Pulling out the dents in Bay State auto insurance

from NEWSLINK, Vol. 8, No. 2, Winter 2004

Without competition and market pricing, the consumer loses

When Anne Higgins heard one of those ubiquitous GEICO ads on the radio, she decided to call the company to see if she could get a better rate on her auto insurance. Higgins is the dream client for most insurance companies: she lives in a low-risk neighborhood, has a good driving record and pays her bills in a timely manner. “I just pay the bill once a year, it’s cheaper that way,” she says.
But much to her dismay, the retired federal employee from North Andover learned that the innovative auto insurance carrier decided long ago not to enter the Massachusetts market. Anne got a lesson in the economics of auto insurance in the Bay State: that government meddling often makes things worse for consumers.

Making the news even more unpleasant for Anne, the insurance commissioner welcomed in the New Year by approving a 2.5% increase in auto rates for 2004. The increase, which became effective January 1, results in an average increase of $25.51 per vehicle, giving Massachusetts the 4th highest average premium in the country at $1,028.62. (See chart nearby.)

In Massachusetts there are many distinctions we’d like to live without: high housing costs, high taxes, high fees and high energy costs. But nothing draws the ire of Massachusetts consumers like high auto insurance premiums. That’s because there’s little that motorists can do about cutting their auto insurance rates. We can make choices to lower the cost of housing (buy less of it or move to different communities with lower property values and property taxes), avoid high taxes (work less or shop in New Hampshire), and pay less for energy (consume less by turning down the thermostat and by using alternate forms of transportation). But there’s nothing we can do when it comes to auto insurance since residents are captive to the Rubik's cube of highly-regulated private insurance companies, busy-body government and the competing interests of insurance agents, auto body shops and so-called consumer advocates.

At the center of the auto insurance mess, (no surprise) is the state government. Massachusetts takes the mantle as the most over-regulated auto insurance system in the country. It is the only state where the insurance commissioner has the authority to “fix and establish” the rates for private passenger auto insurance, when the commissioner deems the market “uncompetitive.”

Like the guest who won’t leave the party, the commissioner never finds it convenient to declare the market competitive. The last time a commissioner deemed the market to be “competitive” was 30 years ago. But claims of competitiveness are a fig leaf. The rates are never determined by the market; they are made on Beacon Hill after careful consideration of all the players, including the Automobile Insurers Bureau, the State Rating Bureau, the Attorney General’s Office, and of course motorists “who want something done about the problem.” The insurance commissioner dictates the maximum rates that insurers may charge drivers, based on certain risk factors, and where the driver lives. And presto! Massachusetts has its very own government mandated auto insurance rate.

“To the outsider, Massachusetts is the nation’s best example of an auto insurance regulatory scheme gone mad,” says Brian Sullivan, editor and publisher of Auto Insurance Report, an industry newsletter. “Insurers can’t set prices to reflect the risks posed by different drivers. They can’t even pick their customers. In many cases they can’t pick their agents. The state sets the prices – for everyone. It sets agent commissions, too."

Over the years, the Commonwealth’s auto insurance system has become a morass of bad incentives, and the strict regulation has served as a disincentive for insurers who might otherwise consider entering the insurance market in Massachusetts. By making it difficult to do business in the state, many insurers will, and do, avoid selling policies here. While consumers in other states enjoy the benefits of dealing directly with firms such as GEICO and Progressive, Massachusetts motorists are left with few choices. Motorists in other states have more choices, compared to the 20 choices currently available through agents across the Commonwealth, none of which are the larger national providers.

Throughout the United States, State Farm and Allstate have a market share in the auto insurance field of 19% and 13%, respectively. GEICO, the company with the better TV commercials, is the fifth largest private passenger automobile insurance company, providing in excess of 5.3 million auto policyholders with more than 8.6 billion cars covered throughout the United States. Yet none of these companies competes in Massachusetts because of the arcane regulatory policies supposedly set up to keep the market competitive.

And while it may not be politically correct to say so, auto insurance companies don’t make much money. Massachusetts produces a 2.5% net loss for the industry according to Sullivan. When it underwrote (note the past tense) policies in the Bay State, Allstate, for example, lost $115 million over the last five years of their stay, largely because of the ‘’unique regulatory environment’’ within the state. This all sounds complicated and inefficient, but the state’s big players do find a way to make a satisfactory profit. “Commerce Group Insurance is acting rationally in the market place before it,” says Sullivan. “They’re smarter.”

Tight restrictions; no refusals

When fewer companies offer insurance, prices go up, leading to political pressures from motorists who decry the latest premium increase. Public officials move to socialize the risks associated with bad drivers – ostensibly spreading the costs of auto insurance to everyone – including good drivers from Boston to the Berkshires. This mechanism is known as the “residual market.” In an attempt to alleviate high premiums, Massachusetts operates an elaborate rating system to subsidize the cost of insuring “undesirable drivers.”
Massachusetts law denies the right of insurers to refuse to sell policies to high-risk drivers. That means any customer that walks into an insurance agency must be placed with an insurer no matter what kind of risk that driver poses. These agents have no incentive or ability to turn down problem drivers.

Under the Commonwealth Automobile Reinsurers (CAR) program, which oversees the residual market drivers, insurance for drivers who are considered high risk is subsidized by other drivers through contributions made by companies to a high-risk pool. These insurers shift high risk drivers to a pool. The insurers pass along selected drivers to this program and pay into the CAR program based on their use. The more drivers they shift to CAR, the more they pay into it. In its current form, this high risk pool penalizes insurance carriers for shuttling these very same drivers beyond an assigned quote. But the current insurance firms have found a way not to directly insure high risk drivers. “It is very important to realize this is a zero-sum game,” remarks Sullivan. “If one company succeeds in beating the system, carrying a relatively light load, another company must have a comparatively large burden to shoulder.”
Massachusetts does not charge these drivers any kind of additional premium for this placement in CAR. Because the premiums charged to drivers in this high-risk pool cannot cover the costs of these drivers, this cost deficit is passed along to safer drivers who must pony up for their less-safe counterparts.

In their study of the Massachusetts rate-setting system, B. Glenn Blackmon Jr. and Richard Zeckhauser of the John F. Kennedy School of Government at Harvard University note that the subsidies are not just between suburban and urban drivers as some believe. Middle-aged drivers subsidize young drivers, and older, experienced drivers subsidize the inexperienced drivers. Women drivers subsidize men and voluntary market drivers subsidize CAR drivers. How extensive are the subsidies? The authors estimated that consumers that were neither in CAR nor in a subsidized territory paid as much as $427 per year to subsidize riskier motorists.

Within these subsidy processes, state regulators often like to gloss over the realities of local conditions for philosophical reasons. For example, state regulators deliberately force insurers to under-price coverage in urban areas, compelling them to make up their losses by charging more to drivers in the suburbs or rural areas. To keep rates “affordable” in Roxbury for example, regulators increase the premiums paid in lower risk communities such as Wrentham. Roxbury has thus emerged as the most subsidized territory in Massachusetts. In 2003, an average policyholder in Roxbury could receive a hidden subsidy of up to $1,159 to cover the true cost of insuring a vehicle there. To the average policy holder in Wrentham that means an additional $66 per year. The problem is that the Wrentham motorist has little or no idea that this transfer is taking place.

It is true that urban roads are more congested, less suited for larger vehicles and home to younger drivers. But the price of insurance premiums should reflect the cost of the higher risks of urban living such as auto theft. (Efforts to prosecute cases of fraud have diminished in recent years despite the state’s insurance industry subsidy of a special prosecutor in the Attorney General’s office.)

While drivers in Boston probably don’t mind this arrangement, it could hardly be considered fair or equitable to the lower-risk suburban drivers. “Once you get away with using the pricing system for social purposes you create distortions and then correct those distortions,” Sullivan tells NewsLink, “It’s a never-ending spiral of tinkering.” Discounts are a case in point.

In response to calls for action on behalf of beleaguered consumers, regulators have prodded insurance companies to offer discounts. Heeding this call a few years ago, and in an effort to capture market share as well, most companies aggressively offered safe driver discounts. But lately they’ve been retreating on this practice. Another discount option, group rates are not available to everyone.

So what do we do? Those who want reform will have to wait for a consumer revolution, the tipping point at which consumers say, “I’m done, I’m not going to put up with this anymore.” In New Jersey, which is now moving to a more liberalized price and risk-setting structure, public officials took action only when State Farm Insurance pulled out of the state; a move that threatened to up-end the balance of the entire market. Even in New Jersey, where the lesson of Massachusetts' last impatient foray of a true competitive system was taken into consideration, the Garden State has slowly lifted the veil of the past socialized system to expose the market to open competition. Unfortunately, change in Massachusetts will only take place when discontent breaks out.

According to industry observers like Sullivan, one way to improve any system would be to remove the “hidden subsidies.” Motorists would have a better idea with an honest process that identifies just how much they are paying to cover high-risk drivers in certain territories. The Boston Globe recently noted that in 2000 the rate of property damage claims per 100 insured drivers was 6.88 in the Commonwealth, the highest in the United States, for comparison Connecticut was only at 4.37 per 100. That is quite a bit of accidents and risky drivers on Massachusetts roads that are costing the rest of us some serious money, unbeknownst to us of course.

With or without more clarity in the system, all seemingly good things must come to an end, even special breaks for bad drivers. Soon companies will no longer be able to subsidize Massachusetts through profits earned in other operations in other more competitive states. Increased crackdowns on fraud, discounts for good drivers, or even discounts for MBTA passes are poor substitutes for genuine pricing and risk assessment that’s sorely needed.

Markets can’t eliminate every unfortunate human experience in car insurance access, affordability, and quality. But new technologies such as the Internet can empower consumers. Unlike centralized and overregulated government “solutions,” free markets don’t guarantee perfect outcomes, just better ones.

What do you think about the state's auto insurance system? Register your opinion on BHI's Pulse Poll at www.beaconhill.org today!

Updated on 03-Mar-2004 10:16