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RIMS takes a stand on Proposition 103.

RIMS Takes a Stand on Proposition 103

The Risk and Insurance Management Society, Inc. recently issued its position on Proposition 103 in California and similar legislation that is being promoted in 14 other states. In a four-page position paper, RIMS states its concern over such legislation, which would mandate insurance rate rollbacks and eliminate the limited antitrust exemptions granted to the insurance industry by the states. Such reforms, RIMS contends, will adversely affect risk managers both as private citizens and as commercial insurance buyers for the companies they represent. The complete text of the position paper follows.

California's recently passed Proposition 103, which significantly impacts the business of insurance, has been hailed as a boon to consumers and denounced as a devastating blow to the ability of insurers to write coverage. As an organization representing more than 4,100 corporate, governmental and non-profit consumers of insurance, the Risk and Insurance Management Society, Inc. must express its deep concern over the implications of this measure.

Rate Rollback is Principal Issue

The principal issue for California voters was certainly the rollback in automobile insurance rates to levels 20 percent below those in effect on November 8, 1987. Lost in the debate was the fact that the rollback applies to all property/casualty lines except workers' compensation, reinsurance and life, health, disability, marine, employers' liability, title and mortgage insurance.

First and foremost, pricing must be the result of sound underwriting practices. This is a cardinal rule which Proposition 103 disregards. Yet only such practices can ensure that both insurance consumers and insurers will be treated equitably.

The rollback conveniently ignores the roots of insurance premium dissatisfaction, choosing to kill the messenger instead of confronting the real problems. Certainly, there has been unacceptable volatility in commercial line premiums (a point on which RIMS has spoken out loud and often). That, however, is not proof that insurers are making unreasonable profits. In the case of private passenger automobile liability coverage, increased premiums more likely reflect changing loss and expense factors, such as health care costs, the civil justice system, drunk driving and the escalation of repair bills for both vehicles and property. How can availability and affordability be seriously addressed when these factors are disregarded as they were during the California initiative process?

The managements of insurance companies have a responsibility to their shareholders to make a profit and to their policyholders to maintain a high level of solvency. With the passage of Proposition 103, A.M. Best Company, an objective rating service of insurance company solvency, stated it may have to downgrade certain insurers because of the rate rollback, as might Standard & Poor's on claims-paying ability. Because such downgrading can have a negative impact on the attractiveness of an insurer's stock to potential investors, carriers will act to prevent it from happening.

Options insurers can take in reaction to the 20-percent rate rollback are limited and unsatisfactory. They include:

* Carriers can withdraw from or limit writing in California. This will remove valuable capacity from the state's market. Capacity is the amount of financial resources available to commit to the writing of insurance. Also, if insurers are forced to write unprofitable business with an insufficient return on investment for stockholders, they will be hindered in their ability to attract investors who provide necessary capital. Without capital, capacity will suffer. Therefore, it is unwise to sacrifice availability for an experiment in affordability.

* Insurers can use lines exempted from Proposition 103 rollbacks to recover losses in unprofitable lines. Thus, California life or marine policyholders would pay part of the cost of covering automobiles. RIMS opposes the subsidization of one class of policyholders by another. Inflating the premiums of one line of coverage to pay for losses incurred in another is the antithesis of the stated goal of Proposition 103 supporters--to promote individual rather than class underwriting.

* Multistate carriers can subsidize their California losses by charging higher premiums for non-California exposures. In addition to the problems discussed, such a reaction would set up an incentive for states to foist the losses incurred by unprofitable lines of coverage to other states by adopting Proposition 103 measures of their own. However, as an alternative approach, state regulators in both Iowa and the state of Washington recently announced that they may prohibit insurers domiciled in their states from writing property/casualty coverage in any state where the insurers expect to consistently lose money, i.e., California. The stated purpose is two-fold: first, to protect their citizens from paying for abnormally high costs in another state, and second, to ensure the solvency of the insurers in question.

If carriers leave the California market or reduce the capacity they make available, the formation of state-administered joint underwriting associations (JUAs) and other residual market mechanisms will be inevitable. Unfortunately, these JUAs will not be short-term mechanisms to bridge an immediate market crisis. They will become marketplace fixtures to replace permanently lost capacity. Judging by the New Jersey and Massachusetts experiences, premiums will not necessarily be lower under JUAs.

Worse still, JUAs originally intended for high-risk drivers may become the dominant force in the marketplace, vitiating competition. From an insurer's perspective, it is more prudent to place unprofitable lines into a JUA, in which losses are shared by numerous carriers, than to write the coverage independently.

Proposition 103 will also change the California Department of Insurance's priorities in a way that is detrimental to consumers. The department has expressed a desire to increase its staff by more than half (several hundred) and have its budget raised by millions of dollars to ensure compliance with the new law. A significant part of this increase will be allocated toward maintaining price controls on insurance, rather than for the monitoring of insurance company solvency, for which these resources are needed far more.

RIMS does not believe consumers are well-served by rigid price regulation. The broad mandate of insurance regulators has traditionally been to make sure rates are neither excessive, inadequate or discriminatory. Yet, with the pressures brought to bear by Proposition 103, regulators may be compelled to go much further, mandating rates as a giant rate-setting board.

Finally, should Proposition 103 spread, RIMS sees an increased likelihood that premiums paid by most policyholders will increase, either as a result of subsidization of unprofitable lines or additional costs to carriers resulting from losses assessed by JUAs. The premiums required to offset these practices will less and less reflect the true cost of risk in all lines.

Maintenance of Tax Revenues

Like many other states, California collects revenue by taxing a percentage of premiums paid by policyholders. If premiums are rolled back by 20 percent, state revenue from such taxes will decrease. To make up for this shortfall, Proposition 103 allows the California State Board of Equalization to hike insurer tax rates.

Presumably, insurers, as businesses traditionally do, will pass the increases on to their customers. If the premiums in a particular line of coverage are limited by Proposition 103, other lines will be used to subsidize the tax increase. Without subsidization, the profitability of offering coverage will be diminished, and therefore, capacity may be adversely affected.

Repeal of Antitrust Exemption

Proposition 103 subjects insurers to California antitrust and unfair business practice laws. This is especially significant in light of federal interest in repealing or modifying the McCarran-Ferguson Act.

Those who fought to repeal California's limited antitrust exemption for the insurance industry imply that it is responsible for high automobile insurance rates. Without such an exemption, proponents argue, true competition would exist and consumers would benefit.

There are numerous weaknesses in this argument. It has been RIMS' experience that the advisory rates promulgated by the carrier's ratemaking organization, the Insurance Services Office (ISO), are just that. More often than not insurers deviate, rather than adhere to, the advisory rates.

Judging by the California experience, those who argue that repealing the limited antitrust exemption will allow marketplace competition to prevail are wrong. The harsh reality is that proponents are replacing the advisory rates set by ISO with rates mandated under Proposition 103 guidelines by the California Department of Insurance. As a result, rates may be set too low, discouraging insurers from committing capacity to the state's risks, and Californians may be faced with a market dominated by a state mandated JUA, with all the inherent problems which that mechanism has encountered in New Jersey and Massachusetts.

While one of ISO's harshest critics, RIMS nevertheless sees the industry's ability to share loss data, promulgate advisory rates and develop common policy forms as being in the interest of insurance consumers. Without these activities, policyholders would have neither a benchmark for rates nor basic policy language with which to compare and understand coverages offered by competing insurers. Access to these advisory rates, policy forms and data also facilitates entry into the insurance marketplace by new players, thereby promoting competition. The supporters of Proposition 103 ignore these vital advantages.

Therefore, it is naive at best and fallacious at worst to argue that increased competition and lower rates will result from repeal of the industry's limited antitrust exemption. Any rate reductions that may occur will be offset by either availability problems or increased premiums paid by policyholders who will subsidize the losses mandated by Proposition 103. In reality, Proposition 103 has changed California from an "open competition" state to a giant rate-setting board, regulating true competition right out of its market.

Yet, no matter where one comes out on the antitrust debate, Proposition 103 submerged this important issue into a rate reduction referendum, guarantying the issue limited public scrutiny. This certainly is not the way to deal with a matter of such importance.

Repeal of Anti-Rebate Law

The proposition repeals California's anti-rebate law, making it legal for agents and brokers to reduce fees charged to, and share commissions with, clients. This is one provision that benefits consumers.

Fees and shared commissions should be a matter between the producer and policyholder. Anti-rebate laws interfere with discounts to consumers, preventing the cost of coverage to the insured from being lowered. Because Proposition 103 concerns itself with reducing the price of insurance, allowing rebates seems a logical step. Unless proponents of anti-rebate statutes can show the necessity of such restrictions, the promise of reduced transaction costs must prevail.

Banks in Insurance

Proposition 103 repeals the California statute which prohibits banks from being licensed as insurance agents and brokers. This should introduce new producers (agents and brokers) into the insurance marketplace.

Perhaps banks, through their existing marketing infrastructure, can deliver the insurance product in a more cost effective manner than is currently being accomplished in California. If so, insurance consumers should benefit from reduced transactional costs which hopefully will be reflected in lower insurance premiums.

Regulators, however, should be prepared to address the potential problem of abusive tie-in arrangements, whereby a bank could conceivably condition the granting of a loan to the purchase of insurance by the creditor from the lender. With proper regulatory safeguards in place to deal with such potential problems, the insurance consumer may be well-served by bank entry into the broker/agent ranks.


Proposition 103 is a simplistic and unwise answer to a complex problem. It is more likely to hurt policyholders in the long run than to alleviate their burdens. RIMS hopes that this is not the forerunner of similar measures around the nation, although we fear otherwise.

Yet, perhaps this can serve as an important message to insurers. They must pay closer attention to the needs of their clientele. If not, consumers have shown that right or wrong, they will strike back.
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Title Annotation:Risk and Insurance Management Society Inc.
Publication:Risk Management
Date:Apr 1, 1989
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