The Future of Insurance Regulation in the United States

Consumer Benefits of an Optional Federal Charter: The Case of Auto Insurance

Akey element of most legislative proposals to establish an optional federal charter (OFC) for insurers is that market competition rather than government regulation would set insurance rates. Insurers choosing the federal charter, therefore, would be free to set premiums based on their actuarial calculations of risk and other competitive considerations. The market would discipline insurers and, as in other sectors, would keep premiums in line with claims, other expenses, and a reasonable allowance for profit (taking account of the relative risks involved in underwriting particular kinds of insurance). In fact this is how insurance rates are generally set today in certain lines of insurance that would be affected by OFC legislation, notably life insurance and most commercial lines. Although technically rates for these lines of insurance must be filed with state regulators, in practice regulators rarely challenge them, and insurers are free to charge the rates they file without prior regulatory approval. A notable exception to this general pattern is personal auto insurance, in which many state insurance commissions play a major role in dictating the premiums that insurers charge, and a few state insurance commissions actively set rates.1 The Consumer Benefits of an Optional Federal Charter: The Case of Auto Insurance Robert E. Litan and Phil O’Connor 145 6 1. We concentrate throughout this chapter on personal auto insurance, as distinct from commercial auto insurance, since much of the political concern about insurance rates is confined to the personal auto line. fear that unregulated auto insurance rates would lead consumers in some states to pay more for this insurance than they do now is one of the reasons that some in Congress may be reluctant to include auto insurance, and perhaps personal lines more broadly, in any OFC legislation. Is there really a basis for this concern? Economists who have studied auto insurance regulation consistently conclude that rate regulation distorts the market, rewarding higher-risk drivers, who would pay more without rate controls, at the expense of safer drivers, who would pay less. The average effects—that is, the impact of rate regulation on the average consumer or on all consumers in a given state—seem more ambiguous; while total insurance costs may be suppressed or reduced by rate regulation in the short run, they may be increased over the longer run. The presence of rate regulation can discourage insurers from lowering premiums when claims costs and expenses are falling. Further, the distortion in the rate structure due to regulation fails to discourage the imprudent driving behavior of higher-risk drivers. As a result, rate regulation can raise claims costs, and ultimately premiums, over the long run. Given the strong interest in auto insurance markets and their seeming centrality to the coverage of any OFC legislation that may eventually pass Congress, we concentrate here on what the evidence suggests would be the most likely impact of enabling federally chartered auto insurers to charge rates for auto insurance determined by market competition; that is to say, the question is, What most likely would happen if Congress eventually approves OFC legislation that would extend to auto insurance? By implication, the conclusions reached here also should apply to homeowners insurance.2 The most statistically valid studies of the impact of rate regulation on average premiums are those that control for other relevant factors that may affect rates. The most recent studies of this kind, those reported in a 2002 volume edited by David Cummins and published by the AEI-Brookings Joint Center for Regulatory Studies, establish that the nature and degree of rate regulation has no statistically significant effect on rates over the long run, and indeed, to the extent that rate regulation fails to discourage higher-risk drivers from driving more carefully, may lead to higher rates.3 We summarize the key findings of the Cummins study in the first part of this chapter. 146 robert e. litan and phil o’connor 2. In what follows, we concentrate solely on rate regulation or deregulation and do not address other forms of regulation, such as the solvency of insurers and perhaps some sort of regulation of insurance products or policy forms, that would continue to be appropriate for federally chartered insurers under an OFC system. 3. Cummins (2002). A simpler, though admittedly less rigorous, way to assess the impact of rate regulation on average premiums is simply to compare average premiums, or proxy measures...