The Effects of an Optional Federal Charter on

Competition in the Life Insurance Industry

Martin F. Grace

Robert W. Klein

Georgia State University

Presentation

ARIA 2007 Meeting

August 6, 2007

Outline

• Motivation and Issues

• State versus OFC Framework

• Structure & Performance of Life Insurance Industry

• Likely Effects of OFC on Competition

Motivation• Many Life & PC insurers now advocate the

creation of an optional federal charter (OFC).

• Some insurers, independent agents and the states oppose OFC.

• OFC legislation has been introduced in Congress.

• The OFC proposal has sparked a strong debate involving several issues, including its likely effects on market competition.

Evolution of Insurance Industry• Insurance markets have become increasingly

national & international in scope.• Under state framework, each state licenses

insurers to operate in its jurisdiction & approves life insurance/annuity products sold and other aspects of market conduct.

• Many multi-state insurers contend that state regulation has become an increasing drag on its efficiency and competitiveness.

• Life insurers increasingly compete with other financial institutions that are federal-regulated & international insurers governed by more efficient regulatory systems.

Issues• To what extent does current state framework

create barriers, raise costs and impede competition.– Pottier (2007) finds significant inefficiency in life

insurance industry attributed to state regulation.

• How would OFC affect life insurance markets?– Effects on structure, conduct and performance.– Effects on competition, efficiency, prices, product

innovation, market conduct and consumer welfare.– Implications for competition in financial services.– Implications for competition in international

markets.

OFC Proposal/Legislation• National Insurance Act (NIA) would allow insurers and

agents to submit to federal regulation.• OFC insurers and agents would not be subject to state

regulation.• Federal insurance regulator would operate much like the

OCC.• States would continue to collect premium taxes on all

insurance written.• State guaranty associations would handle insolvency costs

if they met federal standards; federal regulator would manage receiverships of “national” insurers.

• Insurance contracts would be interpreted under one set of laws.

Life Insurance Industry Structure

Year Ord Life Ord Ann Group Life Grp Ann Ord Life Ord Ann Group Life Grp Ann1985 22.4% 27.8% 37.1% 49.6% 45.2% 54.4% 64.6% 78.9%1990 33.8% 47.2% 49.9% 58.6% 65.3% 79.3% 78.2% 91.3%1995 21.2% 25.2% 42.5% 40.3% 53.1% 58.2% 68.3% 76.9%2000 22.7% 37.2% 36.0% 51.6% 56.3% 70.1% 72.7% 87.5%2005 29.6% 35.0% 45.5% 55.2% 64.4% 76.2% 78.1% 89.1%

Ord Life Ord Ann Group Life Grp Ann Ord Life Ord Ann Group Life Grp Ann1985 32.9% 38.8% 51.7% 63.4% 207 319 461 8961990 49.4% 63.0% 65.5% 76.1% 425 753 825 1,0651995 37.9% 40.1% 55.7% 59.6% 247 288 561 6462000 36.9% 53.9% 54.3% 69.8% 266 489 525 1,1612005 45.5% 53.6% 61.2% 72.0% 410 522 777 971

US Concentration Statistics By Line of Business Measured at the Group Level, 1985-2005Four Firm Concentration Ratio

Eight Firm Concentration Ratio

Sixteen Firm Concentration Ratio

Herfindahl Hirschman Index

State Market Concentration

Line of Business N of StatesOrdinary Life 49Ord Annuity 47Group Life 36Group Annuity 6

Line of Business N of StatesOrdinary Life 2Ord Annuity 4Group Life 10Group Annuity 36

Line of Business N of StatesOrdinary Life 0Ord Annuity 0Group Life 5Group Annuity 9

Panel B. HHI Between 1000 and 1800.

Panel C. HHI Above 1800.

Number of States with HHI's by Each DOJ Category, 2005 (Group Basis)

Panel A. HHI Below 1000.

Firm Value

Insurers Losing Ground to Other FIs

Mergers and Acquisitions

Observations

• Life industry relatively un-concentrated at national & state levels.

• “Natural” entry/exit barriers are low.• Regulatory barriers could be more significant.• Profits, firm value and efficiency sub-optimal.• Industry consolidation continues:

– Effort to increase scale economies– Market access and penetration– Other reasons?

Motives to Opt for OFC

• Incentives to opt for OFC increase with size & geographic scope of operations.

• Competition with other FI’s & internationally also increase incentives for OFC charter.

• Product mix may or may not be a big factor.

• OFC option increases potential returns from and value of M&A’s.

• State progress (or lack of it).

Characteristics of ACLI Members

“Nationally Significant” Insurers

Expectations• Many insurers, accounting for most of the industry’s

output, would opt for OFC.• OFC would facilitate/promote:

– Increased competition.– Industry (market) expansion.– Further consolidation.– Lower regulatory costs, greater efficiency, lower prices,

better products, consumer benefits.– Healthy competition between state/federal regulators– Industry competitiveness w/ other FIs, internationally.

• State-regulated insurers should remain viable if they offer comparative value that exceeds federal regulation efficiencies.