Automobile Insurance Deregulation Martin F. Grace Richard D. Phillips Department of Risk Management and Insurance Robinson College of Business Georgia State University

Conclusions Georgia not in a crisis Best time to re-evaluate regulation Benefits from deregulation exist and have been demonstrated in other states. –More companies competing –More commitment to the state More willing to make fixed-cost investments More willing to commit capital Even in times of ‘crisis’

Congressional Testimony of Ernst Csiszar Director, South Carolina Department of Insurance, April 10, 2003 “For years, neither actuarial methodology nor supply and demand had much to do with automobile insurance ratemaking in South Carolina. Politics drove that ratemaking process within our state. Politically, there was never an opportune time to raise insurance prices. This resulted in significant rate suppression. In the short term, rate suppression kept the costs of insurance down. However, in the longer term, insurers were leaving the market because they were unable to secure an adequate rate for their product. Hence, the level of competition within the market decreased. Rate suppression, as well as frequent legislative changes designed to address short- term ills of one form or another, also sent the wrong signals to the market. These provided incentives to consumers to continue to engage in risky behavior (e.g., speeding), because the insurance premiums they paid were artificially low for some and did not accurately reflect their insurance risk. Consequently, in this system, good-risk drivers were subsidizing the insurance of bad-risk drivers.”

Why Regulate? Monopoly High Entry Barriers Informational Problems What do we have in Automobile Insurance? –Monopoly? –Entry Barriers Little to none in Georgia –Informational Problems? Agents, Internet, A.M. Best Georgia has some 367 Private Passenger Auto Insurers in the State. Each has an incentive to sell insurance. There are plenty of agents and internet resources on auto insurance. Why regulate what looks like a competitive market?

Two Major Styles of Regulation Prior Approval Filing –Insurer seeks regulator’s approval prior to a rate being implemented. Competitive Filing –Insurer can price insurance with few or limited restrictions. Note: There may be a distinction to what the law says and how the regulator behaves.

Actual Rate Regulation Laws State made rates Prior approval with a w/o deemer provision Prior Approval with a deemer provision File and use Use and file File only Flex rating Generally Competitive Generally Prior Approval

Evidence of the Impact Auto Insurance Regulation Overall average impact small –Across all regulated states across time, the average regulate price is close to the average price in competitive states Sometimes prices are lower than competitive markets and sometimes prices are higher than competitive markets. The most rigorous study found that prior approval rate regulation had little effect on prices over the period 1970s to the late 1990s. However, regulation, on average, causes other significant distortions –Reduced incentives by insurers to invest which leads to Reduced competition More expensive distribution mechanisms Lower capital contributions –Reduced choice for consumers –Lower levels of innovation –Greater levels of subsidization of high risk drivers (which increases costs in the future). –Great political dissatisfaction with auto insurance. It becomes a salient political issue in a state. In addition, in some states, the impact of regulation caused severe distortions

Source: Scott Harrington, Effects of Prior Approval Rate Regulation of Auto Insurance, in (Cummins ed) Deregulating Property-Liability Insurance: Restoring Competition and Increasing Market Efficiency (Brookings Institution, 2002)

Personal Automobile Loss Ratios GA, SC, IL, and US Source: NAIC and author’s calculations

Personal Automobile Insurance Profits GA, SC, IL, and US Source: NAIC Report on Profitability By Line By State

Personal Automobile Residual Markets GA, SC, IL, and US Source: AIPSO

Number of Personal Automobile Insurers GA, SC, NJ, MA, and IL Source: NAIC and author’s calculations. Includes all insurers writing $100,000 of NPW in personal automobile liability and personal automobile damage insurance.

What Can We Expect From Deregulation? More consumer choice Lower average prices –Regulated prices can be “high” because firms can not raise and lower them as needed, so they tend to choose on the high side. More commitment to state in hard times More product innovation Better incentives

South Carolina Regulatory Regime ProvisionPre-Reform Rates Prior Approval Risk Classification Restricted Public Rate Hearings Yes Limits on Underwriting Restricted Residual Market Subsidies Yes – Paid by insureds Compulsory Insurance Yes

Large Subsidies Went to High Risk Drivers Chart shows loss ratio and average loss cost for drivers in the residual market for bodily injury losses from

Rate Suppression and Subsidies Reduce Incentives to Control Costs Jurisdiction % Increase South Carolina$615.89$ % Average GA, FL and VA$669.48$ % Nationwide$685.56$ % Table shows average automobile insurance premium in 1991 and 1998 for South Carolina, Southeast States, and Nationwide.

South Carolina Today ProvisionPre-ReformPost-Reform Rates Prior Approval Flex-rating Risk Classification Restricted Increased Public Rate Hearings Yes No Limits on Underwriting Restricted Eased Residual Market Subsidies Yes – Paid by insureds Yes Compulsory Insurance Yes No

Sample South Carolina Statistics Post Reform Number of automobile insurance companies –1998 – 88 companies –2003 – 155 companies Size of the residual market –1998 – 600,000 policies –2003 – 340 policies Eliminated subsidies for risky drivers According to the National Association of Insurance Commissioners, average automobile insurance expenditures dropped for SC relative to the nation –1998 – 24 th highest average premium –2001 – 34 th highest average premium