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A missed opportunity: the Federal Insurance Office's insurance affordability study fails to report the real reasons behind the cost of auto coverage.

Earlier this year, American motorists received some decidedly unwelcome news when The New York Times ran the headline "Millions Live Where Car Insurance Is Unaffordable, Study Says." At the same time, Reuters announced in a story that ran in dozens of news outlets across the country that "nearly 19 million Americans live in areas where auto insurance is unaffordable. 'The "study" to which the Times referred was a report by the Federal Insurance Office (FIO), issued in the waning days of the Obama administration.

While the news stories dutifully reported on the FIO's disturbing findings, few had much to say about the questionable assumptions and methodology on which the report was based. To judge the report's credibility, however, it is necessary to scrutinize the factors that shaped it.

When Congress created the FIO in 2010, one of the tasks it assigned the new agency was to "monitor the extent to which traditionally underserved communities and consumers, minorities, and low- and moderate-income persons have access to affordable insurance products regarding all lines of insurance, except health insurance." The opacity of this mandate naturally raised a host of questions. How would the FIO identify the communities and consumers that are "traditionally underserved" with respect to insurance products? How could the FIO determine whether groups of consumers defined by income, race and ethnicity could "afford" to purchase particular insurance products? Indeed, how would the FIO determine what constitutes an "affordable" insurance product?

The FIO decided to tackle its mandate by focusing on personal automobile liability insurance, noting that drivers are required to purchase this coverage in every state but one. In July 2016, the agency published a notice in the Federal Register describing the method by which it would determine whether auto liability insurance coverage is affordable for minority and low- and moderate-income (LMI) consumers. In the notice, the FIO explained that "personal auto liability insurance is presumed to be affordable if using an affordability index that is calculated by dividing the average annual written personal automobile liability premium in the voluntary market by the median household income for ZIP codes identified as being majority-minority or majority-LMI, the affordability index does not exceed 2%."

Translated, this meant that the FIO would use U.S. census data to compile a list of every ZIP code in which more than one half of the households are racial or ethnic minorities. The list would also include every ZIP code in which more than one half of "families" (not households) have low and moderate incomes. The FIO defined LMI families as those earning less than 80% of the median family income for the ZIP code.

Next, for each of these ZIP codes, the FIO would calculate the average annual written auto liability premium in the voluntary market. It would then divide that figure by the median household income in each of the ZIP codes. This exercise yielded what the FIO termed an "affordability index." If the index showed that the average premium is less than 2% of the median income in the targeted ZIP codes, auto liability insurance would be deemed "affordable."

To observers who were paying attention at the time, the approach described by the FIO raised a number of questions. First, where did the 2% standard come from? The FIO cited an independent study's finding that "national average [automobile] insurance expenditures divided by national median income has been below 2% since 1995." It further cited government data from 2013 showing that "the average [auto insurance] expenditure for all households" was "about 1.6% of average income after taxes. "The problem here is that, all things equal, one would expect a household whose income falls below the national average to spend an above-average share of its income on most of life's basic necessities, including food, housing, utilities, and (assuming the household owns a car) auto insurance--not to mention gasoline, oil and general car maintenance. Indeed, even if an LMI household spent less money for these items than the amount spent by more affluent households, the LMI household's relatively low income could mean that a relatively large percentage of its income would be devoted to these necessities.

A more fundamental question arose from the dubious notion that the FIO is capable of objectively discerning whether something is affordable. True, phrases like "affordable housing," "affordable child care," and "affordable college tuition" appear frequently in common political discourse, but rarely are these terms defined in terms of actual dollars and cents. It seems obvious that the meaning of "affordable" is inherently subjective, mainly because the affordability of a product is contingent, not just on the cost of the product relative to the amount of the prospective buyer's income, but also on the extent of that person's competing financial obligations and spending priorities.

More questions were raised by the FIO's decision to apply its "affordability index" to ZIP codes designated as "majority-minority" and "majority-LMI." The FIO defined a "majority-minority" ZIP code as one in which more than half the residents are "Black American, Native American, Hispanic American, or Asian American." A "majority-LMI" ZIP code is one in which more than half the residents have median family incomes that are less than half of the median family income for the entire ZIP code. When the FIO applied its analytic framework to all 32,452 residential ZIP codes nationwide, it discovered that 9,172 of them were either majority-minority, majority-LMI, or both.

Given that the U.S. Census Bureau estimates that the current population of the United States is approximately 322.8 million, the consumers to whom the FIO's affordability index was applied constituted roughly 35% of the U.S. population. The FIO asserted, without elaborating, that "this approach [...] reflect[s] the intent of the [Dodd-Frank] statute to monitor 'traditionally underserved communities and consumers.'" Anyone who is familiar with the U.S. automobile insurance market would find it hard to believe that more than one-third of American consumers are "traditionally underserved" by auto insurance carriers.

Moreover, since the FIO's objective was to monitor the affordability of automobile liability insurance specifically for minority and LMI consumers, the agency's ZIP-code-level approach was certain to be both under-inclusive and over-inclusive.

It would be under-inclusive in that it will not take account of minority consumers who reside in minority-minority (or majority-nonminority) ZIP codes, just as it would fail to account for LMI consumers who reside in minority-LMI ZIP codes. At the same time, the FIO's approach would be over-inclusive because majority-minority and majority-LMI ZIP codes invariably contain residents who are neither minority nor LMI.

In other words, a ZIP code for which auto liability insurance is deemed "unaffordable" according to the FIO's affordability index would almost certainly contain individuals for whom the average auto liability premium would be considered affordable according to the index. Similarly, a ZIP code for which the average premium is deemed affordable according to the index would almost certainly contain individuals for whom the premium is unaffordable according to the index.

Given the seeming arbitrariness of the FIO's 2%-of-family-income affordability standard and its problematic method of identifying minority and LMI consumers, it is hard to take seriously the report's central finding that the cost of auto insurance is unaffordable for "over 18.6 million residents."

Sadly, the FIO report represents a missed opportunity to help policymakers take steps that could reduce auto insurance prices for all consumers. It is no secret that in the last few years, auto insurance premiums have generally increased across much of the U.S. Unfortunately, the FIO's overly literal interpretation of its statutory mandate prevented it from examining the risk factors that lie behind the uptick in pricing. The report makes a cursory reference to "medical utilization rates" and "the prevalence of crime such as auto theft and insurance fraud " in a half-page section on "factors affecting affordability." But the report makes no attempt to calculate the extent to which these and other insurance cost-drivers, such as escalating vehicle repair costs, attorney involvement in the claim process, and the growing problem of distracted driving, to name a few, affect auto insurance pricing.

With new leadership at the FIO, the office may yet find a way to constructively engage with state legislators, regulators, and insurers to address the challenges facing the U.S. auto insurance market.

Contributor Robert Detlefsen, Ph.D., is vice president, research, National Association of Mutual Insurance Companies. He can be reached at
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Title Annotation:Regulatory Perspectives
Author:Detlefsen, Robert
Publication:Best's Review
Date:May 1, 2017
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