Ending California's liability-insurance crisis will take a little common sense and a lot of political guts. The crisis stems principally from the boom-or-bust nature of the insurance industry and the uncompetitive environment in which it operates. To make the system sane again, California's insurance commissioner will have to be more watchful of industry profits and practices. And the insurance industry will have to give up its special status.
Anyone who pays taxes, buys a consumer product, has children in school or in a day-care center or needs medical attention has been affected by the rising cost of liability insurance. There have been tremendous increases in its cost, and reductions in what is available. Insurance premiums have risen for virtually every business and government whose operation or products might be of some harm to anyone.
The insurance industry has mounted a campaign to reform the legal system, which it says has been too open and too generous. But there is little evidence to suggest that reforming the legal system would make insurance cheaper and more available.
At the heart of the current liability crisis is the cyclical nature of the insurance industry. At the beginning of the current cycle, when interest rates were high, insurance companies went all out to attract investment income by selling liability policies at bargain rates. As long as interest rates were high, companies could recoup money lost on discounted policies. But once interest rates fell, underwriting losses rose, reinsurers backed out of the market, and the insurance companies were stuck with huge losses. To cover themselves, they have raised premium prices. There have been similar periods of high rates, such as the mid-1970s, but the current cycle has been the wildest ever.
The way to bring down the cost of insurance is to flatten out the industry cycle. Doing away with the cycle would be impossible. Interest rates are bound to fluctuate; so, too, are premium prices. Regulators can moderate the swings of the industry cycle, and premium prices, only if they can establish a relationship between rates charged and claims paid. To do this, California's insurance commissioner must be able to examine the profits and pricing decisions of the industry.
California's insurance commissioners have traditionally lacked either the will or the wherewithal to do this. Before the commission approves an industry rate increase, it must determine whether it is justified. Right now it can't. Insurance companies, for example, can tuck away vast sums into reserves and, by so doing, obscure the size of their profits. Because the insurance commissioners have been lax, the industry has charged whatever it pleased. The Legislature should beef up the commission by giving it more resources and more authority.
Perhaps the greatest reason premium prices are so high is that the industry is exempt from federal and state antitrust laws. Unlike most businesses, insurance companies are not prohibited from sharing information, setting prices or dividing markets. Just why the industry has this exemption is unclear, but clearly the Legislature must end it. By being subject to antitrust laws, the insurance industry would have to compete like everybody else. More companies would enter more markets, and rates would come down.
The unwatched, uncontrolled insurance industry bears the primary responsibility for the insurance crisis. Opening up the industry to more competition and more oversight would go a long way toward making insurance affordable again. It would mean taking on one of the country's most powerful lobbies, but the commissioner and the Legislature can, if they are up to it, restore sanity to the liability market.