The Impact of Rate Regulation on Claims: Evidence from Massachusetts Automobile Insurance

The article tests the hypothesis that insurance price subsidies created by rate regulation lead to higher insurance cost growth. The article makes use of data from the Massachusetts private passenger automobile insurance market, where cross-subsidies were explicitly built into the rate structure through rules that limit rate differentials and differences in rate increases across driver rating categories. Two approaches are taken to study the potential loss cost reaction to the Massachusetts cross-subsidies. The first approach compares Massachusetts with all other states while controlling for demographic, regulatory, and liability coverage levels. Loss cost levels that were about 29 percent above the expected level are found for Massachusetts during years 1978–1998, when premiums charged were those fixed by the state and included explicit subsidies for high-risk drivers. A second approach considers changing cost levels across Massachusetts by studying loss cost changes by town and relating those changes to subsidy providers and subsidy receivers. Subsidy data based on accident year data for 1993–2004 show a significant and positive (relative) growth in loss costs and an increasing proportion of high-risk drivers for towns that were subsidy receivers, in line with the theory of underlying incentives for adverse selection and moral hazard. INTRODUCTION Rate regulation is widely practiced in insurance markets. In many U.S. states an important goal of insurance rate regulation is to reduce price variation across purchasers, and specifically to reduce price levels for high-risk purchasers. For example, some state regulations place limits on risk classes, restrict price differences across consumers, and restrict insurers’ ability to deny coverage to high-risk purchasers to achieve these goals. These features of rate regulation may lead to price subsidies to insurance purchasers Richard A. Derrig is with Opal Consulting, LLC; e-mail: [email protected]. Sharon Tennyson is with the Department of Policy Analysis and Management, Cornell University; e-mail: [email protected]. The authors are grateful for the historical data and assistance provided by the Automobile Insurers Bureau, especially Kim A. Barber, William Scully, and Eilish Browne. An anonymous referee and seminar participants at Temple University, Wharton School of the University of Pennsylvania, University of Texas, and the American Risk and Insurance Association meetings provided helpful comments. This article was subject to double-blind peer review.