1. Property damage liability covers Michigan drivers involved in accidents out, of state.

  2. Standard collision pays for damages above a deductible, regardless of whether the insured or other drive: is at fault. Broad collision only includes a deductible if the insured is more than 50 percent at fault. Limited collision only provides coverage if the insured is not more than 50 percent at fault. For additional background on auto insurance coverages and the auto insurance market and regulation in Michigan, see Michigan Insurance Issues Handbook, Public Sector Consultants, for the Michigan Association of Insurance Companies, 1989.

  3. The Essential Insurance Act deals with both auto and homeowners insurance, The present study focuses exclusively on auto insurance, and the discussion concentrates on private passenger auto insurance.

  4. For example, conviction for speeding 16 or more miles per hour over the limit produces four points. The first substantially at-fault accident produces three points, and subsequent at-fault accidents produce four points each.

  5. Prior to 1981, insurers could choose between prior approval regulation of rates and a file-and-use system that allowed the commissioner to order refunds if rates filed under the file-and-use provision were Later found to be excessive. Most insurers submitted rates for prior approval.

  6. Four broad types of involuntary market mechanisms are used in the United States. Most states have assigned risk plans in which drivers are assigned to insurers in proportion to their voluntary market share. A few states have reinsurance facilities. In these states, insurers generally are required to accept almost all applicants, but they are allowed to cede business to the reinsurance facility, Financial results of the facility are pooled among all insurers in proportion to their voluntary market volume. Several states in addition to Michigan have joint underwriting associations, in which a limited number of insurers are paid fees to issue policies and settle claims for involuntary market insureds. The financial results for involuntary market business are shared among all insurers. Maryland has a state insurer for the involuntary market Insurers pay assessments to finance the state insurer's operating losses.

  7. This distinction is important in understanding the problems that arose from the Essential Insurance Act's restrictions on territorial rating. As will be discussed later, a significant disadvantage of reinsurance facilities and joint underwriting associations is that they dilute incentives for efficient claims settlement by insurers.

  8. Insured vehicles are the number of liability insurance written car-years during the year. These data, along with data on passenger car registrations, are available from the Automobile Insurance Plans Service Office (AIPSO, Circular RMC 89-14, April 14, 1989 and AIPSO Facts). Premium comparisons published by the A.M. Best Company are based on vehicle registrations rather than insured vehicles. Michigan's average premium in 1987 was 5509 and ranked 17th among the states using the A.M. Best procedure. The reason that its average premium is lower using insured car-years is that the number of passenger car registrations in 19$7 was 5,440,087 compared to 5,700,936 insured car-years (see AIPSO Circular RMC 89-14). A problem with Best's approach is that states vary widely in their definitions of private passenger vehicle registrations. For example, since many states exclude vans and pickup trucks from the registered vehicle data, the number of insured vehicles often exceeds the number of registrations. Similarly, the use of registered vehicles will not reflect differences across states in the number of uninsured cars. For these reasons, it is probably better to compare premiums per insured vehicle across states. Also see note 9 infra.

  9. The written premium and incurred loss data were obtained from Best's Executive Data Service. Incurred losses are calendar-year values. They equal paid losses plus the change in the loss reserve. Insured vehicles are again defined as liability insurance written car-years. Data on physical damage exposures are not available. As a result, the physical damage results will be affected by any change over time in the proportion of cars that are insured for liability but not physical damage.

  10. Total physical damage premiums declined slightly during 1988, while total physical damage losses increased slightly, Liability premiums increased slightly in 1988; persona, injury protection premiums grew by six percent.

  11. Due largely to discounting of personal injury protection loss reserves by a number of insurers, total reported personal injury protection incurred losses declined by 33 percent :n 1988.

  12. The greater growth rate for premiums is likely to have been influenced by the reduction in interest rates that occurred between 1980 and 1986. Other things being equal, a reduction in interest rates tends to increase premiums because insurers will earn less investment income before claims are paid. The greater the average length of time between the receipt of premiums and the payment of claims, the greater will be the premium increase. Hence, interest rates are likely to have a greater impact on liability premiums than on physical damage premiums.

  13. As shown in the note to Table 2, claim frequency is defined as the annual number of claims per 100 insured vehicles. Claim severity is the average payment per claim. The average claim cost per vehicle is total annual claim costs divided by the number of vehicles.

  14. The bodily injury paid claim frequency and average paid claim cost per vehicle also are lower, and the severity of paid claims is higher in Michigan than the average for other states with no-fault laws due to the greater effectiveness of Michigan's tort threshold in eliminating tort liability for minor injuries.

  15. The countrywide numbers only reflect states with personal injury protection coverage.

  16. If the sum of the results for property damage liability and collision in Michigan is compared to the countrywide sum for property damage liability and collision, the frequency of claims is about the same. and the average cost per vehicle is higher in Michigan.

  17. Of course, the ratios of Detroit results to those for areas outside of Detroit would be higher than the values shown in Table 4.

  18. See ISO and NAII, Factors Affecting Urban Auto Insurance Costs, 1988. Detroit's ratio for the average cost per vehicle for bodily injury liability claims ranked 11th out of the 18 cities.

  19. These data were obtained from Auto Theft in Michigan: A Report to the Legislature, Michigan Insurance Bureau, August 1989. This report provides detailed information about the auto theft problem. In 1984, Michigan had the highest auto theft rate of any state. In 1987, Michigan's theft rate was the fifth highest in the nation.

  20. For evidence of low per capita income in many areas of Detroit, see Auto Insurance Rating In Michigan: The Effects of Public Act 10 of 1986, Michigan insurance Bureau, November 1989, pp. 95-96. This report provided some evidence of greater premium growth in Detroit than statewide since 1986, The analysis and conclusions concerning territorial rating that are contained in this report are examined in Section III below.

  21. See Essential Insurance in Michigan: An Avoidable Crisis, Michigan Insurance Bureau, March 1977. These arguments are reviewed by the Michigan Insurance Bureau along with the Act's performance during 1981 in A Year of Change: The Essential Insurance Act in 1981, June 1982. John Hogan's critique of the 1977 report and legislation proposed in the report (see "Essential Insurance Reform Act: Analysis and Comment", no date) discusses several of the issues that are addressed in the present study, Also see Thomas Wenck, "Michigan's Essential Insurance and No-Fault Laws: Economic and Philosophic Issues", The Michigan Economy, 1 (July-August 1982).

  22. The discussion in the report was not clear as to whether widespread problems existed for auto insurance, for urban property insurance, or both. The implication was that problems were widespread in both areas. See p. 5, Essential Insurance in Michigan, ibid.

  23. The report criticized a section in the insurance code that allowed insurers to utilize any classification scheme that "may measure differences among risks and that may have a probable effect on losses or expenses."

  24. The report also noted that availability problems were aggravated by cyclical fluctuations in insurance prices and in the supply of coverage and that cancellations of policies and denials of coverage renewal created difficulties for some drivers. Many states adopted legislation in the 1970s that specified allowable reasons for insurer cancellation of auto and homeowners coverage. A few states also limited the ability of insurers to deny renewal of coverage.

  25. See Part 5, Essential Insurance in Michigan, note 21 supra.

  26. See Report of the Federal Insurance Administration to the Secretary, Department of Housing and Development, on Full Insurance Availability, 1974. Also see the discussion by James Daoust and George Cabot. The Michigan Essential Insurance Act – Beware!", Federation of Insurance Counsel Quarterly, 34 (1983), pp. 53-72.

  27. The initial Shavers case was filed in 1973 prior to the effective date of no-fault. Both the trial court and the Court of Appeals held that compulsory personal injury protection coverage and the restrictions On tort liability for bodily injury were constitutional, but that no-fault property damage was unconstitutional..

  28. In its discussion of the constitutionality of no-fault, the Court noted that .t would be acceptable for the state to fix rating plans and rate differentials, to prohibit cancellations and nonrenewals and to restrict other insurance company underwriting practices to ensure availability. The discussion was broad enough to make it clear that the type of remedies suggested in the Insurance Bureau's 1977 report would be acceptable. The 1977 report was referenced in the majority opinion. Three justices dissented from the majority in sharply worded opinions. The major objections were that the issue of compulsory coverage and insurance rate regulation had not been brought before the court, and that no factual record existed concerning these matters.

  29. See Daoust and Cabot, note 26 supra, and Wenck, note 21 supra, for discussion of Michigan. For general discussion and discussion of particular states, see Richard Schmalz, "Problems of Insurance Availability – ‘Redlining' , CPCU Journal, 33 (December 1980), pp. 149-157 and "Problems of Insurance Availability – ‘Redlining', Part II", CPCU Journal. 34 (March 1981), pp. 25-36; Auto Insurance: State Regulation Affects Cost and Availability, U.S. General Accounting Office, 1986; Judith Mintel, "New Jersey's Regulatory Policy for Auto Insurance", Journal of Insurance Regulation, 4 (September 1986); Scott Harrington, "Rate Regulation, No-Fault, and the Automobile Insurance Affordability Problem", College of Business Administration, University Of South Carolina, January 1989; Scott Harrington and S. Travis Pritchett, "Auto Insurance Reform in South Carolina", March 1989, South Carolina Policy Council Educational Foundation and Journal of Insurance Regulation (in press) ; and Simon Rottenberg, The Cost of Regulated Pricing A Critical Analysis of Auto insurance Premium Rate-Setting in Massachusetts, Pioneer Institute for Public Policy Research, 1989.

  30. As noted by Schmalz, ibid. 1981, risk assessment constitutes the very heart of the private insurance market.

  31. The incentive to maximize profits leads to cost minimization. Competition produces premiums that provide insurers with only a fair rate of return on capital over time. In most instances, claim settlement is likely to be done in a manner that is consistent with policyholder preferences for quality of service at the time coverage is purchased.

  32. Incentives of insurers and agents to influence legislation to control costs sometimes can be tempered by the desire for greater premium volume and commission volume, respectively. For further discussion, see Scott Harrington, The insurance Industry and Tort Reform," Legal Backgrounder, Washington Legal Foundation, September 16, 1988.

  33. Even without cyclical fluctuations, a small proportion of drivers might be unable to obtain coverage in the voluntary market as a result of adverse selection. A significant number of drivers also may only be able to obtain coverage in the ''nonstandard" voluntary market, as opposed to the standard or "preferred" market. The existence of these segments in the voluntary market reflects the risk assessment process discussed above.

  34. See U.S. General Accounting Office, note 29 supra; Henry Grabowski, W. Kip Viscusi, and William Evans, "Price and Availability Tradeoffs of Automobile insurance Regulation", Journal of Risk and Insurance, 55 (1989), 275-299; and Scott Harrington, "The Relationship Between Voluntary and involuntary Market Rates and Rate Regulation in Automobile Insurance," Journal of Risk and Insurance, 57 (in press).

  35. A similar point is made by John Hogan, note 21 supra, and by Daoust and Cabot, note 26 supra. As suggested in the latter article, the proportion of vehicles insured in the involuntary market will tend to understate proportion of policies insured in the involuntary market if involuntary market insureds are less likely to own and insure more than one car than are voluntary market insureds.

  36. If Michigan had a reinsurance facility rather than the MAIPF, its involuntary market share in 1981 and subsequent years probably would have been much higher, since insurers would have the incentive to cede all business to the facility for which restrictions on rate classification (e.g., unisex rating) produced rates lower than would exist under cost-based pricing. Also see ch. 4, U.S. General Accounting Office, note 29 supra.

  37. Data obtained from AIPSO Facts, 1979 and 1983 editions. Compare these results to the 1977 report's discussion of national availability problems in auto and homeowners insurance (see p. 5, Essential Insurance in Michigan, note 21 supra; also see note 22 supra).

  38. The problem of "clean" risks (drivers without prior accidents or violations) in involuntary markets (see the 1977 report) also is likely to be largely caused by rate regulation.

  39. As is discussed further below, the extent of the third form of subsidy probably has declined since the Essential Insurance Reform Act took effect in 1986. Evidence on the short term impact of the Essential Insurance Act on rate and territorial classification is provided in A Year of Change, note 21 supra. A later study by the Michigan Insurance Bureau (see Frances Wallace, "Unisex Automobile Rating: The Michigan Experience", Journal of Insurance Regulation, 3 (December 1984), pp. 127-139) presented evidence that when the Essential Insurance Act took effect in 1981 total premiums for mandatory coverages increased by no more than 20.9 percent for young females and decreased by no more than 15.1 percent for young males. The U.S. General Accounting Office, note 29 supra, ch. 4, noted that for all coverages combined, the corresponding figures were a 28.9 percent maximum increase and a 20.4 percent maximum decrease. It is often argued by the proponents of unisex rating that greater use of mileage as a rating variable would reduce the adverse consequences of unisex rating to young females. (See, for example, Patrick Butler, Twiss Butler, and Laurie Williams, "Sex-Divided Mileage, Accident, and Insurance Cost Data Show that Auto Insurers Overcharge Most Women", Journal of Insurance Regulation, 6 (March and June 1988).) This discussion generally ignores the cost of verifying mileage accurately and the reduction in the predictive value of mileage that will occur when young persons have a substantial incentive to understate mileage to produce a lower premium. While the thrust of the discussion by Wallace (see above) was that subsidies produced by the Essential Insurance Act were of no real consequence, it also presented evidence that the elimination of marital status as a rating factor led to large premium increases for young married males.

  40. For this reason, theory suggests that the use of these variables is likely to be efficient (even when the impact of subsidies on precautions is ignored) in the sense that the gains to persons whose rates are made lower by their use are less than the costs to persons whose rates are made higher. See Keith Crocker and Arthur Snow, "The Efficiency Effects of Categorical Discrimination in the Insurance Industry", Journal of Political Economy, 94 (1986). Also see the discussion below on the impact of subsidies on accident costs.

  41. For example, the MAIPF assessment for private passenger auto insurance in 1985 was $31.1 million, which represented 1.5 percent of earned premiums. The assessment for 1987 was $7.8 million (0,3 percent, of earned premiums). The assessment data were obtained from the MAIPF (Memorandum Lo Board Members, January 21, 1998, Exhibit. I). Earned premiums were obtained from Best's Executive Data Service.

  42. An increase in the total cost of accidents and accident prevention is suggested by basic economic theory.

  43. For further discussion in the context of insurance, see Rottenberg, Schmalz, and Harrington and Pritchett, note 29 supra. While empirical analysis o£ the possible impact of subsidies on claim costs has not been undertaken, this conclusion is suggested by the fact that taking a given precaution is likely to have a greater impact on expected accident costs for high risk drivers than for low risk drivers, other things being equal. Moreover, a small change in premiums for each person that is "taxed" to finance subsidies is likely to have a less than proportional impact on precautions compared to a large change in premiums for each person that is subsidized.

  44. As an example of the adverse effects of restrictions on risk assessment, it 1s likely that the Essential Insurance Act contributed to the auto theft problem in Michigan. The specified underwriting and rating criteria contained in the Act provided little incentive for a policyholder to take efficient precautions to reduce the likelihood of theft, and the Act is likely to have restricted the ability of insurers to deny coverage or charge higher rates to persons who on average would be more likely to engage in theft-related fraud. As previously noted, the three cities studied by the ISO and NAII (note 18 supra) with the highest theft rates in 1987 were Newark, Boston, and Detroit. The fact that Massachusetts and New Jersey are both well-known for regulatory policies that promote cross-subsidies among motorists (see, for example, Rottenberg and Mintel, note 29 supra) is probably suggestive in this regard.

  45. This problem has plagued states with reinsurance facilities, as well as the New Jersey Joint Underwriting Association. For further discussion, see the U.S. General Accounting Office, Harrington and Pritchett,and Harrington, note 29 supra.

  46. Following the effective date of the Essential Insurance Act, insurers redrew their territories. See A Year of Change, note 21 supra, for details. This study also presents evidence that the ratio of the base rate for the lowest rated territory to that for the highest rated territory was greater than 45 percent in 1981 for each of the insurers studied. Evidence presented for several large insurers in Auto Insurance Rating in Michigan, note 20 supra, indicates that their ratios had declined to 45 percent by 1985 and that they fell below 45 percent following the relaxation of restrictions on territorial rating in 1986 (see below).

  47. For further discussion, see, for example, U.S. General Accounting Office, note 29 supra, ch. 4. Two provisions in the Essential insurance Act suggested that its drafters were aware of the problems that might arise. One provision contained strict limitations on the ability of insurers to cancel contracts with independent agents, Another provision gave the insurance Commissioner authority to order insurers to establish sales offices in areas with inadequate competition. The Latter prevision was repealed in the 1936 Reform Act.

  48. This result assumes that the Insurance. Commissioner would not have exercised authority given in the act (see note 47 supra) to order companies to establish sales offices in Detroit.

  49. The 1986 Reform Act also changed the basis for MAIPF rates from the average of the top ten insurers to the average of the top five. Premium discounts for seatbelt use also were required.

  50. See Auto Theft in Michigan, note 19 supra. The insurer-funded HEAT (Help Eliminate Auto Theft) program, which provides rewards for Lips leading to the arrest o: persons involved with auto theft, also appears to have had some success. See -Here Today Gone Tomorrow", Journal of American Insurance, 65 (i989), pp. 1-5. Recent history in Michigan probably illustrates one likely consequence of significant restrictions on underwriting and rate classification. if restrictions reduce incentives for policyholders to control costs, additional regulations may be necessary to control, the resultant increase in costs.

  51. H.B. 4912, introduced by Representative Nelson Saunders, June 8, 1989.

  52. Auto Insurance Rating in Michigan, note 20 supra. This report was required by the 1986 Act.

  53. The importance of considering ease of entry and expansion in assessing whether a market is competitive is discussed in Section V. On page 30, the 1989 report notes that the market share of the largest four insurers in Detroit (based on insured exposures) was 71 percent in 1987 and states that markets with a ratio of 60 percent or more would be considered highly concentrated. The market shares shown in the report on page 51 for the top-four firms when MAIPF business is excluded sum to 59 percent.

  54. See Exhibits 6, 7, and 8, Auto insurance Rating in Michigan, note 20 supra. The report notes that (p. 54) "while the base rate (in Detroit) may be 'competitive' with the base rates in the voluntary market, the resulting premiums often are not", The Executive Summary states (p, iii): "Premiums charged eligible drivers by the Facility are not competitive with those charged by the top ten insurers, either in Detroit or outstate." Based on the information provided in the report, this latter statement is misleading. The report also notes (p. 106) that the market share of the MAIPF in Detroit increased from 8.1 percent in 1985 to 17.1 percent in 1987, Elsewhere (p. 51), it reports the 1987 market share of the MAIPF as 16 percent. A reason for this discrepancy was not provided.

  55. Comparisons of loss ratios for one year also may be greatly affected by differences inunanticipatedchanges in loss costs across regions. As an example, if theft rates declined more than expected by insurers in Detroit in 1987 compared to the remainder of the state, other things being equal, the loss ratio in Detroit would be lower than in the remainder of the state, (Similarly, if in any given period losses were higher than expected in a given region, the loss ratio would be higher in that region.) It also was not clear whether MAIPF experience, which would be likely to have a significantly greater loss ratio in Detroit, was included in the data.

  56. While the report endorses file-and-use regulation of overall rata levels, it also proposes a significant expansion in the powers of the insurance commissioner if he or she finds that a rata is inconsistent with the standards set forth in the Essential Insurance Act. For example, upon a finding that any rates were excessive, an insurer would have to make refunds to policyholders. The adoption of this proposal could change the file-and-use system to a de facto system of prior approval if it discouraged insurers from changing rates without explicit or tacit regulatory approval.

  57. The proposed restrictions on territorial rating also might not be very successful at targeting subsidies to low income drivers. See Schmalz, note 29 supra, and the references cited therein for general discussion of this point.

  58. One proposal in Michigan that generally meets these criteria would provide auto insurance premium cuts La welfare recipients through an increase in motor vehicle registrations fees.

  59. See Compensation for Automobile Injuries in the United States, All-Industry Research Advisory Council, 1989, as discussed in "Brother Can You Spare a Tort?", Journal of American Insurance, 65 (1989), pp. 16-19.

  60. See Compensating Auto Accident Victims: A Follow-Up Report on No-Fault Insurance Experiences, U.S. Department of Transportation, May 1985, and Brian Smith, "Reexamining the Cost Benefits of No-Fault," CPCU Journal, 42 (March 1989), pp. 28-36.

  61. A package of bills has been proposed that would attempt to improve the performance of the law by strengthening the tort threshold and helping to control. personal injury protection claim costs. The proposals. which were developed by Senator Richard Posthumous, also provide for reductions in personal injury protection and residual liability premiums by an amount sufficient to reduce overall premiums for bodily injury and physical damage coverage by 10 percent.

  62. Attempts to mandate large personal injury protection benefits without imposing significant restrictions have created serious problems in a number of states. See U.S. Department o` Transportation and Smith, note 60 supra. These problems eventually influenced the repeal of no-fault in Pennsylvania and Nevada.

  63. Economic theory suggests this result unless at a given level of wealth a person's marginal valuation in income is significantly greater after an injury than before. See, for example, Philip Cook and Donald Graham, "The Demand for Insurance Protection: The Case of Irreplaceable Commodities", Quarterly Journal of Economics. 91 (1977), pp. 143-156; Michael Spence, "Consumer Misperceptions, Product Failure, and Product Liability," , Review of Economic Studies, 64 (1977), pp, 561-572; and Steven Shave!!, Economic Analysis of Accident Law, Harvard University Press, 1987, ch. 10-11. Also see J. David Cummins and Mary Weiss, °An Economic Analysis of No-Fault Auto Insurance", Wharton School, University of Pennsylvania, 1938; Patricia Danzon, "Liability and Liability Insurance for Medical Malpractice", Journal of Health Economics, 4 (1985), pp. 309-331; and Patricia Danzon and Scott Harrington, The Demand for and Supply of Liability Insurance", Wharton School, University of Pennsylvania, July 1999.

  64. See U.S. Department of Transportation, note 60 supra, and J. David Cummins and Mary Weiss, ibid.

  65. For example, an uninsurable fine of several hundred dollars for substantially at-fault accidents might provide a significant deterrent, For theoretical discussion of the possible advantages of fines in this case, see Spence and Shavell, note 63 supra. It should be noted that the term "unrestricted liability" refers to the potential liability of a person for the full economic and noneconomic loss of an injured party. As a practical matter, liability is restricted by the amount of a motorist's auto liability insurance coverage and, in same instances, personal wealth.

  66. The frequency of personal injury protection claims that will exceed the $250,000 limit is estimated at less than 0.1 percent. See Memorandum on PIP Claims Study, from Herman J. Arends, Auto-Owners Insurance, Lo Insurance Industry Task Force, November, 2, 1989. The most common injuries that produce large claims involve brain damage or paralysis. These injuries typically require lifetime care.

  67. MCCA Annual Statement, 1988. The predicted MCCA deficit as of year-end 1989 is $546 million. See Milliman and Robertson, "An Estimate of the Pure Losses and Loss Expenses for Assessments to be Set by the MCCA for Calendar Year 1990", preliminary draft, Exhibit I (no date).

  68. If this were to be done, all policyholders would need to pay premiums to finance assessments until the MCCA deficit on prior claims was eliminated.

  69. See note 61 supra.

  70. For detailed discussion of this issue and other drawbacks to compulsory coverage, see Scott Harrington, The Efficiency and Equity of Compulsory Automobile Insurance Laws", College of Business Administration. University of South Carolina, January 1989.

  71. While the discussion in this section focuses on Michigan's tort threshold, two other issues concerning tort liability for auto accidents in Michigan merit brief comment. First, since property damage liability claims under the tort system involve lower litigation costs and payments to attorneys and do not entail payment for noneconomic loss, the case for no-fault property damage is less compelling than that for bodily injury. Dissatisfaction with no-fault property damage in Michigan is likely to have influenced the adoption of the law's "mini-tort" provisions, (See the Michigan Insurance Bureau's April 1978 report to the Governor on consumer attitudes on no-fault. ) The possible advantages of returning to the fault system for all property damage claims are worthy of study. Second, Michigan has adopted a "pure" form of comparative negligence that in some instances allows e person who is primarily responsible for an accident to recover damages from a person who is only slightly responsible. Most states with comparative negligence employ a "modified" form in which a driver who is 50 percent or more (or, in some states, more than 50 percent) at fault cannot recover damages. Adoption of the modified form of comparative negligence would reduce the cost of liability coverage. The merits of this change (as well as other issues related to no-fault) are debated in "No-Fault: The Real Story", Michigan Trial Lawyers Association No-Fault Task Force, July 1983, and "Taking the Task Force to Task", Michigan Insurance Federation (no date).

  72. See note 61 supra. The majority opinion in DiFranco emphasized that Cassidy had made it very difficult to recover for noneconomic loss (see p. 21). The implication was that its ruling in DiFranco would increase the number of compensable claims.

  73. Four-quarter averages are used to reduce the impact of any seasonal variation in claim frequency.

  74. The basic concept of optional no-fault was introduced by Jeffrey 0'Connell and Robert Joost, Giving Motorists a Choice Between Fault and No-Fault Insurance", Virginia Law Review, 72 (February 1985).

  75. New Jersey recently modified its no-fault law to allow motorists the choice between a verbal threshold for tort liability and no limitation on liability. (Motorists must sign a form to reject the verbal threshold.) Motorists who select the verbal threshold cannot sue or be sued for noneconomic loss unless the verbal threshold is satisfied. Initial evidence indicates that 83 percent of motorists have accepted the verbal threshold in exchange for lower liability premiums. See "State Watch", Insurance Review, October 1989, p. 18.

  76. See, for example, "Reducing Auto Insurance Rates: A Comprehensive Program," Consumer Federation of America, et a1., May 1989, and Michael Johnson, "The Bottom Line: Hew Insurers Understate Their True Profitability", Voter Revolt, August 1989. Voter Revolt is a California interest group that supported the passage of Proposition 103.

  77. Hearings have begun that will determine the magnitude of the rollback, if any, the procedures to be used in prior approval regulation, and allowable rating factors in auto insurance. As a result of the passage of Proposition 103 and the Court's decision, the California market could become one of the most heavily regulated in the nation. The proposition specifically prohibits the insurance commissioner from considering the degree of competition in the market when making decisions over rates, For over 40 years prior to the enactment of Proposition 103, California regulation had reflected the philosophy that rates should be determined by competitive market forces.

  78. See note 51 supra.

  79. Similarly, a bill passed by the House of Representatives in May 1989 would eliminate the insurance industry's limited antitrust exemption under Michigan law.

  80. See, for example, Robert Klein, "Competition in Private Passenger Automobile Insurance: A Report to the Personal Lines (C) Committee-, National Association of Insurance Commissioners, September 1989; Clarke, et al., "Sources of the Crisis in Liability Insurance: An Empirical Analysis" Yale Journal on Regulation, 5 (1988), pp. 367-395; Danzon and Harrington, note 63 supra; and the references cited therein. Also see Eisenach, note 86 infra, and Danzon and Winter, note 87 infra.

  81. The Herfindahl-Hirschman Index equals the sum of the squared market shares (in percent) for all groups in a specified market. Larger values indicate greater dominance by large firms. For example, a value of 10,000 would indicate a monopoly; a value of 100 would be obtained for a market with 100 firms that each had a one percent market share.

  82. For example, for national markets and broadly defined industries, the Department of Justice classifies all industry as having low concentration if the Herfindahl-Hirschman Index is less than 1000 and moderately concentrated if the index falls between 1000 and 1800. The value of the index for the nationwide auto insurance market is 613. For further discussion of concentration in the auto insurance market, see Klein, note 80 supra.

  83. See, for example, Consumer Federation of America, et al., note 75 supra.

  84. For further details, see Danzon and Harrington, note 63 supra, and the other references listed in note 80 supra. Several authors have argued that state licensing rules and minimum capital and surplus requirements are unlikely to constitute a significant entry barrier (e.g., Klein, note 80 supra). Regulatory restrictions on the sale and underwriting of insurance by banks, which appear to be eroding, may prevent entry by entities that would employ alternative modes of distribution for some lines of business and consumer groups. However, several issues, such as the appropriate form of regulation and the possible existence of market power by some banks, may make the efficiency case for relaxing such restrictions ambiguous.

  85. For states such as Michigan with competitive rating Laws, the Insurance Services Office (ISO, the principal insurance advisory organization) makes available prospective less costs for auto insurance. For states with prior approval regulation, the ISO makes available advisory rates for auto insurance that include an expense and profit loading. Beginning in 1990, the ISO will provide prospective loss costs only for both commercial and personal lines, regardless of the type of rate regulation.

  86. See Jeffrey Eisenach, The Role of Collective Pricing in Auto Insurance, Staff Report, Bureau of Economics, U.S. Federal Trade Commission, 1985, p. 264. Recent evidence of diversity in auto insurance rates across insurers in Michigan is provided in Auto Insurance Rating in Michigan, note 20 supra, and in information on premium rates made available to assist Michigan motorists in shopping for coverage (see note 97 infra).

  87. These activities are especially important in commercial lines. For further discussion of the pro-competitive aspects of the limited antitrust exemption and the activities of insurance advisory organizations, see Patricia Danzon, "Rating Bureaus in U.S. Property-Liability Insurance Markets: Anti- or Pro-Competitive", Geneva Papers on Risk and Insurance, 8 (1983), pp. 371-402; Ralph Winter, The Liability Crisis and the Dynamics of Competitive Insurance Markets", Yale Journal on Regulation, 5 (1988), pp. 455-499; and Scott Harrington, "Fact vs. Fiction on Advisory Rates", Best's Review Property-Casualty Edition, 90 (October 1989).

  88. See, 1988 Insurer Financial Results, ISO, June 1989. The rate of return on surplus in 1988 was 11.5%.

  89. See Klein, note 80 supra, and "S&P Analyzes Auto Insurer Profitability", National Underwriter, Property & Casualty/Risk & Benefits Management Edition, March 27, 1989, p. 6. A recently released report by the U.S. General Accounting Office (GAO/GGD-90-4FS) provided a rough estimate of the average return on surplus for auto insurance of 9.2 percent during 1978-87 (as summarized in "GAO Reports on Insurer Profits", The Executive Letter, Insurance Information Institute, October 16, 1989).

  90. Klein, note 80 supra, reports an average private passenger auto insurance loss ratio of 82 percent for Michigan during 1983-88 and an average for all other states of 74 percent.

  91. In particular, unlimited personal injury protection coverage for medical and rehabilitation expenses in Michigan produces large loss reserves for catastrophic health expenses that will not be paid until many years in the future.

  92. For accidents in 1983 insurers reported $24.2 billion of incurred losses for auto liability insurance in their 1983 statements. As of year-end 1988, they had paid $23.4 billion and showed a remaining reserve for unpaid claims of $1.1 billion. See Best's Aggregates & Averages, 1989 edition. Johnson, note 76 supra, argued that more rapid growth in loss reserves than in paid claims is prima facie evidence of overreserving to hide profits. However, when expected claim costs are growing rapidly over time, loss reserves will naturally grow more quickly than paid claims. The Consumer Federation of America, et al., note 75 supra, estimated the nationwide return on surplus for auto insurance as 17 percent in 1988. The calculation of income used discounted losses, but the allocation of surplus was based on a conventional norm for surplus calculated with undiscounted loss reserves. The effect of this inconsistency is to significantly overstate the rate of return.

  93. See, for example, Johnson, note 76 supra.

  94. While critics of the industry combine loss adjustment costs with underwriting expenses when discussing the industry expense ratio, it would be more appropriate to treat some loss adjustment costs as direct benefits to policyholders. For example, much of the expense in settling liability claims involves defense costs that would be incurred by the policyholder in the absence of insurance coverage. This point is also made in "How Efficient is Your Auto Insurer?", Journal of American Insurance, 65 (1989), pp. 6-9.

  95. See "How Efficient is Your Auto Insurer", ibid, and Klein, note 80 supra.

  96. See, for example, Lawrence Berger, Paul Kleindorfer, and Howard Kunreuther, "A Dynamic Model of Price Information in Auto Insurance Markets", Journal of Risk and Insurance, 56 (March 1989), pp. 17-33. For an opposing view, see M. Plummer, The Availability and Utility of Consumer Information on Auto Insurance, U.S. Federal Trade Commission, 1985.

  97. For Michigan, see "Do Not Buy Car Insurance Until You Read This!", October 1989. Michigan Law also requires agents to provide prospective buyers with the lowest quote for available coverage.

  98. For general discussion of this issue, see Stephen Breyer, Regulation and Its Reform, Harvard University Press, 1982, pp. 161-164.

  99. Breyer, ibid, ch. 9, makes a persuasive argument that price regulation should only be adopted if there is clear evidence that competition is unworkable in a given industry. Chapter three of his book contains detailed discussion of the limitations of price regulation.