UI professor: multi-state insurance regulations increase costs to consumer, company

By Gigi Wood

IOWA CITY — A recent study by a University of Iowa professor quantifies how much more insurance companies pay to comply with regulations in multiple states.

Ty Leverty, a UI finance professor, recently completed his study “The Cost of Duplicative Regulation: Evidence from Risk Retention Groups,” which was published in the Journal of Risk and Insurance.

“Insurance is subject to state-based regulations, so when an insurance company does business in any state, they have to be licensed in that state,” Mr. Leverty said. “So if you took a large insurer that did business in 50 different states, they would be subject to 50 different regulators. Obviously, that has costs.”

The cost to sell insurance in multiple states is 26 percent more compared to the cost of selling insurance in one state.

“It’s always been a public policy debate whether some sort of optional federal chartering or primary state chartering was desirable to improve the regulatory efficiency. That would mean just having one federal regulator or one state that was in charge of regulating wherever you go,” he said. “There are a lot of strong opinions on both sides of the argument.”

While it’s common sense that dealing with multiple regulators would cost companies more money than complying with one regulator, Mr. Leverty said he wanted to quantify that cost.

“What I found interesting was that there was almost no research that quantified the cost of multiple regulators,” he said. “And it’s really a matter of magnitude because if the cost of dealing with multiple regulators is small then I think a strong argument can be made for maintaining the status quo because of the benefits of regulatory competition, appealing to local needs and all these sorts of things are going to outweigh the costs.”

The difficult part of the study was determining the cost of complying with regulations in multiple states compared to one state. Mr. Leverty decided to use risk retention groups (RRGs) — specialized insurance companies allowed to operate in multiple states but comply with regulations in the state in which they are headquartered — as a way to measure the costs.

RRGs sell commercial liability insurance, so regulatory costs of RRGs cannot be compared to all other insurance company costs.

“The conclusions in my study mainly apply to commercial liability,” Mr. Leverty said.

The key, he said, is his study pinpoints the exact costs of multi-state regulation.

“What I think that’s going to allow people to do is make more appropriate decisions when they decide to push for optional federal chartering or if they’re maintaining the status quo of state-based regulation. Before, there was no idea what the costs were.”

The average firm subject to multi-state regulations has a 26 percent higher expense ratio as a result of those regulations, he said.

“These costs are fully passed on to policyholders,” he said. “Most people, I think naively, assume that when you put an additional cost on an insurance company, that just means lower profits for them but that’s not the case. What’s really going to happen is they’re going to pass it on to the consumer. Most buyers of insurance aren’t even aware this is the case. They don’t even participate in this debate at all and that’s who is really being harmed by this.”

Mr. Leverty’s research showed that the average standard insurance company pays $74,500 in new expenses whenever they enter a new state to comply with regulations in the new market. The costs act as a barrier-to-entry, meaning they keep insurance companies from conducting business in new states, limiting competition, he said.

The average RRG does business in an average of nine states, while the average standard insurance company specializing in commercial liability does business in an average of six states.

Meanwhile, inIowa, insurance regulation costs are fairly low, Mr. Leverty said.

“Iowa is very blessed to have great regulators and very efficient regulators; that can’t be said for all states,” Mr. Leverty said.

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.

The study compared the regulatory compliance costs of 85 insurance companies doing business in multiple states with 147 multi-state RRGs and found that traditional insurance companies have significantly higher compliance costs because of those multiple regulations. For instance, he found that the average traditional insurance company in his sample spends $187,000 a year on licensing fees in multiple states, while the average RRG spends only $49,000 for one.

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.

The study is available online at http://onlinelibrary.wiley.com.