How Are Auto Insurance Rates Regulated?

Some of the effects of the various rating laws on insurers are somewhat easier to assess. Experience has shown that the more rigid rate regulatory laws result in long delays in approval of rate filings. Occasionally, rigid regulation also results in regulatory reluctance to approve direct auto insurance rate increases even if they are clearly justified, thus exposing insurers to excessive financial risk or forcing them to abandon lines of business on which they would lose money.

How Rates Are Determined

For example, Massachusetts turned down numerous requests by insurers to increase auto insurance rates in the 1970s while North Carolina imposed a six percent cap on the annual rate increase. Essentially, insurers were barred from collecting sufficient premiums from certain high risk drivers to fund the losses incurred by those drivers and at the same time were barred from raising prices to other drivers sufficient to fund the losses of the high risk groups. Lacking sufficient resources to fund losses, insurers ceased to cover those losses voluntarily.

The greater responsiveness of open-competition laws permits insurers to move more quickly to meet changing circumstances and thus help to stabilize profits. This effect was borne out in the Litzenberger/Nye study which indicated wildly fluctuating profits in highly regulated states and relatively stable profit levels in the open- competition state of California.

Also, any form of prior-approval law places the regulatory authorities under more pressure to hold rates down, since they must actively approve rates before they go into effect. Obviously, the approval of rate increases is not politically popular, and most insurance commissioners obtain their positions through political means, either by direct election or through appointment by an elected governor. Thus, there may be great pressure on regulators to hold rates down artificially, in essence refusing to allow insurers to collect sufficient premiums to fund their losses. Open-competition law7s, by removing the requirement of active approval of rates, take away some political pressure to hold rates down artificially.

Generally, auto insurers prefer competitive rating laws, because they involve less bureaucratic hassle, make it easier to maintain rates that are consistent with costs, contribute to greater profit stability, and help insurers to keep their business more manageable and predictable. In noncompetitive states, insurers are exposed to the constant threat that a refusal by state authorities to approve adequate rates will cause them to operate without sufficient profits to attract needed capital, a negative business condition, which, if allowed to continue long enough, will drive them from the market entirely.

Most insurers, like many others, simply believe, with Adam Smith, that the “invisible hand” of the free market is the best way of assuring at the same time both the health of business and the best possible array of products at the best prices to consumers. In competitive rating states, consumers are assured the lowest possible rates for insurance consistent with costs and more choice about insurers, coverages and policies than in noncompetitive states.


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