Most of the auto insurance industry has for several years been trying to convince North Carolina’s lawmakers to eliminate the last vestiges of the once-common “rate bureau” system, under which the government ordains that companies must use rates set by a collusive cartel.

The current legislative session offered an opportunity to begin unwinding that system through a bill that would allow auto insurance companies to fashion their own definitions of “safe driver” and to treat them accordingly. Alas, it was yanked from the state House Insurance Committee earlier this month and sent to the Rules Committee, where the leadership can dispatch it for the rest of this session.

As written, it was not the bill the insurance industry had hoped to pass anyway, which ideally would have been one that allowed some flexibility in rating and in coverages offered. In the financial services world, insurers are generally not the companies prone to bet the farm or the business on an unproven strategy. But it’s fair to say that they are much more willing to experiment with rates that might attract good customers when they have more flexibility in rating.

By current law, the government decides who can be considered a safe driver in North Carolina, limiting the definition to a person with at least two years of driving experience and no moving violations for the last three years. Since the government-ordained rate for “clean risk” drivers doesn’t actually cover their losses, there is a mandated surcharge added onto the rate that the companies recover to keep them from going out of business. The surcharge is not set out in the premium notice, so most drivers have no idea that they are paying into a fund that equalizes rates for these government-defined “clean risk” drivers with those who are actual safe drivers in the real world, as defined by their aggregate loss costs.

North Carolina maintains a state-backed reinsurance facility for its mandatory auto liability insurance, which serves as the state’s residual market. Auto insurers must provide required coverages to all eligible risks, but for policies they would not willingly take on, they can hand the risk off to the reinsurance facility and just provide administrative services to the policyholder. Between 20 and 25 percent of the liability policies sold in the state are handed over to the facility, which represents about 80 percent of all of the auto insurance residual market policies in the United States.

The companies who argue to change the North Carolina system cite the lack of transparency about the clean risk surcharge and the fact that North Carolina is the only state with a rate bureau that sets auto liability rates for the entire industry. They say that discounts and innovative products widely available in all other states are out of reach for North Carolina drivers because of the government system, and that both the hidden fees and the lack of competition cause rates to be higher for good drivers than they should be.

Opponents note that the surcharge currently is less than $20 per car and that it allows for market stabilization. They point out that North Carolina generally has average rates among the bottom 10 states and suggest this demonstrates that no change is needed. They also argue that the ability to compare policies is enhanced, since all companies are forced to offer the same coverages, and that a loosening of the mandated uniformity of forms would confuse customers.

Of course, all rates are guesses.  The insurance industry is the only major business around that sets the price of a product before the cost is determined.  The most sophisticated guesses are based on the ability to digest large amounts of information that can predict losses.  If an insurer is limited in what data it can use to set rates, the smart thing to do, if one wants to stay in business, is to guess high.

We come down on the side of more competition. Since every auto liability rate charged in the state is built on the government-defined base, none of the permutations are able to deliver either what good drivers deserve or what lousy ones do. Insurers in the state continue to earn decent returns overall, because average rates are due to the legal climate, the weather and the state’s culture. But governments are not particularly good at assessing risk, and there are plenty of checks on excessive rates should a competitive system somehow fail. North Carolina has an elected insurance commissioner, for one thing.

Even though there does not seem to be the kind of crisis that ordinarily would move the Legislature to action, North Carolina should let the experts make rates. A hidden subsidy-rigged system that guarantees insurer profits and in which more than 20 percent of the state’s drivers cannot get an auto insurer to commit to them voluntarily needs to be modernized.

Image by Artamonov Yury

Featured Publications