The Impact of Rate Regulation on Claims Costs: Evidence from Massachusetts Automobile Insurance By Richard A. Derrig Opal Consulting, LLC Sharon Tennyson Department of Policy Analysis and Management Cornell University ARIA Annual Meeting, Quebec City, Canada August 5-8, 2007

Impact of Rate Regulation THEORY Rate regulation systems typically result in premium subsidies –Some consumers pay premiums lower than those they would receive based on actuarial considerations alone Subsidies distort incentives –Subsidy receivers buy more insurance and participate more If subsidies go to high-risks average losses increase –Subsidy systems distort claiming and safety incentives by dampening response of premiums to loss costs Increase in accidents and claims leads to higher average losses HYPOTHESIS: In the aggregate, subsidies drive overall costs higher

Impact of Rate Regulation PRIOR LIT Cost or cost growth is higher in rate-regulated states –Harrington & Danzon (2000) –Barkume and Ruser (2001) –Tennyson, Weiss & Regan (2007) Cost growth is higher in risk classes for which residual market share is higher –Danzon & Harrington (2001) THIS PAPER: Uses data from Massachusetts auto market to more directly link subsidies to cost growth

Massachusetts Auto Insurance Regulations State-set rates Limits on rating factors –Only 9 driver classes Explicit subsidies –Rate capping: limits on rate differences across rating cells –Rate tempering: limits on rate increases for each cell –No residual market surcharges allowed

Impact of Rate Regulation DATA & TESTS State-level data on average loss costs (from NAIC) –50 states, –Before and after Massachusetts cross-subsidy increases (1978) Hypothesis test: –Massachusetts’ loss costs will be higher than otherwise predicted during periods when cross- subsidies are present

Impact of Rate Regulation DATA & TESTS Massachusetts town-level data on loss costs for five auto coverages (from Mass AIB) –360 towns –Biennial data –Link with town subsidy status Hypothesis test: –Loss cost growth will be higher in subsidized towns than in other towns

State Data

State Data ESTIMATION RESULTS Regression estimates show 43% Higher Loss Costs for MA for Significant at 1% level after controlling for Traffic Density, Medical Costs, Income, Rate Regulation, No Fault/Add On, Minimum Limits, NF/Add On Maximum, State Fixed Effects, Year Effects

Town Data - BIL

Town Data - PDL

Town Data ESTIMATION RESULTS Regression estimates show cost growth higher for Subsidy Receiving Towns Significant at 5% level or better for each of the five Coverage Lines after controlling for Lagged Cost, Traffic Density and Demographic Changes

Conclusions This preliminary evidence suggests that Massachusetts cross-subsidy system leads to higher loss costs Additional data (more years at state level, more demographics at town level, more detail on town subsidies) will allow hypothesis tests to be refined