How Illinois, a jurisdiction not usually associated with a strong commitment to free-market principles, became the first state in the nation to allow its insurance rates to be completely controlled by open competition is an accident of history
In 1970, continuing a trend followed by many states in the 1960s, the Illinois General Assembly moved to replace the state’s existing “prior approval” system for regulation of property casualty rates—originally adopted in 1947 after The US Supreme Court decision in United States v. South-Eastern Underwriterswhich found that insurance does, in fact, constitute interstate commerce—with a “file-and-use” system.
Under the new system, insurers can start using the rates they file with the regulator even before receiving an outright approval or disapproval. The only catch were industry agreements to adhere to rates set by a rating bureau—exactly the type of collusion discussed in Underwriters in the South-East—is absolutely forbidden.
A year later, in August 1971, the law and the legislature were set to sink neglected to extend it. The result, whether intended or not, is that Illinois has become the only state in the nation without an insurance rating law. And it remained so (in a few minor exceptions) for a trial of 52 years.
Under HB 2203, for a hearing today before the Illinois House Insurance Committee, each insurer that intends to offer private passenger motor-vehicle liability insurance in the state must file a complete rate application with the Department of Insurance, which is again empowered to approve or disapprove rates on a pre-approval basis. The bill would also prohibit insurers from setting rates based on any “non-driving” factors, including credit history, employment, education, and gender.
The proposal also creates a new system for public intervenors in the rate making process, stating that “any person may initiate or intervene in any procedure permitted or established under the provisions and challenge any action of the Director under the provisions.”
In short, the law would transform Illinois from the nation’s most open and competitive insurance market to one clearly modeled after the most restrictive: the inflexible, state-directed system created by California’s Proposition 103.
The question, of course, is why would the state do this? It’s true that insurance rates are going up in Illinois, but they’re going up everywhere, too. Insurify estimates that the average cost of auto insurance will increase 9% to $1,777 in 2022 and company projects that rates will increase another 7% to $1,895 this year. In fact, auto insurance rates in Illinois really hold up 15.5% less than the national average.
Inflation and ongoing supply-chain challenges are a big part of the story there. Rising rates of distracted driving also seem to be to blame. According to National Highway Traffic Safety AdministrationUS traffic deaths hit a 16-year high in 2021, with 43,000 deaths.
But those are all trends in the underlying loss and claims data. Perhaps a transport regulator could do something to reduce traffic accidents. The Federal Reserve is doing everything it can to prevent out-of-control inflation. But an insurance regulator can’t. Since no insurer can stay in business much longer charging unprofitable rates, the only way rate regulation can actually reduce insurance rates is if a market is uncompetitive, allowing some writers who used monopoly power to extract excess profits.
The evidence that this hypothetical describes Illinois is remarkably thin. There are 230 insurers that offer private passenger car insurance in Illinois. Based on the Herfindahl-Hirschman Index (HHI), which is used by the US Department of Justice (DOJ) and the Federal Trade Commission to assess the degree of monopolistic concentration in a given market, the Illinois auto insurance market scored 1,224 in 2021, the previous year for which NAIC data is available. That is less than even the FTC and DOJ limit (1,500) for a “moderately concentrated” market. Auto insurance in Illinois is competitive.
Not even the state’s largest auto insurer is exactly swimming in profits. Allstate posted a $2.91 billion underwriting loss in 2022, primarily driven by results in the private passenger car market. For GEICO, a subsidiary of Berkshire Hathaway, it was a full-year pretax underwriting loss of $1.88 billion. Bloomington-based State Farm, the largest auto insurer in Illinois and the United States, suffered a large full-year underwriting loss of $13.2 billion.
It would be one thing if the adoption of tighter rate regulation simply failed to accomplish its stated goal of lowering rates, but the evidence is that it is actually showing harm. The most obvious problem with rate regulation is that it restricts the availability of insurance. Insurers naturally responded to rate regulation by tightening their underwriting standards, forcing some consumers to turn to the higher-priced residual market for coverage. In extreme cases, rate suppression can lead some insurers to exit the market altogether.
Empirical evidence of this effect is evident. After California mandated a mandatory 20% rate rollback following the passage of Prop 103 in 1988 (its effects were somewhat blunted by the courts initially), the number of insurers writing auto coverage in the state dropped from 265 in 1988 to 208 in 1993.
FIRMS THAT SELL AUTO INSURANCE IN CALIFORNIA, 1988-1993
SOURCE: NAIC data
New Jersey, likewise, saw 20 insurers exit the market in the decade after the state passed the nearly identical Fair Automobile Insurance Reform Act. When New Jersey eventually liberalized its regulatory system with the passage of the Auto Insurance Reform Act in June 2003, the number of auto writers more than double from 17 to 39 and thousands of previously uninsured drivers entered the system.
A similar effect was seen in South Carolina, where a strict rating system in the 1990s was forced 43% of drivers in the remaining market policies symbolized by the state-run reinsurance facility. After adopting a liberalized flex-band rating law in 1999, as in New Jersey, the number of Insurers offering coverage in South Carolina have doubledthe rest of the market has shrunk (it is, now, only 0.007% of the market), and overall rates have actually gone down.
Even in Massachusetts, which maintains a relatively strict rate approval process, reforms passed in April 2008 to allow insurers to submit competitive rates (they were previously set by the commissioner for all carriers) had a noticeable effect. Within two years of the reforms, there were rates fell 12.7% and a dozen new carriers began offering coverage in the state.
Because it is a highly regulated state, Massachusetts still has a relatively large residual market. According to data from the Automobile Insurance Plan Service Office (AIPSO), by 2022, 3.38% of auto-insurance customers in Massachusetts will have to use the remaining market, the second highest rate in the country. But before 2008, the rest of the Massachusetts market was regularly in the double digits. The only state that still has a double-digit residual market share today is North Carolina, not coincidentally also the only state that relies heavily on rates set by a rate bureau.
Finally, regulation is not free. To finance the additional actuaries and financial inspectors needed to actually implement the new regulatory system in Illinois, HB 2203 proposes that insurers subject to its provisions be assessed an additional fee of 0.05% of their gross annual earned premium. Based on 2021 premiums, that’s an additional $14 million a year, which is in addition to the $106.4 million in fees and assessments the department already levies on industry (not to mention $515 million in premium taxes). The cost of these fees is, of course, passed on to consumers in the form of rate increases.
And what does that extra income actually get you? In 2021, Illinois will spend $67.8 million on insurance regulation (which, it should be noted, is nearly $40 million less than it already collects in fees and assessments). California, by contrast, spent $245.5 million. However, California’s market is no more competitive than Illinois’, and probably less so.
The Land of Lincoln has to admit that’s a pretty bad deal.
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