I am pleased to appear before you today to discuss state rule of car policy. As it turns out, the AEI-Brookings Joint Center on Regulatory Studies will release a major study of this subjugate in several months that was overseen by Professor J. David Cummins of the University of Pennsylvania. If the Subcommittee holds further hearings on this subject, I encourage it to seek testimony from Professor Cummins and others who participated in the survey. In their absence, I will report some of its independent findings .
Background and Summary of Testimony
The car policy diligence presently collects about $ 120 billion in annual premiums, accounting for roughly 40 percentage of overall property-casualty insurance premiums. As the subcommittee is well mindful, approximately half of the states have some form of anterior blessing over car indemnity rates .
The AEI-Brookings indemnity study contains both a statistical analysis of insurance in all states deoxyadenosine monophosphate well as shell studies of policy regulation and deregulation in selected states, all authored by leading scholars in the indemnity field.

The bottom line of all this analysis is very childlike to state. Auto insurance is a competitive industry. It surely is not characterized by monopoly, the traditional footing for price and entrance regulation. Nor is the product thus complicated that it requires government to set rates to protect consumers. indeed, because it is what I would call a “ obviously vanilla ” fiscal product—in large separate because indemnity policies have been standardized through forms regulation—consumers are easily able to use the Internet to shop for car ( and other types of ) policy. In help price comparisons, the Net is making and will continue to make car insurance—and the fiscal services industry more broadly—even more competitive .
In short, from an economic position, there is no footing for regulating rates. furthermore, there is no tell from either the AEI-Brookings survey or in the academic literature of which I am mindful argue that either prices or profits in states that rely on markets to set rates—rather than regulation—are excessive
Experience Under Rate Regulation
What about the states that do regulate policy ? As part of the AEI-Brookings study, Professor John Worrall of Rutgers University examined the experience of New Jersey, while Professors Sharon Tennyson of Cornell and Mary Weiss and Laureen Regan of Temple University studied Massachusetts. In both of these states car indemnity rates are heavily regulated. The authors of these state case studies reached similar conclusions .
In both states, rates have been suppressed below levels that would obtain in a freely competitive environment. On the coat, this may look like a commodity deal for consumers, but closer learn reveals deeper problems. For one thing, rate suppression not alone discourages submission by newly insurers, but encourages existing insurers to leave—which in fact has occurred in both New Jersey and Massachusetts. interim, many more of those insurers who remain engage only in a single state ( either as standalone companies or subsidiaries of national firms that are formed to limit fiscal exposures to the rear companies ). In Massachusetts, for example, in 1982 all top ten car insurers in the state were national firms, but in 1998 this was true for only 3 of the top 10. A similar convention has existed in New Jersey : five of the nation ’ s top 10 car insurers do not do business in the department of state. The net income solution from restrictive rate regulation is less choice for consumers among less diversified firms .
Less choice in regulate states manifests itself in another way as well. In his statistical analysis of policy rates across states, Professor Scott Harrington of the University of South Carolina confirms that insurers in regulate states are less uncoerced to voluntarily cover insurance, leaving a importantly higher fraction of consumers to buy their indemnity in remainder markets ( where most states assign policy holders to insurers based on their shares in the primary or voluntary market ). Again, Massachusetts illustrates the problem : roughly one-half of the state of matter ’ randomness drivers were forced to buy insurance in the residual marketplace during the 1980s ( reaching a high of 72 percentage in 1989 ). The Massachusetts case learn authors report improvements in the 1990s due to some reforms, but besides observe that declining claims costs besides made helpful contributions ( as they did elsewhere, as I discuss by and by ) .
furthermore, regulated rates are frequently distorted by political pressures in order to subsidize sealed classes of drivers. The AEI-Brookings learn found evidence that not only does regulation often oppress average rates, but distorts rates between different classes of drivers—keeping rates for bad drivers artificially broken, while raising rates for lower-risk drivers. This cross-subsidization is accomplished directly through limits on rates in sealed classifications or by channeling subsidies to higher risk drivers by keeping rates gloomy in the remainder market. The Massachusetts lawsuit study, for model, found that some high risk drivers receive subsidies arsenic high as 60 percentage, requiring some lower hazard drivers to pay 11 percentage more in premiums than they would pay in a competitive environment. similarly, the authors of the South Carolina case study discussed concisely report card that the residual market in that department of state ballooned under regulation to 42 percentage of consumers in 1992, requiring meaning subsidies from drivers in the voluntary market. By 1999, the state residual commercialize facility had a accumulative deficit of $ 2.4 billion. Subsidizing bad drivers is hardly a desirable sociable or economic policy because it can lead to higher accident rates and personnel casualty costs ( ascribable to more ownership and drive by higher risk drivers ) .
What about the experience in California, which adopted one of the nation ’ second best known regulative regimes under Proposition 103 enacted in 1988 ? Professors Dwight Jaffee of University of California at Berkeley and Thomas Russell of Santa Clara University conclude that the harmful effects of regulation found by the authors of the Massachusetts and New Jersey case studies—exit of insurers, rising residual market shares, and rate suppression—did not occur in California. The major argue for this unlike leave, however, is that in both absolute and proportional terms, claims costs in California—especially liability costs—fell dramatically after Proposition 103 was implemented. Why did costs fall ? Jaffee and Russell conclude that one argue was that Proposition 103 mandated a 20 % “ good driver ” rebate. But the more significant factors, taken together, were more aggressive enforcement of seat belt and drink drive laws, vitamin a well as the elimination in 1988 of third base party lawsuits in the state against insurers for bad faith. Phillip O ’ Connor, former Insurance Commissioner of Illinois, has besides recently testified to the fact that the most publicized region of Proposition 103—the 20 percentage rate rollback—was never in full implemented ( because of adverse court rulings ) .
In short, the California feel demonstrates that rate regulation need not produce deleterious results if other good things happen at the same clock time and if the regulative government is not that binding. But if there are up pressures on costs, then about by definition, rate regulation will result in rate suppression and the assorted negative consequences that flow from that consequence.

Experience Under Deregulation
In 1999, South Carolina well deregulated car indemnity rates ( under legislation enacted in 1997 ) and began phasing out its subsidies. Professors Robert Klein of Georgia State University and his colleagues Martin Grace and Richard Phillips examined the limited datum available since then and found some strike results. Before deregulation, South Carolina had an median of 59 insurers serving consumers, compared to about 200 insurers in other southeastern states. After deregulation, the number of insurers serving South Carolina roughly doubled. At the same meter, the residual market facility in South Carolina has about disappeared—down to about 50,000 consumers, from a high of one million—because insurers immediately can charge rates based on risk in the volunteer market. overall premiums have fallen, in part because claims costs have fallen ( a result which may have been influenced by the increased use of risk based pricing ) .
car indemnity has been deregulated in Illinois for over three decades ( and indeed, the state is the merely one in the nation without a fink law of any kind ). In his study of this experience for the AEI-Brookings study, Professor Stephen D ’ Arcy of the University of Illinois finds that premiums in Illinois are in line with losses, that they change more frequently and in smaller increments than they do than in determine states ( as one would expect in a competitive market ), and that the remainder grocery store scantily exists in the state ( at less than 1 percentage of the grocery store ). meanwhile, Illinois consumers have roughly doubly the number of car insurers ( 129 ) to choose from than those in New Jersey ( 67 ), where rates are tightly regulated. In sum, the Illinois know is reproducible with that of other states that have alleged competitive rat laws ? laws that do not require anterior approval ? and the department of state accomplishes this result without having to divert scarce regulative resources into monitoring rates ( but can focus on solvency and marketplace mismanage rather ) .
The experience from early industries where prices and introduction have been deregulated besides demonstrates that deregulation, by unleashing the forces of competition, helps drive out inefficiencies and therefore leads to higher productiveness and lower costs.10 In fact, there is tell of significant inefficiency in the indemnity diligence. In another recent study, Professor Cummins and colleagues estimated that on average property-liability indemnity firms could reduce their expenses by an extraordinary 32 percentage if they were all highly efficient.11 Rate deregulation in the states where it still exists would help unleash competitive forces that would help realize these cost savings .
The economic case for eliminating pace regulation in car policy is overpowering and compel. about all economists who have studied the industry over the death several decades have reached this termination. The obvious policy implication : car insurance ? indeed, all lines of insurance ? should be governed by the market, precisely like other industries in our economy. furthermore, like early industries, indemnity ought to be discipline to the antimonopoly laws .
There are several roles for regulation, however : to monitor insurance company solvency ( so that consumers will be paid when cover events occur ), to protect consumers from unscrupulous practices, and to help standardize forms for personal lines and to minor businesses ( so that consumers can easily compare prices ). Eliminating rate regulation would free up resources within insurance departments to pursue each of these functions ( specially solvency and wrongdoing regulation ) more vigorously.
Robert E. Litan: Summary of professional background
Robert E. Litan is Vice President and Director of the Economic Studies Program and Cabot Family Chair in Economics at the Brookings Institution. He is besides the co-director of the AEI-Brookings Joint Center on Regulatory Studies ; co-chairman of the Shadow Financial Regulatory Committee ; and co-editor of the Brookings-Wharton Papers on Financial Services ( with the Financial Institutions Center at Wharton ) and Emerging Markets Finance ( with the World Bank and International Monetary Fund ). He is both an economist and an lawyer .
During his career at Brookings, Dr. Litan has authored, co-author or edited 22 books and over 150 articles in journals, magazines and newspapers on government policies affecting fiscal institutions, regulative and legal issues, international barter, and the economy in general. His most late books include the forthcoming Beyond the Dot.coms ( with Alice Rivlin ) and The GAAP Gap: Corporate Disclosure in the Internet Age ( with Peter Wallison ).

Dr. Litan has consulted for numerous organizations, public and secret, and testified as an technical witness in a kind of legal and regulative proceedings. Among his respective assignments, he has authored or co-authored a act of influential federal reports. Most recently, he co-authored two Congressionally-mandated studies for the Treasury Department on the function of the Community Reinvestment Act after the Financial Modernization Act of 1999. During 1996-97 he has served as a consu
Dr. Litan besides has served in respective capacities in the union politics. During 1995 and 1996, he was Associate Director of the Office of Management and Budget ( where he was responsible for overseeing budgetary and early policies of six cabinet agencies ). From 1993 to 1995, he was Deputy Assistant Attorney General, in commission of civil antimonopoly litigation and regulative issues, at the Department of Justice. From 1977 to 1979, he was the regulative and legal staff specialist at the President ’ s Council of Economic Advisers. In the early 1990s, Dr. Litan was a Member of the Commission on the Causes of the Savings and Loan Crisis .
Dr. Litan received his B.S. in Economics ( summa semen laude ) from the Wharton School of Finance at the University of Pennsylvania ; his J.D. from Yale Law School ; and both his M. Phil. and Ph.D. in Economics from Yale University .

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