Withdrawal restrictions in the automobile insurance market.

• Author: Yelen, Suzanne

Despite substantial increases in automobile insurance premiums in recent years, most American insurers lose money in the private automobile insurance market.(1) Although premiums increased three times faster than inflation between 1984 and 1990,(2) American private insurers lost $2.4 billion on personal auto insurance between 1980 and 1988, while other lines of property and casualty insurance gained $7.1 billion.(3) A large portion of these losses derives from state mandates requiring private companies to write insurance at state regulated rates for drivers whom they deem too risky to insure voluntarily. While some states have created government-operated insurance programs, many of these programs have fared poorly, generating billion dollar deficits.(4)

The number of uninsured motorists, estimated at 17 million in 1991, has increased because some drivers could no longer afford insurance policies once insurance premiums soared.(5) In response, legislators and regulators have increasingly held rates constant below expected claims, forcing insurers to suffer financial losses when covering high risk drivers. Responding in turn, some insurance companies resolved to leave the auto insurance market to avoid such losses.

To leave the market, insurers cease accepting new business and renewing existing policies. To prevent this exodus, two states - New Jersey and Massachusetts - passed regulations restricting insurance companies' withdrawal.(6) In addition, California's Insurance Commissioner attempted to impose a difficult withdrawal procedure, but the California courts found that the procedure violated the California Insurance Code.(7) Because withdrawal regulations essentially compel insurance companies to lose money selling auto insurance, an insurance executive described one state's efforts as "capital imprisonment."(8)

Withdrawal regulations subvert the very goals of available and affordable insurance that they purport to achieve. Moreover, such regulations effect an unconstitutional taking of property(9) and a denial of substantive due process rights.(10) Part I of this Note describes the insurance crises that prompted legislators and regulators in New Jersey, California, and Massachusetts to enact withdrawal restrictions. Part II discusses these regulations in some detail, and Part ITI analyzes their economic effects. It argues that, although in the short run these provisions can compel insurance companies to bear the mounting costs of auto insurance, in the long run they produce perverse effects. The added costs and risks of the new regulations deter new insurance companies from entering the automobile insurance market and reduce the capital available to those companies that remain. Part IV examines the legal basis for withdrawal restrictions and concludes that New Jersey's and Massachusetts' regulations are unconstitutional. To address the soaring costs of auto insurance, legislators instead must develop a comprehensive solution.

1. The Current Auto Insurance Market

   The auto insurance market and the manner in which it is regulated have changed dramatically in the last twenty-five years. Before the 1970's, auto insurance rate regulations set rate floors for premiums to prevent insurance companies from becoming insolvent. In contrast, regulations now strive to keep rates down - sometimes even below the costs the insurance company must pay to provide such insurance - thereby forcing the companies to bear these rapidly escalating costs.(11) Between 1982 and 1991, auto insurance rates increased by 109.5%. However, during that same period, the main factors contributing to the costs of auto insurance also increased at high rates: bodily injury claim costs by 112.1%; hospital room prices by 112.2%; medical costs by 91.4%; auto repair costs by 82.3%; and property damage claim costs by 79.6%.(12) Many drivers cannot afford the premiums necessary to cover the risks, especially urban residents, who tend to have higher risk factors than suburban residents.(13) High auto insurance rates, combined with compulsory auto insurance laws,(14) squeeze drivers who, in turn, pressure legislators and insurance regulators to ensure that auto insurance is available and affordable.(15) In theory, the market could regulate rates, and those unable to afford the insurance premiums could not drive. Although other insurance markets place this burden of high rates on the insured, legislatures encounter great political pressure to treat auto insurance differently.

   This different treatment stemming from political demands has resulted in regulation through rate ceilings. However, such ceilings merely cause insurance companies to sell only to those insureds whose policies will be profitable at the fixed rate. As a result, insurance becomes unavailable to many who want it, and could even afford it, if the state did not enforce a rate ceiling.

   In states where regulators do not fix maximum rates, consumers whom most insurance companies consider undesirable risks can obtain insurance from firms that specialize in insuring high-risk drivers. The market for normal-risk drivers is called the standard voluntary market. Drivers who have higher than normal risk factors obtain insurance from companies specializing in high-risk drivers in the nonstandard voluntary market.(16) These companies stay in business only by charging premiums that are higher, often considerably higher, than those charged in the standard market. Even so, consumers benefit because the insurance is available.(17) For instance, Texas, Wyoming, and Utah have a free market system for auto insurance rates. In those states, between 10% and 20% of all drivers are insured in the nonstandard market and only a small percentage of drivers need coverage in the involuntary market,(18) made up of those drivers who cannot find coverage in either the standard or nonstandard markets. Setting maximum rates undermines the nonstandard market because companies serving high risk insureds cannot charge rates high enough to cover costs and therefore must exit the market. In states without nonstandard markets, the number of drivers in the involuntary market has increased dramatically.(19) When insurers are allowed to charge rates corresponding to risk, most drivers are able to buy insurance in the voluntary market, and the burden of insuring the involuntary market decreases.

   By holding rates down, and thus increasing the size of the involuntary market, states create an expensive problem for themselves - they must meet the needs of these drivers. Though a variety of approaches is possible, each is costly and potentially inefficient. By enforcing compulsory insurance laws in a lax manner, states enable drivers simply not to buy insurance. Yet the inadequacy of this solution - both for the driver and for society - becomes evident when the driver has an accident. States often deal with drivers shut out of the voluntary market by offering insurance themselves or by assigning such drivers to private insurance companies. Forty-two states and the District of Columbia use auto insurance plans in which the involuntary market is split up among the insurers that service the voluntary market.(20) Some states employ joint underwriting associations, state-mandated pooling mechanisms through which all auto insurance companies share the premiums and losses of the involuntary market. Similarly, some states organize reinsurance facilities that accept assignments of unacceptable risks from private insurance companies and then allocate the premiums and the losses to the private insurers. Still other states run their own insurance systems, while requiring private auto insurance companies to pay the costs.(21) All these plans require massive infusions of state resources and often operate at huge deficits.(22)

   Rate ceilings not only saddle the state with the expensive task of insuring the expanded involuntary market, but also increase the burdens on voluntary market drivers because insurers must use the premiums of low-risk drivers to subsidize high-risk drivers.(23) In 1986, Massachusetts auto insurers paid $566 million to subsidize the involuntary market - an average added cost of $363 to each voluntary market policyholder.(24) In 1989, New Jersey charged each driver in the voluntary market a surcharge of $222 to subsidize the involuntary market.(25) A vicious cycle ensues. Insurance companies raise rates on low risk drivers to subsidize high risk drivers. But in response to the higher rates, more marginal low-risk drivers choose to forgo insurance or to enter the involuntary market, thereby depriving insurance companies of some of their consumer base and increasing the burden on the state-subsidized involuntary market. Paradoxically, drivers sometimes prefer to enter involuntary market plans because state regulators have held the premiums for involuntary insurance at the same level as those of the voluntary market.(26)

   As a result of these market distortions, private insurance companies have incurred considerable losses on auto insurance policies. Many desire to leave the auto insurance market altogether.(27) State regulators and legislators need insurance companies to continue writing policies in their state. If insurance companies leave the market, the legislature will have to make insurance available through a state plan or face voter anger. Moreover, states faced with huge deficits from state-run involuntary market insurance plans often wish to force private insurance companies to finance these deficits. This frustrates the state's desire to make auto insurance available. In order to keep the insurers in the market, some states have enacted statutes and regulations making it extremely difficult, if not impossible, for private insurance companies to leave the auto insurance market.(28) State regulation of insurance companies - at least in New Jersey, California, and Massachusetts - is becoming broader, treating...