Report on Mass. Auto Cites Rate Subsidies and Barriers to Entry; Romney to Name Task Force

April 29, 2004

A much-anticipated analysis of the Massachusetts private passenger auto insurance system finds that 14 percent of the state’s drivers pay less than loss costs indicate they should, while 86 percent pay more to subsidize the others.

The degree of subsidization varies by class and territory but in general, rural and suburban rates subsidize urban rates, experienced drivers subsidize inexperienced drivers, and inexperienced female drivers subsidize inexperienced male drivers, according to the study.

The most dramatic example is of non-urban, experienced drivers paying a bit more (less than $100 per policy) while the 4.1 percent of the market that is urban, inexperienced drivers pay $500 below their costs.

The most heavily subsidized class in Massachusetts is inexperienced drivers who have been driving less than three years, most of whom are young, according to the report. The most heavily subsidized areas by territory include the urban areas of Boston, Lawrence, Chelsea, Brockton, Everett, Lynn, Revere and Springfield.

The report, a year in the making, was prepared by Thomas L. Ghezzi and Katharine Barnes, consulting actuaries, in the Boston office of Towers Perrin Tillinghast at the request of the Massachusetts Division of Insurance. According to the DOI, it was paid for by Commonwealth Auto Reinsurers (CAR), the state’s involuntary market organization.

The report was unveiled at a press conference this morning by Gov. Mitt Romney. He also named an auto insurance task force to draw up reform recommendations.

The Towers Perrin report presents an analysis of the marketplace but does not contain recommendations for changes. Many of its findings echo those contained in a report by state Attorney General Tom Reilly’s office last year.

The authors examined rate differentials in California, Connecticut, Illinois, Maryland, New York and Pennsylvania for comparison and found that rate differentials by territory and class are much steeper in these states than in Massachusetts where rates are flattened.

The Towers Perrin report also analyzes the involuntary market, comparing CAR to high risk mechanisms in other states, assessing the distribution of high risk business agencies known as exclusive representative producers (ERPs), and evaluating CAR’s claims handling performance.

The study attempts to answer why the number of carriers writing private passenger auto coverage in the state has plummeted from 53 in 1990 down to 19 today, even as the number of insured cars has increased by 20 percent. While the state-set rates, various rate subsidies and the CAR operation tend to discourage insurers from writing in the state, the authors suggest that several statutes and regulations are also to blame.

“To counteract the natural risks selection tendencies of insurers operating in a market with significant cross subsidies,” the state has created several mechanisms to get insurers to write the under-priced business, the authors write. They identify four such mechanisms:
• The state’s “take-all-comers” law which requires insurers to offer policies to virtually all licensed drivers
• Financial penalties for over-utilizing the involuntary market
• Financial credits for voluntarily writing under-priced business, and
•The creation of special protections for a class of agents (ERPs)

“These incentive mechanisms, on top of subsidized rates, result in a market that is more complex than any other state in the nation. This complexity, combined with state-set rates and subsidies, creates disincentives for carriers to enter the market, due to the severe restrictions in the carriers’ ability to control their own financial results,” the report concludes.

The credits and penalties have contributed to the reduction of the CAR market share from 55 percent in 1990 to 7.4 percent currently, notes the report.

However, CAR’s method of distributing the accounts signed by the ERPs contributes to the market’s woes in the view of insurers. When high risk policies are assigned to insurers, they are assigned as a book by ERP agency, rather than on an individual risk basis. Also, the assignments are made without regard to the loss ratios of the ERPs so that carriers that get ERPs with low loss ratios gain an advantage over those that end up with high loss ratio ERPs, the report adds.

“There is the perception in the Massachusetts private passenger market that carriers have manipulated their ERP assignments through various means. The ‘low loss ratio’ and ‘high loss ratio’ ERPs are not distributed proportionately among carriers. We found instances in which carriers were writing less than half and more than double their market share of the high loss ratio ERPs. Given the high loss ratios of some ERPs, the distribution of these agencies means that the financial results of these agencies are not distributed proportionately among the carriers. Those carriers with a higher proportion of ‘high loss ratio’ ERPs have little chance of making a profit in the state, while carriers with less that their proportionate share of these agencies have had significantly better than average results. Many carriers cite the disproportionate distribution of the ERP loss burden as an important factor in carriers’ decisions to withdraw from the market, and in other carriers’ decisions not to enter the market,” the study maintains.

The study suggests that fraud may be behind the finding that a small group of ERPs is responsible for a disproportionate share of losses. Out of 2,360 agencies in the state, 800 are ERPs. Most agencies including ERPs fall near a 70 percent loss ratio. However, 63 ERP agencies in under-priced territories and another 23 in over-priced territories have unusually high loss ratios in excess of 150 percent., experience which cannot be explained by the rate subsidies alone, says the report.

A committee of industry and public officials has been working since last year at Commissioner Bowler’s urging to come up with its own suggestions for reform, including a procedure for converting CAR to an assigned risk type plan.

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