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companies, or to impose the costs of such mismanagement on responsibility managed companies, and ultimately upon their policyholders. I would also repeat my belief that the proper role of the Federal Government in this field is to supplement industry efforts and state efforts, and that federal legislation should not be structured so as to preclude private solutions to the problem.
Insurance company insolvencies may be brought about in several ways. The four most likely causes are the following:
1. Major catastrophe covered under outstanding policies, as, for example, a major earthquake in a densely populated area;
2. Stock market crash, affecting substantially all the issues in a diversified investment portfolio;
3. Dishonest or inept management;
4. Prolonged rate inadequacy coupled with prohibitions on withdrawal from the market. The first two causes can be avoided to an extent through proper underwriting and investment techniques. They cannot be eliminated entirely, nor can they be specifically anticipated. If they occur, they will require whatever disaster or emergency relief the public sector deems appropriate.
The third cause can be avoided to an extent by proper licensing and examination techniques. It cannot be entirely eliminated, and relief can be afforded through joint private and public efforts as described in my testimony on Senate Bill 2236
The fourth cause can and should be eliminated. Insurance rates must be permitted to respond to the inflationary pressures which are beyond the control of the insurance industry. Given responsive rates, there would be no demand for restrictions on withdrawals from the market.
I disagree with the contention that open competition rating laws increase the need for insolvency protection. I have testified that the need for this protection exists now, and would exist even if the rate of insolvencies were reduced below what we now contemplate.
In the discussions of reliability and integrity of the business and the possible effects of increased competition, it is imperative to distinguish between the economic failure of a business enterprise, and insolvency which leaves policyholders and claimants with unsatisfied claims. If it is true that the present strictures on competition in the insurance industry have fostered inefficiency or perhaps weak management, then it must be anticipated that, as competition is increased, the inefficient or the poorly managed will either improve to meet the challenge, or they will fail.
Economic failure in such circumstances is one of the benefits of our system. These failures are detected at an early stage by company management, business creditors, investors, and regulators. When rehabilitation or other corrective devices are not feasible, the business of such a company is wound up in orderly fashion. There may be losses to the owners, and perhaps to the business creditors, but there should be no injury to the insurance public.
Injury to policyholders and claimants results only when all of the protective mechanisms fail, including the state regulatory system which contemplates detection of incipient failure, and conservatorship or liquidation by the regulator.
INA has long advocated a form of regulation which would shift emphasis from prior approval of rates and forms to effective examination of companies and of their actual practices. We have never advocated, and do not now advocate, abandonment of regulation. On the contrary, we have continuously argued that prior approval in the absence of realistic examination is incapable of preventing insolvency, and that prior approval in addition to effective examination is redundant.
It is my firm position that if regulatory emphasis were shifted from prior approval to effective examination in an open competition market, the probability of injury to the insuring public through insolvency would be substantially reduced.
The next broad area which I would like to discuss is the concept that, as a desirable social goal, every licensed driver should be able to get and keep in. surance at comparable and reasonable prices.
I have been very much encouraged to note the recognition by this subcommittee of the fact that our present driver licensing laws need to be improved. I believe we are in agreement that not every driver presently licensed should be licensed, and that leaves the insurance industry with what I am sure you will agree is a most difficult problem. The subcommittee's inquiry into the effects
of automobile design, highway design, safety devices and related subjects has also been most helpful. In our planning activities, we are free to deal with situations as they should exist, and to seek ways to bring about those results. In our daily operations, of course, we must deal with the situation as it exists today.
The terms comparable and reasonable, as applied to automobile insurance rates, have been the subject of much debate. The words mean different things to different people. As an underwriter, I can tell you that every insurable risk could easily buy insurance if rates were reasonable. In fact, those drivers for whom approved rates are reasonable have little difficulty obtaining and keeping insurance; conversely, those drivers for whom approved rates are not reasonable are the ones who must resort to specialty companies or the assigned risk facilities. Largely for this reason, it is possible that a driver who has had no difficulty in obtaining insurance in one state may, upon moving to another state, experience considerable difficulty.
The opinion of an underwriter on the reasonableness of a rate may quite naturally be expected to differ from the opinion of the insured, and from the opinion of the regulator. It should be emphasized, however, that the insured is not limited to the opinion of one underwriter. He will experience difficulty in obtaining insurance only if the applicable rate is considered inadequate in the separate judgments of many underwriters.
If it is true that a large segment of the public has come to look upon automobile liability insurance as something he is compelled to buy for the benefit of the other party involved in an accident which he does not expect to happen, it is quite natural that he will find any substantial cost unpleasantly high. If he believes that that cost is established by an elected official, he may quite naturally be expected to make his dissatisfaction known.
The word comparable, as applied to insurance rates, is perhaps even more difficult. The fundamental concept of insurance is the pooling of risks by those insured. They would be unwilling to pool their risks with others who present a probability of losses greater than their own, and a primary function of the underwriter is to provide a system for the pooling of comparable risks. This requires the establishment of risk classifications, and refinement of those classifications. The degree of refinement is a matter of judgment and practical capabilities. It is axiomatic that, in a competitive market, a highly refined classification systemassuming the classifications accurately reflect relative risk—will drive out a more general classification system.
One of the many impacts which computer technology has had upon the insurance industry is that it has vastly increased the practical capability to refine risk classification system, and it is not surprising that a highly refined system has evolved.
Some attempt has been made to reflect the individual's own accident experience in the classification system. Of course, the rating system is designed to develop a premium adequate for future experience, not to recapture past losses, and experience classifications are reasonable only to the extent that past experience is indicative of future losses.
One method of reducing the range from the highest rated to the lowest rated risk is to combine several different kinds of coverage in one policy. INA has developed and introduced contracts which combine automobile liability insurance with other forms of insurance. We are not sure how successful these combinations may be, and there has been considerable regulatory resistance to the introduction of this concept.
Another method of leveling costs would be the use of true group insurance in the automobile field. This approach is not without difficulty. For example, those individuals who could purchase separate policies at a rate lower than the group rate would presumably do so, raising the rate required for the group. There is also the possibility that costs would be increased for those who are not members of a group. While there may be practical difficulties in this approach, they have not proved insurmountable in the life and accident fields, and I believe the statutory and regulatory bars to group automobile insurance should be removed.
A related subject which has had the attention of your subcommittee is the rate-making procedure employed by the industry, and the antitrust exemption under which it operates.
In my opinion, the authorization to pool data is desirable and should be continued. For those elements of the insurance premium for which statistical projections are necessary, it is desirable to have access to the broadest possible body of pertinent statistics. I do not believe it is necessary that expense data be pooled, or that companies use average expenses for rate-making purposes.
It should be borne in mind that the compilation of historical data, and the application of adjustments, trend factors, and so forth is not rate making. When all these computations are completed, what you have is an indication of the rate which would probably produce the desired result if you wrote the same risks which made up the experience on which the projection was based. Obviously, if you change your rate unilaterally, it is highly unlikely that you will write the same risks in the future.
One of the great difficulties with the prior approval system of rate regulation is that it has brought about a slavish adherence to rate-making formulae to the exclusion of informed judgment. This is an inherent defect in the prior approval system. A public official can, with adequate staff, satisfy himself and his constituents that the statistical procedures used in the development of a rate indication are proper. It is quite likely that he will accept one statistical procedure and force it upon all of the companies making filings, since it is difficult to approve differing systems as equally proper. To expect a public official to affirmatively approve the management judgment used in developing a rate would be unrealistic even if there were only one management. The very concept of competitive private enterprise requires that many separate managements each apply their individual judgments, and it becomes an impossible task for a regulator to approve each of these diverse judgments as correct.
In any event, the promulgations of a rating bureau, whether they be pure premium indications, or rate indications with standard provisions for expenses, should be considered advisory only. It is the responsibility of the respective management of each company to determine the extent to which such indications will be employed in its own rate-making practice.
I am not qualified to assess the need for continuation of a limited antitrust exemption. I believe that it is necessary for companies to exchange data other than simple historical statistics. If change or repeal of the McCarran Act were to have the effect of precluding such exchanges, it would seem to me that the companies presently having the biggest volume of business, and the greatest assets to support independent research would have a considerable advantage over other companies. To me, as a businessman, it appears that removal of the limited antitrust exemption might tend to increa se concentration in the industry.
In the area of insurance rate making, there has been a great deal of discussion about the role of investment income. I believe the case has been well made that policyholders of a stock insurance company have no legal claim to any part of the company's income (although we still occasionally hear loose references to "funds in trust"). The discussion of this subject now seems to have evolved into a question of whether investment income should be considered in assessing the profitability of the insurance industry, and if so, whether that profitability should be considered in determining whether or not rates are excessive.
Speaking for my own company, of course we consider investment income in determining the profitability of our business. In the past few years, there has been a parade of experts debating whether the insurance business is profitable or unprofitable, and to what extent. Notwithstanding the academic debates, the fact is that corporate management, the financial community and investors have concluded that other businesses are more profitable than the insurance business.
There will always be differences of opinion, and only time will resolve some of the issues. Presumably, those students of the business who claim that it is extraordinarily profitable, and that present management simply doesn't realize it, are actively purchasing the shares which are being disposed of by dissatisfied investors, and will soon be in a position to name new managements.
In my own company, we are not satisfied with the profitability of the insurance operation, and we are taking steps to improve it. We will improve the profitability, and expand our insurance operations in every area where we consider that possible. Conversely, as we locate areas where an adequate profit does not appear possible in the foreseeable future, we are prepared to withdraw.
As I have said, we do consider investment income, and income from all other sources, in determining profitability. We are very much opposed to the use of any part of investment income in ratemaking formulae imposed upon us by regulators.
I would like to relate this comment to my previous comments regarding rigid adherence to standardized formulae under the prior approval form of regulation. We are opposed to this approach in principle. It severely inhibits competition and forces an unnatural uniformity among competitors. It tends to preclude management judgement at the rate-making level, thereby producing marketing problems and restrictive underwriting. The system stands discredited by its own performance; in no case in recent years have the filing companies realized the provision for profit stated in these formulae. To introduce investment income, or any part of it, into such a formula would compound the defects of what is already an unsatisfactory system.
There are a number of other reasons why the systematic use of investment income in such a way would appear to be contrary to the public interest.
One effect of this practice would be to require that companies sell a product below cost, utilizing income from other sources to support the practice. Unrestricted, this practice could have the effect of destroying competition, by driving out of the market those companies unable to meet this form of competition.
Another effect would be to encourage companies to compete on the basis of investment return, and this could lead to unsound investment practices.
The California rating law is, in my opinion, an excellent solution to this problem. It permits management to consider investment income as it deems appropriate in its competitive pricing practices, and provides the regulator with the necessary authority to preclude price war and destructive competition.
It is my recommendation that the California-type rating law, requiring no filings of rates and contemplating realistic and effective examination of companies, be adopted universally. This has been our policy for many years, and we continue to recommend this course to regulators and to state legislative bodies.
The third broad concept raised by your Chairman's speech is that everyone injured in an automobile accident should be compensated, at a minimum, for his actual out-of-pocket expenses and loss of earnings.
This is a matter of public policy, and therefore one to be determined by the public, through their elected representatives. As one element of the private sector, INA favors this proposition. In mid-1967, we presented our views on this subject to the public, and set out to devise a proposal through which this purpose could be accomplished.
At that time, the most prominent proposal available was the very thorough work of Professor Keeton and O'Connell. While we endorsed the objective of that proposal, we had some reservations about details of the plan. In particular, as the authors themselves had indicated, the proposed state legislation would be unconstitutional in some states, and necessary constitutional amendments would require considerable time. The plan was more rigid than we considered necessary, imposing statutory limits, sublimits, and deductibles, and compelling the offset of collateral source recoveries. It was our feeling that the major objectives of such a reform could be accomplished without these undesirable features. The cost estimates of the plan were, in our opinion, highly theoretical, and subsequent studies and criticisms have reaffirmed that opinion. We concluded that an accurate evaluation of the plan could only be accomplished through some experimentation. We also felt that the transition to such a plan would be more orderly if some of the bugs could be worked out before a complete change-over.
Accordingly, the plan which we devised was designed to permit immediate implementation by one or more states, without constitutional amendment; it does not contemplate abrogation of the tort system nor of compensation for pain and suffering damages ; and it places a great emphasis on freedom of choice by the public in electing the inurer to whom they would look for compensation, limits of liability, deductibles, and so forth.
The resulting INA proposal was first publicly presented before the Federation of Insurance Counsel on February 1, 1968. It has since been presented in a number of discussions before bar associations, insurance agency groups, CPCƯ seminars, and was formally submitted to the Consumer Subcommittee of the Senate Commerce Committee, the American Bar Association, and the National Association of Insurance Commissioners. It has also been presented to a number of state legislative bodies and special study commissions.
The proposal of Connecticut Insurance Commissioner Cotter, introduced in bill form in that state last year, incorporated most of the provisions of the INA propoal including, incidentally, an open competition rating law. A bill presently before the Delaware Legislature incorporates substantially all of the INA proposal.
In response to a recent request from New York Superintendent of Insurance Stewart, we submitted the proposal for his consideration. A copy of that submission, which contains a more detailed explanation of the INA plan, is attached to my statement.
In the consideration of this subject, we also considered the probably constitutionality of no-fault legislation at the federal level. Counsel have concluded that such legislation probably would be constitutional and furthermore that if federal legislation prescribed minimum standards to be implemented by state legislation, that state legislation would be valid even though in apparent conflict with the state constitution. We have recommended to the Department of Transportation that the possibility of such minimum standard federal legislation be considered. A copy of a legal memorandum on that subject is also attached for your consideration.
In my opinion, implementation of the INA plan would eliminate much of the dissatisfaction with the present system. Experience under this plan would enable us to determine whether a no-fault system is desirable, and what it would cost. If experience indicated that a no-fault system was desirable, the INA plan would provide an orderly transition. Experience might indicate that the INA plan itself, or some modification of this plan, is a satisfactory solution. If experience under the plan indicated that it was not working well, it could rather easily be abandoned.
The INA plan attacks much of the waste and duplication of the present system. It is designed to minimize the need for litigation, while preserving the right where it is needed. It permits reduction in cost through the election of deductibles, waiting periods, and similar procedures at the election of the insured.
In my judgment, the most significant effect of the plan is that it would enable us to extend to those injured in automobile accidents immediate medical treatment and rehabilitation services. INA has extensive experience with these procedures. In 1965, we inaugurated a formal program to bring the benefits of these procedures to the seriously injured or ill under any of our policies—including automobile liability. The program is known by the acronym MEND for Medical and Educational Needs of the Disabled.
We are proud of all of the efforts and innovations to reduce cost, but the MEND program gives us a very special satisfaction. It actually reduces the amount of loss suffered by the injured party and by the economy.
The economic motivation for the program is simple. Costs of providing prompt medical care, financial assistance, and rehabilitation training are more than offset by the resulting reduction in overall medical expenses and loss of earnings.
Almost 10,000 cases have been successfully handled in the first four years of the program. A detailed analysis of the first one hundred cases indicates a cost saving of $1.5 million. The savings in human values, which far outweigh the economic savings, are free.
Pamphlets describing the MEND program and the INA MEND Institute are attached to my statement. They will give you more details about the program and its results.
We are now applying these techniques in automobile liability cases where it is clear that our liability policy will respond. Adoption of the INA-proposed automobile compensation system would permit us to extend these techniques to substantially all automobile cases. Thank you for the opportunity to present my views to your subcommittee.
DECEMBER 17, 1969. Mr. CHARLES K. Cox, President, Insurance Co. of North America, Philadelphia, Pa.
DEAR MR. Cox: Thank you for submitting your prepared statement and attached material for the hearing record. We would now appreciate it if you would furnish answers to the following questions for inclusion in the hearing record.
1. If, as you indicate on page 6 of your statement, risk classifications and their refinement are required because insureds "would be unwilling to pool their risks with others who present a probability of losses greater than their own," under INA's auto compensation proposal, do you believe that the public would be any more willing to "pool their risks" with more hazardous drivers than they are today?