How did Illinois, a jurisdiction not normally associated with a strong commitment to free market principles, come to be the first state in the nation to allow its insurance rates to be regulated entirely through open competition, is something of a coincidence of history.
Continuing a trend followed by many states in the 1960s, the Illinois General Assembly voted in 1970 to replace the state’s existing “prior approval” system for regulating property-casualty rates – originally issued in 1947 in the wake of the The U.S. Supreme Court in United States v. South-Eastern Underwriters, which found insurance was in fact an interstate commerce – with a “file-and-use” system.
Under the new system, insurers could start using rates they have submitted to the regulator even before they receive explicit approval or denial. The only snag was that industry agreements to adhere to rates set by a rating agency—the very kind of agreements South-Eastern Underwriters was about—were outlawed entirely.
A year later, in August 1971, the law was scheduled to expire and lawmakers failed to renew it. The result, whether intentional or not, is that Illinois became the only state in the nation without an insurance rating law at all. And so it remained (with a few minor exceptions) for the next 52 years.
Under HB 2203, which is due for hearing today before the Illinois House Insurance Committee, any insurer wishing to offer personal motor vehicle liability insurance must submit a complete rate application to the Department of Insurance, which would again have the power to approve or deny rates subject to prior approval . The bill would also ban insurers from setting rates based on factors not related to driving, including credit history, occupation, education and gender.
The measure also creates a new system for public interveners in the rate-finding process, which provides that “any person may commence or intervene in any proceeding permitted or instituted under the Regulations and may contest any action of the Director under the Regulations.”
In short, the law would transform Illinois from the nation’s most open and competitive insurance market to one clearly modeled after its most restrictive: the inflexible and state-directed system created by California’s Proposition 103.
The question is, of course, why should the state do this? It’s true that insurance premiums are rising in Illinois, but they’re rising everywhere else, too. Insurify estimates that the average cost of auto insurance rose 9% to $1,777 in 2022, and the company expects rates to rise during this year year to rise another 7% to $1,895. In fact, Illinois auto insurance rates actually remain 15.5% lower than the national average.
Inflation and ongoing supply chain challenges are a big part of the story there. Increased rates of distracted driving also appear to be partially responsible. According to the National Highway Traffic Safety Administration, U.S. road fatalities in 2021 hit a 16-year high at 43,000 deaths.
But these are all trends in the underlying loss and claims data. Perhaps a traffic authority could do something to reduce traffic accidents. The Federal Reserve is doing its best to contain runaway inflation. But an insurance supervisory authority cannot do both. Since no insurer could stay in business particularly long by charging unprofitable rates, rate regulation could actually lower insurance rates only when a market was uncompetitive, allowing some authors to use monopoly power to rake in excess profits.
The evidence that this hypothesis describes Illinois is remarkably sparse. There are 230 insurers offering personal automobiles in Illinois. Based on the Herfindahl-Hirschman Index (HHI), which the US Department of Justice (DOJ) and the Federal Trade Commission use to assess the degree of monopolistic concentration in a given market, the Illinois auto insurance market earned a score of 1,224 for 2021, the latest year for which NAIC data is available. That’s even below the FTC and DOJ’s threshold (1,500) for a “moderately concentrated” market. Auto insurance in Illinois is competitive.
Even the state’s largest auto insurers aren’t exactly swimming in profits. Allstate posted an underwriting loss of $2.91 billion in 2022, primarily due to results in the private car market. For GEICO, a Berkshire Hathaway subsidiary, it was a pre-tax underwriting loss of $1.88 billion for the full year. Bloomington-based State Farm, the largest auto insurer in both Illinois and the United States, suffered a massive $13.2 billion underwriting loss for the full year.
It would be one thing if enacting stricter tariff regulation simply didn’t achieve the stated goal of lowering tariffs, but the evidence is that it does in fact do obvious harm. The most obvious problem with rate regulation is that it limits the availability of insurance. Insurers are naturally responding to rate regulation by tightening their underwriting criteria, forcing some consumers to look to the higher-priced residual market for coverage. In extreme cases, price suppression can result in some insurers exiting the market altogether.
The empirical evidence for this effect is evident. After California mandated a mandatory 20% tax rate reduction (the effects of which were initially softened somewhat by the courts) following the passage of Prop 103 in 1988, the number of insurers writing auto insurance in the state fell from 265 in 1988 to 208 in 1993.
COMPANIES SELLING AUTO INSURANCE IN CALIFORNIA, 1988-1993
SOURCE: NAIC data
In New Jersey, too, 20 insurers exited the market in the decade after the state passed the very similar Fair Automobile Insurance Reform Act. When New Jersey later liberalized its regulatory system with passage of the Auto Insurance Reform Act in June 2003, the number of auto authors doubled from 17 to 39 and thousands of previously uninsured drivers joined the system.
A similar effect was observed in South Carolina, where a restrictive rating system had forced 43% of drivers into residual market policies backed by a state reinsurance facility in the 1990s. After passage of a liberalized flex-band rating law in 1999, as in New Jersey, the number of insurers offering coverage in South Carolina doubled, and the remaining market shrank (today it accounts for just 0.007% of the market ) and the overall rates actually fall.
Even in Massachusetts, which maintains a fairly restrictive rate-approval process, reforms passed in April 2008 that allowed insurers to submit competitive rates (previously set by the Commissioner for all airlines) had a notable impact. Within two years of the reforms, fares had dropped 12.7% and a dozen new airlines began offering coverage in the state.
Because it’s still a very regulated state, Massachusetts still has a relatively large residual market. According to the Automobile Insurance Plan Service Office (AIPSO), 3.38% of auto insurance customers in Massachusetts had remnant market coverage in 2022, the second-highest rate in the country. But prior to 2008, Massachusetts’ remaining market share was routinely in the double digits. The only state that still has a double-digit residual market share today is North Carolina, not coincidentally also the only state that still relies entirely on rates set by a rate bureau.
After all, regulation is not free. To fund the additional actuaries and financial inspectors needed to actually implement this new regulatory regime in Illinois, HB 2203 proposes that insurers subject to its regulations be charged an additional fee of 0.05% of their total annual premium earned . Based on 2021 premiums, that’s an additional $14 million per year, on top of the $106.4 million in fees and assessments the department already collects from the industry (not to mention the $515 million dollars in premium taxes). The cost of these charges is, of course, passed on to consumers in the form of tariff increases.
And what do you actually get from this additional income? In 2021, Illinois spent $67.8 million on insurance regulation (which, it should be noted, is almost $40 million less than what it already takes in fees and assessments). California, on the other hand, spent $245.5 million. Still, the California market is no more competitive than Illinois’, and arguably much less so.
The Land of Lincoln should realize that’s a pretty bad deal.