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Government Underwriting Restrictions Distort Insurance Markets, Harm Consumers

Unfettered risk-based underwriting promotes competition, reduces loss costs, and lowers premiums

WASHINGTON (Sept. 21, 2004)--The policy debate over insurance price regulation tends to focus on state-administered "rating laws" that require insurers to seek the approval of state insurance departments whenever they wish to raise or lower premiums. A new National Association of Mutual Insurance Companies (NAMIC) Public Policy Paper explains that price regulation also takes a less direct form: state-imposed underwriting restrictions that curtail the ability of insurers to accurately assess and classify risk. NAMIC released the paper at its 109th Annual Convention here today.

"Government restrictions on underwriting freedom ostensibly guard against unfair business practices and ensure that insurance will be available to meet market demand. In many instances, however, these regulatory interventions only create dysfunctional market conditions that are detrimental to insurance consumers," writes Robert Detlefsen, NAMIC Public Policy Director, in "The Case for Underwriting Freedom: How Competitive Risk Analysis Promotes Fairness and Efficiency in Property-Casualty Insurance Markets."

Property insurance underwriting criteria relating to geographic territory, age of a home, and consumer credit history-each of which is a proven risk factor-have frequently been restricted or prohibited by state insurance laws. The paper explains that restrictions on the use of these and other underwriting variables generate cross-subsidies that flow from low-risk insureds to high-risk insureds, thereby subjecting consumers to a hidden wealth transferring scheme. Moreover, weakening insurers' ability to accurately assess and price risk removes an incentive that high-risk individuals would otherwise have to take precautions to avoid loss. The likely result is increased accident rates and insurance loss costs, which ultimately raise the cost of coverage for most consumers.

The rationale for underwriting restrictions often rests on the mistaken belief that insurance should "spread the risk" among dissimilar insureds. According to this view, insurance is a privately administered social welfare program whose purpose is to provide disproportionate benefits to policyholders with relative high levels of risk-i.e., those most prone to loss.

In reality, the paper explains, the true purpose of a market-based system of private insurance is to facilitate risk sharing among homogeneous risk classes consisting of individuals grouped together based on similar risk characteristics. The efficiencies that result from risk-based underwriting lead to increased competition, innovations in risk reduction, and the development of new coverage options tailored to the specific needs and circumstances of particular consumers.

Moreover, permitting insurers to accurately assess risk through competitive underwriting allows them to avoid absorbing more of a particular risk than they are capable of indemnifying, a situation that can lead to financial instability and, in the worst case, insolvency. In effect, competitive underwriting facilitates risk sharing among insurers-an essential aspect of the risk-sharing function of private insurance markets.

"Far from improving the lot of property insurance consumers," the paper concludes, "government-imposed underwriting restrictions prevent consumers from enjoying the full range of benefits that come from unfettered competition."

NAMIC's latest Public Policy Paper is available at NAMIC's website, NAMIC Online.

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For further information contact:
Robert Detlefsen at rdetlefsen@namic.org
or (317) 875-5250