The Great Carjacking

When New Jersey Governor Christine Todd Whitman finally signed a long-promised auto insurance reform bill last May 19, she hoped that it would put to rest an issue that had almost cost her re-election just six months earlier. Whitman's opponent had made much of the fact that while auto insurance premiums nationwide have been rising at double the general inflation rate during the 1990s, New Jersey's rates are more than 40 percent higher than the national average. The new law mandates a 15 percent rate cut paid for by a crackdown on insurance fraud and limitations on the judgments that drivers can win in liability suits. Insurance companies predict the savings will be more like 3 percent, and they threaten to sue the state.

New Jersey's recent experience -- and Whitman's narrow escape from election defeat in 1997 -- demonstrated not only the political potency of the auto insurance issue but also why interest group politics make the issue so difficult to deal with effectively. The $5 billion that New Jersey residents spend annually on premiums is shared by lawyers, doctors, auto repair businesses, con men, insurance brokers and agents, and victims of accidents, both real and concocted. Each group wants changes -- but only to their benefit. So while everyone attacks the system, few politicians ever propose remedies that disturb any of these core interests.

The bill that finally emerged out of the New Jersey legislature this year was a hybrid of the proposals that Whitman and her Democratic opponent, state Senator Jim McGreevey, proposed in last year's election. Each candidate had offered voters a plan that attacked one part of the problem, but neither really took aim at the heart of the matter. The recently signed bill didn't either.

Does it have to be this way? If the auto insurance issue has such political traction, shouldn't systematic and progressive reform be possible? Ironically, New Jersey itself not long ago went a fair way toward proving that the insurance companies themselves might not even be necessary.


A SINGLE-PAYER SYSTEM?

In the early 1980s, New Jersey wrestled with the problem of high-risk drivers who could get insurance only at prohibitively high rates. Various assigned-risk programs had been tried, but none had any lasting success. Finally the state created a public entity called the Joint Underwriting Association (JUA), which provided coverage for high-risk drivers. When JUA drivers got into accidents, the insurance companies handled the details of claims and settlements and sent the bill to the JUA, which paid for the settlement along with a fee for the company.

But as the accident backlog built up, the JUA began to compile a "deficit" because it operated without the reserve fund required of private insurance companies. The insurance companies reckoned that the deficit would eventually have to be paid through an assessment on them -- with each company charged in proportion to its share of the New Jersey market. So the insurers began cutting their share of the market by assigning more and more drivers to the JUA, increasing its market share and its deficit.

What was happening was not unlike what health insurance policy analysts call a "death spiral." All the bad medical risks get dumped into the publicly subsidized or mandated pool while the good risks are "creamed" off by private insurers. In health care pools this process has a mutually reinforcing effect. As the premiums for higher-risk people go up, the only people willing to pay those exorbitant rates are the chronically ill who are in need of frequent and intensive medical treatment. Something similar was happening in New Jersey's auto insurance system -- but with a twist. By the early 1990s, as private insurance companies continued to shed policyholders, the JUA ended up insuring almost two-thirds of New Jersey's motorists. Thus, while the JUA started with the worst drivers and highest rates, the situation "improved" as the insurance companies dumped more and more motorists into the JUA. Eventually, the average level of risk dropped and rates went down. In fact, as the JUA streamlined its own practices, its rates became comparable to the private companies' and appeared to be headed even lower.



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The JUA had become the lowest-cost company in the business, in part because it had much less overhead and fewer middlemen. But there was that supposed deficit of $3 billion -- something that worried the insurance companies, the state government, the press, and the public. In 1990, Governor Jim Florio came to the rescue by shutting down the JUA and financing the deficit with surcharges on insurance companies and motorists.

But in an important sense, the so-called "deficit" was a statistical illusion. At any given moment, the deficit represented an estimate of outstanding unresolved accident claims. But did the JUA, as a state-owned insurance company, really need cash reserves? It couldn't leave the state, and it could not go bankrupt (unless the state did). It could, however, run a pay-as-you-go operation in which current income covered current outgo. Premiums could be adjusted to pay each year's actual costs. As long as its revenue kept pace with its costs, it could continue in this fashion on a permanent basis.

Who knows? If the JUA had remained in business, its costs might have continued to decline and it might have taken over the entire market. In fact, if the JUA had swallowed the entire market, even the deficit would have stabilized. New Jersey, unwittingly, was on its way to a single-payer auto insurance system, created by the actions of dozens of frightened private insurance companies.


MARKET FAILURE

The JUA case reminds us that auto insurance is anything but a perfect market. There are three basic clusters of potential profit makers in the system, none disciplined by the ordinary forces of market competition. First there are the auto insurance companies. Next come the auto repair shops, physicians, and miscellaneous other medical providers that take care of people injured in automobile accidents. In between these two groups is a special class of intermediaries -- the lawyers. The legal profession has prescribed standards that differ from those of the marketplace -- but lawyers still charge as much as they can.

In ordinary markets, competition keeps any of these three "cost centers" from billing us excessively. But auto insurance is simply not a free market. First of all, the coverage itself is mandatory. That takes away the most fundamental of choices -- the choice of whether or not to buy at all. It is almost impossible to shop around for the best deal or even understand the terms of a policy. Price comparisons are difficult to make because policies are not exactly alike, and in most states regulation itself prohibits price competition. What little competition there is in the industry is aimed at creaming the client pool for perfect clients -- good risks who buy lots of coverage and never file a claim. Others who are bad risks simply cannot buy insurance at any price, unless the government steps in.

Nor do the other participants in the system compete in the way we would expect in a simple free market model. Picking doctors, lawyers, and fender repairmen is a game of blindman's buff. They seldom take out newspaper advertisements to broadcast their prices, and they do not publicize their qualifications or the results they achieve. And each tend to trot out their best -- or at least their most expensive -- wares when insurance is paying.

This combination is a perfect prescription for an "inefficient market" -- where one of the worst mistakes is to assume that more of the same combination will provide a better result. A certain amount of intervention is simply a necessity. Under a 1946 federal law enacted at the instigation of the insurance industry, states have exclusive jurisdiction over the regulation of insurance. Therefore what we should demand from the state legislators is pretty simple: a pool of money to transfer to people who have been involved in automobile accidents for medical treatment, property damage, and lost income. The people who are essential to the system are the accident victims, those who put up the money, and those who handle the collections and payments. Doctors, hospitals, and automobile repairmen also play a vital role. But the insurance companies and lawyers may be necessary only to a very limited degree.

In most states, lawyers' fees consume a large portion of the money that would otherwise go to motorists who have suffered physical or financial harm. The question is whe ther those costs are necessary to guarantee equitable reimbursements. If not, premiums could be reduced or benefits increased. This is precisely what many states had in mind when they adopted no-fault insurance legislation in the 1970s. The investigations, trials, and other legal expenses of establishing negligence in accidents ate up close to half of insurance premiums. True no-fault systems would have eliminated nearly all of this expense.

But in most states the influence of trial lawyers assured that, despite nominal no-fault, suits for pain and suffering in the case of many injuries would still be allowed. New Jersey, for instance, adopted a no-fault law in 1972 that was admirable in its grant of quick and generous no-fault payments to the injured. But the trial lawyers managed to sneak a poison pill into the legislation. Pain-and-suffering suits were allowed whenever the medical bills exceeded $200. A person who suffered a two-hour headache could qualify under that rule. Michigan, a state in many ways quite similar to New Jersey, actually did adopt a much stronger no-fault system and its average total premiums today are about 30 percent lower than New Jersey's. True no-fault in New Jersey would save at least the $850 million a year in legal fees that are currently paid out of premiums.


A PROGRESSIVE SOLUTION

Antigovernment rhetoric notwithstanding, voters clearly want the government to watch out for their interests when it comes to auto insurance. The continuing tension among the three key pieces of the system ensure that piecemeal reform is bound to be ineffective: control one more tightly and you'll create new cost pressures from another. Any effective program of reform must target costs. Proposals that simply cut premiums or place arbitrary limits upon them merely shift costs from one group to another, eliminating neither waste nor expense. And, they can have grave social consequences in addition to their economic inefficiencies. High premiums, such as those in New Jersey, are unaffordable for many low-paid workers, forcing them to drop out of the economy or drive illegally.

The goal of a fairer, more efficient auto insurance system should be to minimize the leakage of money to those who have not suffered injury or damage in traffic accidents -- leakages like lawyers' fees, padded hospital and doctors' bills, marketing costs for a compulsory service, fraud that consumes 10 to 20 percent of premiums, and motorists who drive without insurance.

There are two basic alternatives to the present inefficient system -- a single-payer system or a true competitive market, both of which would require states to play a more forceful role. A single-payer system could be run by a state agency, despite the inevitable chorus of concern about government ineptitude and the loss of market efficiencies. After all, there has been little evidence of those efficiencies or entrepreneurial energies in the automobile insurance business. In fact, insurance businesses closely resemble government bureaucracies. And governments do operate various insurance businesses quite effectively. Consider the Social Security system, Medicare, and state pension systems.

A single-payer system also could be operated by private enterprise. But privatizing government functions makes sense only when real competition is involved, and the gravest defect of the present system is that it lacks genuine competition. The state could overcome this defect by using group insurance and competitive bidding. It could collect money through motor vehicle fees and surcharges on gasoline taxes to buy group policies from private companies under competitive bidding. Groups might be based on geographical regions, driver classification, or other reasonable criteria. Or all the state's drivers could be treated as one group.

Collecting a surcharge on gasoline taxes -- so-called pay-at-the-pump plans -- is probably the only way to deal effectively with the problem of uninsured drivers. The money could be used to buy a group liability and personal injury policy from a private company that wins the business in competitive bidding. Motorists could then buy additional coverage directly from insurance companies. Another reform that would help the entire system would be to create a schedule of standardized policies that would allow motorists to get meaningful price quotations.

Fraud is rampant in the auto insurance system now, and combating it is a major problem. Too much of the job is left to insurance companies that lack both the power and the will to stamp out fraud. It must be done by the states, but it should not be left to the offices of their attorneys general, where the prospect of chasing down inflated repair bills does not stir the prosecutorial juices. Insurance departments should be given the job and the authority, using some percentage of the money they recapture to finance their work. That should provide ample incentives to clamp down on the most egregious of the frauds. Reforms like these could reduce the waste and expense of automobile insurance substantially without reducing protections for motorists. In attempting real reforms, the states would be fulfilling their role in the federal system -- to be experimental and innovative.

It's true that sweeping reforms face heavy odds. And the most recent reforms in New Jersey don't give cause for optimism. But given the state of affairs that now exists, it is most important for those who want a fair, efficient system to keep the pressure on -- constantly and intensively. Auto insurance problems will not be solved without concerted action; leave the system alone and it will just get worse.



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