Should Insurance Regulation Be Used as a Political Pawn?
–William F. Shughart II, J. Fish Smith Professor in Public Choice, Utah State University
New Book Examines the ‘Risky Business’ of Insurance Regulation
“Insurance is too important to society and to commerce to be left as a political pawn,” writes Lawrence S. Powell, the editor of the newest Independent Institute book, Risky Business: Insurance Markets and Regulation. Powell’s words are timely because, as with so many natural disasters, Hurricane Sandy has prompted calls for lawmakers to prohibit insurers from adjusting the premiums of homeowners insurance. But such restrictions ultimately harm the consumer because they prevent insurers from rebuilding their loss reserves after a catastrophe. For example, when regulators imposed premium caps in Florida after Hurricane Andrew struck in 1992, insurers were forced to leave the market, and a state-owned agency found itself underwriting policies for more than 50 percent of the houses in the state!
Another example of misguided insurance regulation is when regulators prohibit insurers from using certain information in pricing and underwriting risk—such as personal credit ratings. Because consumers who make their debt payments on time are less likely to file insurance claims, they are a better risk for the insurer. Consequently, in states where insurers are permitted to use credit-based insurance scores, insurers can offer coverage to automobile drivers they would otherwise deem too risky to serve, Powell explains in Risky Business.
One reason that counterproductive regulations are adopted is the extreme mismatch of the time horizons of politicians and insurers: the former typically focus on getting re-elected, whereas the latter must concern themselves with being able to pay claims after a catastrophe that strikes perhaps only once every few decades or once every century. The need to keep political impulses in check is therefore paramount to maintaining a healthy insurance industry—a guideline that reformers should keep in mind if the province of insurance regulation is shifted from the states to the federal government.
Powell and his colleagues in Risky Business suggest that reformers look at the European Union, where lawmakers are allowing insurers more flexibility in managing risk than our politicized and stifling state governments often allow. Unless we study their example, we may end up creating a federal regulatory system that causes mischief that cuts across state lines.
Insurance regulation is risky business indeed.
Risky Business: Insurance Markets and Regulation, edited by Lawrence S. Powell