The mid-May annual meeting of the Casualty Actuarial Society will feature presentations on some of this year's hottest topics in insurance law and regulation.
A general session on the future of finite reinsurance "will review some basics of finite insurance and will present the viewpoints of an auditor, a rating agency, an insurer, and a finite insurance purchaser. It will discuss the prevalence of using finite insurance to mask true results and legitimate uses of finite insurance, as well as how to distinguish between the two."
Other topics include: aviation pricing and modeling, California workers' compensation, medical malpractice costs, the future of TRIA, hurricanes and reinsurance, insurance accounting, privacy of information and terrorism modeling.
I suspect that might draw a crowd this spring in Phoenix.
Thanks to Insurance Journal CAS Talks Mergers and Acquisitions, Finite Insurance at Phoenix Meeting (April 28, 2005).
The ongoing investigations and revelations at American International Group (AIG) are providing Professors Peter J. Henning and Ellen S. Podgor valuable content for their Prof Blog focusing on White Collar Crime. For example, a recent posting reports on revelations involving an in-house lawyer who may have been forced out of AIG after advising AIG of legal problems with accounting for workers comp commissions now under investigation. White Collar Crime Prof Blog: Ignoring Legal Advice at AIG
White Collar Crime Prof Blog (WCCPB?) has an ongoing flow of observations of the AIG investigation, which is likely to be of interest to scholars looking at this saga of corporate governance and insurance regulation.
The new Airbus 380 took off for the first time, laden with tons of testing equipment, but designed to carry 555 passengers. The European Airbus consortium is already reporting 154 orders and commitments for the aircraft, according to Reuters via Yahoo News. On the same day, news stories reported on the FAA investigation of a near collision between BWIA Flight 431 (a Boeing 737) and American Airlines Flight 2198 (a Boeing 757), with hundreds of passengers at risk about 8,000 feet over Miami International Airport. The new Airbus A380 super-jumbo will carry more passengers than any before it. Some think that its size presents a potential liability exposure that exceeds the existing capacity of the aviation insurance market.
To assist in the analysis of this exposure, a paper to the 2002 GIRO convention of the Institute of Actuaries (UK) may be of assistance. Harding, et al "Aviation Insurance." (55 pages in PDF format).
From the introduction:
"The paper briefly describes the main sectors of the airline insurance market, and the factors that are determining results in this area. In particular, the after effects of September 11th are considered in some detail. The Working Party suggests changes that could be made by insurers, expected growth in the main sectors, and high profile factors that may materially impact on future experience. This paper is * * * aimed at those unfamiliar with this esoteric but high profile area of the General Insurance Industry."
A second paper also presented at the 2002 convention, addresses aviation exposures as one of several potentially catastrophic exposures. D.E.A. Sanders (Chair), et al "The Management of Losses Arising from Extreme Events." (261 pages in PDF format). The paper explores extreme events and their insurance impact, including detailed appendices with historical data and graphical presentations. An explanation of Extreme Value Theory and existing catastrophe models is included, with a perspective on realistic disaster scenarios. It includes consideration and probability indications for catastrophic weather, geological events including tsunamis, earthquakes and volcanoes, manmade disasters and collisions with meteorites or comets. A concluding portion addresses the challenge of global insurance capacity to handle these exposures.
From the Introduction:
"If the world’s to globalise then the final conclusion is that the growth of mega cities and mega risks combined with a limited number of ultimate risk takers will mean that there is insufficient world wide insurance capacity to deal with many of the realistic loss scenarios, and that matters will not improve as the process continues. The main alternative is to rely on the wealth of the financial sector to absorb these losses which are minimal compared with daily fluctuations in asset values."
A full listing with links to all of the papers presented at this convention is accessible at the Institute's website for GIRO 2002.
A Michigan judge has thrown out Office of Financial and Insurance Service (OFIS) rules directing rate roll-backs and banning use of credit-based insurance scores in underwriting, according to Insurance Journal. Mich. Judge Rules Insurance Scoring Ban Illegal According to the Journal, the judge's opinion included the finding that the evidence clearly established "that on average a policyholder with a higher insurance score presents lower risk and lower expense, due to a lower number of claims, than a policyholder with a lower insurance score. Since rating plans utilizing insurance scores measure differences in risk that have a probable effect on losses or expenses, such plans are clearly authorized by the Insurance Code."
The sudden financial collapse of Reciprocal of America (ROA) in 2003 left hundreds of doctors and lawyers with no malpractice coverage and many with six-figure unsatisfied malpractice judgments. Top ROA management recently pled guilty to federal criminal charges of malfeasance in connection with claims reserving and financial management. State and federal investigators have critically examined the role of Berkshire Hathaway subsidiary Gen Re in ROA's problems. Berkshire's voluntary disclosures regarding the ROA account in turn led investigators to closer scrutiny of similar Gen Re dealings with AIG. That in turn led to the recent resignation of its longtime top manager, Maurice "Hank" Greenberg.
This Times article looks at the impact of ROA's collapse on its insureds, professionals left with policies worth little but a future claim against ROA's insolvent estate, and injured claimants without financial compensation for their losses. "The Insurance Scandal Shakes Main Street" (New York Times, April 17, 2005)
Executives of Reciprocal of America, a failed Virginia insurer, conspired to defraud policyholders of three risk retention groups domiciled in Tennessee, according to allegations in a federal lawsuit filed by that state's Insurance Commissioner. The 2003 collapse of the three Tennessee companies that were run by ROA left thousands of doctors and lawyers scrambling for professional liability insurance and holding some $200 million in unpaid claims. By federal statute, policyholders of risk retention groups are not eligible for protection by state insurance guaranty funds.
A federal RICO complaint filed by the Commissioner in the Western District of Tennessee lays out allegations of a web of corporate shells and money transfers, alleging fraud, conspiracy, malpractice and abuse of trust against a list of companies and individuals alleged to be involved, the first named of which was Gen Re. The Commissioner maintains a webpage of links to sources concerning the insolvency of the companies, including the full text of the February 9, 2004 complaint.
The RICO suit becomes more interesting in light of more recent reports of Warren Buffett's cooperation with federal and state authorities investigating unusual transactions between Gen Re and AIG similar to those involving ROA's exposures. Stories now emerging suggest that it was Buffett's voluntary delivery of certain information about unusual transactions involving Gen Re and international insurance giant AIG that may have started the series of events leading to the recent departure of Mr. Greenberg from the helm of AIG. See, e.g. Bloomberg.com: "Buffett, King of Transparency, Queried on Reinsurance Secrets U.S." (April 11, 2005)
See also my March 3 posting in: Unintended Consequences: Search for Deep Pockets Widens in Reciprocal of America Case
And on March 28 in: Unintended Consequences: Wharton Looks at AIG and Greenberg
And on April 7 in: Unintended Consequences: Wharton's Thoughts on AIG and "finite reinsurance"
Nick Prettejohn, Lloyd's CEO, exhorted the insurance industry to make an underwriting profit "on more than an occasional basis," repeating a prayer heard often from "thought leaders" in the insurance industry. "Stop destroying value" was how he put it, noting that the insurance industry made an overall underwriting profit (a combined ratio over 100) in 2004 for the first time since 1978. He contended that a return on underwriting is essential for return on capital to be equal to or greater than cost of capital.
Blaming the insurance business cycle was not satisfactory, Prettejohn went on. The cycle "is not an alibi for management inaction." Somehow (he does not say how) industry management should "make return on capital the single most important performance measure for underwriters as well as investors."
The full text of his remarks at at Lloyd's website. Strategic challenges facing the general insurance industry
Warren Buffett, in his 2004 Annual Report Letter to Shareholders, reminds the owners of Berkshire Hathaway of the value of "float," money held by insurers that must eventually be paid to others (policyholders and claimants). He consistently reminds shareholders that the cost of float is a function of the operating ratio, and that even when the ratio is below 100 (an underwriting loss), the cost of float can be below the return obtainable by investing that float wisely. Of course, Berkshire has a long history of investing that float to yield an average annual return about twice that of the S&P 500, largely by a "buy and hold" approach to acquiring substantial stakes in profitable businesses.
Buffett extols the virtues of an underwriting profit, pointing to the 25-year record of National Indemnity Company ("NICO"), one of Berkshire's flagship insurance subsidiaries. A table in the 2005 annual report shows that in all but 5 of those 25 years, National Indemnity produced an underwriting profit. The exceptions were the nasty years in the early 1980's and the infamous 2001.
Where he is more specific than Prettejohn, is in describing the unusual business model that enables National Indemnity to achieve that consistent underwriting profit. That is the willingness to allow a decline in revenue during "soft" markets (when competitors are pricing below cost to gain or maintain market share) and to write fully-priced business when the market is "hard." The 25-year chart in the annual letter shows this history with classic Buffett clarity.
National Indemnity's written premium dwindled in the early 1980's to a low of $58 million in 1983, in the depths of the "soft" market, generating an 18.7% underwriting loss. The next year, the market began to "harden," as below-cost "cash flow underwriting" insurers exited the marketplace, either feet first as insolvents or voluntarily. National Underwriter was ready with capacity and by 1986 wrote $366 million in premium at a 30.7% underwriting profit.
As always, those profit levels attracted new and renewed entrants into the market, which began the long softening that ended only with the disaster of September 11, 2001. National Indemnity's written premium dropped to $232 million in 1987, to $140 million in 1988 and then steadily dropped to a mere $54.5 million in 1999, the underwriting profit steadily dropping (without flipping to a loss).
In most any other company, such a long, steady decline in sales and cash flow into the organization would have been intolerable to management and Wall Street. Yet National Indemnity (like other Berkshire subsidiaries) was able to survive because of what Buffett called "real fortitude -- embedded deep within a company's culture --to operate as NICO does." Buffett notes that insurance prices are now falling, and that NICO's volume will decline, and that as it does, Buffett and his partner Charlie Munger "will applaud ... ever more loudly."
So, if the most consistently successful insurer/investor in modern history is so plain about his business model, why do more insurers not emulate it? A recent article by Sean M. Fitzpatrick in the Connecticut Insurance Law Journal suggests some answers. Sean is a Lecturer in Law at the University of Connecticut School of Law and Senior Vice President and Special Counsel at Chubb & Son, Inc. In "Fear is the Key: A Behavioral Guide to Underwriting Cycles," 10 Conn.Ins.L.J. 255 (2003-2004), he reviews several conventional attempts to explain the insurance business cycle (pricing uncertainty, interest rates and reinsurance pricing) and proposes a behavioral approach that includes three additional components that are rarely voiced out loud, let alone in publication.
The first behavioral component, the compensation structures of insurers, may strike a cord with Lloyd's Prettejohn. Insurers compensate underwriters not on the profitability of the business they write, but on the volume of premiums they write. One reason for this is that ultimate profitability of insurance requires years to determine, and good underwriters want and need compensation and bonuses sooner than that. "Good producers" have the ability to "write and run," to generate and be rewarded for significant growth in premium estimated to be ultimately profitable, then leverage that success to move to another high paying position before the actual profits (or losses) are known.
Another factor is the linkage between profitability and power in the internal bureaucracy of an insurer. Underwriters, claim managers and actuaries have different perspectives on the insurance business than do financial analysts. When financial results are good, conservative viewpoints gain power, but as financial results fall, more liberal voices take prominence and prices tend to be cut.
Fitzpatrick's third factor is the influence of brokers, which have a natural concern that they will lose their customer to another broker with a lower price. So, they constantly play insurers against each other, steadily working prices down and down, eventually below cost. Recent investigations by Atty. General Eliot Spitzer and others have revealed some of the power of brokers to twist even the largest and most powerful of insurers, confirming the power noted by Fitzpatrick.
Fitzpatrick notes that each of these influences reflects rational business managers making rational decisions based on the incentives and constituencies before them. He concludes that "cycles are at root the result of personal judgments ... made each day by individuals. ... If one places these questions in a human context, it becomes clear that underwriting cycles are first and foremost the result of the inconvenient collision of human nature with the essential indeterminancy of risk."
Like Prettejohn, Fitzpatrick closes with an exhortation that: "Insurers need to focus their employees on long-term profitability, brokers need to focus theirs on maintaining stable sources of capacity rather than on obtaining the lowest possible prices, and consumers of insurance need to be willing to forgo short term price reductions in return for a more dependable and consistent market for insurance products."
What he does not address is how to change the deep-seated behavioral patterns in so many managers, brokers and consumers that will be required to achieve the breakthrough state of enlightenment for which he calls. Until some practical way of changing human nature is found, the National Indemnity Companies of this world may continue to quietly outperform, as insurance leaders continue to pray fervently that their congregation and the world about them turn away from temptation.
The Canadian Recording Industry Association (CRIA) wants copyright reform and claims that peer-to-peer ("P2P") file has cost its members billions in lost sales in Canada.
A new peer-reviewed article published by FirstMonday.org analysizes industry statistics to test CRIA's claims. The report found exaggeration in loss claims and challenges CRIA's position. It also examines the possibility that an existing private copying levy system may already compensate artists adequately for private copying in P2P networks.
Controlling for inflation, there was no real increase in medical malpractice claims in Florida over the period 1990 to 2003, according to a study funded by Duke University.
Controversy continues over recent rises in med mal insurance premiums and whether they show the need for tort reform or management of the insurance cycle. "There are two arguments about the cause--one is that the number of claims went up and the other is the insurance industry's business cycle," Neil Vidmar, co-author of the study and a law professor at Duke University was quoted in a Insurance Journal article published April 5, 2005. "We say one of the alleged causes is not the cause--so you're left to fall back on the other alleged cause."
"Uncovering the 'Invisible' Profile of Medical Malpractice Litigation: Insights from Florida," was done by Vidmar and Dr. Paul Lee, an M.D./J.D. and professor at Duke. It will be published soon in the DePaul Law Review, according to the Journal.
Accounting problems at AIG, threats of criminal prosecution from New York A.G. Eliot Spitzer, and the removal of one of the more powerful CEO/Chairmen in the financial services industry. Exciting stuff on which Wharton has some thoughts in a recent article available online.
"The heart of the problem: No one can be sure how big the scandal will grow, because it involves business relationships, insurance products and accounting practices so arcane that few people understand them -- including a controversial product known as 'finite insurance.' This is an obscure product that seems to have been used in ways other than what it was intended for," said Stephen H. Shore, professor of insurance and risk management at Wharton.
The article notes the routine nature of reinsurance between insurers, and the loan-like effects of finite reinsurance. But accounting for finite reinsurance is a gray area.
From the article: "The issue in this deal, as in many finite insurance contracts, is whether AIG was providing insurance coverage or receiving a loan. To be insurance, AIG would have to assume a risk of loss. An industry rule of thumb known as '10/10' says the insurer should face, at a minimum, a 10% chance of losing 10% of the policy amount for the contract to be considered insurance."
"In the absence of that degree of risk, the premiums transferred from General Re to AIG, and repayable later, would be a loan. AIG would then not be able to count the $500 million in premiums as additional reserves, as it had."
The article reports that on March 30, AIG's directors concluded that the GenRe transaction was not properly classified as insurance. As a result of the reclassification as a loan, AIG said it would reduce its reserves by $250 million and increase liabilities by $245 million.
The article notes the use of Bermuda and Barbados reinsurers that were held forth as independent reinsurers when in fact they had sufficient connections to AIG that its account records should have been consolidated with AIG's.
Wharton compared the offshore transactions to those found in the Enron investigation, but on a smaller scale. Time will tell if those uncovered so far are the bulk or the tip of the iceberg.
The network of insurers has fostered loss prevention since the early days of Lloyd's, when underwriters would commission privateers to control attacks on insured shipping. More recently, incentives for policyholders to control losses and improve safety have taken various forms, from formal "loss control" services to retention methods such as large deductible, experience rating and retrospective rating plans.
In medical malpractice insurance, reducing insured losses has the added benefit of reducing adverse medical outcomes, a result benefiting not only health care providers who are policyholders, but also patients, their families and employers. Systems and activities that lead to increased safety in patient treatment have a significant societal benefit.
An April 4, 2005 symposium sponsored by the Insurance Law Center at the University of Connecticut School of Law gathered academics, practitioners and insurer representatives to examine the influences of the med mal insurance system on patient safety and medical care quality.
Prof. Tom Baker, Director of the Insurance Law Center, introduced two panels of speakers with the observation that the recent "insurance crisis" in med mal is merely the latest in a recurring cycle. As in the past, calls for legislative reform of tort laws may die out as new entrants offer additional insurance capacity and reinsurance prices moderate, relieving the crisis before legislatures can find consensus.
The first panel addressed the role of "evidence based medicine" and the principle of "pay for performance" in improving the quality of medical care and reducing medical injuries (and resulting legal liability). "Pay for Performance," or "P4P" is the approach by which better procedures and clinical outcomes are linked to better pay for health care providers. Panelists discussed challenges and potential payoffs possible in the implementation of "P4P".
Challenges include that of measuring quality in medical care. Validating "evidence based standards" of care requires a substantial data base. Some medical societies and benefit consultants have developed standards, some open and some proprietary. Offering incentives to medical plan members to choose more efficient health care providers may lead to differential payments whereby better performing providers may receive a significantly higher rate of payment, with poorer performing providers getting lower rates.
Differential payments based on differential evaluations requires acceptance of the proposition that not all providers are equal in their quality of medical care delivery. While this proposition seems intuitively sound, it is one that concerns health care providers if it is made part of the payment process. Panelists cited an A.M.A. ethical standard requiring that care provider compensation not be based on outcome, and less formal A.M.A. assertions that all quality-based differentials be "additive and voluntary." In other words, one can pay more for better quality, as long as one does not pay less for lesser quality.
Panelists acknowledged the practical challenges of measuring quality in health care delivery. They also saw the appeal of a hypothesis that if one can build an effective and appropriate system of paying for quality results, the health care industry will transform into structures that deliver the results for which incentives are provided. The fragmentation of the provider community, particularly the physician community, points to process measurements rather than outcome measurements as a practical proxy for "quality," in the views of several panelists.
Prof. William Sage (M.D. & J.D.) of Columbia University asserted that few organizations have thought about the "three legged stool" of the interaction of liability, quality of care and the cost of care, each of the three factors squeezing the others toward some equilibrium. Yet medical malpractice liability issues tend to be debated in legislatures less often by health care experts than by tort lawyers, and may be captured as a proxies for movements for generalized tort reform.
Panelists also looked at the value of focusing less on avoiding or winning lawsuits and more on improving outcomes and patient satisfaction. One program with promising results was that of the Colorado Physicians Insurance Company ("COPIC"), which developed a program for reducing malpractice claims by offering advance payments to patients impacted by unfavorable outcomes, without requiring a release. One audience member compared that approach to one successfully used for years by property insurers. Improved communication and human relationships between providers and patients was recognized by panelists as one of the major factors in reducing the incidence of malpractice claims and litigation, given the same incidence of adverse outcomes.
Leslie Norwalk, J.D., Deputy Administrator of the U.S. Centers for Medicare and Medicaid Services ("CMS "), reminded participants that CMS programs administer some $300 billion in public health care money and cover some 25% of the population of the U.S. One way CMS works to influence medical care quality is by offering comparisons of providers through its publicly available "COMPARE" websites. Based on both process and outcome comparisons, the websites offer differential statistics on a nursing homes, dialysis centers, hospitals and other provider types. What CMS has not yet figured out how best to do is to take such differential measurements and turn them into differential payments. Developing such a process requires public comment and legislative action; in preparation for that, the CMS is officially soliciting input on assembling a payment model that would appropriately assign accountability and recognition.
Prof. Baker moderated a second panel that opened by recognizing a framework based on a theory that insurance can both distribute risk and also effect reduction in loss. In its role of reducing loss, insurance is thus in competition with providers of “unbundled” risk management and with the tort system. As described by Baker, insurers may have advantages over those other forces, including better information, greater objectivity and the incentives that come from playing with their own money.
Another panelist, Prof. Charles Silver, J.D. of the Univ. of Texas, called himself lucky to be at the forefront of the movement toward Pay for Performance in health care. He noted an advantage offered by insurers: while hospitals could improve outcomes by investing in various improvements, they may be unlikely to do so if the beneficiaries of the investments are physicians instead of the hospital. Those same investments are too large to be affordable by individual physician practices, and may require data aggregation only possible for insurers. He suggested that patient safety may be a losing proposition for providers, leading to an endemic lack of incentives for quality and prevention. A med mal insurer may be the only institution rationally motivated to make those investments and thereby reduce the exposures of its insureds. He noted an upcoming paper (with Prof. Hyman) to be published in the Cornell Law Review on these issues.
Panelists discussed the absence of experience rating in the med mal insurance industry, and explained it as a consequence of the shortage of non-claim data on which insurers might benchmark providers. Another challenge noted was the opposition of some medical mutuals that were said to find experience rating to be unfair, on the theory that claim frequency is not correlatable with quality of care. Panelists did not challenge the proposition that experience rating needs good non-claim data and large quantities of it, a commodity in short supply in the med mal field. Prof. Silver suggested that the liability system is working better than some may think, with efforts to improve health care quality driven by incentives from government and liability carriers.
The symposium was jointly sponsored by the University of Connecticut School of Law Insurance Law Center, the Connecticut Insurance Law Journal, the University of Connecticut Health Center and the Connecticut AHEC Program.