state leading to higher quali ty-adjusted races. We will label

337 Pages·2007·14.1 MB·English

THE ROLE OF COLLECT VE PRICING IN AUTO INSURANCE
JEFFREY A. EISENACH
Staff .Report
Bureau of Economics
Federal Trade Commission
Washington, D.
1985
November
The analyses and conclusions set forth are those of the author
and do not necessarily reflect the views of other members of the
Bureau of Economics, other Commission staff, or the Commission
itself.
EXECUTIVE SUMMRY
The purpose of this study is to determine the effects of
collective ratemaking on the performance of auto insurance
markets.
Under the McCarran-Ferguson Act the states are
empowered to regulate insurance and insurance is exempt from
federal anti trust regulation. Several states allow or compel
joint ratemaking or joint behavior that may facilitate joint
ratemating by auto insurance companies. Joint ratemaKing may
allow cartel-like behavior by the auto insurance companies in a
state leading to higher quali ty-adjusted races. We will label
this hypothesis the .cartel hypothesis Economic theory
concludes that joint ratemaking is unlikely to have a long term
adverse effect in the absence of impediments to competi tion or
barr iers-to-entry. In some states, regulation results in
impediments to competition by compelling j int ratemaking and/or
enforcing joint rates. In such a situation, if the joint
cheating on the
ratemaking resulted in supra-competitive rates, .
cartel. would be difficult because firms cannot individually set
rates.
Other, less restrictive regulations may result in
impediments to competition that allow for long run supra-
competi tive rates. Therefore theory leads to a prediction that
collective ratemaking could have a pronounced anticompetitive
effect in states with regulatory systems that allow joint
ratemakingl and in states where regulation enforces joint
Exec -1-
ratemaking, the anticompetitive effects may be even more
pronounced.
Alternatively, collective ratemaking may allow the auto
insurance industry in a state to exploit joint efficiences that
would be uncapturable without collective action, leading to lower
quality-adjusted rates.
We will label this hypothesis the
efficiency hypothesis Efficiences from collective ratemaking
might derive from pooling loss information or from a reduction in
the costs of complying with a state s rate filing and other
disclosure requirements.
The study consists of three empirical exercises. Each
exercise relies on in ormation about the activities of a major
ratemaking organization, the Insurance Services Office, .Inc.
(ISO) . ISO is a non-profit organization that provides rating,
statistical, policy form, and related services to member firms
and subscribers.
In theory, ISO might be used as a vehicle for
cartel-like ratemaking (the cartel hypothesis). However, ISO
clearly provides information and other services to auto insurance
companies that may facilitate .greater efficiency (the efficiency
hypothesis) .
The first empirical analysis discussed in the study examines
the structural character istics of the auto insurance industry
across states.
Herfindahl indices of concentration are
calcrlat
under two scenarios.
The reason for the Herfindahl
calculations derives from predictions of economic theory that
cartel-like conduct can occur in the absence of cartelizing
Exec -2-
regulation only if industry concentration is sufficiently high.
First, statewide Herfindahls are calculated under the assumption
that all insurers in a state act independently. Then, statewide
Herfindahls are calculated under the assumption that all members
of ISO in a state act as a single firm.
If for this second
calculation the Herfindahl is sufficiently high, there may be
reason for concern that joint activity facilitated by ISO could
have significant anticompetitive effects.
The second empirical exercise of the study uses data from
ISO' s Premium Comparison. Service, a survey insurer reported
premium for specific auto
liability coverage by state,
territority, and risk class. These data are used to calculate
measures of adherence of individual insurers' rates to ISO rates,
and to relate the .extent of adherence to state collective pricing
and regulatory characteristics. In the third empirical exercise,
we estimate a cross-state multiple regression model of the
effects of collective ratemaking and regulation on premiums and
losses.
The basic conclusions of this study are that there is little.
idence t
at collective ra emaking, as measured by the
categorical and Herfindahl variables in this study, leads to
significant anticompetitive effects. Similarly, there is little
evidence that collective ratemaking relative to the joint
collection of risk or loss data leads to significant
efficiencies.
We caution however that data limitations resulted
in our only being able to derive fairly crude proxies for
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collective ratemaking. Nonetheless, since we used several types
of evidence and measures of collective ratemaking without
discerning any significant effect on rates, until better data is
available to retest the hypotheses, our results suggest that
changing state policies affecting collective ratemaking is not
justified.
The results of the analysis of the effects of different
regulatory environments on rates are somewhat mixed. When states
are categorized dichotomously as a prior-approval or open-
competition states -- the categorization used in virtually all
previous studies of auto insurance markets -- regulation e. ,
(i.
prior-approval requirements) does not have a significant effect
on rates or losses. However, in a multiple regression analysis
ior-approval
in which we model the interaction between pr
regulation and predictions of state insurance commissioner
behavior derived. from a confidential study, we find that
regulation raises rates and losses in some states and lowers them
in others. These conclusions are only suggestive, since our
iables
regulatory and state insurance commissioner behavior var
are crude.
The study consists of seven chapters. Chapter I provides an
overview of the study. Chapter II describes the structure of the
auto insurance .
market across states, focusing on the role of
erwriting.
shared market 1..1ans and their influence on un"
Statewide Herfindahl indices are calculated for 1981 and 1983.
The auto insurance industry is relatively unconcentrated.
Exec -4-
In Chapter III the evolution of the Federal antitrust
exemption of insurance and the role of rating organizations are
described.
Particular attention is given to Insurance Services
Office, Inc. (ISO) in its role as statistical agent and ratemaker
Other ra
for the industry. ing organizations and the few state
rate bureaus are also discussed.
Chapter IV develops the theor ies underlying the cartel and
efficiency hypotheses. First, a standard cartel model is
considered. Then, a model of non-price competition with supra-
(The
competitive rates is described and its results interpreted.
specifics of the model are laid out in Appendix 5. The
efficiency model focuses on the possible importance of service
summry of previous
competi tion. The chapter concludes with a
empirical research on auto insurance.
In Chapter V two types of empirical evidence are
presented.
First, Herfindahls are calculated under the
These
assumption that all ISO members in a state act jOlntly.
Herfindahl indices are sufficiently high in some states that if
ISO members did act jointly, there is a potential for
anticompeti ti ve effects. Next, in order to test the hypothesis
that ISO members act jointly, ISO' s survey of insurers' stated
premium was
compared to ISO-suggested rates to assess adherence
The evidence indicates that insurer s
to ISO-suggested rates.
affiliation with ISO and adherence to ISO prices are greater in
prior-approval states than in open-competition states and also
greater in states for which ISO reports rates than in states in
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,,,
However, even in
which ISO reports only loss and cost data.
prior-approval or ISO-suggested-rates' states, the market share
Furthermore,
accounted for by ISO members is not large.
adherence to ISO-suggested rates in these types of states is not
large. Therefore, 'the structural evidence presented in this
chapter suggests that collec ive ratemaking, alone, is unlikely
to have significant anticompetitive effects.
Chapter VI presents a multiple regression analysis of the
tion.
effects of collective ratemaking on competi Specif ically,
total auto liability insurance premiums (in luding shared-market
premiums) and total losses per car year are regressed on
alternative specifications which include measures of risk,
economic and'demographic characteristics, and measures of the
Three
effectiveness of collective ratemaking and of regulation.
measures of private collective ratemaking are used, including the
Herfindahl index calculated under the assumption that all ISO
tted
members act jointly. None of the specifications permi
rejection of the null hypothesis that collective ratemaking alone
premium or on losses.
has no effect on
Sin e economic theory predicts that regulation is likely to
be a necessary component of anticompeti tive ratemaking,
regulatory variables were also used in the regression analysis.
The states regulate auto insurance in a variety of ways ranging
from state-determi.led rates to prohibitions on collective
ratemaking. Following previous studies, states were categor ized
as prior-approval or open-competition states according to the
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classification scheme devised by the National Association of
In specifications with this
Insurance Commissioners (NAIC).
dichotomous regulatory variable there was no statistically
significant relationship between regulation and premiums or
losses. ical
This result is consistent wi th previous empir
studies.
In some specifications the regulatory variable was
interacted with predictions of state insurance commissioner
This allowed, in
behavior derived from a confidential study.
ccording to the
principle, the effect of regulation to vary
reported goals of state insurance commissioners. The estimates
of the models containing this interaction var
iable indicated that
prior-approval regulation may raise premiums and losses in some
states and lower them in others. These results are consistent
with a model in which some combinations of prior-approval
regulation and regulatory climate raises rates and then these
supra-competitive rates are competed away, reflected by the
increased losses associated with increased premiums. However, we
caution that these results are based on a somewhat crude
categorization of differences of the effects of var ious types of
prior-approval regulation.
The results however do suggest that
further research that focuses on differences in regulations and
regulatory environments is justified.
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TABLE OF CONTENTS
PREFACE.
Chapter
INTRODUCTION
II. INSURCE INDUSTRY.........................
THE AUTO
The Structure of the Auto Insurance
Market......................
Firm-specific Characteristics...............
Concentration and Ease of Entry.............
Mandatory Insurance Requirements,
Underwriting and the Shared Market............
Mandatory Insurance Requirements............
Shared Market Plans.........................
Risk Classification and Underwriting........
i ting and
Interaction Between Underwr
the Shared Market.........................
Sumary.
III.
COLLCTIVE PRICING AND RATING ORGANIZATIONS.........
The Evolution of Rating Organizations...........
i ters and the
South-Eastern UnderwrA ct.....................
McCarr
n-Per9uson
The Trend Towards Open Gompetition..........
Limitation ofI SAnOti.t.r.u.s.t. .I..m.m.u.n.i.t.y. .a..n.d. .t.h.e.....
Adven t of
The Insurance Services Office, Inc..............
History and General Framework...............
Procedures.......................
Ra temak in9
Distr ibution of Rates or
geLnosts.. .C.o.s.t.s....................
ISO as a Statistical JI.
Premium Comparison Service..................
Other Rating Organizations and Related
Organizations.
iii
................. ....... ..............
. ... ... ... ... ... ... ... ... ... .... .... .... .... .... .... .... .... .... .... .... ..... ..... ..... ..... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ....... . . ....... . ....... . ....... ........ ........
AIPSO and the Shared Market.................
State Bureaus...............................
Hawaii Insurance Rating Bureau..............
Advisory and Statistical Organizations......
Sumry.
IV. POTETIAL BENEFITS AND COSTS OF COLLCTIVE PRICING..
Collective Pricing and Economic Efficiency......
Pooling Joint Loss Data and Developing Risk
Classifications.........
Development and Trending of Losse
Ratemaking and Distr ibution..... ....
Research and Development Activities......... 101
Summry of Potential Benefits............... 103
Collective Pricing and Collusion................ 104
The Explicit/Tacit Collusion Hypothesis..... 106
The Role of State Regulation................ 112
123
SUlry.
DATA ON AFFILIATION WITH ISO AND ADHENCE
'l ISO PRICES..................................... 125
Theoretical Predictions Concerning
Affiliation and Adherence..................... 125
Da ta on Adherence to ISO Pr 127
ices.
Da ta On ISO Affiliation......................... 135
S\1ar
143
VI. TH EFFECTS OF COLLCTIVE PRICING ON AUTO
INSURCE
146
PRICES.............
149
Measur ing pr ices.
The Determinants of Auto Insurance Prices....... 156
Estimates
of Model II.I.............................................. 161
Estimates
173
of odel
Non-Pr ice Competi tion and the Welfare
Effects
of Regulation..... 180