I. Introduction and Summary

Increases in the cost of automobile insurance have led to demands for increased regulation of auto insurance rates in many states. One view o£ auto insurance affordability problems is that high and rapidly growing premiums are caused by high and rapidly growing claim costs and that the principal objective of public policy should be the evaluation and possible adoption of changes that will help to control claim costs. A second view is that inadequate competition, inefficiency, and excessive profits in the auto insurance industry make insurance unaffordable for many buyers and that competition that does exist leaves large numbers of buyers without access to coverage at reasonable rates. According to this view, regulation of premium rates, underwriting decisions, and insurance company operating expenses is essential to benefit consumers.

This report evaluates the private passenger auto insurance market in Michigan. It suggests appropriate government policies for dealing with auto insurance affordability problems and for improving the auto insurance system to benefit Michigan motorists. The report considers (1) the nature and causes of affordability problems, (2) the benefits and costs of the current system of auto insurance regulation as set forth under the Essential Insurance Act, (3) the performance of the state's no-fault law, and (4) the competitiveness of the auto insurance market. The major findings are:

  1. Evidence on market structure, ease of entry, and profitability supports the conclusions that the private passenger auto insurance market is competitive and that the principal cause of auto insurance affordability problems is high claims costs. As would be expected in a competitive market, premium rates are higher in Detroit than in other parts of the state because claim costs are higher. The focus of government policy should be on actions that will help to control claim costs. In order to represent the interests of policyholders in the political process, insurers must be willing to accept temporary mandated rate cuts that are closely tied to desirable legislative changes that reduce expected claim costs.

  2. The Essential Insurance Act has reduced certain negative consequences of insurer underwriting practices, but it has created other problems. The law promotes cross-subsidies among consumers and reduces the incentives for many drivers to take precautions that would lower expected accident costs. Consideration should be given to modifying the statutory constraints to allow more discretion in underwriting and rate classification. The primary effect of any additional restrictions on cost-based pricing, such as those that involve territorial rating, would be increased subsidization of some groups at the expense of others. The likely result over time would be even higher claim costs and premiums.

  3. While the state's no-fault law has several characteristics that could serve as models for other states, a number of modifications in the law are desirable to maintain its principal advantages and improve the affordability of coverage. The legislature should take action to provide consumers with significant choice in the selection of personal injury protection benefit levels and to ensure that tort liability for noneconomic losses is restricted to serious injuries. These changes would benefit most motorists; low income groups that face high premiums in Detroit and other areas would especially benefit. Serious consideration also should be given to the possibility of adopting an optional no-fault law that would allow consumers the choice of eliminating the right to sue other drivers for damages in exchange for a corresponding exemption from tort claims. Under this system, motorists who rejected no-fault would be able to recover damages from their own insurer if they were to be injured by an at-fault driver who had chosen no-fault.

  4. Given competition in the auto insurance market, overall rate levels should continue to be governed by file-and-use regulation rather than prior approval.