Some insurers' dream of deregulated auto, home pricing

will meet resistance

By STEVE TUCKEY

If personal lines deregulation is the “third rail” of insurance politics, then at least a few federal lawmakers are tempting fate with just such a proposal in their plans to standardize the state-based regulation system.

Members of Congress are racing through a public input process aimed at getting at least some version of the State Modernization and Regulation Transparency Act on the floor this year. The bill is tentatively set for introduction in the House by midsummer. That could be the first official congressional action starting the nation on the path of not only federal regulatory standards and weakened state authority, but also free-floating insurance rates.

Before that can happen, a provision in SMART calling for virtual rate deregulation by federal fiat will have to pass muster with both chambers and the president in the near future.

Neil Alldredge, state advocacy director for the National Association of Mutual Insurance Companies in Indianapolis, Ind., knows rate deregulation–or modernization as he might put it–would not be an easy sell in and of itself.

“If this was in a vacuum, and this was only about rate regulation, it would be a tough hurdle to get this passed in Washington. That is where the people who are most opposed to rate regulation based on competition are most organized,” he said.

In fact, Mr. Alldredge said NAMIC's wariness of the federal charter concept stems in part from its fear of putting rate regulation in federal hands.

National Association of Insurance Commissioners President-Elect Alessandro Iuppa called rate regulation one of the key SMART issues in terms of potential resistance from state regulators. “Often, Illinois is pointed to as the model state. But when we look at what is proposed in SMART, and we look at the Illinois model, we see a fair number of protections that exist in Illinois will be preempted in SMART,” he said.

Last August, Democrats on the House Financial Services Committee succeeded in putting in a two-year interim period when a so-called “flex-rating” scheme will smooth the transition to full deregulation. That approach has been taken in a number of states over the past several years.

The property-casualty insurance carriers, through their trade associations, may be lukewarm toward SMART, in general, but as a mechanism for eviscerating rate regulation, they view it in more favorable terms.

No NAIC president in recent years has been as outspoken in favor of rate deregulation as former South Carolina Commissioner Ernst Csiszar. In fact, early in his truncated term, he took heat for allegedly moving out too far in front of his organization with his free market advocacy.

Suffering no such constraints today as president of the Chicago-area-based Property Casualty Insurers Association of America, he said that SMART, with a virtually free market rate provision, is the answer for an industry that can't wait for the states to come to the conclusion that such a system best serves personal lines consumers.

“Despite the progress in some states, we are not convinced that the states on their own, or through the NAIC, will be able to generate meaningful and systemic changes that we think need to be made,” he said.

In essence, the question comes down to whether home and auto insurance is just another product like toilet paper or sofa beds –or by virtue of the compulsory nature of its purchase, more like a tax best subject to government oversight?

“If the state tells you that you have to have it, doesn't it also have a duty to make sure it is fairly priced?” asked Robert Hunter, insurance director for the Consumer Federation of America.

Mr. Alldredge counters: “The whole argument about why you need price regulation is not reflected in the marketplace. If that were the case, you would have the highest rates in the nation in Illinois, and you don't.”

To Regulate Or Not To Regulate

But to regulate or not to regulate is not exactly the entire question, since states employ a wide gamut of schemes to satisfy–or in most cases simply mollify–interested parties.

Former Illinois Insurance Division Director Nat Shapo, now an attorney in private practice, takes exception to the contention that his state does not regulate auto and homeowners insurance rates. “Both markets are intensely competitive, and so are best regulated by the most ruthless regulator known to man–the law of supply and demand,” he said.

In addition, the Division annually assesses the competitiveness of the market and how consumers are faring.

“The proof is in the pudding,” he said. “State reports, and all national surveys, demonstrate that Illinois has the most companies writing coverage and generally has rates in the middle or lower nationally, even though the urban markets pose a significant risk.”

The other touchstone state in the debate is California, which has a prior approval system by virtue of Proposition 103 passed by the voters in the late 1980s.

“Competition and regulation can work together. That's what makes Prop 103 in California clearly the best regulatory system in the country,” Mr. Hunter said.

State auto rates that have dipped 8 percent since Prop 103's passage, compared to a 30 percent rise nationwide, serve as testament to its efficacy, he said.

J. Stephan Zielezienski, associate general counsel for the Washington-based American Insurance Association, disputes the notion that Prop 103 drove down prices.

“Analyzing the data more closely, we have discovered that the better insurance climate was due to non-regulatory factors such as tougher auto safety standards, coupled with a more favorable tort environment and enforcement of existing law,” he said.

The California Supreme Court decision eliminating third-party bad faith played a much more significant role in the improvement in the state insurance climate. “One could argue that Prop 103 actually trapped and delayed those benefits by establishing a system where insurers had to get approval from regulators for their insurance rates, and any filed rate decrease might make it more difficult to obtain approval of higher rates from the insurance department when loss experience worsened,” he said.

But whatever role Prop 103 played in pricing, it was nonetheless imposed by the voters–a fact which Commissioner John Garamendi forcefully reminded Rep. Mike Oxley of early last year at the outset of the discussion. And thus, it is not an appropriate mark for federal preemption, he said.

As state and federal lawmakers continue their insurance regulatory pas de deux, impressions count for a lot–particularly in the area of just how serious Congress is in bringing SMART to the finish line at 1600 Pennsylvania Avenue.

“At this point I don't think the SMART draft has pushed too many state legislators. They don't take it too seriously since it has yet to be introduced,” Mr. Alldredge said.

Yet while many dismissed SMART's prospects late last year, the diligence with which Reps. Mike Oxley, R-Ohio, and Richard Baker, R-La., have moved through the early vetting process has impressed observers. But the issue will compete with asbestos reform and TRIA extension for legislators' interest, and ultimately, votes, making any predictions now pretty risky.

State Activity

With SMART failing to meet the “sure-thing test,” the industry will continue its drive for deregulation at the state level, where the results have been mixed over the past few years.

“Most state legislators have recognized the need for more marketplace reforms, but they have differed over the exact approach to be taken,” Mr. Csiszar said.

According to the PCI, between 2003 and 2005 Texas, New Hampshire, Oklahoma and South Dakota enacted what are known as “use and file” or “file and use” systems, which are close to the deregulatory mark in varying degrees.

“Other states, including South Carolina, Louisiana and Rhode Island, took the more modest step of enacting flex rating, opening the door for further comprehensive reforms,” Mr. Csiszar said.

Both the NAIC and the National Conference of Insurance Legislators have endorsed varying degrees of commercial deregulation. But only the latter has come out for it on the personal lines side.

“What is so mystifying is that the NAIC clearly understands the benefits that a competitive market can deliver to commercial consumers, but for some reason …can't reach the understanding personal lines consumers would reap the same rewards from a more competitive system,” Mr. Csiszar said.

Consumer Advocate Birny Birnbaum, director of the Austin-based Center for Economic Justice, agrees from a different perspective that the NAIC has not played a significant role in the debate. “The NAIC simply does not have a strong response to the calls for deregulation, in our view,” he said.

To Mr. Birnbaum, the issue goes beyond rate and form regulation to include oversight of risk classification. “For example, flex-rating deals with overall rate level changes of 5 percent or 7 percent,” he said. “But adding a new risk classification factor such as credit scoring can change a consumer's premiums by 200 percent or 300 percent.”

That argument could gain all the more traction as those companies with the more sophisticated risk categories numbering in the hundreds instead of single digits are expected to flourish in the coming years. But those consumer advocates who favored injecting underwriting guideline issues into market conduct reform efforts will find it just as daunting a task to inject them into rate regulation deliberations.

Still Mr. Birnbaum's assertions do underscore the connectivity of all insurance reform issues–and that is particularly true in the case of rate reform, which was first put forth with the understanding that it would be accompanied by a strong system of market conduct. (In the early stages of the debate, that concept was likened to loosening the fire code while buying more fire engines.)

Trauma and Profits

Since the 1999 passage of the Gramm-Leach-Bliley Act reinvigorated rate deregulation efforts, the insurance industry has been traumatized in varying degrees by the Sept. 11 attacks and the fallout from the Spitzer probes that began last year. Many will argue that deregulation will be all the more challenging to achieve with such events in the backdrop.

Mr. Zielezienski has a different view. “Far from stalling the effort, the tragedy of 9/11 and the broker compensation scandal have demonstrated that a state system preoccupied with government price and product controls is one that is not efficient, and that is misfocused,” he said. Under the present state system, insurers are left with a stark choice of either writing, or not writing risks, rather than having flexibility to work with commercial policyholders to provide a wide range of policy options, he added.

Since insurance regulation has been a province of the states for 60 years, only a handful of federal lawmakers have a strong grasp of the industry issues, many insurance lobbyists have noted. And that could come into play in a number of ways in the upcoming debate.

For example, while at first glance it might seem difficult to discern a downside of the property-casualty industry achieving its first underwriting profit in nearly three decades last year, the existence of that profitable result may make crying the rate regulation blues all the more challenging.

“It might complicate matters but the two do not necessarily go together,” Mr. Alldredge said. “Insurance profitability is a very cyclical thing, and so the issue is not about how much money insurance companies make or don't make.”

He also noted that insurer profitability has not been an issue in those states that have looked at deregulation this year.

SMART in general and rate deregulation in particular will need a strong enforcement mechanism since resistance will be strong in the states. Mr. Csiszar suggested, but not advocated, that such a so-called “hammer” might be the imposition of an optional federal charter system if enough states do not get with the program in a specified period of time.

Pullquote:

“If this was only about rate regulation, it would be a tough hurdle to get this passed in Washington.”

Neil Alldredge, NAMIC

“Competition and regulation can work together. That's what makes Prop 103 in California clearly the best regulatory system in the country.”

J. Robert Hunter, CFA

Ernst Csiszar, PCI President

“Far from stalling the effort, the tragedy of 9/11 and the broker compensation scandal have demonstrated that a state system preoccupied with government price and product controls is one that is not efficient, and that is misfocused.”

J. Stephan Zielezienski, AIA

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