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What Drives Insurance Costs?

With a career spanning 45 years in the insurance industry in roles ranging from actuary to presidential adviser to state insurance commissioner, J. Robert Hunter has seen it all.

Except for this: Hunter doesn't see a clear correlation between tort reform and decreased insurance costs for consumers.

Premiums, he says, rise and fall based on fairly regular economic cycles that have little to do with litigation costs.

"The actuaries who look at the rates don't look at litigation costs. They look at total losses," says Hunter, now the director of insurance for the Consumer Federation of America in Washington, D.C. "It all depends on where the insurance companies are in their economic cycles."

In a so-called soft market, Hunter says, interest rates are high and competition for premium dollars drives prices down. Insurers put premium dollars into investments like bonds, where they can match bond terms to the amount of time they will typically hold onto premium dollars. In insurance lines like medical malpractice, this "float" period can be as much as seven years -- the amount of time it takes before the average medical malpractice claim is resolved.

When interest rates fall and a soft market has left premiums artificially low, the industry enters a hard market, where premiums have to rise rapidly to catch up and to make up for lost investment income -- regardless of whether litigation costs are up or down.

So called "shock events" like Sept. 11 also exacerbate the losses, Hunter says.