Nick Bata: The Insurance Department, a Socialist Institution

Price Controls

Every socialist system establishes and enforces price control policies. We are seeing the consequences of socialism all around us. The price control regime and hyperinflation imposed over the Venezuelan economy is quite evident. As a result, hundreds of thousands of people are separated from basic and essential goods/services. Why is that? The law of supply and demand. Socialism is enforced by Keynesian Economic doctrine. Aggregate demand is Keynesian’s life blood. To achieve “full employment” and “economic equality“, and  “perfect competition” price controls must be implemented.

I discussed price controls at greater length in an article titled, “Regulation: Anti-Capitalist and Unnecessary.” These Keynesian policies are the upheaval of the price system and economic law. Insurance regulation is no different. The North Dakota Insurance Department enforces Keynesian policies drafted by the legislature. This article will specifically focus on “prior rate approval”, “price-fixing”, their consequences and the need to reverse these practices.

Prior Approval Rating

North Dakota is a “prior approval rating” state for commercial lines of insurance with a few exceptions. There is also “product-approval” processes. Most noteworthy, these practices are solely conducted for political reasons. It is far more politically advantageous for bureaucrats and politicians to concoct a scenario where they battle for “consumer protection”. The reality is far from it. The idea that a bureaucrat can be a substitute for hundreds of thousands of consumers and their preferences is ridiculous.

The market is constantly changing and readjusting to internal and external forces. Regulators cannot possibly achieve “Pareto Optimality” with state intervention. This Pareto rule demonstrates state intervention cannot improve social welfare. Hence, social utility improves only when at least one is better off in an exchange and the other(s) no worse. Regulation such as rate setting policies, including “prior approval rating”, therefore, results in a gain for one but at the expense of making someone worse off.

Cross-subsidization

A result of price fixing insurance policies is cross-subsidization; this is the product of price suppression. By lowering rates for the sake of “affordability”, high-risk groups are being subsidized by low-risk groups. Rate suppression also runs the risk of insurance firms exiting the state market. By prohibiting actuarial rates to premiums (reducing supply), results in high-risk individuals losing coverage or being priced out. New-Jersey and Massachusetts auto insurance markets have experienced firms exiting markets. Florida is also experiencing this with property and casualty insurance, and recently health-insurance markets.

Low-risk groups subsidize the highest risk groups through artificially low prices. This cross-subsidization also creates moral hazard. This acting subsidy eliminates incentives for high-risk groups to take preventative measures to reduce risk that would reduce premiums. Price controls such as these eliminate underwriting standards and turns insurance into wealth-distribution. Hence, making it even more advantageous for political pressure.

Price control mechanisms create residual markets. The state subsidizes those unable to find coverage on private markets, resulting in residual markets. It is a subsidy that avoids much examination due to the complexity of insurance markets and regulatory intervention. The moral hazard created becomes further exacerbated when financial development and infrastructure plans revolve around residual market forces. Insurance is meant to spread risk instead of subsidizing risk via wealth-distribution. The boondoggle of Federal Flood Insurance is a prime example. The wealth-transfer goes from low-risk poor and middle-income groups, who cannot afford riverside or lake homes to the high-risk elite can.

Free Market Insurance

Commercial lines of insurance (property and casualty) have more underwriting freedom. As a result, this allows improved accuracy, analysis of risk and incentives to reduce risk. Improving underwriting standards and policy discrimination is the purpose of insurance reducing risk. Also, the more improved the determination of risk the more coverage available. Whereas, the reduction of underwriting standards makes individuals/claims unprofitable and reduces coverage.

Firm solvency is a major focus of insurance regulation. However, the erosion of underwriting standards producing cross-subsidization threatens firm solvency. Regulatory regimes enforce policies that encourage less coverage, insolvency, or market exit to avoid insolvency. Insolvency is more prone to firms in climates with strict price controls and restraining rate-readjustments, including prior approval states, like North Dakota. Furthermore, price controls making policies unprofitable threatens financial stability in times of catastrophe.

By allowing firms to set their rates and strengthen underwriting standards will make insurance markets more accessible to private insurers. This friendly climate will provide more coverage and incentivize risk reduction mechanisms. Not engaging in Keynesian economic price setting schemes will encourage market entry resulting in more competition. Consequently, a robust and competitive insurance market will drive down prices and improve quality. Profit/loss mechanisms in a free market will produce standards for consumer satisfaction and production standards to maximize efficiency. The nature of regulation is costly to the consumer directly, indirectly and will continue to exacerbate the problem using Keynesian wealth distribution policies.