markets means that sellers are able to do so without any financial barriers. Much of the research done on this issue regarding the insurance industry assumes that this means insurers have transaction costs related to licensing requirements, solvency standards and the distribution system. Yet it is equally important that free entry incorporates the idea that a new entrant is not at a cost disadvantage compared to an existing firm when entering a market.10 For insurance, this also means that new entries do not have a difference in the cost and availability of loss cost data. Bureau rates were once the answer to solving this problem. Insurance rate organizations can help to promote competition by allowing smaller or new insurers to have access to information that lowers their cost of ratemaking. As bureau rates have been reduced in importance in most states, insurers have developed the ability to develop their own loss cost data for personal lines. This may also partially explain the price variation that tends to occur in personal lines insurance. However, in many instances smaller companies will either use the bureau rates or the rates of the market leaders as a guide to developing their own rates. Where this is prevalent, there may not be much of an impact on market price variation.
On the demand side of some insurance markets, buyers cannot leave the market because of mandatory liability laws for auto and property insurance requirements by lenders. Most consumers are also constrained by the lack of substitute goods for insurance. On the supply side, the ability of insurers to enter and exit markets is restricted by cancellation and nonrenewal laws, capital and surplus requirements, and certain other entry and exit restrictions contained in state laws.
Competitive market theories also assume that both firms and consumers have all relevant information available to them about the good or service offered. There has been a significant amount of academic research on information as it relates to competitive markets. Economists have stated that “the greater the degree to which the insurance buying public is informed concerning the nature and the price of the insurance product, the greater is the likelihood that workable competition exists.”11 Consumers should have knowledge of price differences as well as differences in the product’s quality and service.
Lack of product information and its impact on consumers in insurance has been well documented. Insufficient consumer knowledge is often a significant obstacle to competition in insurance markets. Some observers attribute regulatory financial oversight of insurers to the fact that there is an information imbalance between insurers and consumers. Even if consumers were interested in finding out for themselves the financial stability of an insurance company, they likely would lack the ability to properly do so. State insurance departments have taken over this role for consumers through their continual analysis of the financial solvency of insurers.
Because personal lines insurance products are complex, it is not clear if consumers have sufficient, relevant information to make good insurance-buying decisions or that consumers feel it to be a worthwhile expenditure of their time to digest the information that is available. In fact, studies have found consumer understanding of insurance disclosures to be limited. Recent NAIC research also indicates consumers have limited understanding of policy coverages. There are significant differences in the coverage provided by insurers’ policy forms, but information about policy provisions is often difficult to obtain. Insurers’ advertising generally does not focus on these differences, and state regulators have usually not felt it to be an efficient use of their limited resources to produce policy form comparisons for the public. With respect to rates, the Internet now gives consumers easier access to price quotes and additional data concerning available coverages, although the utility, user-friendliness and effectiveness of Internet-based quoting systems are still in need of regulatory study to determine the degree to which they cause competitive market assumptions to be met. Price shopping is complicated by issues associated with the consumer’s need to renew the insurance policy, or find a new one, at regular intervals, and by tie-ins such as multi-policy discounts. For example, a consumer who purchases a new auto insurance policy from a different insurer, based on the price of auto insurance, might not realize that he or she just lost a multi-policy discount on his or her homeowners insurance policy, or the consumer might switch auto insurers without realizing that in another six months he or she would have received a three-year claim-free discount on the previous auto insurance policy. Given the increasing complexity of insurers’ rating systems—including credit scoring and tiering rules—even a state insurance department has difficulty compiling meaningful rate comparisons.
An inability of consumers to effectively comparison shop for insurance products may be justification for greater requirements for information disclosure. Regulators have attempted to lessen the information asymmetry that exists between insurance buyers and sellers by mandating certain disclosures, reviewing insurer rates and rating systems, monitoring insurers’ financial condition, regulating market conduct practices of insurers and providing information and education to consumers.12 A key role of regulators is in helping consumers with the insurance buying process by providing information on the insurer’s financial condition and the benefits and nature of the insurance products. Consumers are able to obtain adequate pricing data from insurance agents but this is time consuming and somewhat inconvenient. Valid, meaningful and well-explained pricing
10 Train (1991, p. 303).
11 Hanson, Dineen and Johnson (1974, p. 695).
12 Skipper and Klein (2000, p. 490).
© 2009 National Association of Insurance Commissioners 7