Does Regulation Increase or Decrease Prices?

This is a question that has puzzled me for some time. A large amount of research examined effect of regulation on insurance prices.  Some research finds regulation has little effect on prices and some finds it does influence prices. In a recent paper, Rich Phillips and I look at this problem from a different direction.  We hypothesized that there was more to the story than the type of regulation the state imposed on automobile rates.  In particular, we believed that the regulator’s educational and employment background as well as the regulator’s post-regulatory employment would provide more evidence on how regulators influence prices than merely the type of rating law the state had enacted.

 

We obtained biographical data on regulators in each state from 1985 to 2002 from a number of sources.  We focused on their educational attainment, their experience prior to becoming the regulator (whether in business, in the state’s administrative bureaucracy or in elected office), and whether the regulator was appointed or elected.  We also looked at the position the regulator took after serving as regulator.  These included going to the private sector, seeking higher office, or taking another state administrative position.  We also control for a number of state specific factors such as the size of the state’s residual market, the percent of the auto liability market in no-fault, the percentage of direct writers, and whether the state had prior approval regulation (the ability to set prices).

 

In sum, we attempt to determine the effect of the regulator’s background and future employment opportunities in those states where the regulator has significant power to set prices. We find evidence that consumers in these prior approval states paid significantly higher “unit prices” as measured by the ratio of premiums earned to losses incurred for auto insurance than consumers in states which allow competitive market forces to determine prices.  Furthermore, we find evidence that regulators who seek higher elective office following their tenure as insurance commissioner or those who take private industry jobs allow the highest overall “unit prices” relative to competitive market states.  Finally, the “unit price” of insurance in regulated states is no different from the competitive market outcome for regulators who make lateral moves back into state government.  These results lead to an interesting implication:  If states wanted to remove the effect of this regulatory opportunism and lower prices they should allow the market to determine auto insurance prices.

 

Compare our implications with the comments of Florida Insurance Commissioner Kevin McCarty  (who has prior approval authority over rates) when discussing a Florida Hurricane Insurance Task Force possible recommendation regarding deregulation of homeowners' insurance prices:

Price deregulation "is a red herring," said Insurance Commissioner Kevin McCarty, the task force's chairman. "I don't think that the regulatory framework plays a big role in the capacity of the market." (Sun Sentinel 11/20/05).

 

Commissioner McCarty probably thinks (and I am making this up as I have no direct knowledge of what he actually thinks) that insurers operate in Florida just for the fun of it.  If that was the case, then prices would not matter.  While we look at automobile prices which tend to be pretty political in most other states (like homeowners is in Florida) we find that the unit price is lower in the relatively unregulated state.   Why is there such resistance to letting the market work?