State of recovery: after years of tinkering, New Jersey's auto insurance market is finally well tuned.

The New Jersey automobile insurance experience illustrates the importance of a balanced marketplace, and a road map to achieving it. Regulators well know the challenge. They must provide consumers with real and affordable product choices from a variety of insurers. At the same time they must foster an environment where insurers, as businesses, can operate at a profit and remain solvent. While these two interests often collide, protection of the public and a robust insurance industry are mutually accessible goals.

The history of auto insurance reform in New Jersey offers insights into the relationship among regulation, competition and protection of policyholders, For many years New Jersey regulators tilted toward the policyholder by restricting rates and underwriting criteria. However, the result of those actions--lack of capacity in the admitted market and a high-priced residual market--actually hurt rather than helped the consumer. The lesson learned was that a healthy insurance market best served insurers and consumers, and that a balancing of interests was the best way to achieve it.

A Dysfunctional Marketplace

Three decades of well-intended reform efforts in New Jersey resulted in a system that frustrated drivers and gave them limited choices in coverage, cost and companies. The efforts were marked by a dizzying combination of well-meaning initiatives, immovable obstacles, failed shortcuts, political quagmires and fleeting political victories for lawyers, insurance companies or medical providers--but not policyholders. There were instances of relative improvements, but the market as a whole grew weaker and companies withdrew, failed or hunkered down as New Jersey-only subsidiaries.

How the Problem Started

No-Fault. The seeds of the crisis were enactment of a no-fault system in 1972, largely in response to the hard market cycle of the late 1960s. But the no-fault aspects of the system existed more in name than in substance, and the law came with an actuarially unjustifiable rate rollback, which led to many major insurance companies fleeing the state. Further, in theory, no-fault is a trade-off in which smaller pain and suffering lawsuits are eliminated, but all drivers get medical coverage. However, New Jersey offered the second-most generous first-party benefits in the country without effectively reducing litigation. The result was sustained high costs and increased public dissatisfaction with price.

Reactions to No-Fault

Residual Market. As capacity shrank, legislators moved to create a high-priced residual market to insure those drivers who couldn't find other coverage. In 1983, an underpriced New Jersey Automobile Full Insurance Underwriting Association was established, and territorial rate caps and strict limits on insurer profitability were imposed. By the late 1980s, the growing and under-funded JUA faced demands for some form of depopulation, but that meant imposition of a take-all-comers mandate and severe restrictions on market withdrawals to assure that a voluntary market would be available to handle the new business. New Jersey insurers were left to pay the $1.3 billion JUA deficit and a portion of the successor Market Transition Facility deficit through assessments that could not be recouped from rates. Insurers were discouraged from investing capital in the state and insurance shortages grew. Urban areas experienced the greatest shortage, which prompted the 1997 implementation of a quota program.

Rate Suppression. As the cost of insurance rose, New Jersey continued to promote various forms of rate suppression. In particular, legislators repealed a flex-rate system that had previously ensured rate adequacy and eliminated an insurer's ability to cease writing underpriced business. The public remained convinced that insurance prices were unfairly high, ranking insurance up with crime and taxes as principal concerns. Lawmakers and policymakers needed to respond but recognized that lower rates could lead to further market disintegration and possible insurer insolvencies. The solution ultimately offered was the Auto Insurance Cost Reduction Act of 1998. AICRA's medical and tort-related cost-containment measures proved to be sound and helped to temporarily stabilize the market. Unfortunately, AICRA's mandated rate reductions were immediate and optimistic, while the actual cost savings would take years, if ever, to materialize fully. In the interim, financial pressures grew for the dwindling number of companies left in the market.

Market Withdrawals. Between 1993 and 2003 more than 26 insurers left New Jersey. Close to half the companies actively writing auto insurance experienced financial difficulty. Companies that were losing money had a collective market share of more than 50%; together, they lost more than $430 million in 2001, further eroding the capital base supporting New Jersey's auto insurance coverage. Of the 67 companies writing auto policies in 2001, only 28, or 41.8%, made a profit. Another 19 companies, or 28.3%, were under regulatory watch by July 2002. Insurers of more than 1 million cars were exiting the market and drivers (and agents) were spending weeks or months trying to get coverage. Govermnent had "protected" consumers by creating the worst auto insurance marketplace in state, if not national, history.

A responsible, comprehensive reform package was needed that would provide access to coverage at acceptable rates. It was agreed that this could best be accomplished by fighting fraud, reducing the number of uninsured drivers and getting more carriers into the market. It was quickly recognized that in the absence of legislative action, companies would continue to leave New Jersey, and that the plight of drivers hunting for policies would only get worse. Relief came in 2002 when the New Jersey Legislature enacted a new auto law. (See "The Legislative Fix" on page 84.)

Challenges Ahead

While the success of the reforms to date has exceeded expectations, the market remains in transition and is by no means secure. Insurer capital is returning to New Jersey on the basis of what has been done and what is expected in the future. The future environment is particularly important with respect to progress on territorial rating and the medical fee schedules that will help control personal-injury protection costs. Urban rate caps, the source of most market distortion, have not yet been fully addressed. The territorial rating map, created in the early 1950s, is decades out of date. Suburban drivers continue to subsidize urban drivers in a manner that, while restraining prices in urban areas, creates incentives on insurers to avoid urban risks. New entrants to the marketplace expect these problems to be resolved, and are prepared to employ the eased withdrawal standards if they are not. Territorial rating thus poses a tremendous challenge that can be met only if New Jersey continues to exhibit political courage, creativity and a long-term view.

The transition to rational rating systems must continue. The market needs a system in which the price and premiums paid by drivers reflect the actual risk of claims and expense costs, with a return on investment. It is also critical to maintain a marketplace where carriers use different rating criteria, allowing drivers to select the company best suited to their needs. New Jersey must remain committed to moving away from the one-size-fits-all approach of the past, to accommodate different business strategies and to allow for the growth of small and niche players. A diverse marketplace may prove essential to maintaining a truly thriving, competitive market that works for policyholders.

The challenge going forward is sustaining a regulatory environment that permits an efficient, market-driven industry to coexist with measures that ease the insurance burden on drivers of limited means. That balance must address pressing social concerns in ways that do not disrupt the marketplace. New Jersey drivers, mandated by law to have auto insurance, should not be forced to choose between unaffordable coverage and violating the law. This is at the core of the challenge going forward. Finally, such creativity must include a willingness to incorporate emerging technologies that reduce risk by preventing accidents, into rating systems over the long term.

Key Points

* New Jersey's auto insurance problems began when a no-fault system was adopted in 1972.

* Between 1993 and 2003 more than 26 auto insurers left the Garden State due to regulations and the high cost of doing business.

* Since reforms were implemented, 75% of drivers are paying less for auto insurance and companies are joining the N.J. marketplace.

The Darkness Hour for N.J. Drivers.

The marginal-to-poor condition of many New Jersey auto carriers in the 1990s and early 2000s bad a direct negative impact on consumers. Many companies were unable to take new customers, and each time a company was exempted from take-all-comers due to hardship, the stress on remaining carriers increased. To survive, companies set up roadblocks to writing new business that may have met the letter, but not always the spirit, of the law. Some companies refused to give quotes over the phone or names of agents. In a span of months, nearly all carriers ceased immediate binding of coverage because it made them too "accessible" to money-losing business. Some companies refused to staff (or adequately staff) their phone centers. As one New Jersey driver wrote, "If I offered this kind of customer service, I'd be out of business"--an unbelievable statement in any other industry, yet completely sensible in New Jersey's dysfunctional market. In the backward world of New Jersey auto insurance, bad customer service was good for the bottom line.

In this atmosphere, companies walked the edge of the law. Department of Banking and Insurance investigators called New Jersey auto carriers and found about half were unresponsive. Messages were not returned. Requests for names of agents brought the response, "Look in the Yellow Pages." In response to DOBI demands for action, company management promised to modify practices but continued their pleas to "fix the market." A follow-up survey disclosed additional problems, including widespread refusal to sell the "Basic Policy" created by the Legislature to provide low-income drivers with limited coverage at a lower price.

Company threats to leave became routine. State Farm had already begun withdrawing from New Jersey. American International Group had an option to leave in 2003, which the company promised to exercise if it did not see positive developments. Regulators feared that other carriers would file withdrawal petitions in advance of AIG's departure. Shortages were so acute that it could take months to secure an insurance policy--too long for an insured receiving a 60-day notice of non-renewal to find replacement coverage. There were concerns that drivers who got a non-renewal notice would be at risk of a lapse the moment the envelope hit the mailbox. Policyholders faced the auto insurance equivalent of '70s gas lines: The tank could go empty while drivers wait.

The Legislative Fix

The New Jersey automobile insurance crisis finally produced reform under Gov. James McGreevey's leadership. In 2002, the N.J. Legislature enacted a new auto law and soon regulators were promulgating the details needed to make that law achieve its desired results. These new reforms were different. Past insurance reforms were largely a response to problems created by prior reforms. Now the changes tempered regulatory burdens instead of heaping new ones on an already messy pile. New Jersey was coming into line with the national insurance market.

The major elements of the 2002 reforms were:

* Providing predictability in the rate review and approval process while maintaining regulatory oversight.

* Phasing out take-all-comers as market forces took hold and competition replaced regulation.

* Adapting excess-profit provisions so that insurers could weather unprofitable cycles with resources gained in profitable cycles and invest in New Jersey.

* Assuring the right of insurers to withdraw from the market on a predictable and reasonable schedule.

* Allowing nationally-accepted rating practices with extensive consumer protections.

Lawmakers combined these changes with an aggressive attack on fraud and a series of measures designed to improve consumer education and choices without creating market-distorting burdens. These included:

* Requiring that consumers receive multiple coverage and pricing scenarios. The purpose of this requirement was twofold: first, to decrease the purchase of inappropriate or excessive coverages; and second, to remind consumers of the direct relationship between the decisions they make and the prices they pay.

* Establishing a low-cost, means-tested policy (termed "Dollar-a-Day") to help uninsured drivers get required coverage without burdening other drivers or the state's medical system with accident-related costs. The $365 per year price tag pays for emergency medical treatment while supplementing the state's fund for unsatisfied claims.

* Creating new tools, including an interactive Web-based program, to help consumers determine what coverage they need.

* Creation of an Urban Task Force to examine and mitigate risks unique to urban areas.

* Creation of an Auto Technology Task Force to investigate and promote technologies that would reduce risk and thus reduce premiums.

The impact of these consumer-focused initiatives was almost immediate. Within two months of the signing of the legislation, New Jersey welcomed its first new auto insurer in seven years, Mercury Insurance Co. Within one year of enactment, existing insurers had reduced rates by more than $150 million, the first significant, voluntary rate reductions in state history. That amount has now exceeded $412 million. State Farm Indemnity stopped non-renewing customers and began examining ways to participate in the emerging marketplace. American International Group acted similarly, and Allstate New Jersey grew its agent force and began seeking new customers. Geico then entered the market and wrote more than 40,000 policies in its first seven weeks of operation. Esurance, American Express, Progressive and Unitrin followed.

Put simply, market forces proved far superior to the regulatory mandates of the past. Quickly, and far more rapidly than expected, consumers had greater access to coverage and insurers felt a downward pressure on rates. The New Jersey auto market was functional again.

State of New Jersey

* No. of Licensed Drivers 6.5 million

* No. of registered vehicles 7,6 million

* Avg. cost of auto insurance premium:
$1,102.35--2005

* The percentage of N.J. drivers now paying
less for auto insurance 75%

* Auto insurers that have entered or re-entered
N.J. since the 2003 reforms: Progressive, Geico,
Mercury Indemnity, Esurance and Amex

Sources: N.J. Department of Motor Vehicles;
N.J. Department of Banking and Insurance

Top 5 N.J. Auto Writers--All
Lines (% of Market Share)

Allstate Insurance Group 13.5%

New Jersey Manufacturers Insurance Group
12%
State Farm Group 8.31%
Liberty Mutual Insurance Co. 8,20%
Berkshire Hathaway (Geico) 7.64%

Source: Best's State/Line Reports

Contributor Holly Bakke was New Jersey Commissioner of Banking and Insurance from 2002 to 2006.