Edited by Daniel Schwarcz and Peter Siegelman
Chapter 10: Economics of state versus federal regulation
This chapter examines the theory and evidence regarding the level at which the insurance industry should be regulated. Banking and insurance, two major financial service industries, have different regulatory treatment in the United States. One is now mostly federally regulated (banking) and the other is predominantly regulated by the states (insurance). The state’s regulatory oversight for insurers, discussed further below, is mostly an historical artifact and begs the question where the regulation of financial services rightly goes in our federal system. The theory of the optimal administration and provision of public goods, such as insurance regulation, is based on Oates’s (1972) theory of fiscal federalism. This theory posits that efficiency is maximized when the benefits and costs of a particular government activity are internalized to the level of government making the regulation. A simple example is whether all the benefits (and costs) of solvency regulation, which is currently conducted at the state level, remain solely within a particular state or extend to other states’ residents? Using this theoretical approach this chapter examines the available empirical evidence to provide some guidance on the optimal provision of insurance regulation. It would be nice to state unequivocally that insurance regulation is optimally placed at the federal or state level. However, the evidence is not so clear.
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