Massachusetts Auto Insurance System Not Built for Long Drive, Says Fitch

March 14, 2008

The new managed care auto insurance system that is underway in Massachusetts should benefit most consumers as well as the state’s local insurers in the short run, according to a new report by Fitch Ratings.

However, in the long run, consumers will be denied the full benefits of competition unless the state lifts its ban on credit scoring.

Also, a number of local insurers that took advantage of the old residual market plan’s rules could find themselves struggling in the long run under the new residual market rules that are also being implemented.

The Fitch Ratings report, Massachusetts Private Auto: Drive to Managed Competition, discusses the first major change in over 30 years to the Massachusetts auto insurance market.

The managed care system replaces one under which the state set uniform rates for all auto insurers with one where insurers can file and use their own rates subject to certain restrictions. Competitive rates go into effect April 1.

Overall, Fitch said it expects the new system will benefit both consumers and the marketplace. “Consumers will benefit the most from a wider choice in carriers, innovations in coverage and lower rates for the average consumer,” Fitch says.

However, Fitch maintains that Massachusetts insureds would benefit even more if underwriters were permitted to use credit scoring and other “actuarially significant pricing variables that are believed to adequately reflect risk and have demonstrated value in other markets.”

The state-imposed limits on so-called tiered pricing will discourage national carriers that do not now write in the Bay State from entering the market like they did in New Jersey, the report maintains. Until carriers are allowed to use sophisticated pricing models including credit scores, Fitch predicts that “the entrance of new participants will be more of a trickle than a flood.”

Major national direct writers including Geico, Progressive and State Farm do not write in Masssachusetts, where 85 percent of the auto market is handled through independent insurance agents and their mostly local companies.

The state has 19 auto insurers, with the top three being Commerce, Safety and Arbella —all Massachusetts-based companies. Two insurers not now writing private passenger auto insurance in the state — Peerless (owned by Boston-based Liberty Mutual which already writes auto in the state) and Progressive (online sales only at first; not independent agency sales) have announced they will enter the market.

In addition to allowing managed price competition, the state is altering how insurers share high risk business, switching from a reinsurance facility known as Commonwealth Auto Reinsurers to an assigned risk plan. Fitch believes the new residual market system will have an even greater impact on the local insurers than the new rate system.

Certain local carriers did well by in part by mastering the old CAR system. According to Fitch Ratings, under the new assigned risk plan, those companies are more likely to find themselves with loss experience on their assigned risk business that is equal to that of the overall pool.

“Those local companies that used the prior residual market system to their advantage will be disproportionately affected by the change,” says the report.

The local companies that dominate the Massachusetts market have actually enjoyed years of profitability and aggregate combined ratios below 85% since 2003, according to Fitch. But Fitch says they will now find it more difficult to repeat that performance given competition from new entrants and pressures to lower premiums at a time when nationwide loss costs are increasing and their expense ratios are going up due to increased advertising costs.

Industry-wide private passenger automobile profitability will be challenged in the coming years as a result of lower premiums coupled with increased loss costs and expenses, according to Fitch.

It’s not all bad news for local companies, however. They have an advantage because they “possess an in-depth understanding of the Massachusetts marketplace.” Also consumers in the state are accustomed to buying through these local insurers’ independent agents.

But those advantages enjoyed by local carriers may be short-term. According to Fitch, “long-term success in the Massachusetts market will belong to companies that offer superior claims service levels and properly price the risks.”

The full report is available at www.fitchratings.com under Financial Institutions — Insurance — Special Reports.

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