Regulating Internet insurance

The Internet is quickly becoming an important distribution channel for property and casualty insurers. Many companies have established web sites that currently provide product information although few have moved to exploit the business opportunities for selling insurance on the Internet. At least, insurers have not been as active in pursuing Internet selling to the extent of the banking and securities industries.

Many companies, however, assume that the Internet will be a critical part of their future success. The ability to have an efficient Internet distribution strategy may become a critical success factor for insurance companies in the future. The Internet provides the ability for insurance companies to have a new, low-cost form of distribution channel. It is possible for all aspects of an insurance transaction to be done on the Internet, including initial sales, collection of premiums, issue of policies and payment of claims.

The low cost of maintaining a web site and the use of e-mail compared to direct mail and telemarketing will likely become a key advantage for both brokers and insurers. The insurance industry needs to both lower acquisition costs and improve its expense ratios, and the Internet provides these abilities.

As insurers expand their Internet activities, they will inevitable experience jurisdiction problems and may find that their activities are subject to regulation in other countries. Uncertainty as to what the rules are is a large part of doing business today on the Internet.

Regulatory issues

The Internet provides a huge challenge for insurance regulators. Using the Internet, it may be difficult to determine where an insurance transaction has actually occurred. If insurance is solicited electronically, it is necessary to determine whether the transaction occurs where the producer is located or where the consumer is located.

There are relatively few rules that have been established by insurance regulators to date with respect to Internet insurance transactions. Current insurance regulation is based upon geographic boundaries which are not relevant with respect to the Internet. However, a recent survey of U.S. regulators done by the National Association of Insurance Commissioners (“NAIC”) found that most of them believe that the state in which the consumer was located would have jurisdiction.

The regulatory monitoring of unlicensed insurers is particularly difficult on the Internet due to the size of it. For the first time, it gives consumers easy access to unlicensed insurers. It is also possible for consumers to be solicited by unlicensed brokers.

The regulatory situation with respect to the Internet is similar in Canada to that in the U.S. There have also been few guidelines provided by either the Office of the Superintendent of Financial Institutions (OSFI) or the Financial Services Commission of Ontario (FSCO). Most regulators appear to take the position that the current rules regarding the sale of insurance are also applicable to Internet transactions.

Jurisdiction

The leading case in the U.S on the Internet and jurisdiction is Zippo Manufacturing Company v. Zippo DotCom, Inc. This case held that for a court to assume jurisdiction over a foreign company in an Internet transaction, it was necessary for there to be a “substantial connection” with the jurisdiction. The case held that there was a three-part test for the exercise of jurisdiction over a non-resident:

The defendant has “minimum contacts” with the foreign state;

The claim must arise out of those contacts;

The exercise of jurisdiction must be reasonable.

In essence, the court proposed a sliding scale for different types of transactions. For example, a foreign state would likely be unable to assert jurisdiction over a company where a passive web site was involved. However, if electronic commerce was done knowingly with a non-resident, this activity would likely be subject to jurisdiction. As a result, the exercise of jurisdiction is determined by examining the level of interactivity and the commercial nature of the exchange of information that occurs on the web site.

The leading Canadian case on the Internet is Kostiuk v. Braintech, Inc. This is a recent case of the British Columbia Court of Appeal that follows the Zippo case. The court held that the simple act of posting information on the Internet does not mean that a Canadian company will be subject to foreign laws. It confirmed that some form of active behaviour is required to link a person to a jurisdiction as a result of its on-line activities.

A web site that offers only general insurance information would not likely be considered to be involved in solicitation activities. If specific information, premium rates or quotes are provided, then there would likely be solicitation activity and the laws of the jurisdiction where the insured was located would be applicable.

Although the law with respect to Internet transactions is only beginning to develop, it appears that the courts are attempting to take a practical approach to the applicability of laws of a foreign jurisdiction. However, since there are few clear rules, it is likely that there will continue to be many hidden traps for insurance companies attempting to do business on the Internet.

Consumer Issues

The use of the Internet for insurance transactions also poses a number of consumer issues that may result in regulatory problems. Privacy and confidentiality of information are likely the most important consumer issues. Consumer information that is transmitted over the Internet may be subject to interception by other people. It is also possible that access to such information may be obtained from databases on the Internet.

Premium collection on the Internet, particularly using credit cards, is also an issue. It is necessary for insurance companies to have the ability to conduct secure transactions using the Internet.

Concern by departments of insurance over consumer issues may lead to greater regulation of insurance transactions on the Internet. It is possible that such regulation could significantly reduce the advantages of using the Internet.

In the NAIC survey of insurance transactions using the Internet, the following were identified as some of the most common concerns of U.S. insurance regulators regarding the Internet:

Sale of insurance by unlicensed insurance companies and brokers;

Fraud;

Misleading or deceptive advertising;

Identifying who the broker is and where the product is sold;

Consumer protection;

Confidentiality/privacy;

The enforceability of computer signatures;

The security of transactions, particularly when credit cards are used as the means of payment.

Guidelines for insurance

The greatest challenge with the Internet is to attempt to keep up to date with the changes that are occurring. Because insurance regulators have provided very little guidance as to what is permitted, it is necessary to develop a practical approach to the sale of insurance using the Internet. The following guidelines may provide some assistance:

If an insurance company currently maintains a web site or is planning on establishing one, the purpose of it should be clearly determined (eg., whether it is intended to simply provide information or whether it is an interactive sales oriented web site).

The residency of insureds solicited using the Internet should be determined and applications should not be accepted if the insurance company is not licensed in the applicable jurisdictions. If necessary, fronting arrangements should be used.

The licensing of brokers must be considered. Insurance companies must ensure that their brokers are licensed in jurisdictions where they may be considered to be doing business.

Normal rules with respect to the sale of insurance as provided in the Insurance Act (Ontario) should be followed.

There should be sensitivity to privacy and consumer protection issues.

Rules for Internet transactions including the use of electronic signatures on applications and the payment of premiums using credit cards should be developed.

It is likely that OSFI and FSCO will use their web sites more actively in the future as a means of regulating and communicating with the insurance industry. For example, OSFI has all of its regulations and guidelines available on its web site.

The Internet must be recognised as an important channel of distribution. It is likely that insurance companies in Canada will quickly begin to understand and take advantage of the potential of the Internet. Insurance.com is already a reality in Canada and promises to become an important aspect for insurance companies of their distribution strategies.

The following web sites may provide some assistance to insurance companies and brokers:

OSFI:

www.osfi-bsif.gc.ca

FSCO:

www.fsco.gov.on.ca

NAIC:

www.naic.org

RIBO:

www.ribo.com