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The Impact of Rate Regulation on Claims: Evidence from Massachusetts Automobile Insurance

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Title: The Impact of Rate Regulation on Claims: Evidence from Massachusetts Automobile Insurance


1
The Impact of Rate Regulation on Claims Evidence
from Massachusetts Automobile Insurance
  • Sharon Tennyson Department of Policy Analysis and
    Management Cornell University st96_at_cornell.edu
  • Richard A. Derrig Opal Consulting,
    LLC Richard_at_derrig.com

CAS Spring Meeting Quebec City, Canada June
16-18, 2008
2
Impact of Rate Regulation AGENDA
  • Regulation and Competition The Rationale and
    the Reality
  • A Little Theory and Practice
  • Auto Insurance Brookings/AEI Case Studies
  • The Case of Massachusetts
  • Implications for California

3
Why (now) Do States Regulate P-C Insurance Rates?
  • Automobile insurance
  • Homeowners insurance
  • Workers compensation insurance
  • Medical malpractice insurance
  • Mandatory or socially desirable insurance
  • Uninsured parties shift financial risk to others
    in society
  • Some consumers face high prices
  • Some markets experience price shocks

4
Rate Regulation as Redistribution
  • Not equally practiced in all regulated states or
    lines
  • Some regulated states lightly regulate voluntary
    market rates
  • Residual market rates are regulated in all states
    and lines
  • Implications of redistribution
  • Price subsidies for some consumers
  • To high risk consumers From low risk consumers
  • To high risk consumers From insurance company
    capital
  • To all consumers From insurance company capital

5
Efficient Redistribution?
  • Not Likely
  • Not Sustainable
  • The Problem
  • Competitive Market Forces
  • Attempts to move prices a significant distance
    from competitively-determined prices will distort
    market functioning
  • Company responses to regulation
  • Consumer responses to regulation
  • Regulator responses to the responses

6
Efficiency Consequences Supply
  • Rate suppression distorts insurance supply
  • Decreased writing of voluntary coverage
  • Reduced innovation and quality of service
  • Reduced entry of firms
  • Increased exit of firms
  • Rate uncertainty distorts insurance supply
  • All of the above effects
  • Price stickiness and market volatility

7
Efficiency Consequences Demand
  • Rate subsidies distort consumer behavior
  • Insurance demand
  • Increased demand from high risk consumers
  • Decreased demand from low risk consumers
  • May cause low risk consumers to forego insurance
  • Safety incentives
  • Prices are less responsive to changes in
    losses/risk
  • Claiming incentives
  • Prices are less responsive to changes in
    losses/risk

8
Implications
  • Stringent regulation of insurance rates produces
    unintended effects
  • Reduced competition
  • Higher cost inflation
  • Lower insurance availability
  • Greater market volatility
  • Regulated outcomes may even be contrary to the
    regulatory objectives pursued

9
What is the Empirical Record?
  • On average and over the long run, rate regulation
    has little effect on average loss ratios
    (Harrington, 2002)
  • Not necessary for market functioning
  • Creates uncertainty and costly compliance
  • In states and markets where rate regulation is
    stringently applied, empirical studies find
    effects supportive of theory
  • In states and markets where stringent rate
    regulation is dismantled, empirical studies find
    effects supportive of theory

10
Evidence from Massachusetts
  • State regulation of private passenger auto
    insurance rates has created widely-recognized
    market problems
  • Exit of insurance providers, especially national
    firms
  • Small number of suppliers
  • Larger than normal residual market at times
  • Cost inefficiencies
  • Politicized ratemaking environment
  • Less recognized problem In the aggregate,
    regulation drives overall claims costs higher

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14
Impact of Rate Regulation on Claims
  • First Cut State-level data on average loss costs
  • 50 states
  • 1972-1998 (before and after Massachusetts
    effective subsidies)
  • Hypothesis Massachusetts loss costs will be
    higher than otherwise predicted during period of
    stringent regulation

15
Impact of Rate Regulation on Claims
  • Second cut Massachusetts town-level data on
    loss cost levels for 5 coverages
  • 360 towns
  • Biennial data 1999-2007
  • Hypothesis Loss cost growth higher in subsidized
    towns than in other towns

16
State Data
17
Impact of Rate Regulation State by State
Estimation
  • DATA 1972- 1998 NAIC
  • Coverage Variations
  • Demographics
  • Regulation
  • METHOD Panel Data Regression Models
  • Ln(Liab. Loss / W Car Years)

18
State Regression Estimates
  • Lst ß0 ß1CSYearst ß2MAsCSYearst ?Xst
    ß4StateRegsst ß5StateRegsstCSYearst as Tt
    est
  • CSYears 1978-1998 or 1978-1995
  • Test ß2 gt 0
  • Control variables traffic density, cost of
    hospital stay, per capita income, rate
    regulation, nofault, PIP limits, compulsory
    insurance minimums
  • as and Tt are state and year fixed-effects
  • Adjust S.E. for arbitrary heteroskedasticity and
    for arbitrary correlation within state

19
State Estimation Results
20
State Regression Estimates
  • Lst ß0 ß1CSYearst ?Xst ß4StateRegsst
    ß5StateRegsstCSYearst as Tt est
  • Estimate identical model specification without MA
    data or MA interaction term
  • Apply estimated coefficient vector to
    Massachusetts variable values, 1972-1998
  • Obtain predicted value of Massachusetts loss
    costs for each year
  • Compare Actual Predicted value

21
Actual Predicted Losses
22
Impact of Rate Regulation on Claims Second Cut
  • Panel of Massachusetts town-level data on loss
    cost indices for 5 coverages from AIB
  • 360 towns
  • Biennial data 1999-2007
  • Pure premium index
  • Average class rating factor
  • Hypothesis Indices will grow faster in
    subsidized towns than in other towns

23
Town Data - BIL
24
Town Data - PDL
25
Impact of Rate Regulation Town Level Estimation
  • DATA 5 coverage Town Data
  • AIB Territory Filings
  • Rate Subsidies All Years
  • Town Index Bayesian Estimate/
  • Class Normalized (ACRF)
  • METHOD Regression Models on Town
  • Relativity Growth

26
Town Regression Estimates
  • ?PPit ß0 ß1Subsidyit-t ß2PPit
    ß3?ACRFit ß4?Exposuresit ß5?Densityit
    ß6Bostoni Tt eit
  • Use subsidy from year in which losses were
    generated
  • Test ß1 gt 0
  • Adjust S.E. for arbitrary heteroskedasticity and
    for arbitrary correlation within state

27
Pure Premium Growth Estimates
28
Impact of Rate Regulation California Auto
Territories
  • PROP 103 (1989) Driving History Emphasized for
    Relative Pricing Mandatory and Optional Classes
  • April 2006 Change Territory must be less
    important than Mandatory Prop 103 Factors
    Annual Mileage, Driving Safety Record, Years
    Licensed
  • Implementation gradual full for 7-1-08
  • Effect yet to be seen but moves away from
    cost-based must introduce Mass-like subsides
    varying by insurer
  • Rural to Urban, High Income to Lower Income,
  • High Cost to Low Cost

29
Impact of Rate Regulation California Auto
Territories
  • April 2006 Change Optional Territory Frequency
    and Territory Severity (and 14 others) must each
    be forced to be less important (less relativity
    weight) than Mandatory Prop 103 Factors Annual
    Mileage, Driving Record, Years Licensed
  • DOI Study Showed 3 Scenarios that implied
  • Increases for 53 of 58 Counties (High
    37,Low 1.3)
  • Decreases for 5 of 58 Counties (High
    -0.5,Low -12)
  • LA Zips (High 6, Low -11),
  • Beverly Hills Zips (High -10, Low -23)
  • Corr Prem to LossPP, (Current 0.75, New
    0.725 to 0.62)

30
Papers
  • R.A. Derrig and S. Tennyson (2008), The Impact of
    Rate Regulation on Claims Evidence from
    Massachusetts Automobile Insurance,
    www.casact.org, Spring Meeting, Quebec City,
    Discussion Paper Program.
  • S. Tennyson (2007), Efficiency Consequences of
    Rate Regulation in Insurance Markets, Networks
    Financial Institute Policy Brief,
    www.networksfinancialinstitute.org

31
References (Excerpt)
  • Automobile Insurers Bureau of Massachusetts,
    Actuarial Notice -2 Subsidies in the Rates,
    Boston, MA AIB. Various years.
  • Automobile Insurers Bureau of Massachusetts,
    2006, AIB Recommendations for 2007 Private
    Passenger Automobile Insurance Territory
    Definiitons, MA DOI Docket R2006-03, May 15.
  • Blackmon, B.G. Jr. and R. Zeckhauser, 1991,
    Mispriced Equity Regulated Rates for Auto
    Insurance in Massachusetts, American Economic
    Review, 81 65-69.
  • Burnes, N.S., 2007, Opinion, Findings, and
    Decision on the Operation of Competition in
    Private Passenger Motor Vehicle Insurance in
    2008, Massachusetts Division of Insurance Docket
    No. R2007-03, July 16.
  • Conger, R.F., 1988, The Construction of
    Automobile Rating Territories in Massachusetts,
    Proceedings of the Casualty Actuarial Society,
    71 Part 1, 1-74.
  • Derrig, R.A.,1993, Price Regulation in US
    Automobile Insurance A Case Study of
    Massachusetts Private Passenger Automobile
    Insurance 1978-1990, The Geneva Papers on Risk
    and Insurance, 18 158-173.
  • Derrig, R.A., and Hilary N. Rowan, 2006, Written
    testimony of The California Farm Bureau,
    California Department of Insurance, Proposed
    Amendment of Title 10 of California Code of
    Regulations, Section 2632.8 Optional Auto
    Insurance Rating Factors, CDI File RH 03029820.
  • DuMouchel, W.H., 1983, The Massachusetts
    Automobile Insurance Classification Scheme, The
    Statistician, 32 69-81.
  • Rottenberg, S., 1989, The Cost of Regulated
    Pricing a Critical Analysis of Auto Insurance
    Premium Rate-Setting in Massachusetts, Boston
    Pioneer Institute for Public Policy Research.
  • Tennyson, S., 1997, The Impact of Rate Regulation
    on State Automobile Insurance Markets, Journal of
    Insurance Regulation 15 502-523.

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