America has a deeply troubled auto and homeowners’ insurance system. Fixing it will require hard work and today two United States senators will open the debate over how to do it. New Hampshire Republican John Sununu and North Dakota Democrat Tim Johnson want to let insurance companies do what banks have done since the Civil War–subject themselves to federal rather than state regulation. This proposal won’t fix America’s insurance system alone and, in any case, it seems unlikely to pass for now. But it does show that the America’s long stagnant insurance business could soon face a shakeup.
And the right kind of shakeup would improve things. Even as deregulation has benefited people who buy everything from plane tickets to mortgages, insurance remains stuck in a 19th century mold of regional state-based economies. All 50 states and Washington, D.C. have their own insurance rules and all but one exercise some sort of political control over auto insurance rates. Every state that faces serious hurricane, erosion, or earthquake risks, likewise, controls, subsidizes, or manipulates insurance rates for people living in particularly risky areas.
In effect, there’s no national market for insurance at all. Even when centralized companies like Geico sell policies, every transaction must pass through a state-licensed insurance agent. Every new product needs 51 sets of approvals.
This patchwork regulation increases average rates and reduces economic efficacy. It makes risk pooling harder and undoubtedly contributed to maladies as ranging from the slow pace of rebuilding after Hurricane Katrina to the difficulty of finding affordable wholly private auto insurance in states like Massachusetts. In fact, insurance remains one of the only areas where workers in countries like France and Germany produce more than their American counterparts.
The Sunnunu-Johnson proposal, called Optional Federal Chartering (OFC), would let insurance companies apply to the federal government for recognition and, in theory, bypass state regulations. The devil, of course, is in the details. If structured properly — exempting federally chartered insurance companies from all state regulations besides those that apply equally to all businesses — OFC could improve competition, increase risk pooling, and make things better for consumers. A poorly structured proposal, however, might subject insurance companies to both federal and state regulation. This would make things worse.
Rate regulation, whether by means of direct state rate-setting or burdens imposed in the name of consumer protection, makes no sense in insurance markets. Since all insurance companies have to break even in the long run, any political attempt to reduce rates for one group will lead to corresponding rate increases for another. Thus, rate regulation just redistributes money from groups that have greater risks to those with fewer. To say the least, it’s difficult to see the public good in keeping insurance rates low for bad drivers and people who choose to live atop sand dunes.
Eventually, insurance will work best if the United States sweeps away nearly all rate regulation and lets relative risk, the market force, decide the insurance rates for people’s homes and cars. It’s appropriate to look at most “consumer protection” requirements with enormous skepticism because many of them simply serve to regulate rates by other means.
In any case, the battle lines have begun to appear. Most larger insurers like the Sununu-Johnson proposal with its promise of open markets and a single national regulatory regime. Most independent insurance agents, fearful they’ll find themselves cut out, dislike it. The National Association of Insurance Commissioners officially opposes the proposal but has recently come under fire from an officer of the largest agents’ group for its supposed lack of vehemence. If nothing else, the discussion promises to arouse great interest.
Above all, it’s important to remember that in an increasingly dynamic 21st-century economy, insurance remains mired in a regulatory system left over from an inflexible industrial age of the past. Fixing America’s property and casualty insurance system will take hard work. Senators Sununu and Johnson will begin a useful debate.