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The Impact of Rate Regulation on Claims: Evidence from Massachusetts Automobile Insurance. Sharon Tennyson Department of Policy Analysis and Management Cornell University [email protected] Richard A. Derrig Opal Consulting, LLC [email protected] CAS Spring Meeting

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

Sharon TennysonDepartment of Policy Analysis and ManagementCornell [email protected]

Richard A. DerrigOpal Consulting, [email protected]

CAS Spring Meeting

Quebec City, CanadaJune 16-18, 2008


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Impact of Rate Regulation Massachusetts Automobile InsuranceAGENDA

  • 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


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Automobile insurance Massachusetts 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

Why (now) Do States Regulate P-C Insurance Rates?


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Rate Regulation as Redistribution Massachusetts Automobile Insurance

  • 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


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Efficient Redistribution? Massachusetts Automobile Insurance

  • 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


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Efficiency Consequences: Supply Massachusetts Automobile Insurance

  • 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


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Efficiency Consequences: Demand Massachusetts Automobile Insurance

  • 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


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Implications Massachusetts Automobile Insurance

  • 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


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What is the Empirical Record? Massachusetts Automobile Insurance

  • 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


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Evidence from Massachusetts Massachusetts Automobile Insurance

  • 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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Impact of Rate Regulation on Claims: Massachusetts Automobile Insurance

  • 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


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Impact of Rate Regulation on Claims Massachusetts Automobile Insurance

  • 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


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State Data Massachusetts Automobile Insurance


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Impact of Rate Regulation Massachusetts Automobile InsuranceState by State Estimation

DATA:1972- 1998 NAIC

Coverage Variations

Demographics

Regulation

METHOD: Panel Data Regression Models

Ln(Liab. Loss / W Car Years)


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State Regression Estimates Massachusetts Automobile Insurance

Lst = ß0 + ß1CSYearst + ß2MAsCSYearst + γ’Xst + ß4StateRegsst + ß5StateRegsstCSYearst + as + Tt + εst

CSYears = 1978-1998 or 1978-1995

Test ß2> 0

Control variables = traffic density, cost of hospital stay, per capita income, rate regulation, nofault, PIP limits, compulsory insurance minimums

asand Tt are state and year fixed-effects

Adjust S.E. for arbitrary heteroskedasticityand for arbitrary correlation within state


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State Estimation Results Massachusetts Automobile Insurance


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State Regression Estimates Massachusetts Automobile Insurance

Lst = ß0 + ß1CSYearst + γ’Xst + ß4StateRegsst + ß5StateRegsstCSYearst + as + Tt + εst

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


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Actual – Predicted Losses Massachusetts Automobile Insurance


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Impact of Rate Regulation on Claims: Massachusetts Automobile InsuranceSecond 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


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Town Data - BIL Massachusetts Automobile Insurance


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Impact of Rate Regulation Massachusetts Automobile InsuranceTown 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


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Town Regression Estimates Massachusetts Automobile Insurance

%ΔPPit = ß0 + ß1Subsidyit-τ + ß2PPit + ß3%ΔACRFit + ß4%ΔExposuresit + ß5%ΔDensityit + ß6Bostoni + Tt + εit

Use subsidy from year in which losses were generated

Test ß1> 0

Adjust S.E. for arbitrary heteroskedasticityand for arbitrary correlation within state


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Pure Premium Growth Estimates Massachusetts Automobile Insurance


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Impact of Rate Regulation Massachusetts Automobile InsuranceCalifornia 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


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Impact of Rate Regulation Massachusetts Automobile InsuranceCalifornia 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)


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Papers Massachusetts Automobile Insurance

  • 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


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References (Excerpt) Massachusetts Automobile Insurance

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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