The Cost of Duplicate Regulation
Buyers of commercial liability insurance pay on average 26 percent more in insurer expenses if their insurance company has to comply with regulations from multiple states instead of just a single regulator, according to research by a University of Iowa insurance expert.
Tyler Leverty, a professor of finance in the Tippie College of Business, says that the expenses associated with meeting regulations in every state in which an insurer does business drive up compliance costs by an average 26 percent (and as much as 31 percent) when compared to companies regulated by only one state.
“These high regulatory compliance costs reduce the technical efficiency of firms, deter firms from operating in additional states, and increase the price of insurance,” says Leverty.
Leverty compared the compliance costs of standard property/casualty insurers that solely write commercial liability insurance to the compliance costs of risk retention groups (RRGs), which are permitted to write only commercial liability. Standard insurance companies must comply with regulations in every state in which they are licensed to do business. RRGs are usually focused on a single industry and are allowed by federal law to operate in multiple states, but only have to comply with regulations in the state in which they are headquartered.
Regulatory costs include such expenses as licensing application fees, presenting financial and statistical reports, paying for independent audits and regulatory examinations, and ensuring internal compliance with state regulations. Leverty accounted for differences in expenses between RRGs and insurers, too.
Leverty found that the average traditional insurance company spends $187,000 a year on licensing fees in multiple states, while the average RRG spends only $49,000 for one.
In total, his research showed the average standard insurance company spends about $9 million a year to comply with regulations. RRGs, however, spend an average of $2.9 million to comply with regulations.
Leverty says these costs are passed along to policyholders in the form of higher premiums. They also act as a drag on expansion into new states, he says. The average standard insurer pays $74,500 in new expenses whenever it enters a new state.
Prof. Tyler Leverty’s paper, “The Cost of Duplicative Regulation: Evidence From Risk Retention Groups,” is available on his website at the Tippie College of Business at the University of Iowa and on his SSRN author page.
In the following excerpts from Insurance Journal’s interview, Leverty discusses his research.
Why did you do this particular study?
Leverty: What I found very interesting from an academic standpoint and from a public policy standpoint, is that there is almost no research quantifying the cost of multijurisdictional regulation. There are studies that analyze the merits of federal versus state regulation. But almost all of these studies rely on comparisons to the banking industry or subjective informed opinions. These are smart people weighing in on this. But I thought that good public policy should weight the benefits of the regulatory framework against its cost. There was no research that looked into the estimates of the cost of the statebased regulation in the U.S.
Who paid for this study?
Leverty: This was independent research. It was not contract research. I received nothing from the industry, nothing from consumer advocates. It was all done independently, so, nobody. I guess the University of Iowa.
What were your key findings?
Leverty: An interesting comparison is first to concentrate on the set of risk retention groups and traditional insurance companies that were only operating in one state. I found absolutely no difference in the regulatory compliance costs of these two types of insurance companies. What that really means is that if they’re only subject to one regulator, there is no difference.
However, for firms operating in more than one state, when standard insurers are subject to these multiple regulators and risk retention groups to, in essence, a single regulator, the compliance costs of standard insurers are significantly greater than they are for risk retention groups. I did a number of statistical and econometric controlling techniques here to control for the factors that make risk retention groups differ from standard insurers in statistical simulations. But what these results indicate is that on average, the average firm has a 26 percent higher expense ratio as a result of multijurisdictional regulation.
Are compliance costs a relatively small percentage of overall premium?
Leverty: They’re not a huge part. What I’m concentrating on is the expense ratio of the perunit price. It’s hard to say exactly what the effect is on premiums. But this is a 26 percent higher expense ratio. Since, expense ratios on average, expenses are maybe 30 or 40 percent of the total premium, then it’s 26 percent of that 30 percent or 40 percent.
Is this as an argument for either single state or federal regulation?
Leverty: I’d be cautious to make that point. The reason for my caution is that I am looking at one side of the ledger. I’m looking at the costs. There are strong arguments on the other side, the benefit side of state regulation, dealing with the fact that states have local needs and there’s regulatory competition between the states and they gravitate to some equilibrium policy. The major conclusion or major point in my study is that there probably should be increased efforts to eliminate any unnecessary differences in regulation among the states, and there should be increased efforts to reduce the duplication in regulation.
Do you think you would get similar results looking at personal lines?
Leverty: … I would venture to say that my results would probably be the same and probably the costs would be higher on the personal lines. But again, I don’t want to push on that too hard, given that I didn’t do that and I don’t have the numbers in front of me. That’s my instinct on that.