Insurance Rates: Regulation in Comparison with Open Competition
60 Pages Posted: 2 May 2012 Last revised: 10 Apr 2013
Date Written: May 1, 2012
The article examines rate regulation in the U.S. property and casualty insurance market. Although the regulation of rates is aimed at promoting insurer solvency and preventing oligopolistic pricing, it may also lead to market inefficiencies. This study argues that rate regulation in the U.S. seems to be based more on an historical tradition than on solid economic arguments and proposes rate deregulation as a superior alternative to the current regulation model.
The U.S. property and casualty insurance market presents the structural features of a competitive market. It is characterized by a large number of firms selling products with identical features and the evaluation of the Herfindahl-Hirschman Index for industry concentration indicates that the market is not concentrated. Furthermore, the trend toward an increase in the level of market concentration is oftentimes the result of market competition which results in low-cost and efficient firms replacing high-cost firms. The property and casualty insurance market is also widely regarded as having low barriers to entry for new firms. Even though the market does not have monopolistic or oligopolistic characteristics that would justify rate regulation, purely competitive rate setting systems are seldom used throughout the United States. The article highlights that rate regulation in the U.S. may be adversely impacting insurer profitably, as rate changes are impeded as market conditions change. There is empirical evidence that property and casualty insurance companies have experienced a lower rate of return than other industries. Statistics suggest that these artificially low returns may have led to many insurers’ exits from the market. In particular, with regard to some lines, over the 2000-2009 period, more insurers exited the market than entered it. Deregulation would eliminate compliance costs and allow rate changes. Even if rate deregulation leads to higher rates, in the long run this would be offset by greater market availability and consumer choice.
The need for rate regulation and the desirability of more effective solvency regulation should be distinguished. Solvency concerns can be addressed by focusing on insurers’ reserves and increasing the monitoring of the financial conditions of insurers. There is no evidence that rate regulation has eliminated the possibility of insurer insolvency. It is more likely that allowing insurance companies to set rates commensurate with their costs will enhance their financial strength. For these reasons policy makers should consider greater insurance rate deregulation.
The European Union can provide a helpful case study in considering rate setting deregulation in the U.S. since EU Member States do not have the right to regulate insurance prices, after the European Parliament passed the third non-life insurance Directive in 1992. Previously, Member States exercised considerable rate setting power. The experience has been a positive one. Competition increased, especially in heavily regulated markets and premium rates decreased. The number of insolvencies decreased as prices were better aligned with costs.
Keywords: Insurance, rates, regulation, deregulation, U.S., property and casualty, Europe, Directive, concentration, mergers and acquisitions, availability, price, consumers
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