Academic journal article Journal of Risk and Insurance

Rate Suppression

Academic journal article Journal of Risk and Insurance

Rate Suppression

Article excerpt

"Rate suppression" can be defined broadly as government suppression of insurance rates below levels that would exist without price regulation. For some time now, the property-liability insurance trade press and other industry publications have contained many stories suggesting that regulation has suppressed auto insurance rates in a number of states. Attention has recently turned to rate suppression in workers' compensation insurance and it often is suggested that rate suppression in both lines has become chronic in some states (e.g., Kramer, 1991).

This article considers why some insurance markets may be especially vulnerable to rate suppression. I assume throughout that significant increases in insurance costs produce strong political pressure for reducing rates or limiting rate increases.(1) What is less clear is how this pressure can produce chronic rate suppression. Given the competitive structure of these markets, persistent rate suppression should produce reductions in product quality or exit by insurers. Both possibilities should discourage rate suppression. If quality responses are constrained, the threat of widespread exit alone should give politicians and regulators considerable pause before persistently suppressing rates.

As it stands, the evidence on exits is somewhat puzzling. While significant exit has occurred in some states (see below), it has not really been rapid or truly widespread in any state. It is possible that stories of rate suppression are simply fiction, but this is hard to reconcile with adverse underwriting results and exits that have occurred. Another possibility - that rates are suppressed, but only to levels that provide a fair rate of return - is also difficult to reconcile with long-run equilibrium in a competitively structured industry.

The next section discusses the evolution and forms of rate suppression and summarizes evidence of rate suppression. This is followed by brief discussion of why reductions in product quality are unlikely to prevent significant rate suppression. Two possible explanations of why rate suppression also need not be deterred by the threat of immediate and widespread exit are then considered. I first discuss the possible role of appropriable quasi-rents that arise from state-specific investments involved in the production of insurance. I then consider the ability of government to establish or mandate cash flow insurance plans - that is, "pay-as-you-go" insurance - rather than fully funded coverage. The likely adverse effects of these policies on insurance markets are discussed in both cases.

Background

My analysis focuses on aggregate (or statewide) rate suppression, which I define as a reduction of total premium revenues for all coverage sold in a given line and state below the level that would exist without price regulation. Aggregate rate suppression can occur if average rate increases are not permitted to keep pace with statewide increases in costs. It also can occur if rates are selectively reduced for certain groups of insureds in a given line without an offsetting increase in revenues for other groups (see Harrington, 1990). In principle, cross-subsidies from selective rate suppression can occur without aggregate rate suppression.(2) In what follows the term rate suppression refers to aggregate rate suppression unless otherwise noted.

Between the enactment of the McCarran-ferguson Act in 1945 and the late 1950s, the clear emphasis of rate regulation in most states was on setting minimum rate levels (see Joskow, 1973, and Hanson, Dineen, and Johnson, 1974; also see Kramer, 1991). During the 1960s and early 1970s two distinct trends emerged. First, some states moved towards greater reliance on competition rather than rate regulation. Second, and in direct contrast, the focus of auto insurance rate regulation in a number of other states became affordability of coverage and suppression of rate increases in the face of rising claim costs, especially in high-cost urban areas. …

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