The R Street Institute published its first research project as an independent institution today, a report card of the insurance regulatory environments in each of the 50 states. The report card builds on a series of annual reports my colleague Eli Lehrer previously conducted for the Heartland Institute’s Center on Finance, Insurance and Real Estate, and we plan to make it one of our flagship annual reports as well.
U.S. Supreme Court Justice Louis Brandeis noted in a 1932 decision that, under the U.S. system of federalism, “a single courageous state may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country.” As the largest and most important U.S. industry still primarily regulated at the state level, insurance offers these laboratories of democracy a host of potential controlled experiments. Our reading of the data suggests that the best outcomes for consumers and businesses alike — competitive markets, small residual markets, expansive consumer choice — can be found in states that demonstrate a commitment to limited, effective and efficient government.
Many conservative and free-market groups understandably focus on the “limited” part of that equation. And we agree that it is a terribly important consideration. Several of the variables in our report deal with the levels of pricing freedom that the various states grant to insurers, particularly in the areas of homeowners and private passenger auto insurance. States that permit markets to set rates based on evaluations of risk, including through the use of credit and territorial information, were rewarded. States that maintained stringent prior approval rating systems or imposed significant restrictions on underwriting freedom were penalized. States also were penalized where property and casualty insurance has proven to be a hot button political issue, and where the “desk drawer rules” are applied in ways that are less than fully transparent and predictable.
But the “effective” and “efficient” parts of the equation are equally important, and often get overlooked. While we think insurance markets are largely self-regulating, there are crucial roles for state governments to play in protecting consumers. That’s why we evaluated states’ prowess at monitoring solvency, as judged by how well they’ve kept up with their duties to perform financial examinations of domestic companies and by the relative size of the outstanding claims obligations of domestic companies in run-off, supervision, conservation, receivership, and liquidation. We also looked at how well states are policing insurance fraud, by devoting sufficient staff to investigate fraud, establishing separate criminal fraud units and empowering investigators as officers of the peace.
In addition to recognizing insurance departments that do their jobs well, we also rewarded those who do it efficiently. Of the $18.58 billion states collected from the insurance industry in 2010, only 6.7 percent of that total was spent on insurance regulation. Much of that is due to state and local premium taxes, which, like other sales taxes, go into states’ general fund. But even the regulatory fees and assessments paid by insurers to the states were roughly double the amount spent on insurance regulation, with that “regulatory excess” amount to $1.24 billion of hidden taxes that get passed on to insurance consumers. In the report card, we judged states based both on the overall tax and fee burden placed on insurance markets, as well as penalizing states that diverted excess revenues from regulatory fees and assessments to patch other holes in state budgets.
Based on the metrics we used, Vermont, Illinois and Ohio had the best property and casualty insurance regulatory environments in the U.S. this year, all rating more than two standard deviations above the mean. The best state, Vermont, scored 26 out of a maximum possible score of 55. Only one state, Florida, received a failing grade, falling more than two standard deviations below the mean. Other states falling more than one standard deviation below the mean include Alaska, Michigan, New York, California, Massachusetts and Texas.
Overall, in 2011 and early 2012, we saw continued modest trends toward greater consumer and business freedom in the homeowners and automobile insurance markets, as well as real efforts in some states to scale back, or otherwise place on more sound financial footing, residual insurance markets and state-run insurance entities. Those are positive trends, and we hope this report card encourages other states to move forward in that direction over the next year.