Market repair: headed for a dead-end street, Massachusetts looks to change its auto insurance system.

On June 1, Massachusetts Gov. Mitt Romney took the stage at the castle-like Larz Anderson Auto Museum in Brookline, Mass. to announce a bill aimed at fixing the state's auto-insurance market, which Romney describes as "Soviet style."

Saying as much at the press conference was Edmund E Kelly, chairman, president and chief executive officer of Liberty Mutual Group, who likened the Bay State's situation to a grocery store shelf with only one type of cereal, sold in the same box, for the same price. "This is the only part of the globe, not just in the states, but the globe, where we cannot compete on quality, product and price;' Kelly said. Liberty Mutual was the nation's eighth-largest private-passenger auto writer in 2004.

How It Works

For many insurers in Massachusetts, the crumbs at the bottom of the box amount to a take-all-comers system in which 86% of the market subsidizes the remaining 14%. It's a place where high-risk drivers are rewarded with lower premiums and good drivers are penalized with higher rates and where the residual market distribution results in a boon for some insurers and a bust for others. It's also a place where a rampant auto fraud problem perpetuates the state's distinction of being No. 1 in property-damage liability claims and ranking well above the U.S. average for bodily injury claims.

"Nobody in their right mind would build a system the way this system has been built and constructed. It's not a market-based system. It's a contrived system,' said Massachusetts Insurance Commissioner Julianne M. Bowler.

Getting Out

And that is why, in part, dozens of companies have exited the state since the late 1980s, including national writers such as Allstate, Nationwide, Cigna Group and Aetna Insurance Co. And as the market has dwindled from 53 to 18 auto insurers since 1999, concern has mounted. In early July, Sentry Insurance announced it would become the latest to pull out of the state. Bowler said a major catastrophe or continued departure of companies can leave the state with insufficient capital to provide insurance for all of the customers who need it.

Adding to that concern is the knowledge that 60% to 70% of the marketplace is controlled by five companies, three of which have close to 50% of the market and all of which predominantly write business only in Massachusetts.

"From a management perspective, insurance is a risk business where you manage risk. And how do you do that? You diversify by product line. You diversify by geography," Bowler said. "You don't want to put all of your eggs in one basket. You trip. Boom! What if the stock market crashes? What if we get a Category 4 hurricane that hits the Cape and comes over Route 128 and Interstate 495? We don't have enough capital in the personal lines market to sustain such a catastrophe."

Time to Change

After years of marketplace dysfunction, however, the industry is facing the problem.

"The current system is not sustainable over the long term," said Frank O'Brien, vice president, regional manager and counsel for the Property Casualty Insurers Association of America. "The commissioner realized that, in order for significant market disruptions to be avoided, the system needs to change."

And while Bowler's office has worked over the past few years to gradually place fairness back into the system, the most significant of potential changes on the horizon is the bill her office helped craft, which is now being touted by Romney. Key to the legislation is the replacement of the state's rigid rate-setting system with a flexible model that is more market friendly.

Under the plan, the system would gradually move to a quasi file-and-use paradigm that would allow companies to set their own rates within a given rating band, starting in 2006 with a 5% range and building to a 10% rating range in four years. The bill also calls for an automatic 5% rollback for the state's best drivers and the young who drive occasionally, which together account for 64% of the drivers in Massachusetts.

To fund the rate rollback, claims frequency will be attacked through a crackdown on fraud, especially in seven cities where 21% of the state's bodily injury losses and 53% of its personal injury protection losses originate.

In addition to raising the tort threshold to $4,000 from the current $2,000--making it harder to pad claims to meet the threshold--the law would allow insurers to authorize an independent medical exam for those claims in which more than 50% of costs are derived from nonmedical services, such as chiropractic and physical therapy. Other provisions include allowing insurers to limit the number of non-medical services from the basic contract, and tying the reimbursement rate to a reasonable fee schedule, such as that used in the state's workers' compensation system.

The bill, if passed by the state Legislature, is something Romney believes will bring about changes such as those that took place following the 2003 auto-insurance reforms in New Jersey, which stopped two insurers from leaving the state, welcomed three new insurers and brought rate decreases and dividends totaling more than $333.9 million in savings to consumers.

Key, too, is leveling a top-heavy playing field that causes some insurers to bear the brunt of the residual market. The state's top writer, Commerce Insurance Co., for example, has a 27% voluntary market share, while its involuntary share is 21%.

Some argue that, even ff the governor's bill gets passed, without major changes in the way the residual market is distributed, national companies will continue to avoid crossing the border.

However, insurers and their advocates say they can't think of another time when change has appeared so imminent.

"I refer to it as the secret history of Massachusetts auto insurance," O'Brien said. "We're fighting about some of the issues that were originally raised in the 1920s. How do you handle urban communities vs. non-urban communities? How do you handle the competitive system? What makes this time different from what's happened over the course of 50, 60, 70 years is that we've reached a critical mass. We hope it's this year, it could be next year, but it has to be soon. It simply cannot continue the way it is."

Key Points

* Massachusetts' unique automobile insurance market is characterized by uneven rates, rampant fraud and domination by insurers that write only in that state.

* A new bill supported by Gov. Mitt Romney lowers rates for good drivers and is expected to bring in competition.

* Insurers say the bill must be coupled with a revamp of the residual market distribution for real change to occur.

Learn More

Liberty Mutual Insurance Cos. A.M. Best Company # 00060 Distribution: Direct, independent agents and brokers, captive agents

Commerce Insurance Co. A.M. Best Company # 04663 Distribution: Business pooling arrangement

For ratings and other financial strength information about these companies, visit www.ambest.com

Hot Topic

To address Massachusetts' current auto insurance system, a bill supported by it Gov. Mitt Romney would, among other things, affirm the state insurance commissioner's ability to move to an assigned-risk plan, doing away with the current system run by the Commonwealth Automobile Reinsurers, which presently manages a residual market of more than 1 million drivers.

The provision comes on the heels of Insurance Commissioner Julianne M. Bowler's November 2004 reforms that would have established such a plan, but were contested by some insurers and eventually shot down by a state Superior Court judge who ruled Bowler didn't have the power to make such changes.

As the system operates now, insurers are assigned exclusive representative producers. They then must accept all policies written by those agents. By statute, losses in the system are mandated to be distributed in a "fair and equitable manner." But, over time, since not all producers have similar loss ratios for their auto business, some companies have come up with a greater voluntary market than an involuntary one. Commerce Insurance Co., the state's top personal property/casualty insurer, for example, has a 27% voluntary market share while its involuntary share is 21%. Other insurers might argue that in a truly fair system, a company's involuntary share should be almost equal to its voluntary share.

A sampling of comments on the issue of changing the residual market:

Commerce Insurance Co. President and Chief Executive Officer Arthur J. Remillard Jr.: "People say, 'How can you underwrite in a state where they fix the rates?' You underwrite by keeping or ceding. You keep your underpriced agencies or you put them: in the residual market. That's why our residual market deficit is so much lower than our competitors'. Because we keep business on our own books. If I had to point to the single most important fact as to why our ERPs [exclusive representative producers] are below our competitors', it's because we extend to them the group discount of AAA."

Massachusetts Insurance Commissioner Julianne M. Bowler: "You pull the financial statements of some of the companies that only write auto in Massachusetts and they're doing quite well. So if you had the key to the goose that laid the golden egg, you're certainly not going to give it up willingly. It's going to have to he taken from you."

Attorney Peter T. Robertson: "Let me tell you how sick the system is. The system is bad when people are telling me that my client should not compete for business and that it's going to be used against them in getting fair treatment in the residual market, with the perception being, since they're advertising discounts for good drivers, they're taking good business away from other companies."

Frank O'Brien, vice president, regional manager and counsel for me Property Casualty Insurers Association of America: "Everything's been so regulated and legislated up, that the system is beginning to collapse on its own weight. It's almost as if we're 80 years old and have hardening of the arteries."

James T. Harrington, executive director, the Massachusetts Insurance Federation Inc.: "Every move we make, there's a counter move by those companies (who are doing well by the system) in an effort to scuttle reform; whether it be residual market reform or whether it be the 2005 legislative reform changing the rating law, moving to competition."

Massachusetts Top
Auto Writers--2004

Group market shares (%) are based on direct
Premiums written.

Commerce Group               24.92
Safety                        9.50
Arbella                       8.18
St. Paul Travelers Cos. *     7.45
Liberty Mutual **             7.15

* Writes in Massachusetts as the Premier Insurance Company
Massachusetts

** Writes in Massachusetts as Liberty Mutual Insurance Co.

Note: Table made from bar graph.

Source: Best's State/Line Reports