Amid the confusion after last week's vote to reduce rates on automobile, homeowners' and commercial insurance, a few things are clear:
- Californians voted for reform and regulation of insurance, not simply a one-shot effort to reduce rates.
- A good starting point in thinking about regulation is to ask why auto insurance rates are rising only 5% to 7% a year in New York and Michigan, compared to 20%-plus in California.
- The California Trial Lawyers Assn. is wrong to call the vote on Proposition 103 a victory for lawyers. Rather, it was a statement by Californians that they are tired of argument and want sense in insurance.
Meanwhile, the old world keeps on turning. Predictably, voting for lower rates is easier than achieving them. The California Supreme Court has stayed implementation of Proposition 103, and appeals are certain. Ultimately, the state Legislature will have to pass new insurance laws, especially on automobile coverage.
Need Better Law
But it doesn't take a genius to suggest that the legislators begin studying the no-fault insurance systems of other states for a model of the kind of system that would best serve California. To be sure, a no-fault system, coupled with intelligent regulation, may not bring down insurance rates. But it could halt their dizzy rise.
No-fault is the system in which each driver's insurance company pays his or her claim after an accident, and lawsuits are barred except in accidents causing death or serious injury. By avoiding litigation, insurance companies figure that costs are lower and policyholders get their money faster. Lawyers, understandably, argue that accident victims lose out.
But again, the overriding message of the election is that people are tired of this debate. They want to stop ballooning costs.
So even though the insurance industry's no-fault proposal--Prop. 104--lost on Election Day, the state should adopt a similar but better law, one with strong limits on lawsuits and regulation of allowable payments.
Of the 26 states that have no-fault laws, the notable success stories--New York and Michigan--bar lawsuits except in cases involving death or serious, permanent disfigurement or impairment. New York specifies payments for injuries in auto accidents in the same way that the federal government does in Medicare. By contrast, New Jersey's law gave too much leeway to follow-up lawsuits and now has the most costly and steeply rising insurance rates.
Was Best Market
And in an era characterized by deregulation, the people voted for regulation. They did so because insurance is not a product like jeans or soda pop, a voluntary purchase. It is often involuntary: You couldn't finance a house without insurance; companies couldn't operate without insuring against liability lawsuits or injury to their workers.
In the case of car insurance, it is required by law--not to protect the insured driver but to protect or compensate others for accidental injury. It is a bit silly to talk of a "free" market setting rates for such a legally mandated and critical business. In the case of last week's balloting, the voters clearly said they want a state authority checking prices because they don't trust insurance companies anymore.
In California, the insurance industry spent more than $60 million in television advertising to blame ambulance-chasing lawyers, whose fees are often one-third of each damage award, for rising auto rates. And there was some truth in what the insurance companies said. But as the vote showed, insurers' credibility is lower even than that of lawyers.
The roots of the problem go back to 1984 says Allerton J. Cushman Jr., insurance analyst of Morgan Stanley, who remembers when California was the best insurance market, relatively unregulated and growing.
But in 1984 that came unstuck when interest rates fell and damage awards continued to rise.
To understand, you should know that insurance companies make money two ways: by insuring risk and by investing. The industry collects premiums and sets aside reserves to pay future claims. Meanwhile, premiums and reserves are invested to earn a return. In times of high interest rates, companies can earn more by investing than by insuring risk, and so they often cut rates to draw in premium money for investment.
But if claims become more expensive--because car repair costs go up or courtroom awards increase--then the companies begin to run losses on insurance. And if interest rates then fall, the companies begin to lose money two ways, at which point they abruptly return to charging higher premiums.
Will Cause Change
Which is what happened with a vengeance in 1984. Interest rates fell abruptly, and the industry did a turnaround on premiums. Rates went up, and some coverage was hard to come by. Day-care centers and ski resorts had to self-insure or go out of business. The phenomenon of the school football team unable to play because of high insurance rates made Americans wonder what was wrong.
That experience, when small business and communities were stunned by insurance rates, began the movement that led to this year's ballot initiatives--and ultimately will be the cause of tighter regulation for the insurance industry.
Is regulation bad for business? No, it isn't. The insurance companies threatening to withdraw from California should know that the states in which insurance companies do best are those where regulation is strict and intelligent. Analyst Herbert Goodfriend of Prudential-Bache Securities suggests that they need only look to Ohio, Indiana, Michigan and New York. All have strong regulation, and none have rapidly increasing insurance rates.
But the key is \o7 intelligent \f7 regulation. New York has a staff of professional actuaries judging insurance rates and practices, while California has only a bare-bones commissioner's office.
Sure, intelligent regulation costs money. But, as Californians know too well, weak regulation is costly too.