Capitol Comment 206 – Rethinking Compulsory Auto Insurance Liability Laws

How should a civilized society respond when A crashes his car into a car driven by B, causing injury to B and damaging his property? The common law of tort is predicated on the notion that people who are harmed by the actions of others are owed restitution by those responsible for their losses. But what if the responsible party lacks the financial wherewithal to provide full compensation? Unless he has purchased liability insurance, the accident victim will have to absorb the losses himself. The law can assign responsibility, but it cannot redistribute wealth that does not exist.

That inconvenient fact accounts for the rule enacted in 45 states that requires motorists to carry auto liability insurance. Since people cannot be relied upon voluntarily to carry insurance (or to possess sufficient wealth) to compensate those whom they might harm while driving, states make owning insurance a condition of driving on public thoroughfares. Intuitively, this seems a rational solution to the problem of driver accountability. Experience suggests, however, that compulsory auto liability insurance laws have driven up insurance costs while doing nothing to reduce the uninsured motorist population. A recent study by the National Association of Independent Insurers (NAII) reveals the following:

The number of uninsured motorists in states with mandatory liability coverage generally continues to grow. In those states with compulsory liability laws in effect prior to 1976, the growth in estimated uninsured motorist populations ranged from six percent to almost 300 percent between 1976 and 1985.
Compared to their counterparts in non-mandatory states, insured drivers in mandatory states are 21 percent more likely to file an injury claim caused by an uninsured driver. Moreover, uninsured-motorist coverage for injury claims costs 27 percent more in states with compulsory liability laws than in states without such laws.
The average liability insurance premium for the non-mandatory states is 26 percent less than the nationwide average. Meanwhile, policyholders in states requiring the purchase of insurance pay above-average premiums. Moreover, from 1992 to 1996, the average liability premium in mandatory states rose $46, while rising only $37 in non-mandatory states.
One problem not addressed in the NAII report concerns the tendency of mandates to generate what might be termed “enabling regulation.” When the state requires, as a

matter of law, that people acquire certain goods that are sold in the marketplace, a case can readily be made that the state is obliged either to provide the goods outright, or at least to ensure that they are widely available and affordable.

And so it is with compulsory automobile liability insurance laws. Insurers take account of the higher claim costs they incur in urban areas by practicing “territorial rating,” which means that auto liability coverage generally costs more in the inner city than elsewhere. Consequently, insurance premiums are beyond the financial means of many low-income motorists who reside in the inner city. But the state says they must carry insurance if they are to drive. So to help their citizens comply with the law, state governments have resorted to a variety of interventions—ranging from urban rate caps to assigned-risk pools to bans on territorial rating—to make auto liability insurance more affordable for the less affluent. Yet as one surveys the experience of various states, it is hard not to notice that the more aggressive the government intervention, the more likely insurers are to abandon a state’s market. The perverse result is diminished competition and less consumer choice—the very opposite of what is needed to lower prices and improve service.

The vicious cycle of high liability premiums, burgeoning uninsured motorist populations, and hyper-regulation could be eliminated if the states would simply repeal their compulsory liability insurance laws. Drivers would then be free to purchase first-party insurance to cover their own losses (including those caused by uninsured and impecunious drivers). Well-to-do motorists could also purchase optional third-party liability insurance to protect their assets.

Eventually, relieving motorists of the legal obligation to carry liability insurance would lead more and more people to insure against the risk of their own losses, as opposed to the current state of affairs where compensation for bodily injury is sought only from the party legally deemed “at fault.” Such a transition to first-party auto insurance is exactly what reformers have striven to achieve through the adoption of no-fault laws. But under the scenario envisioned here, the transition would be accomplished by repealing existing laws, rather than by enacting new ones.

It is bad enough when laws that restrict liberty by compelling certain behavior fail to achieve their intended effect. When these same laws also fuel demands for market interventions (e.g., price controls, underwriting prohibitions, and subsidies) that shift costs and produce gross inefficiencies, the case for maintaining them is very weak indeed. Of the 45 states that currently have compulsory auto insurance liability laws, which will be the first to admit error and move to repeal?