Actuarial Notes

Policy Form Regulation

Study guide: Exam DISC-IA

Policy Form Regulation is the states' control over the wording of insurance contracts: legislatures prescribe standard policies and required provisions, insurance departments review the forms insurers file before or after use, courts interpret disputed wording against the insurer that wrote it, and readability laws require consumer policies to be written so a buyer can understand them. It exists because an insurance policy is a contract the insurer drafts and the buyer accepts or rejects as a whole, so the buyer can't bargain over its terms.

F = 206.835 - 1.015\,\frac{W}{S} - 84.6\,\frac{Y}{W}

\text{Readable} \iff F \ge F_{\min}

  • Symbols: F is the Flesch reading ease score of a policy form's text, W its number of words, S its number of sentences and Y its number of syllables. Longer sentences and longer words lower the score. F_{\min} is the minimum the state's readability law requires: 40 under the NAIC Life and Health Insurance Policy Language Simplification Model Act, and 45 under New York's law for the policies it covers. Headings, schedules, defined terms and language a law requires are left out of the count.
  • Standard forms by statute: Some policies are written into law word for word. Massachusetts adopted the first standard fire policy in 1873, and New York's 1943 standard fire policy, with minor statutory variations, came to be used in most states. New York law forbids issuing a fire policy on New York property that does not conform to its standard form, unless an approved form gives the insured terms no less favorable. Supplemental contracts and endorsements adding other perils may be attached with the superintendent's approval.
  • Required provisions: More often the law requires certain provisions rather than whole forms. A life insurance policy, for example, must contain nonforfeiture provisions giving the owner a paid-up benefit or a cash value if premiums stop, and auto and workers compensation policies must include the coverage those laws make mandatory.
  • Filing and approval: Insurers must file their policy forms, endorsements and other contract language with the insurance department. Under a prior approval law, forms must be approved before use, often with a deemer provision that treats a filing as approved if it is not disapproved within a set period. Under the NAIC's commercial rate and form model, forms in a competitive market are filed a set number of days, no more than 30, before use, while in a market the commissioner finds noncompetitive they wait 30 days and are deemed approved unless disapproved. An advisory organization may file forms for its member insurers, and no insurer may issue a policy except under the filings in effect.
  • Exemptions: The same model exempts a form written for one particular risk, lets an insurer use a commercial form that is broader and in no respect narrower than its filed form and file it within 30 days, and applies a state's form rules only to commercial risks primarily located in that state. Some specialty lines, such as directors and officers and employment practices liability, are outside its filing section altogether.
  • The courts' role: An insurance policy is a contract of adhesion, offered on a take-it-or-leave-it basis by a party with far more bargaining power. Under the rule of contra proferentem, an ambiguous term is construed against the party that drafted it, so a court reads ambiguous policy language in favor of coverage. The rule has pushed insurers to spell out exclusions as specific lists rather than rely on general words. Courts may also refuse to enforce an adhesion contract's terms that the buyer would not reasonably have accepted. See Policy Provisions.
  • Readability requirements: Beyond the score, the NAIC life and health model requires at least ten-point type, no undue prominence for any part of the text, and a table of contents or index for a policy of more than 3,000 words or more than three pages. An officer of the insurer certifies the score in the filing, and the commissioner may accept a lower score where the form's nature or legally required language justifies it. Which policies a state's readability law covers varies: New York's applies to life and health policies, private passenger auto policies and policies on dwellings of up to four units.

Scoring a Homeowners Form An insurer files a dwelling policy form in New York, where the minimum Flesch score is 45. The countable text has 6,000 words in 300 sentences with 9,000 syllables. A rewrite by a different author has the same 6,000 words in 200 sentences with 9,900 syllables. Does each pass?

Answer

\begin{align*}
F_1 &= 206.835 - 1.015\left(\frac{6{,}000}{300}\right) - 84.6\left(\frac{9{,}000}{6{,}000}\right) \\
&= 206.835 - 20.30 - 126.90 \\
&= 59.6 \\
F_2 &= 206.835 - 1.015\left(\frac{6{,}000}{200}\right) - 84.6\left(\frac{9{,}900}{6{,}000}\right) \\
&= 206.835 - 30.45 - 139.59 \\
&= 36.8
\end{align*}

The first form passes. The rewrite fails, and would also fail the NAIC model's 40, because its sentences average 30 words and its words 1.65 syllables. Shorter sentences and plainer words raise the score, and defined terms are excluded from the count, so a form can keep its technical vocabulary inside definitions.

Filing Commercial Forms Under the Model A state has adopted the NAIC commercial rate and form model with a 30-day filing period. Which filing rule applies to each form?

  1. A new contractors endorsement for general use, in a market the commissioner treats as competitive.

  2. The same endorsement after the commissioner finds, after a hearing, that the market is not reasonably competitive.

  3. A manuscript endorsement drafted for one stadium's unusual exposure.

  4. An endorsement that broadens the filed form's definition of insured contract and narrows nothing.

Answer

  1. Filed before use, up to 30 days ahead of its effective date. It needs no affirmative approval first.
  2. Filed and held for a 30-day waiting period, which may be extended by up to 30 more days. It is deemed to meet the law unless the commissioner disapproves it within the period.
  3. Exempt from filing, as contract language unique to a particular risk, though the commissioner may restrict the exemption.
  4. Used now and filed within 30 days, if the state's regulation allows broadening forms to be used before filing.

An Ambiguous Water Damage Clause A homeowner's policy covers "water damage" without defining it and has no exclusion for earth movement. A rainstorm sets off a mudslide that pushes mud and water into the house. The insurer argues that the policy meant water escaping from plumbing, not mud. How is a court likely to decide, and how might the insurer prevent the dispute?

Answer "Water damage" can reasonably be read to include a rain-driven mudslide, so the term is ambiguous. Under contra proferentem a court construes it against the insurer, which drafted it, and finds the loss covered. The insurer's remedy is in the drafting: define the covered water perils and add an express exclusion of earth movement and mudslide, then file the revised form. A clear exclusion leaves nothing for the court to construe.

How it appears on the exam

  • DISC-IA: The Insurance Regulation section asks how regulators control insurance policies: legislative requirements such as standard forms and mandatory provisions, the filing and approval of forms, the role of the courts, and readability standards.
  • Applied questions: A question describes a form and a state's filing law and asks whether the form can be used before approval, or describes a disputed clause and asks how a court will read it.
  • Neighbours: Form regulation is paired with State Rating Laws in the same filings, and with Insurance Licensing, Solvency Monitoring and State Market Conduct Regulation as the regulator's tools.

Exam traps

  • File and use is not prior approval: Under file and use an insurer may use a filed form without waiting for approval, and the department can still disapprove it later. Under prior approval it waits for approval or the deemer period.
  • Ambiguity favors the insured, not the reader's preference: Contra proferentem applies only when a term is genuinely ambiguous. Clear wording is enforced as written, even if the insured did not read it.
  • A higher Flesch score is easier, not harder: The score falls as sentences and words get longer, so a minimum score is a floor on readability. A form scoring 36.8 fails a minimum of 40.
  • Standard does not mean identical everywhere: States that use the New York standard fire policy have adopted their own minor variations, and most policy language is filed by each insurer or its advisory organization rather than fixed by statute.