How Illinois, a jurisdiction not usually associated with a strong commitment to free market principles, became the first state in the country to allow its insurance rates to be fully regulated by open competition is something of a historical coincidence.
In 1
970, continuing a trend many states had followed in the 1960s, the Illinois General Assembly moved to replace the state’s existing “prior approval” system of property casualty regulation—originally enacted in 1947 in the wake of the U.S. Supreme Court’s decision in United States v. South-Eastern Underwriterswhich found that insurance in fact constituted interstate commerce – with a “file-and-use” system.Under the new system, insurers could start using rates they submitted to the regulator even before receiving express approval or disapproval. The only catch was that industry agreements to follow rates set by a credit rating agency—exactly the kind of collusion at issue in South-Eastern Underwriters– were completely prohibited.
A year later, in August 1971, the law was to take effect and the legislature neglected to extend it. The result, whether intentional or not, is that Illinois became the only state in the country with no insurance classification law at all. And it remained so (with a few minor exceptions) for the ongoing 52 years.
Until now.
Under HB 2203, set for a hearing today before the Illinois House Insurance Committee, any insurer seeking to offer private passenger motor vehicle liability insurance in the state must submit a complete rate application to the Department of Insurance, which would again have the authority to approve or disapprove rates based on of prior approval. The bill would also prohibit insurers from setting rates based on any “non-driving” factors, including credit history, occupation, education and gender.
The measure also creates a new system for public intervenors in the assessment process, which stipulates that “any person may institute or intervene in any proceeding permitted or established under the regulations challenging the Director’s actions under the regulations.”
In a nutshell, the law would transform Illinois from the most open and competitive insurance market in the country to one clearly modeled after the most restrictive: the inflexible and state-run system created by California’s Proposition 103.
The question is, of course, why would the state do this? It’s true that insurance rates are going up in Illinois, but they’re also going up everywhere else. Insurify estimates that the average cost of car insurance rose 9% to $1,777 in 2022, and the company expects prices to rise another 7% to $1,895 this year. In fact, car insurance rates in Illinois are still 15.5% lower than the national average.
Inflation and continued supply chain challenges are a big part of the story there. Increased rates of distracted driving also appear to be part of the blame. According to the National Highway Traffic Safety Administration, US traffic fatalities reached a 16-year high in 2021, with 43,000 deaths.
But those are all trends in the underlying loss and claims data. Perhaps a transport regulator can do something to reduce traffic accidents. The Federal Reserve is doing its best to keep inflation out of control. But an insurance regulator can do neither. Since no insurer could sustain very long premiums that were unprofitable, the only way rate regulation could actually lower insurance prices is if a market were not competitive, allowing some underwriters to use monopoly power to extract excess profits.
The evidence that this hypothetical describes Illinois is remarkably thin. There are 230 insurance companies that offer private car insurance in Illinois. Based on the Herfindahl-Hirschman Index (HHI), which the U.S. Department of Justice (DOJ) and the Federal Trade Commission use to assess the degree of monopolistic concentration in a given market, the Illinois auto insurance market scored 1,224 in 2021, the last year for which NAIC data are available. That’s even below the FTC and DOJ’s threshold (1,500) for a “moderately concentrated” market. Car insurance in Illinois is competitive.
Nor is the state’s largest car insurance company exactly swimming in profits. Allstate posted an underwriting loss of $2.91 billion in 2022, driven primarily by performance in the private passenger car market. For GEICO, a subsidiary of Berkshire Hathaway, it was a full-year pretax loss of $1.88 billion. Bloomington-based State Farm, the largest auto insurer both in Illinois and in the United States, suffered a massive full-year loss of $13.2 billion.
It would be one thing if the adoption of stricter rate regulation simply failed to achieve its stated goal of lowering tax rates, but the evidence is that it actually did obvious harm. The most obvious problem with rate regulation is that it limits the availability of insurance. Insurers are naturally responding to rate regulation by tightening their underwriting criteria, forcing some consumers to turn to the more expensive remaining market for coverage. In extreme cases, interest rate suppression can lead to some insurance companies leaving the market altogether.
The empirical evidence for this effect is obvious. After California mandated a mandatory 20% rate reinstatement following the passage of Prop 103 in 1988 (the effects of which were initially somewhat blunted by the courts), the number of insurers writing auto coverage in the state dropped from 265 in 1988 to 208 in 1993.
COMPANIES SELLING AUTO INSURANCE IN CALIFORNIA, 1988-1993
SOURCE: NAIC data
New Jersey, similarly, saw 20 insurers exit the market in the decade after the state passed the very similar Fair Automobile Insurance Reform Act. When New Jersey later liberalized its regulatory system by passing the Auto Insurance Reform Act in June 2003, the number of auto underwriters more than doubled from 17 to 39 and thousands of previously uninsured drivers entered the system.
A similar effect was seen in South Carolina, where a restrictive rating system in the 1990s had forced 43% of drivers into residual market insurance underpinned by state reinsurance. After passing a liberalized flex band rating law in 1999, as in New Jersey, the number of insurance companies offering coverage in South Carolina doubled, the remaining market shrank (today it is only 0.007% of the market), and overall rates actually fell.
Even in Massachusetts, which has a fairly restrictive rate approval process, reforms passed in April 2008 to allow insurers to submit competitive rates (they were previously set by the commissioner for all carriers) had a noticeable effect. Within two years of the reforms, fares had dropped by 12.7% and a dozen new airlines began offering coverage in the state.
Because it is still a highly regulated state, Massachusetts still has a relatively large residual market. According to data from the Automobile Insurance Plan Service Office (AIPSO), 3.38% of Massachusetts auto insurance customers had to resort to the residual market in 2022, the second highest rate in the country. But before 2008, Massachusetts’ remaining market share was routinely in the double digits. The only state that still has double-digit residual market share today is North Carolina, not coincidentally also the only state that still relies entirely on rates set by a taxing agency.
Finally, regulation is not free. To fund the additional actuaries and financial examiners needed to actually implement this new regulatory system in Illinois, HB 2203 proposes that insurers subject to its provisions be assessed an additional fee of 0.05% of their total annual premium earned. Based on 2021 premiums, that’s an additional $14 million per year, which is on top of the $106.4 million in fees and assessments the department already has on the industry (not to mention $515 million in premium taxes). The cost of these fees is naturally passed on to consumers in the form of tariff increases.
And what does the extra income actually get you? In 2021, Illinois spent $67.8 million on insurance regulation (which is, it should be noted, nearly $40 million less than it already collects in fees and assessments). California, by contrast, spent $245.5 million. Still, California’s market is no more competitive than Illinois’, and arguably much less so.
The land of Lincoln should realize that’s a pretty bad deal.
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