Insurance Law

Ted links to a CJ&D complaint that insurers are making profits.  It is hard to believe that we are talking about this.  Under our economic system profits are good thing.  Profit attracts capital, firms enter, and competition is enhanced.

What many people seem to think is that profits are an extra and that this extra is an immoral extraction of money from consumers.  Of course, it is possible, that collusion among the providers might lead to extraordinary high profits.  In that case the extraction of ?extra? might be immoral. However, this is not the case in the insurance industry.  No one has made the case that there is collusion and many have made quite a bit of noise about it.  Perhaps the Florida insurance commissioner will find some secret memo among the subpoenaed documents that says something like this memo I recently received.

 

To all in the insurance industry and selected bloggers:   Our regularly scheduled secret meeting will not be held tonight because Debbie has a Girl Scout meeting tonight.  She just forgot about it when she originally scheduled the  secret meeting and she is the cookie coordinator.  Debbie suggests that we  postpone the secret meeting until next Tuesday.      Also, Debbie wanted to remind everyone, especially Ed S., that while smoke filled rooms might have been de rigueur in the past, smoking will lead to immediate banishment to the corridor C hallway where a special close circuit video connection will allow smokers to watch the secret proceedings.     Oh, by the way our head number cruncher suggests that we should overcharge every household   by $950 up from $870 this last year. We can talk about this at our next secret meeting.      Finally, Progressive Allied Indemnity of Secaucus also volunteered to bring the donuts.      Thanks guys,         Mickey Secret Insurance Cabal Coordinator

I suppose that if this memo existed, I?d change my mind about collusion, but this is a canard that keeps being repeated without any type of proof.

There are numerous firms competing for our insurance dollar expect in those states that won?t let the industry compete.  In those states we see insurers leaving the state.  All one has to do is look at the automobile insurance markets in New Jersey, South Carolina, and now Massachusetts.  In each case the state regulated prices severely.  This caused companies to leave the market and prices ended up rising because of massive subsidization schemes that rewarded high risk drivers at the expense of the low risk driver.  In each case, deregulation occurred because the state had to throw its hands up in defeat.  It could not manage the market through increasingly hostile regulation.  Insurance is a voluntary business and at some point, companies will just leave.  After de-regulation each market responded with lower prices for many consumers and more insurers were willing to write in the state.

This week we saw a number of things which are consistent with this market based view.  First, State Farm threw up its collective hands in Florida. In addition to deciding to write no new polices it cut 50 thousand policies. 

Alex Sink the CFO of Florida is worried about the effect of upcoming surcharges on the policyholders of Citizens Property Insurance (the state owned insurance company).  There could be serious (double digit) increases for these customers in the company of last resort.  Citizens is the fifth largest insurance company in the US in terms of exposure (which is not a typical way of measuring insurance company size, but because it is owned by the state, its asset base is essentially the borrowing ability of the state.

Florida looks like a tremendously mismanaged risk exposure. Therefore it is going to be more costly for everyone involved including both private and public participants.

In addition, a study came out this week in Natural Hazard Review that said hurricanes were no worse in terms of severity than in the past.  What has changed is the economic harm that they can cause.  This is because people are putting property and other assets into high risk zones.  By itself, this causes an annualized real economic loss from hurricanes of about $10 billion per year. Over the past 7 years (2000-2006) the combined homeowners and commercial property premium volume in 2006 dollars averaged 4.2 billion.  This does not include Citizens? premiums which are currently about $1.6 billion.  So if we expect to have $10 billion in annual losses we do not take in that much in terms of insurance premiums.  While the $10 billion dollar annualized loss includes both insured and non-insured losses, if we assume that 50 percent of the losses are insured losses then our premium volume is pretty close to the expected annual losses.  This leaves no room for profit, underwriting or claims costs.  It is no wonder that firms are reluctant to operate in Florida.  There is no profit opportunity because the state has chased out the private market, allowed increased concentration of risk on the high risk areas, and subsidized the state?s own rates by using its power to tax all residents of the state to cover losses by Citizens.

Finally, the NAIC, the group of state insurance regulators publishes an annual document called the ?NAIC Profitability Report?. In the 2006 edition there is a table on page 36 which compares the insurance industry with a fortune All Industry (Finance and Industrial) average return net worth.  The highest return for the insurance industry was in 2006 with a return on net worth of 12.2 percent.  The highest year for the All Industry net worth was also 2006 and the return was 15.4 percent.  Over the last 10 years (see graph below) the insurance industry averaged 7.2 percent and the All Industry average was 13.5 percent.  Further the return for the insurance industry has a standard deviation of 3.8 compared to the All Industry return standard deviation of 1.86.  Thus, the insurance industry?s returns are volatile compared to the All Industry returns.  Now, one can quibble about the proper definition of profit, but most definitions will give similar results in terms of relative profitability and volatility.  So, profits are good.  Regulatory mismanagement is bad!  Demagoguery is beneath the pale, but par for the course!

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