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Turmoil in the Texas auto insurance market.

The market for personal automobile insurance in Texas has encountered some hurricane force winds in recent years. The first major problem began when increased enforcement of the revised financial responsibility law took effect in 1991, making liability insurance compulsory for car owners and drivers. As a consequence, a large number of first-time buyers of automobile liability insurance entered the insurance market. The second major problem involves the rapid increase in the costs of automobile liability insurance in Texas in recent years. Dramatic cost increases have led consumers to demand reforms in the current accident compensation and insurance system. Even with major increases in premiums, however, many insurance companies have failed to earn a competitive profit from writing automobile liability insurance in Texas. The combination of these two problems has created a situation where all concerned parties appear to be unhappy with both the automobile accident compensation system and the availability and affordability problems associated with compulsory automobile liability insurance.

Political pressures have led to attempts to solve some of these affordability and availability problems through various market restrictions and regulations. As a consequence, certain classes of insureds appear to be receiving cross-subsidies from other classes of insureds in the voluntary market. For example, rate regulations can be such that certain rate levels are set too low, and insurers are forced to make up for these losses from other risk groups or other lines of insurance. Also, regulations can be imposed that limit insurers' ability to use certain classification factors in the rate-setting process in order to flatten the rate structure. For example, it is currently being debated whether or not insurers should be allowed to charge insureds a higher insurance rate if they have no prior history of purchasing automobile liability insurance.

In private competitive insurance markets, it is imperative that all insureds pay a premium that reflects their expected losses and other associated costs. Any regulations that constrain impersonal market forces and prevent this from occurring can lead to severe availability problems and potential market failure in the long run.

Suggested Remedies

Evidence on the conduct, structure, and performance of insurers in the auto insurance market shows the Texas market is highly competitive and growing. A large number of suppliers, a lack of excessive concentration, relative ease of market entry and exit, and no perceptible major economies of scale make additional rate regulation costly and economically ineffective.

In a reasonably competitive market, reforms should be directed at controlling the underlying cost factors that drive the price of automobile insurance. However, the current regulatory system seems to encourage cross-subsidies among certain classes of drivers. Greater pricing freedom for insurers and a more refined cost-based rate classification system could eliminate any such subsidies.

Compulsory auto liability insurance creates an adverse situation whereby many low-income individuals cannot afford to purchase the mandatory third-party coverage. However, many lower income families are faced with a dilemma in that they frequently cannot find a job without a car. This and other essential uses of automobiles have convinced many public policymakers that steps must be taken to make compulsory auto insurance affordable for all drivers.

Political pressures may have led to certain regulations requiring private insurance companies to force some classes of drivers to subsidize other classes of high-cost drivers. Hidden in the voluntary market rate structure, these subsidies are generally harmful to private markets. They reduce incentives for driving safely, promote overuse of motor vehicles among subsidized high-risk drivers, and distort the supply of insurance in the market. While not all low-income drivers are necessarily high-risk (cost) drivers, many are. Therefore, actuarially fair prices of insurance to cover drivers who are in both the low-income and high-risk categories often exceed their ability and/or willingness to pay.

One way to solve the problems of low-income drivers is to reduce the level of mandatory coverages required. This could be accomplished through lower required limits of coverage or the elimination of mandated coverages. If subsidies are to be used, it is suggested that it would be much better to do this directly through the use of public funds and full disclosure, rather than the current regulatory practice TABULAR DATA OMITTED TABULAR DATA OMITTED of hiding these subsidies in class rate structures for automobile insurance in the voluntary market.

The affordability problem can actually be broken down into two separate issues: the ability of low-income parties to afford the mandatory coverages and the high underlying costs of providing this insurance. While certain income redistribution measures could be taken to be both cost-effective and a solution for the affordability problem, the latter issue of system cost will require a different set of reforms. Because the insurance market is already competitive, further rate regulations will solve little, if anything. However, changes in the accident compensation system could have a dramatic effect on insurance costs. Such changes could be accomplished through reforms of the tort liability compensation system. A cost-effective no-fault compensation system for less severe injuries and residual tort liability for serious personal injury could lead to lower premiums for insurers and thus lower costs for buyers of insurance if they were developed on a balanced cost-benefit basis.


If it is deemed to be in society's best interest to subsidize some high-risk and/or low-income drivers, the problem of affordability of insurance could best be handled through a direct public subsidy program. Another option would be lower mandatory coverage requirements. However, this could lead to a larger number of underinsured drivers, which may not be in society's interest. The larger problem of high and rapidly rising auto insurance costs cannot be solved through suppressive rate regulation. Reform efforts should be focused on the underlying cost factors that determine and drive the price charged by automobile insurers in competitive markets. The costs for automobile insurance could be lowered if meaningful reforms were made in the automobile accident compensation system. For example, tort reform or the introduction of an elective no-fault compensation program with residual tort liability for serious personal injuries could help to lower the relative cost for automobile insurance.

It appears that the current regulatory process tends to make these availability and affordability problems worse rather than better. Rate regulation may be politically helpful in the short run, but will definitely fail in the long run in competitive markets. As long as the underlying cost factors go unchecked, the price for automobile insurance will continue to rise. Under any scenario, insurance companies must be allowed to charge a premium to cover all their costs and to earn a fair risk-adjusted rate of return on their invested capital in a competitive market, or they will channel their capacity and capital to other states and lines of insurance. Such a result would be harmful to consumers and the business environment in Texas.

Robert C. Witt Gus S. Wortham Chair in Risk Management and Insurance, Patrick L. Brockett Joseph Blades Professor of Risk Management and Insurance University of Texas at Austin, and Paul Aird Risk Manager for Projects Bechtel Group Inc. San Francisco, California
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Author:Witt, Robert C.; Brockett, Patrick L.; Aird, Paul
Publication:Texas Business Review
Date:Oct 1, 1993
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