California Regulatory System Analyzed

December 12, 2001

The California system held up by a consumer group as a model for auto insurance regulation in fact may have kept California consumers from enjoying billions of dollars in premium reductions over the past decade. That’s among the key findings of an analysis of California’s regulatory system by one of the country’s most respected insurance researchers.

“It is possible that California consumers would have saved in excess of $10 billion over the past decade if a competitive market had been permitted to function in the state,” instead of the choking regulations of Proposition 103, concluded David Appel, Ph.D., in his paper released Monday at the winter meeting of the National Association of Insurance Commissioners (NAIC).

Earlier this year, a report by the Consumer Federation of America (CFA) concluded that the state of California, under the provisions of 1988’s Proposition 103, should serve as a model for state insurance regulation.

At the request of the Alliance of American Insurers, the American Insurance Association (AIA), the National Association of Independent Insurers (NAII) and the National Association of Mutual Insurance Companies (NAMIC), Appel conducted a review of the CFA study.

In his study, Appel found that the political uncertainty imposed on the auto insurance rate approval system by Proposition 103 cost California auto insurance buyers between $8.6 billion and $13 billion.

“If Prop 103 increased insurers’ risk and therefore discouraged them from reducing premiums more in response to slower loss growth, the magnitude of these numbers suggests that the effects could have dwarfed the magnitude of any rate rollbacks” that were a direct result of Proposition 103, Appel noted.

Appel’s other principal conclusions were:

* CFA’s “regulatory standards of excellence” are inconsistent with a modern understanding of the role of regulation in a competitive market. In its paper, the CFA puts forth eight standards by which insurance regulation should be measured – so-called “standards of excellence.” While some of the standards are unassailable on their own merits (i.e. fair profits for insurers and fair treatment for consumers), as a whole they judge a state’s regulatory environment by the extent to which regulations suppress or stifle competition.

“The entire CFA paper is based on the philosophy that aggressive government intervention in the competitive economy is needed to achieve the CFA’s vision of appropriate ‘social’ goals,” Appel concluded. This view, he found, is archaic and has generally been abandoned over the past two decades in favor of a market-driven, pro- competition philosophy.

* CFA’s “objective analysis” of regulatory results lacks scientific rigor and is fatally flawed. CFA’s conclusions are based on the simplistic and inaccurate premise that since consumer expenditures – that is, total auto premiums paid — have decreased over roughly the same period that Proposition 103 has been in effect, then the measure must have been responsible for that decrease.

“The majority of the CFA’s claims are based on an incomplete grasp of relevant facts, if not their outright mischaracterization,” Appel noted. “The rest are undocumented assertions of cause-and-effect relationships, which amount to little more than claiming that all favorable changes since Proposition 103 are caused by Proposition 103. These claims fail to withstand close scrutiny.”

* A serious analysis of California insurance premiums indicates that Proposition 103 had no meaningful effect on auto insurance costs in California. The CFA paper ignores the fact that the primary determinant of insurance rates is the underlying cost of claims, Appel concluded. Over the last decade, all three branches of California government have implemented changes that have controlled what had been rapidly escalating costs.

Some of the examples cited by Appel include:

A reduction of the blood alcohol standard for driving under the influence (DUI) from .10 percent to .08 percent.

* A mandatory seatbelt law with primary enforcement.

* A near doubling in California Auto Assign Risk Plan (CAARP) rates and more stringent qualifying requirements for drivers in the Plan led to a 96 percent reduction in assigned risk policies.

* Legislators passed laws increasing penalties for uninsured drivers and voters passed an initiative limiting insurance recoveries by uninsured drivers, both in 1996.

* Implementation of substantial anti-fraud measures.

* The California Supreme Court’s Moradi-Shalal decision, which prohibited third-party lawsuits for insurer bad faith under the state’s Unfair Trade Practices Act.

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