Welcome to the fourth edition of the R Street Institute’s Insurance Regulation Report Card, our annual examination of which states do the best job of regulating the business of insurance.
R Street is dedicated to: “Free markets. Real solutions.” Toward that end, the approach we apply in this annual survey is to test which state regulatory systems best embody the principles of limited, effective and efficient government. We believe states should regulate only those market activities where government is best-positioned to act; that they should do so competently and with measurable results; and that their activities should lay the minimum possible financial burden on policyholders, companies and ultimately, taxpayers.
There are three fundamental questions this report seeks to answer:
- How free are consumers to choose the insurance products they want?
- How free are insurers to provide the insurance products consumers want?
- How effectively are states discharging their duties to monitor insurer solvency, police fraud and consumer abuse and foster competitive, private insurance markets?
The insurance market is both the largest and most significant portion of the financial services industry to be regulated almost entirely at the state level (health insurance benefits are something of an exception, as they increasingly come under federal regulation). While state banking and securities regulators largely have been preempted by federal law in recent decades, Congress reserved to the states the duty of overseeing the “business of insurance” as part of 1945’s McCarran-Ferguson Act.
On balance, we believe states have done an effective job of encouraging competition and, at least since the broad adoption of risk-based capital requirements, of ensuring solvency. As a whole and in most individual states, U.S. personal lines and workers’ compensation markets are not overly concentrated. Insolvencies are relatively rare and, through the runoff process and guaranty fund protections enacted in nearly every state, quite manageable.
However, there are certainly ways in which the thicket of state-by-state regulations leads to inefficiencies, as well as particular state policies that have the effect of discouraging capital formation, stifling competition and concentrating risk. Central among these are rate controls.
While explicit price-and-wage controls largely have fallen by the wayside in most industries (outside of natural monopolies like utilities), pure rate regulation remains commonplace in insurance. Some degree of rating and underwriting regulation persists in nearly every one of the 50 states. This is, to a large degree, a relic of an earlier time, when nearly all insurance rates and forms were established collectively by industry-owned rate bureaus, as individual insurers generally were too small to make credible actuarial projections. McCarran-Ferguson charged states with reviewing the rates submitted by these bureaus because of concerns of anticompetitive collusion. With the notable exception of North Carolina, rate bureaus no longer play a central role in most personal lines markets, and many larger insurers now establish rates using their own proprietary formulas, rather than relying on rate bureau recommendations.
Regulation also may, in some cases, hinder the speed with which new products are brought to market. We believe innovative new products could be more widespread if more states were to free their insurance markets by embracing regulatory modernization. The most recent illustration of this challenge can be seen in the approaches different states have taken to enable the timely introduction of commercial and personal policies to cover risks associated with ridesharing, as well as the more limited initiatives in some states to foster private options for flood insurance. We believe an open-and-free insurance market maximizes the effectiveness of competition and best serves consumers.
For this year’s report, we have adjusted the weightings of some categories and incorporated new data sets into our analysis, most notably in the use of capitalization ratios to gauge the solvency of property/casualty insurance markets. We also have jettisoned some factors – such as last year’s category tracking states’ adoption of various “regulatory modernization” initiatives – whose measurement, we concluded, ultimately required too many subjective judgment calls.
The changes no doubt alter how some states would otherwise score, but a greater portion of the sometimes significant changes in this year’s grades are a reflection of what appear to be notable shifts in the landscape of state insurance regulation. Reviewing the data on insurance in 2015, we see a mix of positive and negative trends.
States that for, for years, allowed excess risk to build up on the backs of taxpayers, such as Florida and Louisiana, have made profound progress in shrinking the size of their residual property insurance markets. The shift in Florida has been so notable, including the success of the “glide path” to bring the state-run Citizens Property Insurance Corp. back to actuarially appropriate rates, that we have reassessed how to score the rate-making freedom that state now extends to private insurers.
Even in the dysfunctional Michigan auto insurance market – where a misguided version of the “no fault” system requires all auto insurers to pay uncapped lifetime medical benefits – we can see light at the end of the tunnel. Reform efforts once again gained momentum, before ultimately falling short. But perhaps more notably, for the first time in years, Michigan auto insurers were able to collect more in premium than they paid out in claims.
We also see some markedly and alarmingly negative trends. To start, North Carolina’s residual markets – both in the home and auto insurance markets – continued to grow, bucking Florida’s example. Lawmakers in Texas and Hawaii also passed legislation that would allow their residual property insurance markets to grow larger still.
There was a renewed push by consumer groups and some regulators to limit the use of factors like credit, education, occupation and marital status in underwriting and rate-setting, despite demonstrated proof that these factors are predictive of risk. Relatedly, a practice that would hardly raise an eyebrow in other industries – considering the elasticity of consumer demand in setting prices – prompted a raft of regulatory bulletins and calls to ban the practice of so-called “price optimization.”
In Oklahoma, an elected insurance commissioner issued what appears to be a politically motivated threat to crack down on insurers who invoke exclusions of man-made earthquake claims in cases where the underwriters believe they were related to deep-well injections.
And even in Illinois, long a free-market beacon for allowing rates to be determined purely by market forces, the state’s General Assembly came awfully close to voting in a prior-approval system for workers’ compensation insurance.
The regulatory landscape is changing. We hope this report captures how those changes may impact both the industry and insurance consumers in the days to come.