2016 Insurance Regulation Report Card
R Street is dedicated to the mantra: “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 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. 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 markets are not overly concentrated. Insolvencies are relatively rare and, through the runoff process and guaranty fund protections enacted in nearly every state, generally 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. An open and free insurance market maximizes the effectiveness of competition and best serves consumers.
For this year’s report, we have sought to streamline our analysis and have shed a few categories that we’d previously employed in recent versions of the report card. Most notable among these are our analysis of the competitiveness of state workers’ compensation markets and the metrics we’d developed to measure states’ effectiveness in responding to consumer complaints and fraud. In the case of workers’ comp, the divisions in policy choices—four states continue to maintain state-run monopoly systems and a handful of others are dominated by residual markets—ultimately left comparisons somewhat fraught. Monopoly states were strongly penalized on two separate metrics – their concentration and the size of their “residual” markets. Even comparing loss ratios proved near impossible where no private industry coverage was available to draw from. In this report, we preserve some acknowledgement of the undesirability of monopoly or otherwise large state funds under the now separate Residual Markets section, but otherwise limit our focus on market competitiveness to the more standard products of home and auto insurance.
The consumer protection and especially the antifraud metrics were thornier still. Both relied primarily on admittedly crude ratios of insurance department staff devoted to those particular functions to their purported caseloads – consumer complaints and inquiries for the former and questionable claims for the latter. In both cases, it was never fully clear that the comparisons were apt or that the ratios actually represented a progressive function, rather than serving as proxies for other immutable factors, like population and size of state government.
With the antifraud measure, there were two additional confounding factors. One for which prior editions of the report card attempted to correct is that those states that employ no-fault systems of auto insurance tend to experience much higher rates of fraud, and hence employ more fraud inspectors to deal with that problem. The other limitation is with the data itself – the National Insurance Crime Bureau no longer publishes annual state-by-state estimates of questionable claims.
Given these inherent limitations, the decision was made to excise these measurements from this year’s edition of the report, though future editions may revisit the topics if more robust means of measuring which states achieve the greatest results in these areas can be found.
In compiling this year’s report, attempts also were made to find more nuanced ways to examine such issues as how insurance regulators are chosen, the capitalization of state property-casualty insurance markets and how states apply underwriting and rate-setting regulations. Many variables also are measured with more granular separation of performance, rather than grouping sets of similar states together.
The changes no doubt alter the 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 appears to be notable shifts in the landscape of state insurance regulation. Perhaps most notable were the emergence of more significant federal interventions in insurance markets, highlighted by negotiations between the United States and European Union to reach a “covered agreement” that could ultimately pre-empt certain longstanding state insurance rules and the promulgation by the Federal Reserve of capital standards for two sets of insurance groups it oversees under terms of the Dodd-Frank Act – those deemed systemically significant and the somewhat larger group of insurers who own banks or thrifts.
Both developments prompted backlash from state lawmakers, insurance regulators and insurance trade associations that long have opposed federal intervention. How they will play out under a new administration that is notably less sanguine about both international trade and federal regulation will be among the most consequential questions of 2017.
At the state level, we continue to see progress in shrinking residual property insurance markets, which have fallen from $3.39 billion in premium and 3.32 percent of the market in 2011 to $2.20 billion in premium and 1.87 percent of the market in 2015. But the progress hasn’t been even distributed. A startling comparison can be found between the states of Florida and North Carolina. In 2011, Florida’s state-run Citizens Property Insurance Corp. wrote 14.28 percent of the market, while North Carolina’s Beach Plan and FAIR Plan wrote 3.37 percent and 0.62 percent of that state’s market, respectively. As of 2015, Citizens was down to just 5.0 percent of the market, while the North Carolina FAIR Plan was up to 2.16 percent and the North Carolina Beach Plan was up to 7.03 percent.
Not coincidentally, when R Street issued its first regulation report card in 2012, Florida ranked dead last and North Carolina was somewhere in the middle. This year, North Carolina is dead last and Florida is somewhere in the middle.
As it has in years past, 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.
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