Insurance is a highly regulated industry because insurance companies have a long history of failing to honor promises, going bankrupt or finding unethical novel methods to gain a competitive edge. State insurance commissioners and attorney generals are charged with enforcing laws and regulations protecting consumers. I posed a question about whether state insurance commissioners and attorney generals are doing enough to protect insurance consumers following a discussion about an insurance policy that specifically excluded any benefits for the cost of matching damaged portions of a residential structure with adjacent undamaged portions of the home. The homeowner had fire damage in the kitchen and the insurance adjuster refused to pay to match cabinets, paint and wallpaper.

An insurance transaction is unique. The actual product, the policy, is not provided to the policyholder at the point of sale. Indeed, the ability to study, analyze and then compare the terms with other policies before purchase is rare. Except for insurance agents, I bet $10 that nobody reading this blog can honestly say they read three or four policies to compare the available products before they purchased one. While we spend several minutes choosing which tomato is the best choice for dinner, we do not even read or compare much more important insurance products even though they cost significantly more and potentially determine whether we will financially recover from a disaster. It is impossible in most cases because most carriers do not provide a copy of the policy before purchase.

The purchase of insurance is a “pay now, terms later” transaction. Standard insurance policies with minimum requirements of protection were developed and mandated in the late 19th century, in part, to protect consumers and prevent problems resulting when insurance companies sold fire insurance but significantly minimized the coverage with boilerplate terms. Until recently, most insurance companies followed ISO standard forms. This is no longer the case.

In Reevaluating Standardized Insurance Policies,1 Professor Daniel Schwarcz notes the failure of the current regulatory scheme of the insurance industry:

The failure of state insurance regulators to provide some modicum of transparency in personal-lines insurance markets is troubling. Perhaps the least controversial element of consumer protection regulation is that it should promote transparency so that consumers understand the products they are purchasing. To be sure, insurance regulation has traditionally gone beyond mere transparency and disclosure in protecting consumers. But such efforts certainly do not eliminate the need for keeping consumers informed about their options in the market place. How can it be that regulators ignored this basic feature of regulation for so long?

There are at least two answers, both of which have important implications for how best to structure financial regulation more generally. First, the lack of transparency in insurance markets is not the type of problem that will produce consumer complaints. Indeed, in opposing transparency-oriented reforms, one important insurance lobbyist emphasized just this point, suggesting that the absence of consumer complaints on this issue indicated that consumer representatives were pursuing pointless regulations. Unlike issues such as premiums, cancellation, and prompt claims payment, consumers do not know what they do not know when it comes to the lack of insurance policy transparency. This means that the political pressures on regulators to address this problem are limited. Less cynically, it may be that consumer ignorance means that regulators are not particularly likely to learn about this issue, as regulators often rely on consumer complaints to identify market problems.

The second key explanation for the failures of state insurance regulators in this context is historical. The regulatory regime of state regulators makes perfect sense in a world where insurance policies are indeed completely standardized, as they used to be. It is therefore no wonder that, in initially designing insurance regulation, policymakers did not develop any mechanisms for keeping consumers abreast of the content of different insurers’ policies. As with all financial markets, however, insurers evolved over time such that it is no longer necessary, or apparently desirable, for many large insurers simply to use the standardized ISO policy. Insurance regulators failed to evolve along with this market change.” (citations omitted)

So, what do we do about insurance companies that sell defective products which limit or do not match items that must be repaired with the rest of the house? The answer to this problem is not litigation over a defective product. Although selling an insurance policy without disclosing the defective terms at the point of sale or offering alternatives seems actionable. The issue and resolution lies with Departments of Insurance and their decisions to forms of insurance to be sold. Attorneys general should investigate these policies as a new type of bait and switch fraud which routinely takes place at the point of sale for residential insurance policies.

While in a different context, I noted this problem previously in Insurance Regulators and Lawmakers, Judges and Insurance Consumer Advocates Should Study Professor Daniel Schwarcz’s Work and A Call for Homeowners Insurance Reform. We need leaders who will enforce public policy requiring transparency, ethical dealing, and honesty at the point sale. We all lose without honesty and ethics.

1 Daniel Schwarcz, Reevaluating Standardized Insurance Policies, 78 University of Chicago Law Review 1263 (2011).