Most states require consumers to purchase liability insurance for the legal operation of a motor vehicle. In the presence of insurance costs that are rising faster than the CPI, consumers are demanding lower insurance rates. The insurance industry is regulated at the state level. Insurance commissioners in more than half of the states have the authority to intervene in or oversee rate-setting in the state. When controlling insurance rates, insurance commissioners attempt to balance affordability and availability of insurance across two-tiered insurance markets while keeping the industry solvent. Though these may be conflicting objectives, many commissioners are popularly elected and as such have incentive to select rates reflecting consumer preferences. Yet in two-tiered insurance markets, a unified public interest may not exist. A theoretical model of a two-tiered insurance market is developed to determine if insurance commissioners can lower liability rates across both tiers of the market simultaneously. The model identifies feasible outcomes under the assumption that consumer interests dominate the regulatory agenda and firms are kept solvent. Using these rates, a median voter model is employed to determine the insurance rates a purely politically-motivated insurance commissioner will choose. Finally, using state-level annual data from 1987-1992, multivariate regression analysis estimates whether or not insurance market outcomes reflect consumer preferences as carried out through politically-motivated insurance commissioners. Significantly, the model predicts that commissioners will impose voluntary market rate regulation as a majority rule equilibrium. With such regulation, insurance commissioners can lower all regulated rates simultaneously and keep the industry solvent. However, due to the two-tiered nature of the market, not all drivers will pay lower rates and no Pareto improvement will be achieved. Furthermore, if insurance rates are set through a political mechanism, the majority will always vote to minimize their rates while maximizing the rates paid by the minority. Empirically, the analysis finds market outcomes reflective of theoretical predictions in states with elected insurance commissioners. The analysis clarifies the meaning of lower insurance rates in a two-tiered market, identifies the limits to the political rhetoric of lowering those rates and reveals a need to educate consumers about insurance regulatory mechanisms.
