the fourth part reviews recent Federal Reserve Board actions and evaluates whether they are likely to bring meaningful change. The note concludes that although the Fed’s regulations are a positive step, an outright ban on SPCI is needed and predatory lending must be stopped entirely.

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Regulation of Large Financial Institutions: Lessons From Corporate Finance Theory

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John P. Harding & Stephen L. Ross

Volume 16

Issue 1

PUBLISHED

Fall 2009

Abstract

This article applies a model of firm capital structure to the current financial crisis and summarizes the insights the model offers for regulating large financial institutions in a post-crisis world. Firm capital structure is evaluated by examining how firms finance their activities using debt and equity, which reflects an important component of firm risk-taking. The article first summarizes the simple model, then uses its results to interpret the evolution of the financial crisis and place it in context. Finally, it presents forward-looking observations and suggestions for future regulation. The article concludes that any effective new regulatory framework must include a robust method for addressing the expanded “Too Big to Fail” umbrella, which has extended moral hazard risks beyond depository institutions. It argues that a successful framework must impose stringent capital standards on financial institutions, backed by regulators with both the authority and the resolve to enforce those standards—putting owners and managers at risk when violations occur, even during crises when regulators may be tempted to accommodate firms to preserve asset value. The framework should also be flexible enough to adapt to changing financial conditions, especially developments affecting franchise value, and must expose uninsured debtors to risk when capital standards are violated so that debt holders have incentives to monitor the activities of very large financial firms.

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The Law and Economics of First-Party Insurance Bad Faith Liability

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Sharon Tennyson & William J. Warfel

Volume 16

Issue 1

PUBLISHED

Fall 2009

Abstract

States differ in the legal avenues available to policyholders pursuing actions against their insurers for bad faith in claims settlement. This article discusses the various approaches that states have taken to first-party insurance bad faith law and examines the potential benefits and costs of each. Legal regimes that are likely to award large damages to aggrieved policyholders provide the strongest deterrent to insurer bad faith, but they may also encourage fraudulent insurance claims and discourage insurers from conducting rigorous claim investigations. The article evaluates the empirical significance of these potential incentive distortions by analyzing automobile insurance claim settlement data from states with different bad faith regimes. The data indicate that claim characteristics and investigative practices differ significantly in states permitting tort-based bad faith actions compared to those with other approaches, in ways consistent with the hypothesized incentive effects.

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Risk Data in Insurance Interpretation

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Michelle Boardman

Volume 16

Issue 1

PUBLISHED

Fall 2009

Abstract

Insurance companies rely heavily on actuarial data—facts about past risks—in developing products and navigating regulatory approval. Given the centrality of such data to drafting, pricing, and legitimizing insurance policies, it is striking that courts, insurers, and policyholders largely ignore it when interpreting policies in litigation. This article explores how actuarial data could be used and considers informal explanations for why it is not invoked more often. It identifies three ways actuarial data could improve interpretation and construction. First, actuarial data can help prove or disprove insurer good faith: comparing premiums collected with risks covered can confirm or refute suspicions of bait-and-switch practices. Second, actuarial data can substantiate an insurer’s claimed actuarial purpose, providing contextual clarity that resolves ambiguities—crucial because a finding of ambiguity almost always favors the policyholder. Third, actuarial data can reveal insurer intent, offering insight beyond merely showing the absence of bad faith and generating benefits for both insurers and consumers. The article argues that courts in insurance cases often engage in a task that is both more and less than interpretation—they effectively regulate insurance policies by determining which clauses may be enforced. Actuarial function gives courts intent on regulating the insurance field a clearer view of the policy implications of their rulings, enabling them to consider the interests of policyholders beyond the litigant immediately before them.

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Whither the Duty of Good Faith in UK Insurance Contracts?

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John Lowry

Volume 16

Issue 1

PUBLISHED

Fall 2009

Abstract

This article explores the current state of United Kingdom law concerning the duty of good faith in insurance contracts. Recent case law shows that the insured’s duty of disclosure continues to evolve, and the article argues that, given the fragmented nature of the current law, future reform should focus on creating a consistent regime for insurance contracts—one flexible enough to encompass both consumer and commercial insurance while maintaining clear and certain objectives. The first part examines the insured’s duty of disclosure as originally articulated by Lord Mansfield CJ. The second part analyzes post–Carter v. Boehm case law, which developed the notion of good faith and expanded it into a duty of utmost good faith. The third part explores the discomfort of UK courts and law reform agencies regarding the severity of the insured’s duty and the injustices that result when insurers avoid policies for nondisclosure. The fourth part assesses recent judicial efforts to alleviate the harshness of the existing regime. The concluding section briefly reviews the 2009 Consumer Insurance (Disclosure and Representations) Bill, published by the English and Scottish Law Commissions, and proposes an alternative model informed by developments in Australian law. The article argues that reform should focus on balancing the economic costs of change with the benefits of a more equitable system that does not artificially distinguish between consumer and business insureds.

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The Road From “Twin Peaks” – And The Way Back

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Michael W. Taylor

Volume 16

Issue 1

PUBLISHED

Fall 2009

Abstract

This article explores the fragmented regulatory structure of U.S. financial markets in light of the recent financial crisis and examines two regulatory reform approaches originating in the United Kingdom. The first approach calls for the creation of a unified regulatory agency responsible for overseeing all major segments of the financial services industry. The second, known as the “Twin Peaks” model, proposes dividing regulatory authority between two agencies: one dedicated to overseeing the safety and soundness of financial firms, and the other focused on regulating their sales practices. The article describes the debate in the UK that preceded the establishment of the unified Financial Services Authority (FSA), explores the justifications for such a single regulator, and discusses the UK’s rejection of the Twin Peaks approach. It then examines the debate surrounding the role of a central bank, such as the Bank of England, in financial oversight. The article reviews U.S. regulatory reform efforts in light of the British experience with unified regulation and concludes that some variation of the Twin Peaks model would likely be more successful in the United States than a single-regulator approach.

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Credit Derivatives Are Not “Insurance”

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M. Todd Henderson

Volume 16

Issue 1

PUBLISHED

Fall 2009

Abstract

This article explores whether credit derivatives should be regulated as insurance and proposes an alternative regulatory approach for these financial instruments. The largely unregulated credit derivatives market has been cited as a contributing factor to the recent housing market collapse and resulting credit crunch. The article examines the possibility of regulating credit derivatives as insurance but concludes that, although some credit derivatives allow banks and other debt providers to share risk with investors, this characteristic alone is insufficient to classify such contracts as “insurance.” It argues that insurance regulation is not suitable for the credit derivatives market, while acknowledging that some form of regulation is necessary. The first section provides an overview of the basics of credit derivatives; the second presents arguments supporting insurance-style regulation; the third explains why credit derivatives, despite facilitating risk sharing or transfer, fall outside the scope of insurance law; and the final section outlines what an appropriate regulatory framework for credit derivatives might look like and contrasts it with traditional insurance regulation.

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