by Steve Adams

Understanding the auto insurance regulatory system in North Carolina

requires patience and persistence. This eight part article first explains the

system that has evolved, particularly during the 12-year tenure of John R.

Ingram (1973-85). It then examines assumptions underlying the regulatory

process, including: how demographic considerations affect statistical and

social equity in setting rates, why "reinsured" drivers are treated differently

than drivers in the "voluntary" market, and how investment income affects

consumer auto premiums. Finally, recommendations are offered to the

legislature and Commissioner James E. Long, including: considering all

investment income in the ratemaking process, allowing group auto insurance

policies, consider eliminating the dual system of rates for drivers in the

reinsured and voluntary markets, and reducing the excessive surcharges for

drivers with bad driving records.

28 North Carolina Insight

Policy,

Politics, and

Philosophy:

The Context for

Auto Insurance

A farmer in eastern North

Carolina buys a new 1984

Ford Escort. His driving

record is unblemished.

When he goes to his insur-

ance agent to buy liability insurance, as state law

says he must, he is told the annual premium will

be $78.

On the same day, a 17-year-old in Charlotte

applies for liability insurance on his new red

Corvette. In a year and a half of driving, he has

held on to his license despite convictions for

speeding over 75 mph (twice), for a fender-

bender resulting in damages of $750, and for

passing illegally. He uses his car for work. The

insurance agent tells the teenager his annual

bill-for liability insurance alone-will probably

be $1,727. This will buy no more coverage than

the farmer gets for $78.1

The farmer and the teenager represent the

range of rates North Carolinians pay for basic

auto liability insurance, which covers damages to

others in accidents in which you are at fault. Is it

fair for one consumer to pay 20 times more than

another for the same coverage? The question is

complicated by two basic facts. The state regulates

insurance rates, making them a matter of public

policy, not just a matter of the marketplace.

Second, liability insurance is a legal and practical

necessity.

North Carolina law requires anyone who

registers a car with the Division of Motor

Vehicles to have liability insurance.2 The insur-

ance is on the vehicle, rather than the driver. For

sake of simplicity, however, insuring the car and

insuring the driver are used interchangeably in

these articles.

The law also requires companies and agents

that sell auto insurance in North Carolina to

accept all applications for liability coverage.3 If a

company determines that a person is not a good

risk-as it probably would in the case of the

teenager-it can transfer or "cede" the policy to

the N.C. Reinsurance Facility. The facility is a

pool through which insurers share the losses of

drivers they consider poor risks. Drivers whose

policies are ceded to the facility are called

"reinsured" drivers.

As new car owners, the teenager and the

farmer would also need comprehensive and

collision coverage. Although these are not legally

required, lending institutions require them as a

condition of issuing car loans. Collision covers

damage to your car in accidents, regardless of

fault. Comprehensive covers theft and other

damages (fire, vandalism, etc.) caused by some-

thing other than a crash.

To keep this discussion in manageable

bounds, the following articles focus on liability

insurance. Despite some significant differences,

rates for collision and comprehensive are set in

basically the same way as liability rates. In

approaching this topic, it is important to keep

several distinctions in mind.

Setting Overall Rate Levels vs. Allocating

Insurance Costs Among Drivers. Setting overall

rate levels involves determining the insurance

industry's revenue requirements. In contrast,

allocating costs among drivers involves deter-

mining who pays-setting the odds, if you will-

for individual'drivers through a driver classifi-

cation system. An oversimplified example shows

the difference: Suppose the revenue requirements

were $200, and there were only two drivers. The

Steve Adams, a Raleigh -based writer, has covered

insurance issues for seven years , as a reporter and editorial

writer . Photos and artwork by Carol Majors.

February 1985 29

$200 could be obtained either by charging both

drivers $100 or by charging one $150 and the

other $50. Thus, determining the overall rate

level ($200) and setting up a system for classifying

drivers ($150 vs. $50) are separate issues.

Statistical Equity vs. Social Equity. One

method of classifying drivers-the one the insur-

ance industry appears to prefer-is similar to

oddsmaking. This approach requires finding the

most accurate way available for predicting which

classes of drivers are likely to have accidents and

charging them accordingly.

The result of such oddsmaking might be

statistically equitable but socially inequitable.

Many drivers, especially the poor, might be

priced out of the market, perhaps on the basis of

factors beyond their control. Driving is an

economic necessity; liability insurance is legally

required; and ratemaking is a matter of public

policy. These are compelling social reasons to

keep rates reasonable for all drivers. This might

sacrifice statistical precision for the sake of social

equity.

Demographic Characteristics vs. Driving

Behavior . Historically, the insurance industry

has classified groups of drivers according to such

criteria as age, sex, marital status, place of

residence, and car use. Such demographic charac-

teristics, for practical purposes, are beyond a

person's control. Insurance companies sometimes

have also classified drivers by occupation and

various personal characteristics, although this is

not permitted in North Carolina.4 Drivers in

some categories appear to be more likely to cause

accidents than others. Insurance underwriting is

a prospective enterprise, attempting to estimate

future losses according to classes of drivers. But

demographic classifications inevitably penalize

many safe drivers.

The alternative to demographic criteria is

basing classifications on behavior. People with

poor driving records may be expected to cause

more than their share of accidents. People who

drive many miles are more likely to have accidents

than those who only putter around town. North

Carolina's present system relies both on demo-

graphic criteria and on driving record, leaning

more heavily on the latter. Mileage is considered

only indirectly, except for the "car use" category

that distinguishes between commuting more or

less than 10 miles.

Ratemaking vs. Punishment . Should insurance

ratemaking entail moral judgments? Should, for

example, drivers convicted of drunk driving pay

more than their fair share of the cost of the

insurance system because they have done wrong?

As a matter of public policy, there are compelling

considerations against punitive rates. The strong-

est is that punishment for breaking the law is the

proper province of the criminal courts and not a

matter for profit by private businesses.

These four distinctions have become more

evident in the last 12 years, as the state's insurance

laws and regulatory system have been repeatedly

revised. Throughout his tenure, former Insurance

Commissioner John R. Ingram (1973-85) cam-

paigned as a consumer advocate, doing battle

with the insurance industry in the hearing rooms,

in the legislature, and in the courts. The insurance

industry, meanwhile, maintained one of the

largest and most experienced core of lobbyists in

the General Assembly and spared no expense to

win administrative and judicial battles.

Like boxers, Ingram and the industry would

retire to their corners after each round, then

return to center ring, sparring again and again.

The result was a series of piecemeal changes,

observes William Hale, for many years an attor-

ney in the legislature's General Research Division

and now a deputy commissioner in the Insurance

Department. (The "landmark dates" sidebar

summarizes these changes.) The state has still not

decided on a consistent approach to auto insur-

ance regulation.

Ingram advocated rates based primarily on

driving record rather than on demographic fac-

tors. In 1975, for example, at Ingram's urging,

North Carolina took the national lead in banning

age and sex as factors in determining insurance

rates.5 Before this law took effect in 1977, men

under 25 (particularly single men) paid substan-

tially higher premiums. Under the new law, the

age and sex test has been replaced with an

automatic 100 percent increase in rates for

drivers with less than two years' driving experi-

ence.

The insurance industry, in contrast, tended

to advocate setting rates much in the manner that

oddsmakers set point spreads, preferring demo-

graphic driver classifications, particularly age

and sex. John Hall, chairman of the insurance

department at Georgia State University, explained

this process to a North Carolina legislative study

committee in 1982: "[T]here are significant,

statistical, predictive differences between indi-

viduals .... The most satisfactory surrogate

unit so far discovered for measuring these differ-

ences involves age and gender. Young drivers do

have significantly greater average loss costs than

those of us who are older. Young females have

significantly better records, on average, than

younger males."6

While the insurance industry lost the battle

on rate discrimination based on age and sex, it

won major concessions on overall rate levels.

Most notable were the right to put rate increases

30 North Carolina Insight

Landmark Dates in Automobile Insurance Regulation

by William K. Hale and Jody George

Insurance

Commissioner

in Office Date

Daniel C. Boney

(1927-42)

William P. Hodges

(1942-49)

Waldo C. Cheek

(1949-53)

Charles F. Gold

(1953-62)

Edwin S. Lanier

(1962-73)

John R. Ingram

(1973-85)

James E. Long

(1985- )

Action Taken

1931 First auto financial responsibility law enacted.

1947 Financial responsibility laws rewritten.

1953 Financial responsibility laws rewritten;

Assigned risk plan established;

1957 Compulsory automobile liability insurance law enacted. NCGS 20-309;

Safe driver reward plan established;

Uninsured motorist coverage established. NCGS 20-279.21(b)(3).

1973 N.C. Motor Vehicle Reinsurance Facility replaces assigned risk plan; higher

rates not allowed for drivers in Facility. NCGS 58-248.27ff.

1975 Rates may no longer be based on age or sex of insured. NCGS 58-30.3;

Driver Classification plan simplied. NCGS 58-30.4;

Current Safe Driver Insurance Plan passed. NCGS 58-30.4.

1977 "File and use" replaces "prior approval" system of regulation.

NCGS 58-124.20;

Deviations from mandatory rates permitted. NCGS 58-124.23;

Drivers in Reinsurance Facility allowed higher rates than drivers in the

voluntary market; facility rates require no waiting period, as do voluntary

market rate filings.

Reinsurance Facility required to break even and may recover losses by

recoupments. NCGS 58-248.34;

Six percent annual limit on rate increases (voluntary market and Reinsurance

Facility) put into effect. NCGS 58-124.26.

1979 "Clean risks" ceded to Reinsurance Facility do not have to pay higher facility

rates. NCGS 58-248.33(1);

Reinsurance Facility begins to implement recoupment surcharges;

Underinsured motorist coverage authorized by law. NCGS 20-279.21 (b)(4)

1981 Recoupment surcharges barred for drivers with no SDIP points in or out of the

Reinsurance Facility. NCGS 58-248.34(f);

Supreme Court rules that recoupment surcharges are not subject to review and

approval of commissioner because they are not rates. State ex rel. Hunt v.

North Carolina Reinsurance Facility, 302 NC 274;

Six percent annual limit on rate increases taken off facility rates, so there is no

maximum to these rates;

Maximum annual rate increase for voluntary market tied to consumer price

index (CPI).

1983 "Clean risks" allowed one speeding violation (10 mph or less over limit and not

in school zone) without being assigned points under Safe Driver Insurance

Plan. NCGS 58-30.5;

Annual limit on voluntary market rate increases (tied to CPI) expires by

operation of law, so there is no maximum to these rates.

February 1985 31

Table 1. Top 10 Auto Liability Insurance

Writers in North Carolina, 1983 (for private

passenger autos, in millions of dollars)

Nationwide Mutual Insurance Co.

$71.3

State Farm Mutual Auto. Insur. Co.

63.4

Allstate Insurance Co.

47.9

N.C. Farm Bureau Mutual Insur. Co.

30.7

Aetna Casualty and Surety

21.5

Integon General Insur. Co.

14.4

U.S. Fidelity & Guaranty Co.

11.4

Travelers Indemnity Co.

10.9

Lumbermens Mutual Casualty Co.

10.8

South Carolina Insurance Co.

10.6

Total for Top 10

$292.9

Total for All Companies $486.8

Source: N.C. Rate Bureau

into effect under a "file-and-use" system and a

complicated system of surcharges to offset losses

of the N.C. Reinsurance Facility.

Despite the 12-year controversy and make-

shift adaptations of the law, both consumers and

the insurance industry have fared reasonably

well. On average, North Carolinians pay among

the lowest auto insurance rates in the nation. In

recent years, the auto insurance industry has

achieved profits in North Carolina at approxi-

mately the national average.? (For a list of the

top ten auto insurance companies in North

Carolina, see Table 1 above.)

In 1983, the average cost of insurance per

car, for all types of coverage, was $237 in North

Carolina, nearly a third less than the national

average of $323. The state ranked 46th in cost of

insurance among the 50 states and the District of

Columbia. Only such rural states as Tennessee

and Alabama had lower average rates. The

highest rates were in New Jersey, New York, and

Massachusetts, all heavily urban (see next page).

North Carolina's low rates, however, are

not so much a triumph of consumer-oriented

regulation as a reflection of the state's social

climate and mostly rural character. "The basic

characteristics of the legal, social, economic, and

religious climate of the state generate lower

losses," Georgia State's Hall explains. "Even at

an adequate level, insurance rates in North

Carolina should be lower than in almost any

other jurisdiction in the United States."

Even though the state ranks 10th nationally

in population, it has no city of more than

400,000. Accidents are more frequent in heavy

city traffic than in less densely populated areas.

32 North Carolina Insight

Medical services and auto repairs also tend to be

more expensive in urban areas, and large awards

to plaintiffs by juries in some states have driven

up insurance rates.

The protracted battle between the insurance

industry and the insurance commissioner may

have come to an end with the election of James E.

Long as Ingram's successor. "I will have a more

open-minded style," Long says. "I'll be willing to

hear the facts before making decisions. The

weaknesses in our system have been the confron-

tation between the department and the companies

and/or the [N.C.] Rate Bureau [which files

statewide rates on the companies' behalf], the

confrontation between the department and the

General Assembly, and the confrontation between

the department and the agents. Those have

combined to bring the whole system into one of

confrontation rather than cooperation."

Long has not set an agenda for reform,

although he does propose recodification by 1987

of the laws governing auto, homeowners, and

workers' compensation insurance. His priorities

as commissioner, he says, will be twofold: "to

keep rates as low as possible and to maintain

[rates] at an adequate level to maintain [company]

solvency."

The issues before Long and the legislature,

however, run deeper than balancing low overall

rates against company solvency. This eight-part

article explains why four areas, in particular,

need attention. The sections that follow set forth

the original research that leads to the assertions

in this introduction.

1. Demographics . Classifying drivers on the

basis of factors beyond their control remains an

issue. The industry would like to set rates on the

basis of age and sex, and some industry lobbyists

are advocating deregulation in general. Since no

violations or accidents are charged against 80

percent of the state's vehicles, driving record

alone appears limited as the primary tool for

setting varying rates. Moreover, the system of

assessments for poor driving records is badly

flawed because drivers are not required to report

traffic violations to their insurers. Better report-

ing of accidents to insurers would improve the

usefulness of driving records to predict which

drivers will cause losses. A simple solution

remains elusive, however. The best that can be

done in this article is to explain the problems.

2. Equity. The current system of classifying

drivers results in excessively high rates for drivers

with poor records. Drivers like the teenager

with the Corvette pay punitively high rates,

according to the latest available data. In addition,

there are so few drivers with bad driving records

that their high rates do not significantly reduce

the cost of insurance for "good" drivers. Thus the

driver classification system is neither statistically

nor socially equitable and needs to be revised.

3. Overall Rate of Return . If the current

formula for setting overall rates worked as it is

designed to, it would produce unreasonably high

profits for insurance companies. The formula

ignores most income earned on investments,

despite the fact that this is a major revenue

source for insurance companies. The high profits

have not materialized only because companies

generally have not earned the five percent under-

writing profit contemplated by the formula. The

formula should be changed to reflect all invest-

ment income.

4. The Reinsurance Facility. Current law

governing the N.C. Reinsurance Facility needs

revising. Drivers who have had accidents or

traffic violations pay higher rates (currently, 40

to 44 percent higher) if they are ceded to the

facility. But there are no criteria whatever for

assigning drivers to the facility; thus, insurance

companies have the option of boosting some

drivers'rates for any reason they please. Average

rates charged to reinsured drivers with poor driving

records appear excessive. In addition, the rate-

making formula needs to be examined, specifi-

cally in relation to total investment income.

The following sections are intended as a

guide through the maze of automobile insurance

regulation in North Carolina. They describe how

the system works, provide some statistical analy-

sis, and conclude with proposed solutions.

Premiums by State - North Carolina Near the Bottom

In 1981, North Carolinians paid an average of $211 for automobile insurance -48th among the 50 states and the District of

Columbia. Two years later, the average was $237, and the ranking was 46th (see list below). From 1981 to 1983, the average North

Carolina auto premium jumped 22 percent, 5 percent higher than the national average.

Best's Insurance Management Reports calculated these average premiums by taking the total direct premiums written and

dividing by the number of auto registrations for each state. Premium data came from Best's Executive Data Services. Auto

registration statistics are estimated totals from the Federal Highway Administration and are slightly inflated due to the inclusion

of taxicabs.

Average Automobile Premiums

1983 1983

1983

Average

% Increase

1983 Average

% Increase

Ranking

State

Premium

1981-1983

Ranking

State

Premium 1981-1983

I New Jersey

$516.89

25.5

26 New Hampshire 292.45

24.9

2 New York 429.20 22.1

Arkansas

287.98

31.5

Massachusetts

424.73

25.4 28 Missouri

287.73

11.4

Alaska 399.80

19.0 29

Virginia 282.61

23.6

5 Pennsylvania 390.93 22.6

30 Kansas 282.38 12.0

Nevada

387.37

1.9 31 Florida

281.22 20.2

District of Columbia

384.67 50.5

32 Oklahoma

281.19

19.6

8 Louisiana 377.57 8.5

Vermont 268.00

8.6

California 368.17 9.6

Utah

267.53 9.3

10 Maryland

364.21

23.2 35 Wyoming

263.07 2.1

11 West Virginia 355.89 37.8

36 Nebraska 256.31 5.3

12 Hawaii 355.38 22.3 37

Indiana 255.94 12.0

13 Arizona

348.38

19.7 38 Maine

251.43 8.4

Texas

340.55

40.0 39 Montana

250.64 -1.4

15 Connecticut 339.34

14.5

North Dakota

248.61 4.9

16 Rhode Island 332.45 22.6

41 Idaho 246.28

6.1

South Carolina

330.11 19.1

42 Wisconsin 242.74 7.2

18 Michigan 326.81 8.7

43 New Mexico 241.63 -2.0

19 Delaware 322.31

14.7

Ohio

241.15

7.5

20 Colorado 315.01 24.1

45 Kentucky

238.90

5.8

21 Illinois 309.27

17.8

NORTH CAROLINA

236.91

22.2

22 Oregon 302.09 11.7

47 Iowa

234.45

4.6

23 Washington 301.05 13.9

Mississippi

231.56

9.6

Minnesota 298.25 6.9

49 Tennessee

216.48 17.7

25 Georgia 295.00 19.4 50 South Dakota

211.10

7.0

Alabama

205.86

10.0

National Average $322.63

17.4

Source: Best's Insurance Management Reports, On-Line Reports, No. 26, December 3, 1984.

For more information, call On-Lines Report Editor Virginia Vogt, 201-439-2200.

February 1985 33