north carolina's auto insurance system: still unfair, still in need of improvements

North Carolina’s Auto Insurance System: Still Unfair, Still in Need of Improvements

EL I LEHRERAPRIL 2011

P O L I C Y R E P O R T

North Carolina’s Auto Insurance System: Still Unfair, Still in Need of Improvements

EL I LEHRERAp r i l , 2 0 1 1

3 Executive Summary

4 Introduction

4 How the System Works

10 Consequences for the State

11 Reform Proposals

14 Conclusion

15 Notes

16 About the Author

The views expressed in this report are solely those of the author and do not necessarily reflect those of the staff or board of the John Locke Foundation. For more information, call 919-828-3876 or visit www.JohnLocke.org. ©2011 by John Locke Foundation.

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Executive Summary

North Carolina’s auto insurance system is unfair to low-risk drivers because it overcharges them in order to subsidize some of the state’s more risky and dangerous drivers.

Every insured driver pays a hidden tax – which averages about 6 percent – that goes to the govern-ment-mandated, privately run insurance pool for risky drivers. This pool uses the tax to subsidize the policies of risky drivers who should, but don’t, pay higher rates because of a legal cap. Insurance com-panies are allowed to dump into a risk pool anyone who has risk factors that make them unprofitable. The tax money is used to make up the difference between the capped rate and the amount that the high-risk driver should pay.

Some private insurance companies like the system because it guarantees them a profit by allow-ing them to dump risky drivers into the government-mandated tax-subsidized pool. In fact, almost a quarter of N.C. policyholders are in the pool com-pared to less than 1 percent nationally. Not only is the tax hidden, the pool is hidden because risky drivers in the pool continue to receive bills from their private insurance company. This allows the

private company to sell these customers other types of insurance, including collision coverage for their cars as well as life and home insurance.

Who are these risky drivers who receive unfair subsidies from good drivers? Nobody knows for certain since companies can cede any risky driver they want into the pool. But it’s highly likely that many are teenage males who may have clean driv-ing records, but as a group are more prone to tickets and accidents. Since the government-controlled rate-setting process does not allow insurance com-panies to use age as a factor, the 18-year-old who drives a red sports car pays a rate that does not reflect his risk of an accident. (Drivers with multiple tickets or serious accidents regardless of age also end up in the government-mandated risk pool, but, on balance, they do pay rates that reflect their risks.)

While average rates in North Carolina are in line with other states in the Southeast, good drivers are still paying more than they should. The reforms suggested in this paper would simplify the current bureaucratic and secretive system and lower rates for many, if not most, drivers in the state.

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Five parties play major roles in setting North Car-olina’s automobile rates: a rate bureau, the insurance commissioner, the court system, the Reinsurance Facility, and private insurers. The resulting system is stable but inflexible and resistant to innovation. Understanding the role that each party plays can illuminate the workings of the system and explain why the system remains unclear to consumers.

The North Carolina Rate Bureau, a state agency independent of the Insurance Department and largely under the control of the insurance industry, begins the rate-setting process.2 Under state law, the Rate Bureau develops a rate plan that all insurers

must use as the basis for their rates.3 In creating the rate plan, it creates a single rating matrix that impacts the rates for every person in the state. Although it considers things like driving history, driving experi-ence, and geographic location, the rate plan must exclude factors like age (although certain proxies for age like years of driving experience are allowed) and gender that many insurers would use if the state would allow it. The rate plan also contains actuarial justifications showing why the rates make sense. It also builds in a degree of profit for insurance com-pany owners. By law, North Carolina’s insurance commissioner must consider this profit. Each rate

North Carolina’s automobile insurance does not allow customers to purchase the products they want and does not allow insurers to sell them. About one North Carolina resident in four cannot find cover-age in the private market at any price and must purchase it instead through a government-mandated insurance pool.1 Although hidden from the state’s public via a system that keeps private companies’ names on every insurance policy in the state, the sheer size of this government-mandated market has consequences for almost everyone who drives in North Carolina.

This paper analyzes North Carolina’s current automobile insurance system and outlines its con-sequences for the consumer. The paper consists of three sections: The first describes how the system works, the second examines its consequences for the state’s consumers, and the third considers a number of ways to improve and change the system. The pa-per reaches a simple bottom line: North Carolina’s insurance system is unjust, expensive for good driv-ers, choice-limiting for all drivers, and burdensome for insurers. With the right polices, it would be better.

I. How the System Works

Introduction

CHART 1: RESIDUAL MARKET POLICIES BY STATE AS A PERCENTAGE OF THE NATIONAL RESIDUAL MARKET

North Carolina: 1 ,455 ,000 (78 %)

Massachusetts: 112 ,000 (6 %)

New York: 92 ,000 (5 %)

Maryland: 73 ,000 (4 %)

Pennsylvania: 19 ,000 (~1 %)

New Jersey: 15 ,000 (~1 %)

Rhode Island: 9 ,000 (>1 %)

California: 6 ,000 (>1 %)

Hawaii: 5 ,000 (>1 %)

Virginia: 1 ,460 (>1 %)

All other states combined: ~1 ,500

Source: Automobile Insurance Plans Service Office.

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plan contains an overall increase or decrease in rates based on changes in insurers’ underlying costs, as well as macroeconomic risk factors like the costs of car repairs and the number of traffic accidents during the previous year.

The insurance commissioner receives the plan from the Bureau and reviews it. He or she can ac-cept it without changes – something that has never happened – or request changes.4 In approving the plan, the commissioner must assure that the industry makes a profit. The industry would be entitled to sue the commissioner and the state if a plan that did not include a profit were approved. If the commissioner requests changes, he or she must also hold hearings unless he can settle with the insurance industry be-fore the hearings take place. The public hearings, a process that can often last more than a week, require the commissioner to play a dual role as both hear-ing officer and advocate. While the law requires the commissioner to serve an impartial role as a hearing officer, the commissioner also has an obligation to speak for his or her department.5 Following the hear-ings, the commissioner makes a decision and, if the Rate Bureau – which represents the industry – does not like the decision, it may take the matter to court.6 In the meantime, the insurers may charge based on the Bureau’s rate plan (or another one that takes some but not all of the commissioner’s concerns into account) but must escrow the difference between the commissioner’s approved rate plan and their own and pay back money at the prime lending rate plus 3 percent to anybody to whom they refund.

Disagreement between the Rate Bureau and successive insurance commissioners has almost al-ways ended up with a spilt decision. One 1996 case illustrates a typical outcome.7 The Bureau had asked for a 10.8 percent increase in private automobile rates, and the commissioner wanted a 13.8 percent decrease. The court faulted the commissioner for failing to take dividends (payments to policy holders made by mutual companies) and deviations (lower rates granted to people with preferred risk charac-teristics) into account. In addition, it ruled that the commissioner calculated the insurers’ total rate of return correctly and acted within his powers to use accounting measures different from those the Rate Bureau used. The court also faulted the Rate Bureau for using data and trend models that “lack credibil-

ity.” As a result, the court upheld some parts of the decision, vacated (overturned) others, and remanded others to the insurance commissioner for further consideration. Eventually, the Rate Bureau and the commissioner settled the case in 2000 (perhaps not coincidentally, an election year), resulting in partial refunds to nearly all North Carolina drivers.8

But even these compromises do not result in the final rates. Instead, the rates that most North Caro-lina residents actually pay come from “rate devia-tions” that insurance companies file – rating plans that depart from the criteria in the Bureau plan that the commissioner approves. Under North Carolina’s current system, insurers can always charge less than the Bureau rates but not more. A few deviations, most importantly the safe-driver discount for people who have avoided serious accidents and speeding tickets, exist in a long-standing statute law called the Safe Driver Incentive Plan.9 All other deviations that exist come from other underwriting criteria that insurers decide to use. Some insurers, for example, might extend special discounts to people with very long accident-free periods or particularly desirable risk characteristics like good credit scores. The rates that result from the system thus almost always fall below the rate plan approved by the Bureau. Drivers with particularly undesirable risk characteristics – young male drivers in high-density areas who own sports cars, for example – still do not pay private rates above those in the approved plan.

These drivers, and many others, end up in the state’s so-called residual insurance market – the market of last resort. The North Carolina Reinsur-ance Facility, which shares staff and offices with the Rate Bureau, remains opaque to most people – even those who receive insurance coverage through it. The Facility – only one other state, Rhode Island, has a similar entity – allows any insurer with doubts about the profitability of any policy to transfer it (cede in insurance parlance) to the Facility. The insurer does give up its fundamental business profitability for the liability insurance it writes when it does this. Drivers covered by the Facility get statements that look almost identical to those other drivers receive, do business with the same agents, and call the same 800 numbers for policy questions; but liability for damage that they cause is carried by the Facility rather than private insurers. The Facility and the

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D OES T HE FA C IL I T Y BENEF I T T HE IN SUR AN CE IN D US T RY ?

The Reinsurance Facility itself maintains that the system does not benefit the industry, but some evidence indicates that it does. To begin with, a quote from its website can illustrate the predomi-nant industry position:

There appears to be a common misconception that

an insurance company somehow benefits from

placing business in the Facility. First, there is

no financial benefit to any company in ceding a

profitable risk to the Facility. Any opportunity

for making a profit on that risk is forfeited by the

company once it is ceded. The only profit a com-

pany can make is on that business that it retains

on its own books through the voluntary market. 10

Although none of this is untrue on its face, it requires a certain amount of explanation: While not a major profit center, the Reinsurance Facility’s existence – and the openness of access to it – does help insurers make money by helping them to collect fees and sell other products to the Facility. A look at the actual nature of the North Carolina insurance market indicates that some players have found participation in the Facility to be a viable way to do business and retain employ-ees while taking on no economic risk.

To begin with, the industry benefits from the Facility when it collects fees for writing policies and when it cross-sells other products, includ-ing other types of auto coverage. Fees first: A company with a policy in the Facility still takes in revenue for servicing the policy. The fees it receives for day-to-day service are calibrated to its own costs or industry averages – whichever is lower. This doesn’t produce economic profits that a company can use to invest in other operations or expand business, but it does keep salaries paid, lights on, and overhead costs met. Furthermore, under a process called “consent rating,” the same insurer can write a policy for the auto’s physical damage — collision coverage — which may produce profits by any measure. Although it’s theoretically possible to procure liability and collision from

separate companies, few companies have estab-lished methods for writing collision coverage to people to whom they don’t provide liability cover-age. In any case, since Facility policies will differ by only a few dollars regardless of who services them, few consumers would bother to look for separate collision and liability policies. In addi-tion, the insurer has more opportunities to sell the customer homeowners’ insurance, investments, life insurance, and more.

A look at the Facility’s record provides strong evidence that some companies find the Facility a business advantage. Most larger insurance groups cede just about the state average percentage of business – 23.47 percent in 2009, the most recent data available – to the Facility 11. But some smaller insurers cede all of their business to the Facility, and one large national insurer cedes far more than the industry average. (See Chart.) This indicates that they must see some business advantage in doing so.

Two factors may explain the current situa-tion. First, some insurers serve distinctly different populations. USAA, for example, focuses heavily on people who have served in the military, and it’s possible that they may simply be insurable at

CHART 2: CO MPANIES THAT DO ALM OST ENTIRELY FACILITY BUSINESS

Atlantic Casualty Insurance Company: $8.89 M illion - 99.68 Percent

Discovery Insurance Company: $10.18 M illion - 100 Percent

Greenville Casualty Insurance Company: $4.98 M illion – 96.55 Percent

Peak Property and Casualty Insurance Corporation: $22.05 M illion – 90.4 Percent

Chartis Group (Two Companies): $2.27 M illion – 97.98 Percent

O ne large national market player, Progressive, also cedes more than 60 percent of its overall business to the facility. Some companies such as GEIC O place all ceded policies in one corporate entity and then cede no policies from another.

Source: North Carolina Reinsurance Facility. Ceeded Premium by Volume by Company or Group. Circular Letter to All Member Companies, January 10, 2011

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private insurance industry claim that this system is not a benefit to the industry, but there is significant reason to doubt this. (See sidebar.)

CLEAN R I S K S AN D D I R T Y: A C O N FUS -

ING , EX PEN S IVE S Y S TE M

Drivers sent into the Facility – few of whom likely even know of its existence – fall into two groups: one called “clean risks” and the other called “other than clean” or “dirty” risks. Essentially, “dirty risks” are people who have committed traffic offenses or made insurance claims that “count” under state law, while clean risks have not done these things. By any objective standard, clean risks do not necessarily have clean driving records, nor is there any lack of proof that they pose a risk. Likewise, even though all of the very worst drivers are “dirty risks,” a given “dirty risk” is not necessarily a worse driver than a given “clean risk.”

Thus, the two categories are the product of state law rather than any calculation of actuarial risks. Clean risks can commit quite a few traffic offenses. Many may have multiple speeding tickets, gotten into accidents, and had tickets dealt with under “prayer for judgment continued” (a simple continu-ance that a judge grants without making a decision). Although nearly all truly awful drivers – people with DUI and reckless driving convictions – are “dirty” risks, many not-so-bad drivers also may fall into the dirty risk category.

Some examples may help clarify things. A male 18-year-old with a new Chevy Camaro who gets two speeding tickets in a year (one for going 15 miles over

the speed limit, the other for going 9 miles over the speed limit) can stay in the “clean risk” category. He would do this by getting the 15 mph ticket dealt with under “prayer for judgment continued” and paying the fine on the other. A female 60-year-old who drives a Buick Lucerne and has a perfect driv-ing record will very likely get counted as a “dirty risk” the day she backs into a Mercedes in a parking garage and damages its $2,000 headlights.

This has significant fiscal implications because, in 2010, 71 percent of people in the Facility remained in the “clean risk” category.13 In general, “clean” risks in the Facility pay the maximum rates allowed under the approved rate plan for private liability coverage. “Dirty” risks, on the other hand, pay much higher rates. The crucial difference is this: “Dirty” risks cover their own way, and clean risks do not. Instead, everybody in the state subsidizes the clean risks.

A TEENAGER TA X

The tax subsidizing clean risks, officially the “Reinsurance Facility clean risk surcharge,” aver-ages about 6 percent a year on every auto insurance policy in the state. It provides a yearly reminder that the government-authorized underwriting criteria do not provide a proper assessment of the risks. If “clean” risks really were truly clean and actually had good driving records, then, in the aggregate, the Facility would break even writing insurance for them. Since they do not have good “clean” driving records, the Facility loses money each year, and the state as a whole must pay for it.


lower rates. Second, some insurers may have dif-ferent business models that allow them to manage capital more effectively by ceding policies. An insurer that believes it can get a 10 percent return on capital might not tie it up writing a profitable insurance policy that would return only 3 percent.

That said, it’s hard to know exactly how these companies work and why things change. “We don’t need to know and, in fact, can’t really know why companies cede business to the Facility,” explained Ray Evans of the North Carolina Rate Bureau (which operates together with the Reinsurance Facility)12. Companies are not

generally willing to discuss on the record exactly what business they cede to the Facility. Based on several conversations with industry insiders, how-ever, it’s possible to make some generalizations: The people ceded to the Facility are generally younger males (often teenagers), very old drivers, and people with other “risk factors” that tend to increase the chances of needing to pay very large claims.

On balance, it’s fair to conclude that the struc-ture of the Reinsurance Facility is an advantage for the industry and, for some companies, the key to their business models.

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Few North Carolina residents know about the tax because, for more than 20 years, insurers have been forbidden to disclose it on statements. Insur-ance agents were behind the change. “Agents found it very difficult to explain, everyone was asking,” Bob Bird of the Independent Insurance Agents of North Carolina said in a 2008 interview. “So it was just easier to leave it out.”14 Bird adds that many people did not pay the surcharge (contending they hadn’t “ordered it”) and, thus, under state law, found them-selves dropped by their insurers for non-payment of premiums. He concluded, “not having the surcharge is really a consumer benefit.”

Whatever one thinks of the surcharge, it surely raises automobile insurance rates at least a bit for a minimum of 75 percent of the state’s drivers. The chart below shows its size in recent years. It has aver-aged slightly less than 6 percent a year over the last ten years. (On one occasion, in the last ten years a “loss surcharge” was also imposed.)

T HE V O LUN TA RY M A R KET

Most auto policies – around 75 percent – do not end up in the Facility. Instead, insurers write them in the private market. While any insurer operating in the state can simply use the Bureau’s rate plan, nearly all file “deviations.” On average, motorists

pay less than the Bureau rates, about 13 percent less.15 These rates are roughly average for nearby states: North Carolina drivers pay more than drivers in South Carolina (not surprising, as the state lacks a large city), almost exactly the same rates as drivers in Virginia, and less than those in Florida and Geor-gia.16 In short, North Carolina residents do not pay rates that are significantly higher — or significantly lower — than those in nearby states. There’s no evi-dence of price fixing, little evidence of overall rate suppression (if there were, insurers would flee the state), not much evidence that insurers make hugely


CHART 3: CLEAN RISK RECOUPMENT FACTOR, 2001 TO PRESENT

0

2%

4%

6%

8%

10%Average: 5.91%

Between 4 /05 and 4 /2006 an additional “ loss recoupment” for “dirty risks” was also imposed.

10/2010 to

10 /2011

4.33%

10/2009 to

10 /2010

6.41%

10/2008 to

10 /2009

4.24%

10/2007 to

10 /2008

2.48%

10/2006 to

10 /2007

8.82%

10/2005 to

10 /2006

9.71%

4/2005 to

10 /2005

6.43%

7/2004 to

4 /2005

5.35%

7/2002 to

7 /2003

5.05%

7/2001 to

7 /2002

7.22%

CHART 4: 2010 AVERAGE AUTO INSURANCE RATES BY STATE

Source: Insure.com. http://www.insure.com/car-insurance/car-insurance-rates.html.

$1800

$1600

$1400

$1200

$1000

$800

$1,095SC

$1,154NC

$1,237VA

$1,476FL

$1,670GA

7/2003 to

7 /2004

5.05%

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more than they do elsewhere, but plenty of evidence that the system treats some unfairly.

Given that 75 percent of the state can get insur-ance at costs less than the bureau/court/insurance commissioner-imposed rate cap, little evidence ex-ists that the rate cap stops insurers from “soaking” good drivers. If the rate cap actually suppressed rates, then insurers would either leave the state (since they would be losing money) or, at minimum, charge everyone the maximum rate the insurance commissioner would allow. Since neither of these things has happened, it’s logical to conclude that the system does not suppress rates. Most North Carolina drivers pay just about the same rates they would elsewhere.

So, whatever its flaws, the system seems stable. Indeed, for the insurance industry, it seems to be good: There’s no shortage of insurers willing to write coverage in North Carolina, and, according to the firm SNL Financial, more than nine new companies have entered the state to write insurance business in the past five years.17 If it does not save money, the system also does not seem unduly expensive for the state’s drivers. Insurers have not fled the state, and most North Carolina residents pay reasonably low insurance rates. Thus, a question arises: Does the system need change? Many people think it does not. In fact, however, there’s a good case to be made that it does.


Wayne Goodw in, North Carolina’s insur-ance commissioner, since 2009 has developed a reputation as someone w illing to make changes. Confronted w ith a coastal i nsuran c e marke t t ha t threa tened to imp lode and had chased away at least one large insurer, he took a leadership role just months after taking office and led the legislature to pass a reform plan that stabilized the market and attracted several large new property insur-ers to the state. During Goodw in’s campaign, he expressed concern about the size of the state’s residual insurance market. But he tells the author that he considers the system essentially effective today. “ We’re the largest state w ith the lowest rates, ” he says, in public statements, although he continues to acknow ledge that the system is “not perfect. ” He has attributed parts of the reform bills to “ corporate greed. ”

Goodw in says that he does not feel any of

the legislation to modify the state’s auto insur-ance system currently before the leg islature would be acceptable in its current form and that he does not see room for some of the things included in it, most particularly the broad “flex band” (see below for more on this) that some industry groups say they want. O n the other hand, he says he is open to a system that would abolish the Rate Bureau if the insurance depart-ment could increase its staffing component (see below for more on this).

A lthough Goodw in administers the current system, he has no power to change the current underlying law and — although doing so would result in enormous political battles — the legis-lature has the ability to change insurance laws w ithout his consent. G iven that the insurance commissioner has a good deal of autonomous power and that Goodw in has proven himself w illing to work w ith diverse groups to forward reforms, the legislature and private industry would do well to try to partner w ith him on any reforms and try to find a compromise.

WHAT COULD THE INSURANCE COM MISSIONER DO?

Wayne Goodwin

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North Carolina’s auto insurance system does indeed need change because it harms consumers. It has at least four negative effects:

1) It guarantees profits to private insurers.2) It denies the best rates to good drivers.3) It hurts women and older residents.4) It hampers product innovation.

Although its defenders – quite possibly out of sincere belief – claim that North Carolina’s cum-bersome system benefits consumers, it appears to bring the greatest benefit to privately run insurers. The unique-in-the country system of “free ceding” to a state-backed, statutorily defined Reinsurance Facility guarantees that no company needs to take a risk writing insurance in North Carolina. This keeps business in the state and provides assurance that profits continue to flow. If a company has the slightest doubt about a given policy, it can always take it off its books. For certain companies – particu-larly regulated utilities with significant infrastructure costs – some economists believe that a form of profit guarantee makes some sense.20 The theories of guar-anteed profits, however, always rely on the idea that the industry is a “natural monopoly” (most efficiently served by a single provider) and that a return on investment simply provides a continued inflow of new capital for investment. Neither of these factors appears true of automobile insurance. Nobody in the United States contends that auto insurance is a natural monopoly, and, aside from a few Canadian provinces – where it’s had poor results – nobody outside the United States does, either.21 While economies of scale exist in the insurance business, there’s no theoretical advantage to having just one company. Thus, while it may limit total profits, the current system assures that only a company with truly awful management could ever lose money writing automobile insurance in North Carolina. Indeed, the fact that several private companies place all or almost all of their business in the Facility means that it must have a benefit. Thus, through govern-ment regulation, North Carolina guarantees profits to private business.

The safest North Carolina drivers, furthermore, do not get the best rates under the current system.

Insurance industry sources freely admit this. This happens because of the practice of free ceding to the Facility: a driver with a few speeding tickets will pay a higher rate and, because of the risks, produce more profits for a well-run insurer.22 Some of these profits will go to lower premiums for desirable good drivers. (Companies don’t do this because they are nice – they do it because good drivers are the most profitable and worth competing for.) In North Carolina, however, insurers are guaranteed a profit on good drivers but cannot write policies to riskier drivers. Thus, a subsidy that good drivers would typically receive from bad drivers simply disappears.

To make up for the fact that they cannot charge moderately risky drivers sufficient premiums, North Carolina insurers jack up premiums on the state’s best drivers. The “teenager tax” alone assures that roughly 75 percent of the state pays an extra 6 per-cent (on average) in their auto premiums each year.

Women and older residents also lose under the current system. North Carolina, unique in the coun-try, bans the use of both gender and age in setting automobile rates. As a result, even the Bureau rates often get prices “wrong.”23 Every study done on the topic shows what most people know: Men are worse drivers than women, and young people are worse drivers than older ones. The most significant and detailed analysis done to date came to some simple conclusions: Men are about 1.5 times more likely to get into fatal auto accidents than women, and teenagers are about three times more likely to get into serious crashes than more mature adults.24 Instead of using age, North Carolina insurers typi-cally use the length of time that an individual has had a license, and the state has typically allowed them to raise rates for newly licensed drivers for three years. This makes it possible to raise rates on 16- to 19-year-olds (who, by definition, have less than three years experience) but makes it impossible to take age as such into account per se. Nonetheless, the consequences are sometimes perverse. Since age and gender cannot be taken into account, insurers can’t differentiate between a 45-year-old woman who has relocated from New York City where she always took the subway and let her license lapse and a 16-year-

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II. Consequences for the State

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old male who just started driving. Common sense and a wealth of research suggest that middle-aged women drive better than young males, but, under current law, insurers must charge the two almost the same premium if they drive the same type of car. In this case, the 45-year-old woman almost certainly pays too much.

Finally, the current system hampers product in-novation. The state mandate that all insurers use a Bureau rate plan as the basis for their own products coupled with a long approval cycle for new products means that insurers are not eager to offer new or innovative products in North Carolina. Progressive, for example, widely advertises its willingness to offer its competitors rate quotes on its website: Customers in Virginia, South Carolina, and almost every other state can find rate quotes. North Carolina customers can’t.25 Nationwide, the state’s largest insurer, does not offer its nationally advertised “vanishing deduct-ible” to North Carolina residents.26 No specific bar

exists on offering these products, but the burden of the system makes it difficult to do so because the products would have to be described as “devia-tions” from a single rate plan, and doing so would require enormous paperwork that would likely eat up the gains companies expect from introducing these products. Some companies do work their way through the morass and offer North Carolina product lineups that are the same as those offered elsewhere. For the most part, this is an exception. Cutting-edge products like pay-per-mile auto insur-ance (which charges a per-mile rather than per-year premium) simply don’t exist anywhere in North Carolina’s personal automobile insurance market. While many companies operate in North Carolina, in other words, many products are not available. The government, for the most part, decides what products North Carolina citizens can and cannot buy. This may limit corporate profits, but it also limits the degree of genuine choice for consumers.

North Carolina’s automobile insurance system needs to change. Although it has undergone a va-riety of incremental changes, the most important sections of the state’s auto insurance law date back to 1957. No other state has retained the basics of its automobile insurance system for nearly as long a time. To fix its system, lower rates, and provide more choices for consumers, North Carolina should do five major things:

(1) End the Rate Bureau’s Role in Setting Insur-ance Rates; Require Insurers to File Rate Plans at Their Own Expense; Increase Insur-ance Department Staffing Levels

(2) End the Insurance Industry’s Profit Guarantee (3) Over Time, Require “Clean Risks” to Pay

Their Own Way in the Facility.(4) Establish a “Flex Band” For Smaller Changes

in Insurance Rates(5) Encourage Product Innovation by Expanding

Insurers’ Ability to Use a Wide Range of Data. Specific recommendations follow.

End the Rate Bureau’s Role in Setting Insurance Rates; Require Insurers to File Rate Plans at Their Own Expense; Increase Insurance Department Staffing Levels

Although most states once maintained rate bu-reaus – and a handful still exist on paper – North Carolina’s remains the only one in the country that actually establishes a rate plan for all automobile insurance in the state. There’s little efficiency gain for consumers or insurers from having a single rating structure or lengthy hearings intended to determine auto insurance rates. The costs of maintaining the Bureau – although nominally paid by insurance companies – almost certainly do work their way into insurance rates. All companies already file significant rate plans on their own, so the Bureau’s work, in many cases, simply duplicates efforts that companies make anyway. Although the Bureau isn’t large, its existence and the roughly $10 million insurers spend to support it likely do make insurance slightly more expensive in the state. Although certain parts of the Bureau operations (particularly the Reinsurance

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III. Reform Proposals

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Facility and Guarantee Fund) should continue, the Bureau’s own role in setting rates could and should safely be done away with. Sen. Bob Rucho (R-39), the proponent of a bill that would abolish the Bu-reau, puts it well. “In every other state, the industry makes do without a bureau. We should do the same,” he says.27 Insurers should not be able to rely on a quasi-state entity to do their paperwork.

On the other hand, Goodwin makes a valid point when he says that the insurance department could not realistically maintain a reasonable level of ser-vice without more resources.28 Although it may be possible to find savings in the overall budget under Goodwin’s supervision (his office also includes the state Fire Marshal), it’s not practical or wise to cut back on any of the department’s insurance-related functions. North Carolina’s insurance department is already smaller and less expensive (less than half the size, in fact) of the insurance departments in Georgia and New Jersey that have roughly the same populations.29 Although some of these dif-ferences may stem from different responsibilities, there’s little doubt that shrinking the department while abolishing the Rate Bureau could result in significant problems. Any plan to abolish the Rate Bureau should include some effort to increase insur-ance department staffing to allow it to continue to process paperwork in an efficient manner.

End the Insurance Industry’s Profit GuaranteeGoodwin has accused insurers of being greedy.

Insurers admit that they seek to make money. Right now, they’re assured of that. If insurers that want changes get what they want (and, for some compa-nies, a possibility of making more money on policies currently ceded to the Facility), they should also have to give something up: guaranteed profits.

The current system, which requires the insurance commissioner to consider insurers’ rates of return in the system, is not fair to consumers: No private business operating in a competitive market should ever be assured a profit. State Rep. Verla Insko (D-55) makes an important point: “Some people who say they support free markets don’t have any sense of what they are. They aren’t about profit guarantees,” she says.30 There should be no assurance that any private company make a profit writing auto insur-ance in North Carolina. The insurance department,

of course, can’t try to force companies to lose money (if so, companies would just withdraw from the state), but they shouldn’t have any legal entitlement to profits, either. That’s simply unfair. Change would benefit some insurers, but it would also benefit North Carolina residents.

Over Time, Require “Clean Risks” to Pay Their Own Way in the Facility and Thereby Encourage Them to Find Private Market Coverage

Current “clean” risks pay voluntary market rates within the Reinsurance Facility – the maximum rates allowed under the approved rate plan. Private companies transfer them to the Facility because they do not want to write insurance policies for these drivers at the approved Bureau rates. In the aggregate, insurers appear to be right to give up these risky drivers: 75 percent of the state’s drivers pay a yearly surcharge – the “teenager tax,” which averages about 6 percent – in order to support these supposedly “clean” drivers. In other words, these drivers get into more accidents, have more tickets, and incur more costs than other drivers in the private market. This system has little value for the state. It lowers premiums for people who insurers know will not be good drivers while raising them for everyone else. To remove the risk and the tax imposed by the facility, North Carolina should disclose the tax, work to phase it out over a period of years, and encour-age wholly private insurance for those currently in the Facility.

Disclosure should come first. There’s simply no reason that the tax imposed by virtue of the Facil-ity’s existence should be kept secret. The Facility surcharge should be disclosed on bills, company websites, and on the insurance department’s website immediately.

But disclosure is not enough. Over time, the tax needs to go. Sen. Wesley Meredith, co-chair of the Senate Insurance Committee, put it well. “The [clean risk] surcharge is the worst part of the system. Get-ting rid of it is one of the best things that we could do,” he says.31 Rather than disrupting the market by throwing people out of the Facility immediately or even ending “free ceding,” the state should phase up rates in the Facility by requiring people in the Facility to pay a higher share of the surcharge each year. They should also be able to leave the Facility


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(even with less than the customary six months notice) for any insurer that offers them a lower premium or more attractive overall insurance package than what they would receive in the Facility. So-called “dirty risks” should also be able to leave the Facility. Since they pay their own way within the Facility, no real little harm accrues from keeping them in the Facility. Their insurance rates, however, are very high. While some may have serious problems that would cause many insurers to turn their backs immediately, many more may simply have a few accidents or traffic violations that make them risky but not uninsurable. Allowing insurers to charge higher-than-current-Rate-Bureau but lower-than-current-Facility rates for these drivers would very likely serve to take them out of the Facility while lowering their overall rates. Some insurers may be able to find ways to operate more efficiently than the Facility or simply manage their premiums differently and thereby make profits while requesting premiums well below Facility levels. In short, the state has little or nothing to lose by letting insurers compete for the business of the state’s higher-risk drivers.

Over time, the Facility – insofar as it exists at all – should be redesigned as a true “market of last resort” for those unable to purchase insurance coverage in the private market at any price. In the future, the legislature may wish to consider bars on ceding certain types of risks to the Facility.32 In the near term, however, the Facility is a necessary part of the system, and it should be phased out over time rather than severely limited overnight.

Establish a “Flex Band” For Smaller Changes in Insurance Rates

Right now, all changes to insurance rates and forms in North Carolina require “prior approval” of the insurance department. The system, in some respects, serves North Carolina well: The Heartland Institute’s annual report ranking insurance environ-ments gives North Carolina bonus points for admin-istering it in a clear and understandable fashion.33 The current Rate Bureau system does facilitate this to some extent by building small amounts of flexibil-ity into the underlying rate plan for all companies. Rather than ditching the entire system, the state should build on it by abolishing the Rate Bureau as described above and establishing a “flex band”

that allows insurers to tweak automobile insurance rates upwards or downwards with a minimum of paperwork.

Flex rating – which exists in concert with prior approval systems in several states – allows insurers to change their rates within a certain “flex band” (a few percentage points difference) with little or no paperwork. Most states with flex rating allow flex-ibility in a range of between 5 and 15 percent. Such a system does not remove all oversight from insurance rates. if a filing appears fraudulent, actuarially inad-equate (collects too little revenue for the company to actually provide insurance), or bases insurance rates on characteristics that the law prohibits, then states can take action even within the flex band. Goodwin and others express doubts that a system that does not allow disapproval for “excessive” rates could adequately protect consumers from unscrupulous players.34 Certainly, whatever happens, any sort of “flex band” cannot become a way to violate existing laws or ignore protections.

Encourage Product Innovation by Expanding In-surers’ Ability to Use a Wide Range of Data

Some insurers suggest that North Carolina traf-fic safety laws make it difficult to collect accurate information about drivers. Currently, as mentioned above, state laws let motorists plead down more seri-ous offenses into less serious ones or receive “Prayer for Judgment Continued” (PJC) from a judge. (PJCs are common for traffic offenses and first-time minor crimes like petit larceny.) Under PJC the motorist is assessed court costs but has no violation attached, and, typically, the offense vanishes from a motorist’s insurance record provided that the motorist accumu-lates no more than two PJCs in a rolling three-year period.35 Likewise, judges can reduce other offenses to those that do not involve points assessed. Com-monly, speeding tickets get reduced to equipment violations. Although the PJC – which, explicitly, involves no attached conditions – appears to exist only in North and South Carolina, all judges in com-mon law systems can always grant continuances and dismiss cases. All of this matters because the state’s “safe driver incentive program” mandates rate cuts for people who remain “clean” under state law.36

The particulars of traffic laws, however, may have less significance than they appear to on the


14

surface. Tim Moore, a general practice attorney who serves in the state legislature and has been active on insurance issues, explained in 2008: “It doesn’t matter what the law is.“In some places, there will always be ways to get tickets reduced or eliminated. In other places, you won’t be able to . . . and that’s the way it works now in the state.” Trying to modify traffic laws as such makes little sense. Instead, the legislature and insurance commissioner should let insurers and consumers decide what data matters and what data does not. If insurers find that a single PJC results in higher accident rates, they should be able to raise the premiums following it. If, likewise, insurers choose to ignore convictions for speeding 11 miles over the limit – something that the safe driver incentive program makes it nearly impossible

for them to do – they should also be able to do that. The safe driver incentive program should be

continued but made optional: insurers that want to offer another scheme to reward safe drivers should be able to do so. Rather than mandating rate cuts for people with certain types of traffic records (which aren’t always spotless), insurers should be able to find ways of identifying safe drivers on their own.

A freer system that allowed broader use of traf-fic and other data in determining rates would make it easier for companies to offer a wide range of products in North Carolina. Innovations currently unavailable in the state — pay-by-mile auto insur-ance among them — might well become available in such a setting.


Conclusion

This paper has reviewed and described North Carolina’s messy, complex system for provid-ing automobile insurance and laid out an agenda for changing it. It has examined the labyrinthine approval process and described how it places many of North Carolina’s best and safest drivers at a dis-advantage in its insurance market. It has argued that the system proves fundamentally unfair and needs to change quickly.

The paper proposes a number of measures for change. Many of these – such as a phase- out of the

“teenager tax” and abolition of the Rate Bureau – should come within the very near future.

Although it is stable in some respects, North Carolina’s automobile insurance system has problems and ought to change. Notably, North Carolina’s citizens should have the ability to pur-chase the insurance products they want. Such a system could reduce rates for many drivers and would provide fairer insurance rates for everyone.

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1 Automobile Insurance Plans Service Offices. “Residual Markets, 2005,” 2005. (AIPSO.org), http://www.iii.org/media/facts/statsbyissue/auto/.

2 The Rate Bureau actually consists of three closely related organizations: the North Carolina Rate Bureau (which does the rate filings), the North Carolina Re-insurance Facility (which provides coverage to motor-ists), and the North Carolina Guarantee Fund (which provides last-resort coverage for policy holders of failed insurance companies). The three organizations share staff, office space, members’ companies, and a Web page. In general, the entire organization is referred to as the Rate Bureau except where a distinction needs to be made. All states have guarantee funds, and most are structured like North Carolina’s. Only one other state, Rhode Island, has a Reinsurance Facility

3 NC Code 36 § 58-36-1 (1) for the bureau’s existence, se § 58-36-5 (1) for mandatory participation in the Bureau and its corporate-owned structure, and § 58-36-30 for the mandate to use the Bureau’s rate plans.

4 NCC 36 § 58-36-20.5 The statutes don’t actually mandate that the commis-

sioner create an alternate plan, but, historically, the insurance commissioner always has done so. Theoreti-cally, only the Rate Bureau creates plans in the first place.

6 § 58-36-25.7 All cases have the State of North Carolina, Commis-

sioner of Insurance as the appellee and the North Carolina Rate Bureau as the Appellant. The case in question is 124 N.C. App. 675, 478, S.E. 2d 792.

8 Refunds were also made in 1994. 9 North Carolina Department of Insurance. “North Caro-

lina Safe Driver Incentive Plan,” http://www.ncdoi.com/consumer/consumer_publications/automobile/safe%20driver%20incentive%20plan.pdf.

10 North Carolina Reinsurance Facility. “About NCRF: Ceding To The Facility,” http://www.ncrb.org/ncrf/AboutNCRF/tabid/247/Default.aspx. 2011.

11 North Carolina Reinsurance Facility. Ceeded Premium by Volume by Company or Group. Circular Letter to All Member Companies, January 10, 2011. http://www.ncrb.org/NCRF/LinkClick.aspx?fileticket=gR-siyGWTwo%3D&tabid=245.

12 Interview, June 11, 2008.13 North Carolina Reinsurance Facility. “Annual Report,

2010,” http://www.ncrb.org/ncrf/AboutNCRF/An-nualReports/tabid/252/Default.aspx, 7.

14 Telephone interview, June 6, 2008. 15 Insurance Federation of North Carolina. Insurance 101:

2007-2008, 12. http://www.insurancefederationnc.com/insurance/auto-insurance-faq/

16 Barbara Marquand. “Car insurance rates by state: The most and least expensive places to buy auto insurance in 2011,” Insure.com, March 14, 2010. http://www.in-

sure.com/car-insurance/car-insurance-rates.html. The National Association of Insurance Commissioners has 2009 data that also provide state averages. NAIC data, however, are based on filed rate plans rather than actual quote prices.

17 SNL Financial. “Market Entry Report: North Caro-lina,” Query run February 9, 2011.

18 Telephone Interview, March 30, 2011. 19 David Ranii. “Insurance Chief Fights Bill to Curb

His Role,” Charlotte Observer. April 12, 2011. http://www.charlotteobserver.com/2011/04/12/2216949/insurance-chief-fights-bill-to.html

20 Others disagree. For another perspective and a litera-ture review, see Vernon L. Smith, “Regulatory Reform in the Electrical Power Industry,” in Regulation: The Cato Review of Business and Government, Vol. 19, No. 1.

21 Brett Skinner. Auto Insurance Market Quality Index 2006. The Fraser Institute, October 2006, http://www.fra-serinstitute.org/COMMERCE.WEB/product_files/AIMQI06.pdf.

22 An insurer also runs a risk of losing significant amounts of money writing insurance for a bad driver. Except in North Carolina, all insurers lose money on some drivers.

23 The state does allow “inexperienced driver” surcharges for people with three years or less of driving experience. Since residents cannot generally get an unrestricted license until age 16, this, in effect, raises rates on all those between 16 and 19.

24 Dawn L. Massie and Kenneth L. Campbell. Analysis of Accident Rates by Age, Gender, and Time of Day Based on the 1990 Nationwide Personal Transportation Survey, Insurance Institute for Highway Safety, 1993, i.

25 Authors’ own investigation, April 12, 2011.26 Nationwide Mutual Automobile Insurance Corpora-

tion. “Vanishing Deductible,” http://www.nationwide.com/vanishing-deductible.jsp , April 12, 2011.

27 Personal Interview, April 6, 2011. 28 Personal Interview, March 30, 2011. 29 National Association of Insurance Commissioners.

2009 Insurance Department Resources Report. NAIC, 2010. 30 Personal Interview, April 5, 2011. 31 For example, people entirely clean driving records—

even if they have significant risk factors like poor credit scores or young age.

32 Of course, if rating freedom existed, few if any insurers would transfer policies anyway.

33 Eli Lehrer. Property and Casualty Insurance: Where Does Your State Rank?, The Heartland Institute, 2010. http://www.heartland.org/full/27755/Property_and_Casu-alty_Insurance_Where_Does_Your_State_Rank.html.

34 Personal Conversation, April 14, 2011.35 Autoinsurance.com, “What is a Prayer for Judgment?”

http://www.carinsurance.com/kb/content27086.aspx.36 NC Statutes 36 § 58-36-65.


Notes

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About the John Locke Foundation

The John Locke Foundation is a nonprofit, nonpartisan policy institute based in Raleigh. Its mission is to develop and promote solutions to the state’s most critical challenges. The Locke Foundation seeks to transform state and local government through the principles of competition, innovation, personal freedom, and personal responsibility in order to strike a better balance between the public sector and private institu-tions of family, faith, community, and enterprise.

To pursue these goals, the Locke Foundation operates a number of programs and services to provide information and observations to legislators, policymakers, business executives, citizen activists, civic and community leaders, and the news media. These services and programs include the foundation’s monthly newspaper, Carolina Journal; its daily news service, CarolinaJournal.com; its weekly e-newsletter, Carolina Journal Weekly Report; its quarterly newsletter, The Locke Letter; and regular events, conferences, and research reports on important topics facing state and local governments.

The Foundation is a 501(c)(3) public charity, tax-exempt education foundation and is funded solely from voluntary contributions from individuals, corporations, and charitable foundations. It ws founded in 1990. For more information visit www.JohnLocke.org.

About the Author

Eli Lehrer is a Vice President of the Heartland Institute who oversees Heartland’s Washington, D.C., office as well as field offices in Tallahassee, Florida, and Austin, Texas. In addition, Lehrer heads Heartland’s Center on Finance, Insurance, and Real Estate, which coordinates Heartland’s work addressing issues relat-ing to insurance, risk, and credit markets. He wrote a previous John Locke Foundation report about the North Carolina automobile insurance system in 2008.

Lehrer also played a major role in founding the smartersafer.org coalition, a coalition of taxpayer, environmental, insurance, and free-market groups dedicated to risk-based insurance rates, mitigation, and environmental protection.

Prior to joining Heartland, Lehrer worked as speechwriter to United States Senate Majority Leader Bill Frist (R.-Tenn.). He has previously worked as a manager in the Unisys Corporation’s Homeland Security Practice, senior editor of The American Enterprise magazine, and as a fellow for The Heritage Foundation. He has spoken at Yale and George Washington universities and published his work in dozens of major public policy magazines and newspapers.

N O R T H C A R O L I N A’ S A U T O I N S U R A N C E S Y S T E M : S T I L L U N F A I R , S T I L L I N N E E D O F I M P R O V E M E N T S | A B O U T T H E A U T H O R

“To prejudge other men’s notions before we have looked into them is not to show their darkness but to put out our own eyes.”

JOHN LOCKE (1632–1704)

AUTHOR , TWO TREATI SES OF GOVERNMENT AND FUNDAMENTAL CON STITUTION S OF CAROL I NA

200 West Morgan St.Raleigh, NC 27601V: 919-828-3876F: [email protected]

north carolina's auto insurance system: still unfair, still in need of improvements

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