PERSPECTIVES ON INSURANCE REFORM : An Unfree Market Keeps Rates High : Californians have paid more and insurers have made higher profits than they would have without Proposition 103.

No matter who is elected California insurance commissioner, it is time to recognize that the administration of Proposition 103, passed by the voters in 1988 to control costs, has instead forced consumers to pay more for auto insurance that they would have under the less-regulated, free-market system that existed before 103.

Estimates of how much more California drivers have paid for auto insurance because 103 is law range from $3 billion to $6 billion. I know those numbers don’t square with the proclamations of Insurance Commissioner John Garamendi and consumer activist Harvey Rosenfield, whose personal and political interests demand that they demonstrate benefits for their constituents. Their self-justification drives them to make the flawed assertion that 103 has saved Californians $4.5 billion because auto insurance rates in California rose 9 percentage points less than the national average since it became law. Their numbers ignore the effect of claims suddenly plummeting with the onset of California’s recession. (Hard times mean lower costs because of less driving and fewer accidents.)

Auto insurance rates are the sum of expected claims and costs of doing business, less expected investment income on underwriting cash flow, plus planned profit. In a competitive state, rates follow costs down almost immediately. This didn’t happen in California, because 103 forced insurance decision-makers, faced with suffocating regulation and profit controls, to ignore their competitive instincts.

In 1989, some large companies, including mine, pulled back from the California market. Almost no companies reduced rates when their California profit jumped, as they always had before, and do in other states. Why? Because they knew that increases they would need when inflation or claims increased would require approval by a politician who depends on being elected.

The cost of 103 to Californians is evident in how much more profit companies have made on auto insurance in this state during the past five years than they would have without the law. Before 103, auto insurers’ profit margins in California were consistently 2 percentage points below the national average because the state’s “open rating” law made it the most competitive U.S. auto insurance market. Since 103, California auto insurance profit margins have ballooned to 3.6 percentage points above the national average because regulation has replaced competition. That’s where the $3 billion to $6 billion overpayment estimates come from.

Savvy consumers who know what they need and can readily buy from many companies can manage the trade-offs in price, quality and innovations; bureaucrats, let alone politicians, can’t. Would a California “computer” commissioner have driven down prices in that highly competitive industry any faster than Compaq, Dell, AST and others did themselves? The beauty of the competitive free-enterprise system is that it forces companies to deliver a better combination of price, quality and innovation, because doing so rewards them with profit and growth.

There are many ways to meet California consumers’ demands for lower auto insurance rates, the most powerful being to re-establish the competitive market. Another would be to eliminate all requirements for people to buy liability insurance, relying on uninsured motorists coverage to protect against injury by those who chose not to buy.

A further method would be to eliminate abuse of the legal system. Sure, there are many legitimate, large or complex claims needing lawyers, but there is huge waste in those questionable and inflated claims contested by personal-injury lawyers, who have made a business exploiting the fact that insurance companies too often responded to insured and claimants slowly and discourteously.

Unfortunately, it is a time-consuming hassle for consumers to shop carefully enough to take advantage of the large price differences that result from the intense competition in auto insurance. The insurance commissioner could help consumers save money by complying with Proposition 103’s requirement that his office provide an easy way to shop the market. Typical of 103, however, is its ludicrous mandate that the commissioner develop a shopping system that cannot be built economically.

My company tested a more realistic consumer comparison shopping program in California in 1992. Data showed large price disparities among the companies we compared, enabling huge savings for people using our service.

The sad fact is that we will not offer free comparison shopping in California. The costs and risks of doing business here require the opportunity (not the certainty) to earn much higher returns on capital then those allowed by the state. I have no doubt our competitors have their own new programs that Californians will not enjoy, unless and until the insurance commissioner learns the dominant economic lesson of this century--private enterprise and free markets are better at business than government is.