Innovate to win: Overcoming regulatory barriers to insurance product and service innovation

The need for rapid innovation in the insurance industry

Global challenges require fast responses and innovative solutions from insurers. In an industry not often noted for innovation, COVID-19 has proven that insurers can rapidly innovate to help businesses and consumers manage risks and protect against losses. For example, insurers quickly added benefits for COVID-19 critical illnesses and waived member cost sharing for diagnostic testing related to COVID-19. In addition to COVID-19, other significant changes, such as technological advances and healthcare reform, have fostered innovation in life and health insurance products.

Innovative products and services enable insurers to respond to client needs in new ways that competitors have not considered or been able to provide. However, innovation may be viewed as disruptive in the heavily regulated insurance industry, and regulators charged with protecting consumers might be concerned with ideas that are untested. Even when regulators are convinced that an innovative insurance product or service would greatly benefit a consumer population, they might be constrained by regulatory limitations. Because regulation moves slowly and innovation moves fast, a more flexible framework is needed for insurers to rapidly bring innovative products and services to market.

Benefits of a principles-based approach

A principles-based approach to insurance industry regulation may be a more effective way to foster innovation. Principles-based regulation means moving away from reliance on detailed, prescriptive rules and relying more on high-level, broadly stated rules or principles to set the standards by which regulated firms must conduct business¹, such as:

• Is this product or service consumer friendly?
• Is this product or service in the general interest of the public?
• Is this product or service non-discriminatory?

Principles-based regulation gives insurers significant flexibility to quickly react to current events and meet their business objectives, while delivering the outcomes required by regulators. Consumers benefit from a more innovative insurance industry that can rapidly respond as standards of care change and technology advances over time. Regulators and state governments benefit from innovative solutions that reduce the financial strain of underinsured populations, and mitigate consumer risk.

Although principles-based regulation is more common in Europe, regulators in the U.S. have begun to adopt this approach in the insurance sector with principle-based reserving (PBR) as a prime example. PBR, now law throughout the U.S., allows life insurers to model their reserves based on a set of fundamental principles rather than one-size-fits-all rules. This allows an insurer to reflect its own unique experience and risks in calculating services.²

NAIC fosters innovation through principles-based regulation

Another prime example of principles-based regulation are the proposed revisions to the National Association of Insurance Commissioners (NAIC) Model Unfair Trade Practices Act.³ The NAIC Innovations and Technology Task Force recognized the need for principles-based regulation to foster innovation, proposing revisions to address coverage of non-insurance services or “value-added benefits” offered with insurance plans under certain circumstances. This flexible approach encourages insurers to find innovative ways to benefit both consumers and the industry. For example:

• Health insurers and life insurers might offer wellness plans that incentivize healthy behavior by providing discounts on gym memberships, wearable health and fitness devices like Apple Watches or Fitbits, nutritional counseling, or other benefits. The insurer gains healthier policyholders with fewer claims, and consumers benefit from the opportunity to monitor or improve their wellness at no charge or at a discounted rate.
• Property and casualty insurers might expand homeowner policies to cover equipment designed to make homes safer, like mold and moisture detection devices. Early detection enables the insurance company to mitigate risk by identifying and dealing with small issues before they turn into expensive repairs.
• Automotive insurers might offer safe driver apps with telematics-based tracking to incentivize good driving habits with discounts for safe driving. Devices plugged into car computers collect data, such as how many times automatic emergency braking was activated and if the driver travels into areas where there is a higher risk of automotive theft. All that information is made readily available to insurers via wireless transmission. Insurers can then use that data to determine patterns of risk.

Under current law, offering something of value in connection with an insurance sale might be deemed an illegal rebate if the item is not specified in the insurance contract. Not all states allow value-added benefits to be included in insurance contracts, and not all insurers know exactly what types of incentives they will offer over time as technology changes. These factors make specificity in the contract a challenge. Initially, NAIC sought to create a regulation that listed the benefits that would be allowed. However, NAIC quickly recognized that a prescriptive list would not work because enabling technologies are rapidly changing and insurers are continually finding more creative ways to incentivize good behavior. As a result, NAIC proposed a more flexible list of questions or criteria that should be addressed to determine if a non-insurance benefit is acceptable:

1. Does the value-added service or product, taken as a whole, foster the solvency of the applicable insurers and protect consumers?
2. Is the value-added service or product, taken as a whole, offered in a manner that is not unfairly discriminatory to consumers?
3. Does the service or product mitigate loss or provide loss control that aligns with the risks of the policy, or educate about, assess or monitor risk, identify sources of risk, or develop strategies for eliminating or reducing those risks?⁴

Making insurance more accessible to underserved populations

Principles-based regulation has the potential to help insurers and regulators widen the reach of insurance services to protect the health and livelihoods of under-served, low-- income populations. Microinsurance products, products that are intentionally designed for low-income populations, are common in developing countries. These products have been successful in providing coverage to low-income individuals or households for their assets, and compensation for death, injury, or illness. Successful microinsurance products are simple in design, efficient in managing expenses, accessible to the people who need it most, and use technology intelligently. Rather than using traditional producers for sales, these products might be sold by mobile network operators, pawnbrokers, churches, retailers, and other entities that are easily accessible for uninsured or underinsured populations. Premium payments may be made via mobile networks or by other means that are convenient for insureds. As a result of this flexibility and user-friendliness, hundreds of millions of people worldwide have some form of microinsurance.

Although microinsurance products have been relatively successful in emerging markets, they are challenging to implement in the U.S. due to insurance industry regulations. U.S. market barriers include life insurance producer licensing regulations, replacement rules, group regulation, and other regulatory issues. By allowing what is reasonable in a specific market, principles-based regulation would add more flexibility to sales of low face amount insurance products designed for underserved markets. Rather than regulating the details of plan design, pricing, and solicitation, principles-based regulation would focus on the fairness of the plan and the reasonableness of rates and benefits. Insurers would gain the freedom to find innovative ways to reach out to low-income populations with much needed coverage, while still remaining profitable.

Challenges to effective principles-based regulation

For principles-based regulation to work effectively, decision-makers in both insurance companies and regulatory boards will need to understand the value of a principles-based approach and have the critical insight to weigh the benefits of flexibility against the clear direction that comes with prescriptive rules. Principles-based regulation can be ambiguous and open to interpretation, which can create uncertainty for insurers as to whether they are complying with the law. Insurers, governed by multiple states, are subject to each state’s laws and interpretations and an action deemed acceptable in one state might be deemed inappropriate in another state, even if the two states have the exact same regulation. It will be important for parties to distinguish between actions that are violating minimum standards and actions that are not preferred but are not violating minimum standards. Without this distinction, the industry could end up with desk drawer rules, where regulators’ interpretations result in inconsistent applications of the law create confusion.

Another challenge of principles-based regulation is that bad actors might take advantage of the flexibility for their own personal gain. Senior insurance company management will be responsible for self-policing and will be held accountable by regulators if consumers are harmed by actions taken by the insurer or its agents. Insurers need to pay claims fairly, monitor agents who make bad sales, and ensure that any consumer-facing materials are clearly worded and accurate. Most insurers are already vigilant, but a principles-based regulatory approach will require even more self-policing to protect consumers and the company’s reputation. It is important to note that a principles-based approach will not necessarily result in less insurance regulation—just different regulation. Instead of direct guidance, the regulation will need to include more ongoing monitoring and oversight of company activities and consumer outcomes.

For the most part, these challenges can be overcome by good communication between regulators and the insurance industry. Principles--based regulation requires insurers and regulators to act as partners and understand each other’s perspectives. To capitalize on the benefits of principles-based regulation, insurers should reach out to regulators in states where they plan to launch new products and services to discuss innovative concepts in advance. In turn, regulators should be willing to listen and provide constructive feedback. This dialogue enables insurers to adjust early in product design to avoid or mitigate consumer problems or regulatory pitfalls. Steps like extra disclosure or specific training for producers that are selling the product might help overcome potential regulatory hurdles and consumer complaints.

Despite these challenges, the insurance industry, and insurance regulation, must be able to innovate and adapt. The flexibility provided by a principles-based approach to regulation can help with this effort.

For more information, contact Stacy Koron at stacy.koron@millman.com.

¹Black, Julia, Hopper, Martyn, and Band, Christa. (May 2007). Making a success of Principles-based Regulation. Law and Financial Markets Review. Retrieved on June 8, 2020, from http://www.lse.ac.uk/law/people/academic-staff/julia-black/Documents/black5.pdf.

²Principle-Based Reserving: A New Way to Insure for Life. (June 2016). American Academy of Actuaries. Retrieved on June 26, 2020, from https://www.actuary.org/sites/default/files/files/publications/EE.PBR_.06.16.pdf

³Unfair Trade Practices Act, Model 880. (January 2004). National Association of Insurance Commissioners. Retrieved on June 26, 2020, from https://www.naic.org/store/free/MDL-880.pdf

⁴Rate Reduction, Loss Control & Loss Mitigation Value-Added Products And Services Offered Or Provided By Insurance Companies. North Dakota Insurance Bulletin. Retrieved on June 8, 2020, from https://content.naic.org/sites/default/files/inline-files/ND_Rebating_Bulletin_V6.3.pdf