2005 Insurance Reference Manual

Personal Insurance Federation of California Insurance Reference Book

Impact of petition to modify use of Optional Rating Factors

Executive Summary

Prepared by Robert Downer, Fellow of the Casualty Actuarial Society, President, ARM Consultants, Inc.

OVERVIEW

A number of consumer groups have petitioned the Commissioner of Insurance to modify and limit the opportunity for insurers in California to use optional rating factors in setting private passenger automobile rates. Optional rating factors are those other than the three mandatory factors - driving safety record, annual mileage and years of driving experience - that are substantially related to loss. The Personal Insurance Federation of California ("PIFC") and the Association of California Insurance Companies ("ACIC") commissioned a study of the impact of the proposals made by the petitioners.

Using comprehensive data from four large California private passenger automobile insurance companies, the impact of the proposal was assessed relative to (1) all drivers, (2) experienced drivers, (3) California good drivers, and (4) "bad" drivers (i.e., drivers not meeting California good driver criteria). The results of the study show:

More than 60% of all California drivers would experience rate increases.
Nearly three quarters (73%) of California drivers with 34 or more years experience - generally drivers age 50 and older - would receive rate increases.
63% of California good drivers would receive rate increases.
56% of "bad" drivers - drivers not meeting the California good driver criteria - would receive rate decreases.

None of these effects are related to risk of loss. To the contrary, they result from "tempering", which in purpose and effect disassociates rates and premiums from risk of loss.

In order to perform this study, data was collected from four large insurance companies: State Farm Mutual Automobile Insurance Company, Zurich/Farmers, Allstate, and USAA. Together, these insurers comprise 37.8% of the California private passenger liability market (per 2002 DOI market share statistics). These insurers write private passenger auto insurance throughout the state; the impact for all California drivers is expected to be consistent with the findings from the business of these four companies.

FINDINGS OF THE STUDY

The petitioners' proposal creates increases in rates for some and decreases for others. Many of the rate changes are substantial (>10%). None of the changes are related to risk of loss, or the cost of providing the insurance. Some of the specific changes observed include:

All Drivers - 61% of California drivers - thirteen and a half million drivers - would receive a rate increase. Nearly one-third of all California drivers (32%) - seven million drivers - would receive a substantial rate increase of greater than 10%. There is no change in risk of loss, just a rate increase unrelated to risk of loss. The rate changes are illustrated in Exhibit 1.
Experienced Drivers - Nearly three-quarters of experienced drivers (those with 34+ years of driving experience) would receive rate increases. Almost one-half (46%) of experienced drivers would receive a substantial rate increase of greater than 10%. These drivers, who are usually age 50 and up, are generally better drivers because of experience and maturity. Insurers generally see lower losses for the experienced drivers in this category. But, under petitioners' proposal, this group would unfairly receive rate increases entirely unrelated to their risk of loss. The rate changes are illustrated in Exhibit 2.
California Good Drivers - 63% of California good drivers would receive rate increases. That is, petitioners' proposal harms the majority of good drivers, by forcing them to pay higher rates without regard to risk of loss. The rate changes are illustrated in Exhibit 3.
Bad Drivers - 56% of "bad" drivers - drivers not meeting the California good driver criteria - would, conversely, receive rate decreases, favorably affecting poor drivers without basis in their risk or driving record. That is, petitioners' proposal benefits the majority of bad drivers while harming the majority of good drivers. This result is also illustrated in Exhibit 3.
Towns & Communities - Most communities in California will experience average rate increases; 973 of 1193 California towns and cities will receive average rate increases.
Counties - Fifty-two of California's fifty-eight counties would experience average rate increases under petitioners' Alternative 2. The rate changes by county are illustrated on Exhibit 4.

IMPLICATIONS AND RAMIFICATIONS

There are a number of negative implications from implementation of petitioners' proposal, most importantly:

Financial disruption to individuals and households - Huge numbers of drivers would get unexpected, unjustified and substantial auto rate increases - unfairly and adversely impacting their family finances.
Rates that are not risk-based - The changes requested in the petition will impose rate changes that are not cost or risk-based. Limiting the weight applied to optional rating factors limits the chance to use rating variables that are related to and actuarially predictive of losses.
Rate subsidies - Subsidies will be produced all through the California automobile insurance market: suburban and rural communities will subsidize urban communities, experienced drivers will subsidize inexperienced drivers, and good drivers will subsidize bad drivers. All these subsidies are unrelated to risk of loss resulting in rates that are unfair and arbitrary.
Constraints on competition - If subsidies in rates are allowed to prosper and flourish, competition will be diminished. Subsidies arise when rates are not cost-based - lower risk drivers paying a portion of premium for higher risk drivers. Where this exists, there is reduced financial incentive by companies to write those drivers being subsidized, i.e. the higher risk drivers. There is no financial incentive; in fact, there is dis-incentive to write drivers having expected losses which exceed premiums. These conditions are not only actuarially inappropriate but also unhealthy to an active and competitive insurance marketplace.

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