Media Attention, Insurance Regulation, and Liability Insurance Pricing

Abstract

ABSTRACT The goal of this article is to test whether the threat of regulating (or of more stringent regulation of) automobile liability insurance as portrayed in the popular and industry press induces insurers to change the way they price their policies. More to the point, using quarterly state data from 1984 to 1993, the author attempts to determine whether insurance companies reduced premium increases to avoid regulation, a test the article will call the Regulatory Threat Hypothesis. The results suggest that automobile liability insurance premiums increased at a slower pace (or decrease) in the presence of a regulatory threat. INTRODUCTION AND MOTIVATION It is well known that firms react to outside pressure. Many companies have public relations departments to deal with pressure groups and other outside forces that may affect profits. Insurance companies faced such outside pressure in the mid- to late-1980s during the so-called insurance liability crisis. This crisis affected all types of liability insurance, including personal automobile liability insurance. [1] The 1980s was also a period of great political pressure on state regulators. Consumer groups throughout the United States petitioned state regulators to mandate insurance firms to reduce premiums, or at least the rate of increase. One consumer group collected so many signatures that California held a referendum in November 1988 on automobile insurance premiums regulation. The referendum was known as Proposition 103. [2] The referendum basically asked whether insurance companies should be mandated to reduce automobile liability premiums and whether any premium increase should be approved by an elected insurance commissioner. [3] The popular vote was almost evenly divided, but ultimately Proposition 103 passed with 51 percent of the vote. A main driver of the vote was the behavior of city dwellers (especially in Orange County) who saw an opportunity to extract money from suburban residents. Higher premiums are paid in cities, and city dwellers voted in favor of Proposition 103 since it asked for rates to be based on experience rather than geographic location. This behavior would follow the argument initiated by Peltzman (1976), who argued that different groups use their political clout to influence regulation. The vote rocked the stock market, as the value of insurance companies publicly traded plummeted. Fields et al. (1990) found that insurance companies doing business in California had an average cumulative abnormal return of -6.9 percent, which means that insurers' stock prices under-performed the market by 6.9 percent. In addition, the more business a company had in California, the greater the negative cumulative abnormal return. What is even more surprising is that a firm's proportion of business in states neighboring California also had a negative effect on the cumulative abnormal return. Moreover, the stock price of some firms with no operation in California also fell. [4] One possible explanation for this phenomenon is that investors in firms operating in states neighboring California were afraid that insurance rates were going to be controlled there as well. In fact, this concern may have been well founded; according to a survey, 90 percent of Americans would be in favor of passing a law similar to California's Proposition 103. [5] If investors perceived threats of regulation in states other than California, then one has to wonder whether the insurance companies themselves perceived such regulatory threats. If the insurance industry acknowledges the possibility of regulation, then it seems natural to conclude that it will do something to reduce the probability of such regulation. The question is, What should the industry do? The insurance industry can react to the threat of regulation in at least two ways. The first is to influence the regulator so that it becomes more conciliatory toward insurers. …