Munich Re has released its 2007 review of natural catastrophe experience and its announcement of a strategic re-direction to address climate change, which it describes as "one of the greatest risks facing mankind."
It is especially valuable to remind U.S. policymakers that while 2007 was a relatively easy "natural catastrophe" year for the U.S., Europe, Asia and Australia were not so lucky. The U.S. will get its turn again, as it did in 2005.
In the report:
* The monsoon between a curse and a blessing
* North Atlantic hurricane activity in 2007
* Catastrophe portraits from Europe, United States, Oman, Australia, UK and Japan
* World Climate Conference in Bali smooths the way for the successor to the Kyoto Protocol
* Living with climate change – The strategic repositioning of the Munich Re Group
* NatCatSERVICE – The year in figures
Thanks to ClimateandInsurance.org for alerting us to this important report.
(read more after the break)
From Munich Re's Report, p. 39:
Climate change is one of the greatest risks facing mankind. In recent years, the insurance industry – and Munich Re in particular – has been instrumental in ensuring that this message is received loud and clear by politicians, industry, and society as a whole. Now we are going one step further and are turning our knowledge into even more action – with the aid of an all-embracing strategic approach – in the areas of “risk management”, “product development”, and “capital market management”.
Munich Re goes on to speak highly of the "visionary" Stern Review:
Investments in adaptation measures designed to deal with the effects of climate change and in the reduction of greenhouse gas emissions pay off: that is a view also shared by the former chief economist of the World Bank, Sir Nicolas Stern. One of the core messages in The Stern Review, published in autumn 2006 and recognised throughout the world as a visionary work, is as follows: Climate change is the greatest market failure of all time – the only economically reasonable solution: take action immediately!
That means:
– meeting the ambitious CO2 targets by initiating concrete legislative procedures and specifying energy production and efficiency requirements,
– implementing new energy production technologies and new energy-saving construction methods,
– employing new mechanisms to (further) develop carbon emissions trading.
Ibid., pp. 38 - 39.
The full report, "Topics Geo - Natural catastrophes 2007 - Analyses, assessments, positions" is available for free public download in PDF form.
According to the Stern Review of the Economics of Climate Change cited by Munich Re, unchecked human-caused global warming will cause trillions of dollars in damages in our lifetimes, with impact comparable to a world war or global depression, but shifting to a low-carbon economy will bring huge economic growth opportunities. The economic benefit of reducing carbon emissions could total $2.5 trillion each year, according to the most comprehensive economic analysis of the effects of global warming, released in October 2006 by Sir Nicholas Stern, Head of the U.K.'s Government Economic Service and former World Bank Chief Economist.
An index of the elements of the Stern Review of the Economics of Climate Change is available here: Stern Review Index page, which includes links to his presentation slides, comments on the report by other economists, supporting research.
See also some earlier thoughts on "Stern's Prescription and Dirty Harry's Question," Unintended Consequences, Nov. 4, 2006.
In an October 2007 report commissioned by Ceres, author Even Mills, Ph.D., of the Lawrence Berkeley National Laboratory, identified several hundred innovations to address climate change that have been implemented by insurance companies and brokers world-wide. These include insurance products to cover alternative energy providers, underwriting to encourage less driving and use of fuel-efficient vehicles as well as suites of insurance products tailored to the special needs of "green building." Still, only a minority of insurers have taken visible action or offered innovative products and services to address climate change, according to the report.
Evan Mills, "From Risk to Opportunity: 2007 - Insurer Responses to Climate Change" (Ceres, 2007)
Beyond direct exposure to property loss and business interruption, both the global insurance industry and its business clients are exposed to third party liability claims generated by climate-change outcomes, according to an article for a 2007 Symposium on Climate Change Risk. According to the paper, Goldman Sachs has estimated such corporate liabilities could be comparable to those for asbestos exposures.
Ross, Christina, Mills, Evan and Hecht, Sean B., "Limiting Liability in the Greenhouse: Insurance Risk-Management Strategies in the Context of Global Climate Change". Stanford Environmental Law Journal, Vol. 26A, p. 251, 2007 Available at SSRN or at Lawrence Berkeley National Laboratory (U.S.Dept. of Energy):
The Investor Network on Climate Risk (INCR) has released its latest Action Plan. INCR is a growing organization of individuals, officials and funds that together control some $1.75 trillion in invested assets. Its members include several state treasurers and pension funds with a history of social activism, such as CalPERS. In its Action Plan, the signatories present their agenda for action, with this preface:
"As fiduciaries and long-term investors, we see significant short and long-term risks from climate change to the value and security of our investments and capital markets more broadly. And we recognize that the impacts of climate change will continue to be multi-dimensional – affecting corporations’ abilities to secure the full range of necessary resources such as energy and water. At the same time, we also see opportunities presented by the transition to a low-carbon future."
"Prudence, common sense, and fiduciary duty compel us to renew our efforts to examine and address the financial ramifications of climate change and to respond to climate challenges and opportunities. Accordingly, we hereby state our intentions to manage our investments; to engage companies, investors, and others; and to support policy action to the best of our abilities, in line with the following agenda:"
The Action Plan is accessible at INCR INCR and at Ceres.
Publicly traded businesses are coming under increasing pressure to comply with existing securities laws and regulations that require the disclosure of material exposures to environmental loss and liability. The U.S. Securities and Exchange Commission has been criticized and pressured by Congressional leaders to enforce those laws, with little response from the present administration. See, e.g. “SEC Pressed to Require Climate-Risk Disclosures” By Steven Mufson,
Washington Post, September 18, 2007; D01, and “Investors praise U.S. Senate leaders for pushing SEC to require full corporate disclosure of climate change risks,” Ceres, December 7, 2007.
DougSimpson.com/blog
"WASHINGTON, D.C. - April 19, 2007 - Senate Homeland Security and Governmental Affairs Chairman Joe Lieberman, (D-Conn.), and Ranking Member Susan Collins, (R-Me.), Thursday cautioned federal insurance providers to consider the impact of global warming when assessing property risk or face billions of dollars in possible damage claims - at a cost to the American taxpayer and the national debt."
"At a hearing entitled "Dangerous Exposure: The Impact of Global Warming on Private and Federal Insurance," the Senators examined the practices of two taxpayer funded programs, the National Flood Insurance Program, run by the Federal Emergency Management Agency (FEMA), within the Department of Homeland Security, and the Federal Crop Insurance Corporation, run by the U.S. Department of Agriculture. According to a report released at the hearing by the Government Accountability Office, both insurance programs have not developed a long-term strategy to deal with the potentially devastating and protracted effects of global climate change, putting them far behind private insurers that have incorporated these risks into their overall assessments."
Increasing costs of federal insurance programs (NFIP and FCIC) driven by climate change threaten long-term fiscal imbalance unless Congress acts, says the GAO.
Quoting from Abstract of GAO-07-760T, April 19, 2007 testimony:
"Weather-related events in the United States have caused tens of billions of dollars in damages annually over the past decade. A major portion of these losses is borne by private insurers and by two federal insurance programs-- the Federal Emergency Management Agency's National Flood Insurance Program (NFIP), which insures properties against flooding, and the Department of Agriculture's Federal Crop Insurance Corporation (FCIC), which insures crops against drought or other weather disasters. In this testimony, GAO (1) describes how climate change may affect future weather-related losses, (2) provides information on past insured weather-related losses, and (3) determines what major private insurers and federal insurers are doing to prepare for potential increases in such losses. This testimony is based on a report entitled Climate Change: Financial Risks to Federal and Private Insurers in Coming Decades are Potentially Significant (GAO-07-285) being released today."
"Abstract - Climate Change: Financial Risks to Federal and Private Insurers in Coming Decades are Potentially Significant, GAO-07-760T, April 19, 2007"
Contingencies has published a short article about finite risk transfer, an alternative method of managing risk that emerged from obscurity during recent inquiries into insurance company practices. Though it is powerful medicine that is safe when used as directed, abuse can lead to investigations, indictments and increased government regulation. "Finite Risk Transfer: May Be Habit Forming - Use Only As Directed" by Douglas Simpson.
The same March/April 2007 issue includes an article on "Climate and Hurricanes - What Happened in 2006?" by David A. Lalonde
Contingencies is published online and in print by The American Academy of Actuaries.
The U.S. District Court, E.D.La. has issued its opinion concerning whether the Water Damage Exclusion in a number of all risk policies precludes coverage for the policy holders for damage due to the Katrina Canal breach. To read that opinion, see Doc. No. 1803.
The Court has also posted an notice that it has learned that the Supreme Court of the United States denied writs on a Motion to Recuse Judge Duval.
Canal Cases webpage at website of the U.S. District Court - Eastern District of Louisiana
Both criticism and praise have greeted the Stern Review on the Economics of Climate Change, which forecasts the possibility that preventable climate change will cause economic harm like that of a global depression or a world war, and calculates that the cost of preventing it is a better economic bargain. Press Release re Stern Review on the Economics of Climate Change (Oct. 30, 2006). See also: Unintended Consequences: Stern Report "Optimistic" IF Governments Act (Nov. 1, 2006). Stern's prescription is controversial and criticisms like that in the Wall Street Journal find support in the economic literature, but the Economist concludes it doesn't matter. They argue that investing in prevention is an insurance premium that needs to be paid. Dirty Harry asked the same question in a different context.
(read more below the virtual fold)
Despite widespread praise of Sir Nicholas' report, especially in Europe, editors at the Wall Street Journal chose to publish and adopt the critical remarks of Bjørn Lomborg (Wikipedia, the free encyclopedia), a Danish statistician who is one of the more controversial climate skeptics around. In a 11/2/06 piece for the Journal, Lomborg agrees that climate change is real and human caused, but disagrees that it makes economic sense to focus resources on changing consumption patterns. As an example, he points to economic studies that cite likelihood of increased agricultural productivity in places like Sibera due to global warming.
As an editorial in the Economist notes, many economic analyses agree with Lomborg, and assess the cost/benefit of climate change using negative impacts in the range of 0%-3% of global output. Those studies suggest that the industrialized world populations might tend to come out neutral or gain, with the developing nations (more dependent on subsistence agriculture) being hurt. See "It May Be Hot in Washington, Too" (Economist, 11/2/06, p. 69).
This is consistent with studies such as those mentioned in today's New York Times Magazine, in Dubner & Levitt, "The Price of Climate Change : What Global Warming Might Do To Us" (p. 26). Dubner and Levitt are the authors of the popular book "Freakonomics," and more information about their article is on their website at Freakonomics in the New York Times: The Price of Global Warming - by Steven D. Levitt and Stephen J. Dubner (Nov. 5, 2006)
According to Dubner and Levitt, academic papers authored by Olivier Duschenes (U.C.S.B.) and Michael Greenstone (M.I.T.) examined the future of agriculture in the U.S., using long-range climate models to look out at the impact of climate change through the end of this century. According to the article, the 2004 paper forecast a net gain of about $1.3 billion in annual agricultural profits. The benefits, however, would not be uniform. Some states (New York, for example) will benefit at the expense of others (California, for example) who will suffer. You can read it yourself at: SSRN-The Economic Impacts of Climate Change: Evidence from Agricultural Profits and Random Fluctuations in Weather by Olivier Deschenes, Michael Greenstone (SSRN, July 2004)
But the whole story, even for the U.S., is not positive. Dubner and Levitt point out that Deschenes and Greenstone are just now polishing up a more recent article that looks at the likely effects of climate change on mortality in the U.S. toward the end of this century. They see a 1.7% increase in the death rate for American males and 0.4% increase in death rate for American females, totalling some 30,000 deaths a year. Most of this will be due to cardiac and respiratory problems made worse by hotter weather. The economic loss, they calculate, will be about $31 billion per year, according to the Times article. For more, see: Michael Greenstone : Papers
These conclusions about disparate impact even in the U.S. are consistent with other studies released just in the last year.
In February, the California Climate Change Center released a study commissioned by the California Energy Commission and the California EPA. It forecasts "serious risks" in the form of increased fires, floods and agricultural damage that can be moderated by prompt reduction in greenhouse gas (GHG) and other global warming pollution emitted by human use of fossil fuels. See: Unintended Consequences: Serious Risks to California from Climate Change: White Paper (October 16, 2006).
An October report from the Northeast Climate Impacts Assessment (NECIA), included a similar conclusion about the impact of heat, especially to vulnerable urban populations:
"While summer heat affects us all, extreme heat is a particular concern in big cities. Hot temperatures intensified by the urban heat island effect can create dangerous conditions, especially for the elderly, infants, the poor, and other vulnerable populations. * * * These projections show that conditions dangerous to human health could become commonplace in most of the region’s major urban centers over the course of this century." See: Unintended Consequences: Hotter Cities Will Endanger Health in Northeast States (October 6, 2006).
In his 2004 book, "Catastrophe: Risk and Reward," Richard Posner brings the Chicago school of law and economics perspective to the questions of how to respond to the threat of the sorts of catastrophes that threaten the survival of the human race: big asteroid hits, sudden global warming, terrorist-spawned pandemics and the like. Although remote, such events are possible; even a once-in-a-million-years event could happen tomorrow. There are measures that can be taken to prevent or protect against them. In this book, Professor Posner analyzes the cultural, psychological and economic factors that may explain what action is taken (or not taken).
Those cultural factors include what Posner calls "scientific illiteracy" and the problem of "limited horizons" by which politicians cut their own throat if they propose to raise taxes today to reduce the possibility of catastrophes in the far distant future. He points to the "economy of attention," the fact that the human brain can stay focused on only so many things at a time. This may justify disregarding the least likely risks, or the most complicated, as distractions from those more immediate or more understandable that face us daily.
According to Posner, "global decentralization" adds to the challenge. For example, while the wealthy industrialized countries are the biggest contributors to global warming, the poor countries near the equator are likely to be the principal victims. Yet the latter lack the financial ability to compensate the former for the costs of reducing greenhouse gases. Hence the refusal of the present U.S. administration to ratify the Kyoto Protocol.
He points also to Public Choice Theory, the body of scholarship "that tries to explain public policy as the outcome of rationally self-interested behavior." (Id. p. 133) He suggests that "(h)aving a limited time horizon, politicians prefer policies that yield tangible benefits for constituents in the near term." (Posner, Catastrophe, p. 137). To that, he adds the significant public doubt about the global warming threat, and the inertia of public policy, reminding readers: "Think of how, for many years, even slight scientific uncertainty enabled the tobacco industry to issue plausible denials that smoking was hazardous to health." (Id. p. 138). (For more about Posner's book, see Unintended Consequences: Reading: Posner, 'Catastrophe: Risk and Response' (2004))
In a page 12 editorial today, The Economist notes the widespread controversy over Sir Nicholas' report, and acknowledges that economists can dicker with Sir Nicholas' warning and prescription. They conclude that it does not matter, because the possibility that Sir Nicholas is right, and that Lomborg is wrong presents a risk of catastrophe that merits response in the nature of an insurance premium. The Economist closes their editorial by restating Sir Nicholas' central thesis:
"that governments should act not on the basis of the likeliest outcome from climate change but on the risk of something really catastrophic (such as the melting of Greenland's ice sheet, which would raise sea levels by six to seven metres). Just as people spend a small slice of their incomes on buying insurance on the off-chance that their house might burn down, and nations use a slice of taxpayers' money to pay for standing armies just in case a rival power might try to invade them, so the world should invest a small proportion of its resources in trying to avert the risk of boiling the planet. The costs are not huge. The dangers are."
Economics of climate change | Stern warning | Economist.com (Nov. 4, 2006).
Clint Eastwood's roughshod cop Dirty Harry Callaghan (1971) put it more concisely, to the armed bad guy he'd cornered after a hot pursuit:
"I know what you're thinking. 'Did he fire six shots or only five?' Well, to tell you the truth, in all this excitement I kind of lost track myself. But being as this is a .44 Magnum, the most powerful handgun in the world, and would blow your head clean off, you've got to ask yourself a question:
..... Do I feel lucky?
..... Well, do ya, punk? "
Marc Mayerson over at Insurance Scrawl writes an analysis of the recently announced deal by Berkshire to reinsure Lloyd's Equitas legacy exposures. Its contingent on some UK governmental assurances, but represents the kind of deal that Warren Buffett is so good at: taking the long view. Insurance Scrawl: Berkshire Hath A Way Out for Equitas and Lloyd%u2019s
Risk Prof is reporting on initiatives by particular insurers to address global warming. RiskProf : Global Warming Redux (Oct. 12, 2006).
To add to his developing list, a recent report from Ceres, "From Risk to Opportunity: How Insurers Can Proactively and Profitably Manage Climate Change," concentrates the role the insurance industry has played in developing responses to emerging risks. Just as they devised tools to deal with earthquakes, killer hurricanes and assure availability of insurance in hard-to-insure sectors, they have much to contribute to responding to global warming.
According the Ceres announcement of the release of the report, it "identifies 190 innovative products and services available or in the pipeline from dozens of insurance providers in 16 countries. Many provide win-win benefits, by reducing financial losses and greenhouse gas emissions. More than half of the activities come from U.S. companies, covering climate change solutions including energy efficiency, green building design, carbon emissions trading and sustainable driving practices." Ceres | Dozens of New Insurance Products Emerging to Tackle Climate Change and Rising Weather Losses (Sep. 7, 2006).
United States Attorney Kevin O'Connor announced a superseding indictment of four former Gen Re executives and one AIG senior executive arising from allegations of conspiracy, securities fraud, mail fraud and false statments to the SEC in connection with finite reinsurance transactions in 2000 and 2001. The defendants are accused of using the transactions in order to mislead investors as to AIG's financial situation.
Related charges were contained in a federal grand jury indictment returned in February 2006 in Norfolk Virginia. Venue was transferred to the District of Connecticut in April for the convenience of the parties. Press Release: "Gen Re and AIG Executives Charged in Superseding Indictment" (September 20, 2006).
A copy of the full 49-page indictment, with detailed allegations as the alleged overt acts, is accessible from a link in the press release or here: Superseding Indictment: United States of America v. Ferguson, et al, 3:06-CR-137(PCD)
Earlier references in Unintended Consequences regarding finite reinsurance and these actions include:
Unintended Consequences: Four Indicted in Finite Reinsurance Probe(Feb. 6, 2006)
Unintended Consequences: Wharton's Thoughts on AIG and "finite reinsurance" (April 7, 2005)
Unintended Consequences: "Finite Risk Reinsurance" background online (Nov. 24, 2004)
Unintended Consequences: Spitzer and SEC investigate "finite insurance" (Nov. 16, 2004)
Unintended Consequences: AIG targeted by US Grand Jury, AP reports (Oct. 22, 2004)
The Miami Herald points to the recent spike in business property insurance costs as threatening the continued strength of the South Florida economy. "The massive collapse of the hurricane insurance market for Florida businesses has morphed from an economic headache just weeks ago into a clear and growing threat to the region's economic vitality, experts say." MiamiHerald.com | 07/22/2006 | 'A crisis' for business in Florida (July 22, 2006)
Unlike homeowners, commercial property owners have no "insurer of last resort" provided by the State of Florida. Some businesses are "going bare," others are accepting higher deductibles or deliberately under-insuring their business properties. Others are talking about moving their operations out of South Florida. For some, lender restrictions leave them fewer choices.
The binge of building in the storm-threatened South Coast has for years depended on cheap insurance, short-sighted building codes and zoning decisions and deliberately subsidized federal flood insurance. See, e.g. Unintended Consequences: Government Policies Increase Hurricane Damage: Climatologists (July 26, 2006). It may not have seemed cheap at the time, as state and federal regulators and aggressive competition kept the cost of development and rebuilding low.
(read more below the fold)
Hurricane Katrina and Rita reminded insurers and reinsurers of the vulnerability of the coastal zone to really big storms that cause massive catastrophe losses. As a result, the "weak hands" have folded and left the game. Some insurers have been closed by the Insurance Department for lack of sufficient reinsurance, and others have voluntarily reduced their policycount and raised premiums, with the approval of the Insurance Department. Reinsurers, many of them European and Asian giants beyond the regulatory reach of local politicians, have brought back market discipline. See "Unintended Consequences: Reinsurance shortages shutter Florida insurers" (July 21, 2006)
Economic discipline is sometimes hard for the local economy and local politicians to accept. In similar situations, other states have given in to the temptation to install "quick fixes" to counteract natural free market forces. Those quick fixes may tax the general population to subsidize coastal insurance, may saddle insurers with the deficits of "residual market" plans, or may attempt to "lock in" insurers at inadequate rates or unreasonable terms.
Any of those choices only postpone the inevitable bill for costs of over-building in harm's way. The temptation is real to put those costs off to a later administration, to a time after the next election, after the next fiscal year. The temptation is real to "whistle past the graveyard" and hope that the next big one won't hit while you are underinsured or "bare." But the future eventually catches up, and yesterday's expedience becomes today's disaster.
As Knowledge Problem points out, the future has arrived in Queens, where years of politically expedient decisions to put off investment in electric generation and conservation infrastructure have caught up with hundreds of thousands of customers left for days without light, air conditioning or refrigeration during a lingering heat wave. Risk Prof comments: "Political institutions do not care about capacity (until it is too late) as long as prices are low. This is exactly the same problem Florida has for insurance and reinsurance capacity." RiskProf : Queen's Blackout is Related to Florida Hurricane Crisis (July 26, 2006).
Thanks to: RiskProf : More on Business Property Insurance in Florida (July 24, 2006)
Ten leading experts in climatology disagree on whether or not global warming is making hurricanes stronger. They do not disagree that continued development in coastal regions in harms way means that hurricanes will be more destructive in the future than they have in the past.
As they say in their statement: "Rapidly escalating hurricane damage in recent decades owes much to government policies that serve to subsidize risk. State regulation of insurance is captive to political pressures that hold down premiums in risky coastal areas at the expense of higher premiums in less risky places. Federal flood insurance programs likewise undercharge property owners in vulnerable areas. Federal disaster policies, while providing obvious humanitarian benefits, also serve to promote risky behavior in the long run."Climate Experts Warn of More Coastal Building - New York Times (July 25, 2006).
A copy of the statement signed by the experts is on the Kerry Emanuel's Homepage, Dr. Emanuel is a Professor of Atmospheric Science at M.I.T. and the author of "Divine Wind: The History and Science of Hurricanes" (Oxford Univerisity Press, Sept., 2005)
Florida insurance regulators took control of the first insurance companies lacking sufficient reinsurance in the face of the coming hurricane season. Florida Select writes about 70,000 homeowners policies and is the 20th largest insurer in the state, according to the Business Journal of Jacksonville. The list is expected to grow as global reinsurers pass through the expected cost of more damaging coastal storms. Once an insurer is declared insolvent and ordered liquidated, the cost of hurricane claims can be passed to the Florida Insurance Guaranty Association (FIGA), which passes them in turn to all other insurers continuing to write in the state. Reinsurance crisis may spark more takeovers - The Business Journal of Jacksonville: (July 17, 2006).
State Farm received approval of an average 52% rate increase for homeowners and 70% for condominium owners, with the biggest increases in coastal areas. According to the South Florida Sun-Sentinel and other media outlets. The cost and availability of reinsurance is driving the increases, which are as much as 94% in parts of Brevard County. Following Katrina, reinsurers are rebuilding capital and surplus and re-assessing risks and the likelihood of increasing damage from coastal storms. State Farm rate hikes hit coast hardest - Orlando Sentinel : State News State Farm rate hikes hit coast hardest - Orlando Sentinel : State News (July 19, 2006)
The second severe storm in a week struck St. Louis this week, leaving 200,000 electric customers without power, days after over 500,000 were blacked out. Ameren, the local power company for over a century, said the earlier storm was "the worst storm in company history," almost half of its 2.4 million customers in two states were out. New storm socks Ameren St. Louis customers - Yahoo! News (July 21, 2006).
Many climatologists associate global warming with increased hurricane activity and more intense thunderstorms and inland flooding, as warmer oceans put more water vapor into the warmer atmosphere. For additional readings on the reaction of the global insurance community to the climate changes brought on by human activities increasing greenhouse gases in the atmosphere, see: Unintended Consequences: Insurers "Feeling the Heat" of Climate Change (July 9, 2006)
The present and future crisis of climate change, already driving up insurance losses, threatens investment portfolios as well. Insurance companies have been described as a combination of risk spreader and mutual fund. As such, they face a compound exposure. First, from increased losses due to stronger and less predictable windstorms, wildfires and floods. Second, due to the coming decline in value of investments in companies unprepared for the change in climate or regulatory response.
Joel Lang, in "The Insurance Industry is Feeling the Heat of Global Warming," Hartford Courant, Northeast Magazine (July 9, 2006) provides a concise briefing on the responses of leading insurance giants and public investment managers, including Lloyds of London, Marsh, Inc., American International Group (AIG), Risk Management Services (RMS), the investment coalition Ceres and the State of Connecticut's Treasurer Denise Nappier.
Ceres, an investor coalition formed to promote environmentally responsible corporate actions, offers Ceres Publications that include Availability and Affordability of Insurance Under Climate Change: A Growing Challenge for the U.S. (Dec. 2005), which includes a postscript on Hurricane Katrina.
One of its authors, Even Mills of the U.S. Department of Energy, wrote "Insurance in a Climate of Change," (Science, 12 August 2005), in which he described the $3.2 trillion insurance industry as a "lightning rod" for disruptions to the global economy.
Ceres manages INCR, Investor Network on Climate Risk, of which the State of Connecticut is a member. State Treasurer Denise Nappier, fiduciary of $23 billion in Connecticut retirement and trust funds, is one of the INCR participants pushing for greater disclosure of climate change risks by publicly held companies. INCR News - "$1 Trillion of Investors Call on SEC To Require Corporate Disclosure on Financial Risks of Climate Change" (June 14, 2006).
At Marsh, Inc.'s resource page on climate change, it offers a Risk Alert - Marsh - "Climate Change: Business Risks and Solutions" - that looks at the complex global issue from a risk management perspective. (free download, online registration required). Marsh affiliate NERA Economic Consulting provides additional information on the economic impact of climate change. NERA Economic Consulting | Focus Area.
Lang's article quotes AIG's policy statement accepting the reality of human-driven climate change: "AIG recognizes the scientific consensus that climate change is a reality and is likely in large part the result of human activities that have led to increasing concentrations of greenhouse gases in the earth's atmosphere." AIG’s Policy and Programs on Environment and Climate Change
Lloyd's of London, an important source of reinsurance and catastrophe insurance, has warned insurers in a May 6, 2006 press release that they "must act now to understand and actively manage risks from emerging threats such as greenhouse gases and rising sea levels. With recent scientific evidence suggesting that climate change is happening faster than previously thought, investment in research and a change in industry behaviour is long overdue." The warning is in Lloyd's report "Climate Change: Adapt or Bust".
At a June, 2006 conference, the National Association of Insurance Commissioners (NAIC) resolved to ask Congress to create a Natural Catastrophe Preparedness Commission. 2006 Amended Resolution in Support of a Comprehensive Legislative Solution To The Problems Presented by Natural Catastrophic Exposures For the Benefit of All Americans
Apartment owners in New Orleans face dramatic insurance price hikes on renewal, as insurance capital withdraws from the Gulf Coast wind exposure. While they can turn to the Louisiana Citizens Property Insurance Corp at higher prices, or self-insure, local business people see the higher costs as restricting development in New Orleans. Apartment premiums skyrocket -- New Orleans CityBusiness -- Deon Roberts, July 3, 2006.
The market for "cat bonds," debt securities that respond to catastrophes such as hurricanes and earthquakes, nearly doubled following Hurricanes Katrina, Rita and Wilma. The alternative risk transfer mechanism steps in when reinsurers withdraw from the market, a recurring market dynamic following a catastrophe. Katrina alone cost insurers $38 billion, of which reinsurers absorbed $20 billion, with some threatened with insolvency, according to Global insurers shift more risk to bond market | Reuters.com (June 23, 2006)
Bob Sargent wrote about these market forces shortly after Katrina, in: Specialty Insurance Blog: Katrina Chat (Sep 21, 2005).
In November 2005, Risk Prof provided some insights and useful links to theoretical models explaining insurance price increases resulting from Katrina, Rita and Wilma. Capacity constriction and costs of raising new capital suggested that existing insurers would pull back and build capital internally. At the same time, new capital is emerging in new reinsurers, some backed by hedge funds. Though insurance consumers and their elected representatives are likely to be unhappy, this looks like the capitalist system at work. RiskProf: Explaining Price Increases Post-Katrina (November 16, 2005).
For more on the Gulf States' "wind pools," see: Unintended Consequences: Impact of Katrina on Gulf states' wind pools (Sep. 17, 2005)
Insurance Managers face the inconvenient truth that global warming will continue driving increased rainfall in interior of the Eastern United States, as well as stronger and more frequent tropical windstorms hitting coastal regions. National Resources Defense Council - Global Warming Fact Sheet See also the EPA's fact sheet on global warming impact on North America.
The National Flood Insurance Program is already financially exhausted due to the combination of Hurricane Katrina and Congressional decisions to subsidize coastal and floodplain development by providing below-cost insurance guaranteed by the taxpayer. "NFIP current financial condition unsustainable: CBO", Unintended Consequences (June 6, 2006). See also "GAO re Katrina: 1993 Andrew Advice Still Holds; NFIP 'essentially bankrupt'", Unintended Consequences March 8, 2006.
Congress is now considering program changes that will raise premiums, increase deductibles and make coastal development and post-Katrina rebuilding more expensive. According to the Washington Post, "The House voted 416-4 Tuesday [June 27) to phase out subsidies on some vacation homes and commercial property and raise premiums at a faster rate. The bill also increases the amount of coverage a property owner can buy and boosts fines for mortgage lenders who don't tell customers they have to buy flood insurance."
Back in the 1920's, it was not coastal storms that caused the biggest natural disaster ever experienced by the United States. It was an unrelenting series of interior rainstorms that persisted month after month, saturating the Mississippi River basin and finally overtopping levees, sending an inland sea throughout the Delta. This led to uncounted deaths, mostly of rural poor blacks, untold human misery and massive relocation of the population of the lower Delta to northern cities. John M. Barry's book "Rising Tide: The Great Mississippi Flood of 1927 and How It Changed America (1998) documents this nation-changing event. See New Orleans lawyer-blogger Ernest Svenson'scomparison of the Great Flood of 1927 to Katrina in the "Ernie the Attorney"
No one can say for sure that the inland storms and flooding that have hit the Northeast in the last few months (New England in the Fall of 2005 and the record-breaking MD-PA-NJ-NY inland rainstorm of June 2006) are caused by global warming. The consensus of climatologists is that the likelihood of such climate chaos is increased by rising ocean temperatures and the resulting increase in atmospheric moisture.
Insurance managers and legislatures must consider that the actuarial costs of windstorm and flood insurance are likely to increase, not diminish, that the recent disasters may not be "outliers" but rather fore-runners of worse to come. They must decide whether to price private and government programs realistically or to cave to market and political forces to take the cheap solution.
Private managers have the discipline of the private reinsurance market and shareholders to keep them rational. We already are seeing the effects of that as private windstorm insurance becomes more expensive and harder to get, with fewer providers.
Government programs have only the discipline of the ballot box, which is dependent on the electorate. We will see if the political will exists to accept the inconvenient truth that subsidizing those who build on sand has longterm unintended consequences.
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Cat 3, 4 or 5 hurricanes hitting highly developed east coast areas could result in $100 billion in insured losses, bankrupting 20 to 50 insurance companies, according to a new A.M. Best study. After Hurricane Andrew hit Florida in 1992, multiple insurers concentrated in the Florida market failed; their failures triggered a cash crisis in the insurance guaranty fund that back up failed insurers. The impact of a big storm hitting highly developed areas today would be four times that of Hurricane Andrew.
The new studies combined risk modelling tools, data about the build-up of property values along areas such as Florida and the Jersey Shore-Hudson River area and interviews with insurance leaders to develop models of the impact of a major storm that hit such areas. A major hurricane landfall in the U.S. has been estimated by some climatologists as 55% above average for the hurricane season about to start. "Thinking the Unthinkable: How 'Mega-Cats' May Bruise Insurers," A.M.Best, (May, 2006).
See also: A.M. Best: A 'Mega-Cat' Hurricane Would Be Fatal to Some Insurers, Insurance Journal (June 1, 2006).
Thanks to Specialty Insurance Blog: AM Best Hurricane Study (June 4, 2006)
UCONN Law School's Sean Fitzpatrick argues that contingent commissions for insurance agents have been used for a century because they are effective and efficient, and good for consumers as well as the insurance industry. His Fordham Law Review article, published in SSRN, reviews the recent investigations by Eliot Spitzer and the limited legislative response in states. He also provides a useful primer on the history and economics of the business of insurance.
He touches on theories introduced in one of his earlier articles that perverse incentives internal to insurance broker and company organizations may have led to the serious malfeasance acknowledged by several national brokerages and insurance companies. Explorations of such perverse incentives may also be of interest to students of public choice theory, the recurring failure of governments to respond to impending disasters such as hurricanes, earthquakes or global warming, and the general challenges of external costs in complex systems subject to "the tragedy of the commons." Fitzpatrick's views were addressed in more detail in "Fear is the Key: A Behavioral Guide to Underwriting Cycles," 10 Conn.Ins.L.J. 255 (2003-2004), which can also be found on SSRN at http://papers.ssrn.com/abstract=690316 and was briefly summarized in an earlier posting in this place: Unintended Consequences: Lloyd's Boss Prays for Insurance Underwriting Profit (April 9, 2005).
Fitzpatrick argues that banning contingent commissions could have the unintended consequence of hurting the competitiveness of small, local, independent insurance agents and driving increased consolidation into large, national brokerage houses like Marsh and Aon. He closes with a practical suggestion for a requirement of disclosure of contingent commissions comparable to that found in the real estate industry. SSRN-The Small Laws: Eliot Spitzer and the Way to Insurance Market Reform, Sean Fitzpatrick, University of Connecticut School of Law, Fordham Law Review, Vol. 74, pp. 3041-71, 2006.
Thanks for the tip about this new article to Specialty Insurance Blog: Contingent Compensation (May 26, 2006).
Zurich American Insurance (ZA) will pay $172 million in a multi-state settlement of charges regarding "contingent commissions" paid to agents and brokers. Multiple states will participate in the funds. The deal follows a similar one recently reached with insurance broker giant Marsh & McLennan.
Although ZA admits to no wrongdoing, it commits to commission disclosure standards, a compliance program and continuing cooperation with state attorneys general and insurance authorities. Insurance Commissioner John Garamendi Announces Landmark Settlement with Zurich American Insurance Co. to End Practice of Paying Secret Commissions (March 20, 2006)
The text of the settlement is available here.
A November 2004 backgrounder on Broker/Agent Compensation is available at the Insurance Information Institute, including an analysis of a Consumer Federation of America Report on Contingent Commissions.
Florida's CFO Tom Gallagher filed a civil racketering suit against Marsh & McLennan based on allegations of bid-rigging and "contingent commissions" detailed in a Settlement Agreement over a year ago. Marsh representatives have protested that the suit is in derogation of signed releases pursuant to that agreement. Mr. Gallagher's office claims that the $850 million settlement, negotiated by New York Attorney General Spitzer for the benefit of multiple states' residents, left money on the table for which Mr. Gallagher can now sue.
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In May of 2005, Marsh & McLennan Companies (MMC) released its 10-Q for the quarter ended March 31, 2005. Page 18 through 31 details various "Claims, Lawsuits and Other Contingencies". This included information about the January 30, 2005 Settlement Agreement with the New York Attorney General (NYAG) and the New York State Insurance Department (NYSID) regarding allegations of bid-rigging in the placement of commercial insurance. Pursuant to that Settlement Agreement, MMC set up a $850 million fund for policyholders and agreed to various business reforms. Several former MMC employees pled guilty to felony charges also disclosed in that document. The settlement provided for monies from the fund to be distributed to policyholders outside of New York through state authorities that agreed to the settlement.
The document also disclosed various ongoing civil actions on behalf of investors who alleged that MMC inflated its earnings by the use of allegedly improper "contingent commissions" and the bid-rigging alleged in the NYAG And NYSID charges. The disclosure also pointed out that the AGs in 20 other states and the government of Australia had initiated separate investigations. 10Q_1stQtr_05.pdf (application/pdf Object)
On March 13, 2006, the California Attorney General agreed to accept approximately $100 million out of the $850 million settlement. Insurance Commissioner John Garamendi Reaches Settlement With Broker to Enforce An End to Harmful Secret Commissions
Despite entering a release in connection with that Settlement Agreement, the State of Florida's CFO, Tom Gallagher, has filed suit on behalf of Florida policyholders against MMC based on the same facts, and alleging racketeering violations. In a March 14, 2006 press release, Mr. Gallagher's office said that:
"According to Gallagher, Marsh and its affiliates brokered approximately 15,000 insurance contracts in Florida between 1998 and 2004 for public entities and private businesses in Florida.
Gallagher said the Department’s complaint charges Marsh and three of its affiliated companies with numerous violations of Florida’s Racketeer Influenced and Corrupt Organization (RICO) Act. Specifically, the complaint accuses Marsh of engaging in a pattern of racketeering activity, including soliciting hidden payments in the form of contingency commissions, and steering hundreds of millions of dollars in business to insurance carriers willing to 'pay-to-play.'"
According to the FLDFS press release, the complaint can be read at The Florida DFS Press Office.
MMC representatives protested the move by Florida's Gallagher, according to a March 14, 2006 article in National Underwriter Property & Casualty. According to that article, Mr. Gallagher believes “the Spitzer settlement did not fully compensate the entities harmed by Marsh’s conduct.” According to The National Underwriter, MMC stated that “This complaint should never have been filed. It distorts the facts and disregards the events of the past 18 months and ignores releases signed by the State of Florida itself,” In response, although acknowledging that Florida government agencies and MMC clients signed releases for the New York settlement, Mr. Gallagher alleged that he “retains and is exercising his authority to seek full restitution for any Florida entity, public or private, that was harmed by Marsh’s conduct.”
The Government Accountability Office released a 50-page "Preliminary Observations" report to a Senate Subcommittee examining the government response to Hurricanes Katrina. Comptroller General David M. Walker made clear that recommendations made following Hurricane Andrew remain unimplemented and remain good advice, the federal flood insurance program is "essentially bankrupt," and government and private sector leadership does not agree on how best to provide a financial cushion against future "mega-catastrophes."
Some excerpts from Hurricane Katrina - GAO's Preliminary Observations Regarding Preparedness, Response, and Recovery - GAO 06-442T (March 8, 2006) follow.
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2005 Hurricanes re-teach same lessons taught in 1992 and 1989.
Unfortunately, many of the lessons emerging from Hurricanes Katrina and Rita are similar to those we identified more than a decade ago, in the aftermath of Hurricane Andrew in 1992, which leveled much of South Florida. The experience of Hurricane Andrew raised questions about whether and how national disaster response efforts had incorporated lessons from experiences with Hurricane Hugo in 1989. All critical players must do much more to learn from past mistakes and actually implement recommendations that address prior deficiencies in preparing for and responding to catastrophic disasters. However, these actions will not be cost-free—posing a range of challenges in determining the priority of various action steps and how they will be funded. Ibid. p. 2
"In 1993, we conducted several reviews examining the federal response to Hurricane Andrew. The reviews focused on the unique challenges involved in responding to 'catastrophic disasters.' These reviews defined “catastrophic disasters” as a subset of other disasters requiring federal assistance. Unlike the bulk of the disasters requiring FEMA to respond, catastrophic disasters can overwhelm the ability of state, local and voluntary agencies to adequately provide victims with essential services, such as food and water, within 12 to 24 hours. These prior GAO reports focused on improving the immediate response to catastrophic disasters, and we made various recommendations within this context. We recommended that, in a catastrophic disaster, (1) a single individual directly responsible and accountable to the President should be designated to act as the central focal point to lead and coordinate the overall federal response when a catastrophic disaster has happened or is imminent, (2) FEMA should immediately establish a disaster unit to independently assess damage and estimate response needs following a catastrophic disaster, and (3) FEMA should enhance the capacity of state and local governments to respond to catastrophic disasters by (a) continuing to give them increasing flexibility to match grant funding with individual response needs, (b) upgrading training and exercises for catastrophic disaster response, and (c) assessing each state’s preparedness for catastrophic disaster response. We also recommended that Congress should consider (1) giving FEMA and other federal agencies explicit authority to take actions to prepare for catastrophic disasters when there is warning and (2) removing statutory restrictions on DOD’s authority to activate Reserve units for catastrophic disaster relief." Id., p. 3
"Unfortunately, some of these recommendations were not adopted or in effect when Hurricane Katrina hit the Gulf Coast. We continue to believe, for the most part, these recommendations are still viable, as we discuss later in this testimony." Id., p. 3
National Flood Insurance Program (NFIP) "Essentially Bankrupt"
"The federal flood insurance program faces major financial difficulties challenges (sic) as the Gulf Coast recovers. The program is essentially bankrupt. FEMA officials estimate that Hurricanes Katrina and Rita will result in flood insurance claims of about $23 billion, far surpassing the total amount of claims paid in the entire history of the National Flood Insurance Program (NFIP) through 2004." Id., p. 38
The magnitude and severity of the flood losses from Hurricanes Katrina and Rita overwhelmed the ability of the NFIP to absorb the costs of paying claims, providing an illustration of the extent to which the federal government is exposed to claims coverage in catastrophic loss years. Id., p. 38
Government "Backstops" or Private Sector Solutions?
The GAO also noted that Hurricane Katrina affected the insurance industry's ability and willingness to provide insurance coverage for catastrophes, and mentioned competing proposals for private sector solutions and TRIA-like government "backstops."
"The National Association of Insurance Commissioners (NAIC) is considering a broad national plan that would create a mechanism to handle disasters, especially those larger than Hurricane Katrina. The plan proposes a public-private partnership that would reward hazard mitigation and spread catastrophic risk broadly among individual insureds, insurers, reinsurers, state reinsurance funds, and the federal government, according to NAIC. The federal government could provide a top layer of protection by acting as a reinsurer of last resort or, alternatively, by providing financial capacity to a multi-state risk pooling mechanism that could borrow from the federal government should catastrophic losses exceed the pool’s accumulated funds. This plan is similar in scope to the Terrorism Risk Insurance Act (TRIA), which Congress enacted to create a program of shared public and private compensation for insured losses attributable to acts of terrorism. Under the NAIC plan, however, taxpayers would presumably not have to pay for losses.". Id., p. 42.
"However, some in the insurance industry oppose additional government involvement and others have set forth alternative proposals. Some insurance company representatives believe that the private market for catastrophic coverage for natural events continues to exist and that insurance costs should be based upon free market principles. Still others have proposed that insurance companies be permitted to set aside additional catastrophic disaster reserves on a pre-tax basis. Supporters of tax-deductible reserves argue that the tax-free status would give insurers a financial incentive to increase their reserves and expand insurers’ capacity to cover catastrophic risks and avoid insolvency." Id., p. 42.
The full text of the Comptroller General's "Preliminary Observations" to the Senate Homeland Security and Governmental Affairs Subcommittee is at: Hurricane Katrina - GAO's Preliminary Observations Regarding Preparedness, Response, and Recovery - GAO 06-442T (March 8, 2006)
American International Group (AIG) agreed to pay over $1.6 billion to settle allegations of fraud, bid-rigging and improper accounting brought by the State of New York and the S.E.C. Below are links to the press releases and the original settlement agreement and S.E.C. complaint.
AIG Settles Fraud, Bid-rigging And Improper Accounting Charges (Press Release - New York State Ins. Dept., Feb. 9, 2006)
Signed Settlement Agreement (PDF - 56 pages) (Dated Jan. 18, 2006, announced Feb. 9, 2006).
The Settlement Agreement references a Summons and Complaint (PDF, 38 pages) filed May 26, 2005.
AIG to Pay $800 Million to Settle Securities Fraud Charges by SEC; Press Release No. 2006-19; February 9, 2006 (U.S. Securities and Exchange Commission)
SEC v. AIG Complaint 06 CV 1000(PDF - 29 pages)(filed Feb. 9, 2006)
Thanks to Marc Mayerson's Insurance Scrawl for the pointer to these primary sources on AIG's settlement. Insurance Scrawl: AIG Settles NY State Charges and Buys Insurance Against Future Liability (Feb. 9, 2006)
Some research on the tension between federal and state ambitions in insurance regulation was posted in June 2005. It focused on hearings held about that time that focused on long-standing issues with Optional Federal Charter for Insurers ("OFC"), Oxley “Road Map” and “SMART” Bill, and NAIC Responses to Federal Initiatives ("Interstate Compact").
Unintended Consequences: Hearings on "SMART" : Federalizing insurance regulation? (June 23, 2005)
It may be of interest to those following the story about a U.S. Treasury spokesman who was again advocating a greater federal role in insurance regulation at a recent NAIC meeting. Specialty Insurance Blog: Federal Insurance Regulation
To repeat my editorial views on the subject from June 2005:
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One of the strengths of complex systems is the capacity of its components to interact independently because of the existence of diversity. That independence has repeatedly been shown to protect the overall system from vunerability to unexpected consequences that lead to cascading failures in "monoculture" systems that are highly interlinked. (See: Unintended Consequences: Reading: Barabasi, Linked: The New Science of Networks (2003))
The vulnerability of monoculture systems to catastrophic results of otherwise survivable errors or attacks has been observed again and again, from the Irish Potato Famine (Fraser, "Conservation Ecology: Social vulnerability and ecological fragility: building bridges between social and natural sciences using the Irish Potato Famine as a case study" (2003) to the recent New England electrical blackout (Unintended Consequences: Blackout Report: Maintenance, Training and Communication Errors (2003). During the Blackout of 2003, only the systems that were able to independently decide to disconnect from the "efficiency" of the centralized, unified controls avoided being sucked into the collapse of the highly connected network.
Looking back on decades of ill-conceived centralized government "solutions" to insurance availability and affordability "crises" in state after state, in automobile insurance, workers compensation insurance, medical malpractice insurance and product liability insurance, we see a record of attempts to solve political problems with price controls and lock-ins that caused long-term damage to the whole economic system. If our decentralized insurance system gets federalized, mistakes that would have an impact on only one state may impact every insurance transaction in the entire nation. Time will tell if the game of "chicken" going on between state and federal regulators has a net positive or negative effect. Whatever happens, I'm counting on unintended consequences.
Today, I can also add the caution that the federal agency with the most experience in insurance is FEMA, which runs the National Flood Insurance Program (NFIP). A GAO report in 2003 found serious financial challenges with NFIP unmet by federal regulators. See Unintended Consequences: 2003 GAO Report on Financial Challenges to NFIP (Sep. 16, 2005). Within weeks after Hurricane Katrina, the NFIP had run out of funds and was unable to pay claims without massive borrowing authority from the Congress. Unintended Consequences: FEMA, out of funds, freezes flood insurance payments (Nov. 19, 2005). One must consider if a catastrophe performance like FEMA's in 2005 is what we can expect to result more frequently as a result of federal insurance regulation.
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Grand jury indictments and an SEC civil enforcement action were filed by the United States on February 2, 2006 against individuals alleged to have used finite reinsurance contracts to help AIG mislead its investors about its loss reserves. Individuals named in the indictment were Ronald Ferguson, Elizabeth Monrad and Robert Graham formerly of GenRe and Christian Milton formerly of AIG. Also named in the enforcement action complaint but not in the indictment was Christopher Garand formerly of GenRe.
According to a press release by the SEC:
"The complaint details recorded conversations among the defendants and other evidence reflecting the planning and implementation of the sham transaction. On the basis of this evidence, the complaint charges that the defendants understood from the beginning that they were structuring a sham transaction involving the creation of phony documents for the purpose of providing apparent support for false accounting entries AIG made on its books."
http://www.sec.gov/news/press/2006-15.htm
The 40-page complaint in the enforcement action is here:
http://www.sec.gov/litigation/complaints/comp19552.pdf
The Department of Justice press release regarding the indictments in the Eastern District of Virginia is here:
http://www.usdoj.gov/opa/pr/2006/February/06_crm_057.html
Earlier references in Unintended Consequences regarding finite reinsurance and these actions include:
Unintended Consequences: Wharton's Thoughts on AIG and "finite reinsurance" (April 7, 2005)
Unintended Consequences: "Finite Risk Reinsurance" background online (Nov. 24, 2004)
Unintended Consequences: Spitzer and SEC investigate "finite insurance" (Nov. 16, 2004)
Unintended Consequences: AIG targeted by US Grand Jury, AP reports (Oct. 22, 2004)
The insurance industry can recover from a terrorist attack, although a large insurer may be disrupted, according to a recent GAO study of insurers, regulators and the NAIC. Impairment of a large insurer would not likely spread due to the limited interdependency between insurers and the absence of a central clearing function. The insurance industry differs from the securities industry in this way. Although insurers increasingly outsource certain business functions, regulators have not regularly audited such service functions, according to the GAO report.
GAO Report 06-85, November 18, 2005 (37 pages) GAO: Summary
USA Today reports that FEMA has suspended payments of flood insurance claims until the Congress approves more funding. Those "Write Your Own" insurers that are adjusting claims have limited lines of credit and may choose not to front funds on their own credit. USATODAY.com - FEMA halts flood insurance payments
Marc Mayerson, in Insurance Scrawl, has collected a few cases pertinent to the cash crunch, which has serious consequences on those awaiting flood insurance settlements. Insurance Scrawl: Stranded without Recourse: FEMA Halts Payment of Flood-Insurance Claims
Events like this may bring home the reality of federally-subsidized insurance that encourages development in disaster-prone areas. Debate over long term cost/benefit will be healthy, but is not likely to be calm or detached.
This development is also likely to aggravate the controversy over efforts to override flood exclusions in conventional windstorm policies.
Risk Prof provides some insights and useful links to theoretical models explaining insurance price increases resulting from Katrina, Rita and Wilma. Capacity constriction and costs of raising new capital suggest that existing insurers will pull back and build capital internally. At the same time, new capital is emerging in new reinsurers, some backed by hedge funds.
Though insurance consumers and their elected representatives are likely to be unhappy, this looks like the capitalist system at work. RiskProf : Explaining Price Increases Post-Katrina
David Stratton has compiled a useful set of links with some commentary, regaring the "History of Flood Insurance".
You'll find it in his Insurance Defense Blog.
Hurricane Katrina's liability implications will be examined in a half-day panel discussion organized by the American Enterprise Institute in Washington D.C. on Monday, October 3, 2005. The Mississippi Attorney General's suit to invalidate the flood exclusion in homeowners policies will be on the agenda. AEI - Events - Katrina's Liability Implications
The panel, moderated by AEI resident fellow and Liability Project director Ted Frank, will include Robert W. Klein, former chief economist for the National Association of Insurance Commissioners and current director of the Center for Risk Management and Insurance Research at Georgia State University; Martin F. Grace, Georgia State University professor and associate director of the university’s Center for Risk Management and Insurance Research; Adam Scales, a Washington and Lee University professor who specializes in tort and insurance law; and Joanne Doroshow, president and executive director of the Center for Justice & Democracy and co-founder of Americans for Insurance Reform.
RiskProf : Ex Post Flood Insurance compares finite insurance to the ex-post flood insurance concept floated in Mississippi. Taylor plans bill to help residents without flood insurance - The Clarion-Ledger (Sep. 27, 2005)
The analogy is tempting, and promotes thoughtful debate, but a few differences occur to me.
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Those who sell finite insurance, and finite reinsurance, typically are smarter and bigger than the average bear: Warren Buffet's National Indemnity comes to mind. Not always smarter, though: Warren Buffet's Gen Re comes to mind, too. That means they take so little risk, they sometimes get investigated for participating in a sham transaction. See: Unintended Consequences: Spitzer and SEC investigate "finite insurance" (Nov. 16, 2004)
Although such transactions are usually quiet and private, we know from public disclosures made in connection with Atty. Gen. Spitzer's investigations and SEC filings (as well as some infamous insolvenies such as Reciprocal of America) that they usually involve the up-front transfer from buyer to seller of most or all of the money that the insurer/reinsurer expects to pay out.
The benefit to the assuming company from finite insurance or reinsurance is that they get a nice premium with so little exposure that they sometimes have to scratch and wriggle to find enough insurance or credit risk to persuade their lawyers that it really is insurance, and not a disguised loan.
The benefit to the ceding company is mostly due to the magic of tax accounting and "statutory" accounting. It enables an insurer facing a big income statement hit to disguise or "rationalize" it as a surplus haircut. The potentially material distortion of earnings is what excites some CEOs, the SEC, and the disappointed creditors of the ceding companies that don't survive.
Homeowners and small business owners are not in the same circumstances. They are less worried about tax and statutory accounting and being eyeballed by a suspicious regulator than they are about not having the cash to rebuild and have a place to live. Unlike the cedents in a "finite insurance" transaction, they are not long on assets and short on earnings.
If these homeowners and small business owners don't pay for all of the retroactive insurance up front, the credit risk from this promise to pay flood insurance "forever" sounds like the drowning man's promise to God: "Save me Lord, and I'll go to services forever! I swear!" Some keep it, but a lot don't.
Without some obligation that "runs with the land" and "binds the assignees" (like the proverbial Fee tail), what is to prevent the newly liquid owner of a moldy shell that was once a house from collecting his retro flood coverage, paying off the mortgage, selling his plot to the friendly neighborhood condo/casino developer and then taking the money to a new parcel?
Haven't thought this all through, but I've had enough experience with insurance sold on credit to know that when the bill goes unpaid, there is often a lot of money that is left "Blowin' in the Wind," sometimes leaving the insurer "Waist Deep in the Big Muddy".
And thanks, RiskProf, for the link to Unintended Consequences: "Finite Risk Reinsurance" background online (Nov. 24, 2004). I've "got your six," good buddy.
Doug Simpson is a Connecticut lawyer who spent 25 years with the law department of a major insurance company and who now practices and teaches law and writes occasionally about disruptive technologies, networks, and insurance law in his weblog, Unintended Consequences.
This Congressional Research Service report introduces its subject: "Some insurance and disaster policy experts suggest the time has come to implement a federal insurance or reinsurance program for earthquakes and other seismic risks. Conversely, other experts question the need for such a program."
* * *
And summarizes its conclusions: "Given that the states have acted to provide catastrophe funding for the small to moderate-sized hurricane and earthquake, Congress might consider a strict economic approach that calls for fairly mild reforms of the insurance industry — that still allows the possibility of people being uninsured (and not getting relief), and thereby uses that outcome to encourage the public to engage in loss-prevention measures. Alternatively, Congress might consider a potentially economically less efficient approach that calls for the creation of a federal disaster insurance system at the higher layers of coverage. Such legislation might, however, result in overinvestment in hazard-prone areas. In pursuing this potentially less efficient solution, the approach might be one of finding the least expensive way of making sure everyone is protected from major economic losses from natural disaster."
CRS Report for Congress: Tsunamis and Earthquakes: Is Federal Disaster Insurance in Our Future? (April 6, 2005).
H.R. 846, a bill introduced in the House, would provide a federal reinsurance facility to enhance availability of homeowners insurance despite catastrophic loss exposures. Introduced before Hurricane Katrina hit, the bill is now attracting more attention. Bill Summary & Status
According the the summary by the Congressional Research Service, the bill calls for the creation of a Disaster Reinsurance Fund and a National Commission on Catastrophe Risks and Insurance Loss Costs.
The state-managed California Earthquake Authority (CEA) wants to increase the low percentage of homeowners now buying earthquake insurance. Presently, less than 15% obtain the coverage, down about 50% from the year after the Northridge Quake. Before Hurricane Katrina, that quake was the costliest disaster in the U.S., according to "Calif. May Lower Quake Insurance Rates in Wake of Katrina" (Insurance Journal, Sep. 25, 2005).
Under the CEA's propsed rate filing, prices for quake insurance would go down in most places in California, up in a few areas. Commissioner Garamendi argues that lower prices will increase the number of homeowners who buy the coverage. Commercial insurance trade associations argue that the prices are not conservative enough and will imperil the financial health of the CEA, according to the article.
According to the Southern California Earthquake Center (SCEC), a quake in the recently discovered Puente Hills fault under Los Angeles could result in thousands of deaths and $250 billion in damage, although it is an infrequent event. Major Losses of Up to $250 Billion Projected for Earthquakes on Puente Hills Fault Under Los Angeles. SCEC works closely with the CEA and private insurers and provides educational materials discussing issues of earthquake insurance availability, affordability and "take-up" rates. Earthquakes and Insurance, Then and Now
See also: USGS Response to an Urban Earthquake-Northridge '94
And: Insurance Information Institute - Earthquakes: Risk and Insurance Issues
The Texas Department of Insurance and its Commission on Environmental Quality include on their websites warnings about the importance of flood insurance because ordinary insurance does not cover flood. Links to just two follow.
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The D.O.I., following Tropical Storm Allison, placed an advisory on its website concerning flood and windstorm damage:
"Two basic principles apply to flood coverage:
* Homeowners and other residential property policies don´t cover flood. National Flood Insurance Program policies, sold by local agents, can fill this gap.
* Automobile policies with "comprehensive" coverage pay for flood damage. Because "mobilowners" policies on manufactured homes technically are auto policies, they, too, generally cover flood damage. However, insurers may exclude flood coverage for manufactured homes in Texas´ 14 coastal counties."
Texas Department of Insurance - Flood Raised Insurance Questions
The Texas Commission on Environmental Quality points visitors to its website to "The National Flood Insurance Program: How to Join and How it Works (PDF). From page 5 of this 16-page brochure emphasizing the cost of flooding in Texas and the importance of participation in the NFIP:
"In 1999, the Texas Legislature passed a law that requires the governing bodies of each city and county in Texas to take the necessary action to become eligible for participation in the National Flood Insurance Program by January 1, 2001. Devastating floods in Del Rio, Houston, and South Texas in the fall of 1998 prompted the Legislature to act. These floods caused 41 deaths and $245 million in property damage."
"In the wake of the 1998 floods, many residents in flood-prone areas discovered that they could not obtain federal financial assistance because their communities had not chosen to participate in the National Flood Insurance Program (NFIP). Information about the program in this brochure will help city and county leaders understand the steps they need to take to comply with Texas law and to meet the needs of their residents by participating in the NFIP."
Last week, I posted preliminary thoughts on the potential damage from the "Robin Hood" lawsuits seeking to avoid the flood exclusions in windstorm insurance. Unintended Consequences: Unintended Consequences of Flood Exclusion Avoidance Suits (September 17, 2005).
A private email from a legislator in the affected region suggested that I'd not made clear the risk of industry abandonment if the confiscatory lawsuits go forward. Below are some additional thoughts that may clarify my theories. Comments and contrary arguments are welcome. Because of the excessive spamming of this site, I have disabled comments and trackbacks. Comments can go by email to: Doug "at" DougSimpson.com.
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Mass withdrawal by insurers from affected states is very much in my mind as a likelihood if these "Robin Hood" suits succeed, or even survive the motion to dismiss / demurrer stage. Perhaps my list was unclear, because I deliberately avoided any implication that insurers would act in concert, but the likelihood of independent withdrawal was implied in my bullet list items:
*** Declination by primary and reinsurance companies to write coverage in the affected states on reconstruction contractors, homeowners, apartment owners and business owners;
*** "Lock-in" legislation by affected states attempting to mandate availability and forbid withdrawal;
I have a very clear memory of the struggles in past decades by insurers, including my former employer, to withdraw from states (e.g. Massachusetts and New Jersey) that had imposed oppressive political restrictions on pricing flexibility in auto insurance, and which imposed the deficits from the state plan on all licensed insurers. In one instance, my employer had to endure extended litigation and negotiation and ultimately pay what was clearly a multi-million dollar "ransom" to the state in order to gain approval of the insurance commissioner for the surrender of its license that freed it from the crushing deficit burden from the auto plan.
Apart from the regulatory resistance, withdrawal is politically and legally very difficult, for a number of complex reasons.
One of them is economic. Insurance groups write not only homeowners and commercial windstorm insurance, but also lines that are presently economically viable, such as workers compensation, commercial general liability and other commercial insurance. It is often difficult or impossible to withdraw from homeowners and commercial multi-peril without also abandoning the other commercial lines, because they are often written by the same corporate entities.
Another is regulatory. Many states already have, or can quickly pass, legislation limiting or forbidding cancellation or non-renewal of insurance policies. Another is to impose the losses of "residual market" or "assigned risk" programs such as FAIR and beach plans upon insurers based upon prior years' writings. Such legislation is often a response to an "availability crisis" that can result from an unexpected decision or discovery imposing unexpected potential liability. If an insurer cannot non-renew expiring policies, or remains liable for the losses in a residual market plan despite running off its book, its only option is to surrender its license, which can then become another regulatory nightmare.
Another difficulty is the very real threat of antitrust lawsuits, such as those which followed the industry's adverse reaction to the 1984 ISO forms that did not exclude pollution coverage, leading to the U.S. Supreme Court's 1993 decision in Hartford Fire v. California < http://laws.findlaw.com/us/509/764.html > construing the McCarran-Ferguson Act's term "boycott."
Another is the industry's historical dedication to its role of being there in times of trouble, instead of ducking and running. Like any smart soldier or firefighter, smart insurance executives know when "its time to go." Most insurance people are honest, hard-working folks who want to provide solutions, not problems. They know how to absorb loss and abuse, because that is part of their business experience. They will not, however, allow themselves to be abused beyond a certain point, because that will destroy their own companies and their ability to help others.
Doug Simpson
Wethersfield, CT
Doug Simpson retired after 25 years in the law department of a major insurance company and now practices and teaches law in Hartford, Connecticut and serves as an ADR neutral. His research notes and comments are at: DougSimpson.com/blog
The Ninth Circuit has allowed an insurance policy coverage question action to proceed against the insolvent Reliance Insurance in Liquidation, although brought in California, outside of the company's domiciliary jurisdiction, where Reliance's liquidation is pending. Issues of McCarran-Ferguson, Burford abstention, full faith and credit and construction of the Uniform Insurers Liquidation Act (UILA) were resolved by the Court of Appeals.
Lawyers for Reliance unsuccessfully argued that the liquidation court's pending stay of legal action against Reliance applied to bar the Hawthorne action. Although the plaintiff was allowed to reduce his claim to judgment, execution thereon will continue to be channelled to the liquidation court in Pennsylvania, according to Marc' brief.
Mark Mayerson at Insurance Scrawl provides a background brief on the decision in Hawthorne Savings FSB v. Reliance Ins. Co., (9th Cir. Aug. 24, 2005) Insurance Scrawl: Stay What? Coverage Claims May Proceed Against Insolvent Insurers
For more background links about Reliance, see: Unintended Consequences: Reliance: $85 MM Settlement with Directors
Catastrophe Risk: U.S. and European Approaches to Insure Natural Catastrophe and Terrorism Risks, GAO-05-199, February 28, 2005.
Highlights-PDF -- PDF -- Accessible Text
Thanks to Insurance Journal: New GAO Study: U.S. Needs Government Help to Insure for Catastrophes and Terrorism
From the abstract: "Natural catastrophes and terrorist attacks can place enormous financial demands on the insurance industry, result in sharply higher premiums and substantially reduced coverage. As a result, interest has been raised in mechanisms to increase the capacity of the insurance industry to manage these types of events. In this report, GAO (1) provides an overview of the insurance industry's current capacity to cover natural catastrophic risk and discusses the impacts of the 2004 hurricanes; (2) analyzes the potential of catastrophe bonds--a type of security issued by insurers and reinsurers (companies that offer insurance to insurance companies) and sold to institutional investors--and tax-deductible reserves to enhance private-sector capacity; and (3) describes the approaches that six European countries have taken to address natural and terrorist catastrophe risk, including whether these countries permit insurers to use tax-deductible reserves for such events. We provided a draft of this report to the Department of the Treasury and the National Association of Insurance Commissioners. Treasury provided technical comments that were incorporated as appropriate."
(originally posted in Unintended Consequences on March 31, 2005)
Continuation of abstract: "Despite steps that governments and insurers have taken in recent years to strengthen insurer capacity for catastrophic risk, the industry has not been tested by a major catastrophic event or series of events (at least $50 billion or more in insured losses). While insurers suffered losses of over $20 billion in Florida from the 2004 hurricanes, steps such as implementing stronger building codes and stricter underwriting standards may have limited market disruptions as compared with the aftermath of Hurricane Andrew in 1992. For example, in 2004, only 1 Florida insurance company failed in contrast to the 11 that failed after Hurricane Andrew in 1992. However, a more severe catastrophic event or series of events could severely disrupt insurance markets and impose recovery costs on governments, businesses, and individuals. Some insurers and reinsurers benefit from catastrophe bonds because the bonds diversify their funding base for catastrophic risk. However, these bonds currently occupy a small niche in the global catastrophe reinsurance market and many insurers view the costs associated with issuing them as significantly exceeding traditional reinsurance. In addition, industry participants do not consider catastrophe bonds for terrorism risk feasible at this time. Authorizing insurers to establish tax-deductible reserves for potential catastrophic events has been advanced as a means to enhance industry capacity, but according to some industry analysts such reserves would lower federal tax receipts and not necessarily bring about a meaningful increase in capacity because insurers may substitute the reserves for other types of capacity. The six European countries GAO studied use a variety of approaches to address catastrophe risk. Some governments require insurers to provide natural catastrophe insurance and provide financial assistance to insurers in the wake of catastrophic events, while others generally rely on the private market. However, the majority of these governments have established national terrorism insurance programs. Although their approaches vary, insurers in all six countries were allowed to establish tax-deductible reserves for potential catastrophic events as of 2004."
Our friend Bob Sargent reports on the buzz from a recent conference of professional insurance folks about the impact of Hurricane Katrina on prices, surplus, and flood coverage. Specialty Insurance Blog: Katrina Chat
Hurricane Rita can only aggravate the tendencies that Bob's colleagues see. As as happened after past mega-disasters, the weak may fail, the strong will survive, but the public policy debate and insurance marketplace will be altered.
A summit meeting of leading states' insurance commissioners will address formation of national responses to mega-catastrophes like Hurricane Katrina. California's John Garamendi told the press: "As insurers begin to sort through a deluge of claims, and as survivors confront the fact that some losses won't be covered, it will become painfully clear that a single, national policy is the only answer." Other big states' insurance regulators made similar statements supporting a national policy for assuring comprehensive insurance coverage for mega-catastrophes. Insurance Commissioners To Form National CAT Insurance Program
At the same time, the Congressional Research Office just released a paper dated 9/15/05 that records discussion in Washington about the need for a federal solution to assure availability of insurance for mega-catastrophes. Congressional Research Service: Hurricane Katrina: Insurance Losses and National Capacities for Financing Disaster Risk
The tension between competing state and federal proposals for an insurance solution to an uninsurable hazard is reminiscent of the tension between state and federal authorities over who will regulate insurance, and to what end. Unintended Consequences: Hearings on "SMART" : Federalizing insurance regulation? (June 23, 2005)
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Meanwhile, reports about FEMA indicate that it is living on a hand-to-mouth basis, without significant reserves. This is very comparable to the situation of the principal state wind pools in states ravaged by Hurricane Katrina Unintended Consequences: Impact of Katrina on Gulf states' wind pools (September 17, 2005). According to the Atlanta Journal Constitution, FEMA reports about $100 million on hand, with a routine line of credit from the U.S. Treasury of $1.5 billion, which is being raised by the Congress. An advisor at FEMA estimated about $2 billion in flood claim losses from some 244,000 flood policies, nearly 90% of them in Louisiana. The advisor reminded the Journal Constitution that many of the hardest-hit areas were public housing that municipal housing authorities self-insure.
According to the report, FEMA is statutorily prevented from raising rates more than 10% year-to-year, so its going to be unable to recoup its losses for many years, if ever. In other words, the American taxpayer will be paying for the losses of those that bought NFIP insurance, because the federal government assured that NFIP cannot recoup a mega-loss from its surviving rate base. Katrina: The Aftermath: Flood claims to bring tide of red ink (Atlanta Journal Constitution Sep. 17, 2005) (free registration required).
At that level of analysis, even the existing government "insurance" for disasters looks a lot like "spend and tax," without the rigor of risk evaluation, underwriting judgment, actuarial pricing, rational reserving and conservative financial audits. And we all know now about the management at FEMA.
Is that the sort of solution likely to come out of Washington if left to political forces? One cannot expect rational business people that manage commercial insurers to be able to offer alternatives to "spend and tax" programs. The result may be further government subsidies of development in vulnerable areas, leading to further loss of life and property during the inevitable next "big wind" to hit the affected areas.
And, as Hurricane Rita is now reminding us, sometimes that next "big wind" comes sooner than you think. For latest tropical storm status, see: FEMA: Tropical Storm Watch
A concise report issued by the Congressional Research Service on September 15, 2005 provides comparisons of the likely financial impact of Katrina to past disasters, summary data on the financial picture of the insurance industry, and suggests an increased role for the federal governement.
"In the aftermath of Katrina, policy makers, disaster experts, and insurance companies have expressed concerns about the financial costs and challenges of recovering from Hurricane Katrina. Further, they note the potential vulnerability of the insurance industry to a future mega-catastrophic event, and raise questions about what role, if any, the federal government should play in financing catastrophe risks.
* * *
As Members of Congress explore ways to respond to Hurricane Katrina, they may be called upon to consider federal policy alternatives to build national capabilities for disaster risk management. Among measures that might be explored are various legislative proposals to pre-fund the cost of disasters with insurance or capital market instruments (risk securitization)." Congressional Research Service: Hurricane Katrina: Insurance Losses and National
Capacities for Financing Disaster Risk
Thanks for this link to: beSpacific: Recent CRS Reports on Katrina Aftermath Address Tax, Financial Services, Medicaid and Employment Issues
"Wind pools" or "beach plans" are those programs created by state statutue and regulation intended to provide essential wind, fire and multiperil insurance to owners of properties located in areas at the highest risk of catastrophic windstorm. These are the properties that we see on television now, utterly destroyed by Hurricane Katrina. Without such programs, such properties would be unable to obtain insurance against windstorms, because no rational commercial insurer would write coverage in such areas at a rate acceptable to the public. These programs fall in the more general category of "residual market" or "assigned risk" plans.
A look at rough numbers in the financial statements for the three most affected wind pools indicates some $17,000 million of property value insured by such pools, about 90% of that in Louisiana. Some early estimates are that 50% of those properties have claims, many of them total losses. For the sake of argument, let's think about a 25% loss, or 4,250 million, just for windstorm losses covered by the pools.
Except for approximately $600 million in reinsurance and less than $100 million in cash on hand, virtually all of the money to pay those windstorm claims will come not from the surplus of individual insurers, but from pro-rata assessments spread over the coming decades against all the property insurers in those states. That load will be added to the rate base, so that all the property owners in those states will be paying for the Katrina wind pool losses for decades. In the interim, the necessary cash flow ($4,250 million loss minus $700 million cash and reinsurance equals $3,550 million) will come from municipal bond issuance unless government relief is implemented.
For supporting detail and links, see below.
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Beach plans vary on a central theme by which the exposure is taken up and distributed (through reinsurance or a syndicate policy) to all property insurers licensed in that state. In many cases, government stands behind the pool's ability to raise cash in a pinch, by authorizing the issuance of tax-free municipal bonds following a mega-catastrophe. Of course, such bonds, like your home mortgage, must be repaid and the cost of repayment must fall upon someone. Most pools are politically unable to lay aside invested reserves or a "rainy day fund" for future catastrophes that all know are inevitable. Instead, like the federal government, they depend upon their ability to make assessments upon their members for operating losses, assessments that are distributed among members in proportion to their "voluntary" premium written in the state.
Paying those assessments, sometimes for many years after such a disaster, becomes a cost and opportunity of doing business for member insurers. In theory, this spreads the burden of insuring properties near the beach throughout the state's entire rating base. Of course, these assessment costs, like other "board and bureau" costs, become part of the rate base that insurance departments must consider when reviewing and approving premium rate filings for property insurance. So, those costs are paid by the people of the affected state, for years thereafter. In effect, all insurance ratepayers in the state subsidize the insurance costs of their brethren and sistren who build houses, apartments and businesses near the shore, and subsidize their rebuilding on the same locations. See also an Insurance Information Institute (III) backgrounder that includes recent developments in wind pool legislation and policy: III - Residual Markets
Although the hard data is not yet publicly available, insurance pros know, as surely as the Mighty Mississippi flows to the sea, that when a hurricane like Camille, Hugo, Andrew or Katrina comes, the wind pools will take the brunt of the damage. Those wind pools, like other windstorm insurers, have for decades excluded damage due to flood or rising water, whether caused by windstorm or storm-induced levee break or any other direct, indirect, proximate or concurrent cause. (See: Unintended Consequences: Flood Insurance and Exclusions, Proximate and Concurrent Causation)
If the public and private lawsuits aimed at invalidating the long-standing precedents behind those exclusions succeed (See: Unintended Consequences: Mississippi AG's Complaint Seeking to Void Standard Flood Exclusions), the biggest impact is likely to be upon those pools. Accordingly, to understand the implications of those lawsuits requires getting a strong cup of coffee and wading into the deep waters of the law and economics of windstorm pools. This is not stuff that makes for good television, and not the stuff that makes for politicians' sound bites. It is the stuff that rebuilds America after the devastation of natural diaster, and keeps an insurance market alive for the recovery.
Recent rough estimates use figures of $60 billion in insured losses, many more in uninsured losses, such as damage and loss of government infrastructure and costs of fire, police, military and other first responders. Most of that will be in Alabama, Mississippi and Louisiana. When reading the following figures, which are in single and tens of millions, remember that the early estimate is $60,000 million of insured losses. BestWire has provided some information about the status of those states' residual market plans.
Alabama
Best reported on 9/1/05 that the Alabama Insurance Underwriting Association ("Beach Pool") has $8.6 million in cash on hand and reinsurance of $50 million in excess of a $20 million retention, and insurance regulators expect to make a statutory maximum assessment. AIUA's reinsurance report on their website uses the same figures and shows a $377 million Total Insured Value (TIV). AIUA 2005 Reinsurance Review This TIV is confirmed in 10/04 figures in an AIUA Exposure Table, showing its distribution among seven categories and that 99% of it is in about 3,000 residential policies, the remainder in 44 commercial policies. This suggests an average value per policy of about $125 thousand.
According to the AIUA Plan of Operation effective 2002, the pool will issue a syndicate policy to eligible applicants, on which member insurers will participate on a several and not joint basis. At the Alabama Beach Pool's website, the basic coverage description states: "If the property is located in an area which is classified as Zone "A" or "V" according to the National Flood Insurance Program, a flood insurance policy is required to be in place before an AIUA policy is issued. Flood coverage must be at least equal to or greater than the AIUA amount of coverage." October 31, 2004 financial statements there suggest the Alabama pool then had about $9.0 million in Members' Equity, about $3.5 million in earned premium, and about $1.4 million negative cash flow for the twelve months preceding that date
Mississippi
BestWire also reported that the Mississippi Windstorm Underwriting Association (MWUA) has $2.1 million in cash on hand and reinsurance of $175 million excess of a $10 million retention. A $20 million early assessment of members was expected. KnowledgePlex: Article: GULF HIGH-RISK POOLS MAY ASSESS INSURERS (BestWire Sep. 1, 2005).
On the Association's website is found the MWUA Accounting Report for Year Ended December 31, 2004 which suggests that the MWUA then had negative $2.1 million (a deficit) in Members' Equity, about $11.6 million earned premium and less than one million in cash flow for 2004. Exhibit 5 to that same report shows Insurance In-Force of $1,632 million in 14,796 policies with 90% of values in Hancock, Harrison and Jackson counties. This suggests an average value per policy of about $110 thousand.
The MWUA operates as a reinsurance program using Servicing Carriers, commercial insurers that accept a fee to issue and adjust claims on behalf of the MWUA, to which 100% of the liability is ceded. See: MWUA Rules & Procedures See also: MWUA - Plan of Operation. The underwriting rules include a provision that "Applications for wind and hail coverages for property located on any of the barrier islands must provide evidence of flood coverage if the property is located in an area where flood coverage is available."
Louisiana
Effective Jan. 1, 2004, the Louisiana Joint Reinsurance Plan (FAIR Plan) and the Louisiana Insurance Underwriting Plan (Beach Plan) were combined into Louisiana Citizens Property Insurance Corporation (LCPIC). According to BestWire as of 9/1/05, its executive officer, Terry M. Lisotta, was expecting 60,000 homeowners claims, but adjusting had been delayed by the flood waters. This figure echoes III reports that about half of its 135,000 policyholders are expected to file Katrina claims. III - Residual Markets. According to Best Wire, LCPIC presently has $100 million in cash on hand and reinsurance of $340 million in excess of a $35 million retention. BestWire, 9/1/05, supra.
Year-end 2004 financial statements accessible at the LCPIC's website suggest that the FAIR Plan then had about $5 million in surplus, about $51 million in earned premium and about $62 million in net cash flow for 2004. Invested income was not significant ($141 thousand). The Beach or Coastal Plan reported $772 thousand in surplus, about $4.3 million in earned premium for 2004, and about $4.7 million net cash flow, with negligible investment income. Together, they had about $65 million in cash and investments at that time. Another 9 months of cash flow at $65 million per year would add up to $100 million figure cited by Mr. Lisotta.
I could not find Total insured values (TIV) data on the LCIC website, but if one uses the $110 thousand average value per policy figure calculated above for Mississippi, 135,000 policies would suggest total insured value around $14,850 million.
In September 2004, Louisiana Insurance Commissioner Robert Wooley said that if a major storm like Hurricane Andrew hit his state, "we would have to go to our line of credit because we wouldn't have sufficient reserves to pay all of the losses. We would have to issue tax-free bonds to pay for the losses and we would allow the companies to recoup those losses and pay their portion of the losses over an extended period of time." Ibid "Recoup losses" likely means member insurers would be able to load those losses into the rate base and recover them from policyholders. How "extended" the time would be depends on the ratio of loss to the rate base. Adding unexpected flood losses to the covered windstorm losses would increase the load on the rate base, by an amount to be determined.
According to the Times-Picayune on September 8, 2005, Louisiana homeowners will be hit with a 20% surcharge and continuing surcharges for years to pay for the hit on the LCPIC. The article describes the process by which the fund will get immediate cash and then spread the burden upon ratepayers throughout the state over coming years. This process was necessary because of reluctance of commercial insurers to write coverage in the state without such a protection. The article states that: "The coverage does not include flood damage, which is handled by a federal insurance program.". NOLA.com: Insurance Rates to Rise (Times-Picayune, September 8, 2005).
Within 3 weeks of Hurricane Katrina, private and public lawsuits have sought to make private insurers pay for flood claims despite policy exclusions and decades of availability of subsidized flood insurance from the National Flood Insurance Program (NFIP). (Unintended Consequences: Mississippi AG's Complaint Seeking to Void Standard Flood Exclusions)
If they are successful in their actions, the unintended consequences for society are likely to be signficant. Societal impacts may include:
*** Exacerbation of already heavy underwriting losses by private and public insurers with Gulf Coast exposures;
*** Impairment of insurance industry capital available for coverage during recovery;
*** Possible destruction of the marketability of federal flood insurance;
*** Increased insolvency of insurers with Gulf Coast property exposure concentrations;
*** Cash flow or solvency crises in the affected states' Insurance Guaranty Associations, windpools and FAIR plans;
*** Declination by primary and reinsurance companies to write coverage in the affected states on reconstruction contractors, homeowners, apartment owners and business owners;
*** "Lock-in" legislation by affected states attempting to mandate availability and forbid withdrawal;
*** Creation of new state-run insurance availability plans operated by political appointees without insurance experience.
The uncertainty surrounding these ill-considered lawsuits are likely to have some immediate impacts, as year-end renewal cycles approach. Responsible insurers may begin issuing protective non-renewal notices as soon as any "lock-in" moratoria expire, in order to preserve their contractual rights. Reinsurers and "surplus lines" carriers, being largely outside of the reach of local regulation, may take action despite attempted "lock-ins" seen in past insurance crises.
Later consequences may include:
*** Expensive antitrust actions, based on Hartford Fire Ins. Co. v. California, 509 U.S. 764 (1993), to discourage insurers from withdrawing;
*** Federal mandates of purchase of flood insurance, just as it requires contributions to Social Security;
*** Federal reform of the flood insurance scheme to include "channelling" protection for the enforceability of policy exclusions, along the lines of the Price-Anderson Act or the Terrorism Risk Insurance Act (TRIA).
Watch for emerging research and analysis relating to the above hypotheses as we study these effects. Suggestions and links are welcome, by email to: doug "at" dougsimpson.com.
See also: P.S. on "Unintended Consequences of Flood Exclusion Avoidance Suits" (Sep. 24, 2005)
Mark Mayerson at Insurance Scrawl says what he really thinks about the Mississippi Attorney General's expropriation lawsuit. "[W]hat the state's argument highlights is the failure of its insurance-regulatory scheme. Mississippi should not have permitted insurance policies to be issued in the state with flood exclusions if such exclusions are so violative of public policy. Besides arguing on the merits that the exclusions are proper, insurers will argue that voiding them constitutes a taking of property (meaning that the taxpayers will then fund the losses)." Insurance Scrawl: Tragedy and Failure
Mayerson goes on to argue that the attempted expropriation of insurer capital will not fall onto overseas reinsurers, as plaintiffs bar attorneys have implied, because any ex gratia payments and expropriation losses are outside of the scope of reinsurance coverage.
If Mayerson is correct, many smaller, regional and local insurance companies focused on Mississippi are likely to fail if the Attorney General's suit succeeds. In which case, the claims liability may fall to the Mississippi Insurance Guaranty Association. The National Conference of Insurance Guaranty Funds (NCIGF) offers text and summary of that state's guaranty fund laws at Guaranty Fund State Laws & Summaries.
In 1992, following Hurricane Andrew, the resulting failure of ten insurers due to wind claims exhausted the cash reserves and near-term assessment capacity of the the Florida Insurance Guaranty Associaton (FIGA). $400 to $500 million was required to pay the insolvents' claims. The statutory maximum assessment would raise only $65 million per year.
To provide the necessary cash flow to pay the wind claims against insolvent insurers, special 1992 legislation authorized the ground-zero city of Homestead to issue municipal revenue bonds, loan the resulting $500 million to FIGA at interest, and then collect principal and interest from FIGA for years thereafter. FIGA was allowed an extra assessment against surviving insurer's premiums and had enough funds by 2000 to pay off the Homestead bonds. Senate Staff Analysis and Economic Impact Statement on Florida Bill CS/SB 2184, regarding changes to the law of insurance company insolvencies and obligations of the Florida Insurance Guaranty Association, April 22, 2005, page 4 (PDF)
If the A.G.'s suit succeeds, how many insurers will be thrown into insolvency? How long will the Mississippi Insurance Guaranty Association be in the red and loading the cost into the few remaining voluntary premium dollars? The Department of Insurance's website has some information about the MIGA suggesting that claims the size of the Katrina expropriation bill will be beyond extraordinary: "Founded in 1970, the Mississippi Insurance Guaranty Association has handled 75 insolvencies, paying out nearly $52 million in benefits to policyholders." Mississippi Department of Insurance: Who Insures the Insurance Company
How many of the surviving insurers will be willing to continue writing in Mississippi, knowing that they must provide flood insurance for free, if the "Robin Hood Attorney General" succeeds?
In 2003, the Government Accountability Office testified to the House of Representatives on "Challenges Facing the National Flood Insurance Program". GAO has for years reported on financial issues of the NFIP administered by FEMA.
As the testimony explains: "In 1968, in recognition of the increasing amount of flood damage, the lack of readily available insurance for property owners, and the cost to the taxpayer for flood-related disaster relief, the Congress enacted the National Flood Insurance Act (P.L. 90-448) that created the National Flood Insurance Program. Since its inception, the program has sought to minimize flood-related property losses by making flood insurance available on reasonable terms and encouraging its purchase by people who need flood insurance protection—particularly those living in floodprone areas known as special flood hazard areas."
The report points to several fundamental problems with the NFIP:
... Cash-based budgeting and accounting, instead of accrual accounting that would reflect actuarial realities;
... Subsidies and coverage of "repetitive loss properties" (properties that make claims every 10 years or so because they regularly flood)
... Lack of participation in the program, with less than 50% of eligible properties participating and even "mandatory" purchases may not be happening.
We look at 37 years of legislative and judicial recognition that flood hazards are simply not commercially insurable, and the federal subsidy of affordable flood insurance even for those who insist on living in the most exposed areas.
It is hard to know where to begin to address claims by public officials that the flood exclusions in standard in homeowners policies, as approved by the Insurance Commissioners and repeatedly upheld by the courts, "bear no reasonable relationship to the risks and needs of the business of the Defendant" insurers and are not enforceable. Unintended Consequences: Mississippi AG's Complaint Seeking to Void Standard Flood Exclusions
The Attorney General's action is sure to add false hope and the burden of frivolous litigation to a population already suffering enough. And what will it do to flood insurance sales if the A.G. convinces the citizens that, through some magic of elected politics, they retroactively get flood coverage free in their homeowners policy, despite the clear language of the flood exclusion and the repeated warnings accompanying their policies? Not only is this action unfair to the insurance industry, it is prejudicial to the entire National Flood Insurance Program.
See also: See Unintended Consequences: Flood Insurance and Exclusions, Proximate and Concurrent Causation
As reported in the Washington Post (Mississippi Sues Insurers Over Flooding Exclusions) and by the Risk Prof blog (RiskProf : Well, It Has Happened!), the Attorney General of Mississippi has sued the state's insurers, alleging that standard flood exclusions in homeowners policies approved by the Mississippi Insurance Commissioner are "void and unenforceable" and seeking an injunction against their enforcement. Attorney General Jim Hood's Press Release.
The causes of action include counts alleging that the standard flood exlusions:
... contravene Mississippi law concerning proximate causation and policyholders' reasonable expectations,
... are too hard to understand and unconscionable, having "no reasonable relationship to the risks and needs of the business of the Defendants",
... are ambiguous and must be construed against the insurers and
... constitute an unfair or deceptive trade practice.
A copy of the A.G.'s Complaint and Motion for TRO is HERE (PDF).
The Insurance Commissioner of the State of Mississippi, George Dale, in his "Insurance Consumer's Hurricane Checklist" on the DOI's website, says:
Check your policy’s coverages. Remember that homeowners’ policies do not cover flood damage caused by rising water. Check the special maps kept by your county that show flood plains. If you live in a flood-prone area, contact your agent about obtaining flood insurance, which is written by the National Flood Insurance Program. Do not procrastinate; there is a 30-day waiting period before the policy goes into effect."
Government Accountability Office GAO-05-536: "RISK RETENTION GROUPS: Common Regulatory Standards and Greater Member Protections Are Needed" (August 2005)
Over two decades ago, Congress passed laws allowing businesses to group together and form their own liability insurance company. The goal was to provide an alternative to commercial insurance in a time of limited availability of affordable insurance. During "hard markets," these Liability Risk Retention Groups (LRRG) have increased in number, offering a useful addition to insurance capacity.
Loose regulations in some states that host LLRGs have also allowed short-sighted, negligent or corrupt managers to abuse the trust of the LLRG members, according to allegations by government regulators. See Unintended Consequences: Buffett Cooperation Illuminates Racketeering Suit and Spitzer Investigations. In recent years, this abuse has led to some troubling insolvencies that have proved costly to LRRG members and their claimants. Many times those claimants are individual consumers of members' services, including hospital patients, doctors and nurses.
Recent LRRG failures include the 2003 collapse of Reciprocal of America (ROA), which left hundreds of doctors and lawyers with no malpractice coverage and many with six-figure unsatisfied judgments. See Unintended Consequences: Impact of Reciprocal of America on Mainstreet Professionals.
Risk Retention Reporter identified $2.2 billion in 2004 premium flowing to LLRGs, up from $1.7 billion in 2003. See Unintended Consequences: RRG premium tops $2 B in wake of hard market. If Hurricane Katrina constricts the capital available for insurance generally (as did the 9/11 disaster), a hard market in liability insurance as well as property insurance may follow, increasing the motivation for businesses to form LLRGs. And increasing the opportunties for entrepreneurs to form LLRGs to meet the increased demand.
The GAO has performed an audit of the LRRG system and made recommendations for changes in the regulatory scheme. They found instances of conflicts of interest between LRRG managers (often entrepreneurs with no financial interest in the solvency of the LRRG) and its members. They also found that some states treat LLRGs as "captive insurers," for which relaxed capitalization standards are appropriate. As a "new item," the 120-page full report is available HERE (PDF).
Among its recommendations is greater and more standardized state regulation of LRRGs.
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From the GAO Results in Brief:
Quote:
In 1981, in response to recurring shortages of liability insurance, Congress passed the Product Risk Retention Liability Act, now known as the Liability Risk Retention Act (LRRA), which authorized the creation of risk retention groups (RRG) to increase the availability and affordability of commercial liability insurance. An RRG is a group of similar businesses with similar risk exposures, such as educational institutions or building contractors, which create their own insurance company to self-insure their risks on a group basis.
RRGs have had a small but important effect in increasing the availability and affordability of commercial liability insurance for certain groups with limited access to insurance. In 2003, according to NAIC estimates, RRGs provided about $1.8 billion or 1.17 percent of all commercial liability insurance. While the overall impact on the liability market has been small, most state regulators we surveyed believed that RRGs have increased the availability and affordability of insurance for groups that have had difficulties obtaining affordable coverage such as healthcare providers, building contractors, and commercial trucking firms.
According to state regulators and RRG industry representatives, members have benefited in several important ways by using RRGs to self-insure their risks. These benefits include controlling their costs by targeting their coverage to the specific needs of members and designing programs to reduce risks. The representatives indicated that RRGs might not always benefit from the lowest insurance prices but could benefit from prices that remained stable over time.
In recent years, a shortage of affordable liability insurance also prompted the creation of many new RRGs. From 2002 through 2004, 117 RRGs were formed, more than the total formed over the previous 15 years. In particular, a shortage of affordable medical malpractice insurance prompted healthcare providers to form about three-quarters of the new RRGs. As a result, more than half of all currently operating RRGs provide insurance in healthcare-related areas.
LRRA’s partial preemption of state insurance laws has resulted in a regulatory environment characterized by widely varying state standards and limited regulator confidence in the system.
The circumstances surrounding more than half of past RRG failures we examined suggest that management companies or managers have promoted their own interests at the expense of the insureds—for example, by charging excessive management fees or promoting transactions unfavorable to the RRG. Regulators knowledgeable about these failures said that the insureds likely were more interested in obtaining affordable insurance than assuming the responsibilities of owning an insurance company. Consequently, even though an insured’s insurance policy may have stated that the RRG lacked guaranty fund coverage, the insureds may not have been fully aware of this restriction or the consequences of lacking such protection.
Further, LRRA does not require RRGs to disclose to prospective claimants, those who submit claims for loss, that the RRGs would not benefit from guaranty fund protection should they fail. This can be of special consequence to certain claimants—consumers who purchase extended service contracts from the insureds of RRGs—because contracts issued by these insureds take on the appearance of insurance when, in most cases, they are not.
This report contains recommendations for the states, as well as matters for congressional consideration that, if implemented, would create a more consistent regulatory framework for overseeing the chartering and management of RRGs, provide more reliable information about the financial condition of RRGs, and provide RRG members needed protections to help ensure that companies managing RRGs operate in the insureds’ best interests. In addition, enhancing the availability and contents of the guaranty fund disclosure would provide RRG insureds, as well as consumers who purchase extended service contracts from RRG insureds, a better understanding of the lack of guaranty fund coverage.
Endquote
DougSimpson.com/blog
Louisiana's Valued Property Law may afford rich opportunities for litigation over recovery on property losses, when both flood and wind policies covered a risk, Bob Stratton suggests in Insurance Defense Blog: Katrina Losses/Coverage
He points to a thought-provoking article about last year's Florida decision in Mierzwa v. Florida Windstorm Underwriting Association, Case No. 4D02-4996 (Fla. App., 2004) by John V. Garaffa of Butler Pappas: Florida's "Valued Policy" Law - The Eye of the Storm. The decision and the article raise the spectre that owners of properties insured by one policy against wind and against flood by a separate policy may be demanding a double policy limits recovery, even if they choose not to rebuild, if they have a constructive total loss.
Commentators are now discussing the likelihood that Louisiana may adopt a similar interpretation.
Not discussed in what I've scanned so far is the question of subrogation, or the impact of "other insurance" clauses.
I'm making an initial mental list of readings for a proposal for a possible law school seminar at the Insurance Law Center at Univ. of Connecticut School of Law, many of which would be multi-disciplinary.
I'm just finishing Jared Diamond's "Collapse: How Societies Choose to Fail or Succeed."
On my stack are:
..* Richard A. (aka "Judge") Posner, "Catastrophe: Risk and Response"
..* Ted Steinberg, "Acts of God: The Unnatural History of Natural Disasters in America"
..* R.A. Scotti, "Sudden Sea: The Great Hurricane of 1938"
Suggestions are welcome.
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A threat similar to Katrina may exist in the Sacramento and San Joaquin river valleys in California, where Prof. Jeffery Mount at U.Cal. Davis says: "Levee failure is not an 'if', it's a 'when'. * * * There seems to be a willingness to tolerate the human suffering and property loss that might come with these events." Underpriced flood insurance, land subsidence and under-investment in levee maintenance, plus thousands in the vulnerable area who have no autos, appear to be an issue there, as in New Orleans. See "Thousands in California at higher flood risk than in New Orleans," Mercury News, September 14, 2005. See also the New York Times, Sunday, September 11, 2005 "Disasters Waiting to Happen" (p. BU 1).
Galveston, Texas was wiped out in a hurricane in1900, and hit hard since then, but in recent years invested a great deal in raising the level of their Gulf Coast island.
For example, I want to find (or build) an objective legislative and policy history of flood insurance in the U.S., which is not that old, dating back to the 1968 National Flood Insurance Act. It's administered by FEMA.
There is a theory that while federally subsidized flood insurance may be good for developers and home builders (e.g. California), those who want cheap nearby housing for minimum-wage labor (e.g. New Orleans), Katrina has shown that encouraging people to build and to live in flood plains inevitably kills some of them and traumatizes many more.
In this country, few of our legislators live in flood plains without cars. In Holland, almost the whole country lives below sea level, and legislators take the situation more seriously because its their mother, spouse or child who could drown. Especially since 2,000 Dutch citizens died in the February 1953 flood caused by bad flood management (another good case study) and have since taken things much more seriously.
The GAO study of "Risk Retention Groups: Common Regulatory Standards and Greater Member Protections Are Needed," just out in August 2005, can provide another case study about groups that federal law encourages to voluntarily self-subsidize their own liability insurance, possibly leading members into economic traps that take years to discover, and only when it is too late. Similar traps have been found in self-insurance pools. See, e.g. Unintended Consequences: AIK Comp Members Liable for $97 MM: Dangers of Forced "Affordability"
Similar circumstances exist in states (like Massachusetts, Maine, Louisiana and others) who for years suppressed residual market prices on workers comp or auto liability insurance, in order to make "essential insurance affordable." Those systems eventually became abused and insolvent and they collapsed, at significant hidden "back-end" costs to taxpayers and ratepayers. They were typically replaced by similar but "new" systems. How many unsafe conditions on our roads and in our workplaces were subsidized by those political decisions, if any? Might make an interesting study.
I fear I reveal a certain bias. Perhaps, by postponing the inevitable reckoning and saving the cost of commercial insurance rates (or the lost opportunity cost of undeveloped flood plains), those politicians and member organizations are making a sound economic decision. Judge Posner addresses some of those issues in his book and weblog. The Becker-Posner Blog: The Tsunami and the Economics of Catastrophic Risk
I'm willing to be persuaded. But those whose loved ones drowned in Katrina, and who may drown in California, should have a representative voice. And the public safety implications for coming and past legislation should be evaluated in light of current awareness.
Do you see the way this seminar might go? Comments or suggestions by email to doug "at" dougsimpson.com. (I've turned off my Trackback and Comments because I grew tired of spending hours deleting porno and pharma spam).
In the wake of Hurricane Katrina, journalists, government representatives and "just folks" around the world are raising important questions that must be answered. Not all of the answers will be simple or easy to accept.
For one, folks are now facing the reality that their homeowners insurance does not cover that part of the storm damage caused by flooding, whether the flooding is a direct result of Hurricane Katrina's storm surge or the overtopping and breach of inadequate levees. Those whose homes or businesses were damaged in part by direct action of wind, looting or fire following a flood may find their loss partially covered. But for thousands of people, their homes will be condemned solely because of damage from weeks of soaking in toxic flood waters.
(typo in 9/12 original corrected to replace "RAIN" with "WIND" in Safeco policy quoted in Guyton)
(read more)
Insurance policies routinely include front page warnings like that on my own policy: "NOTICE! This policy does not cover flood loss or damage. Call your (name of company) representative ... to obtain a flood insurance policy."
For decades, federally subsidized flood insurance has been available, has been widely promoted and sold through local insurance agents by the National Flood Insurance Program (NFIP), a division of FEMA. See Annotation, "Rain, flood, or water damage insurance; National Flood Insurance Act," 43 Am. Jur. 2d Insurance § 486. Every year, a large percentage of those eligible to buy federally subsidized flood insurance do not. Like public officials who knowingly choose to invest only enough money in flood control to survive a Cat III hurricane but not a Cat IV hurricane, homeowners gamble their property on the theory that "flood insurance is too expensive."
After every major disaster involving extensive flooding, we see politicians and class action attorneys taking aim at the flood exclusion in homeowners policies, looking for ways to overcome decades of legal precedent behind that part of the insurance contract. Sometimes they succeed, after which insurance companies examine their policies and make adjustments so that their policies are as clear and unambiguous as possible that damage due to flood is not covered. They then file those policy contract forms with state insurance regulators and negotiate the terms until they can obtain approval from the state and issue them to policyholders.
Some of those encounters with creative policyholder advocates are instructive and involve principles that should be familiar to any seasoned insurance practitioner. General practice lawyers may be hearing more about them in coming months. One of those is the principle of "concurrent causation," another the concept of "efficient proximate cause."
The principle of concurrent causation has been widely recognized for many decades and works in favor of policyholders. To understand it, you have to keep in your head the difference between cause and effect. An insurance policy specifies what causes it covers (usually called "hazards" or “perils”). It also specifies what effects it covers (usually called "loss" or "damage") and which perils and losses are excluded from coverage. Those details are found in various sections of the policy language, such as “Perils Insured Against” and “Exclusions”.
Concurrent causation principles say that if two causes combine to produce loss or damage, and one of the two causes is excluded (e.g. flood) and the other cause is covered (e.g. windstorm), the loss will be covered. Insurance companies have been drafting their policies in light of this basic principle for over a century, tweaking policies from time to time as fine points were re-interpreted, often in response to disasters that revealed unanticipated exposures. Many of those disasters, and the law interpreting the policies, comes out of the state of California and its earthquakes, mudslides, floods and brushfires.
Although Alabama, Louisiana and Mississippi are not California, the latter state has a more substantial body of law interpreting policy provisions in light of many varied circumstances. A look at some of its law illustrates the complexity of the issues faced by insurers following Hurricane Katrina. California's law derives from interpretation of decisions of its Supreme Court, especially Sabella v. Wisler, 59 Cal. 2d 21, 377 P.2d 889 (1963) and State Farm v. Partridge, 10 Cal.3d 94, 514 P.2d 123 (1973).
Sabella established that when more than one cause is sequentially involved in a loss, the court must determine the single cause that set into motion the other causes or chain of events leading to the damage. In that case, a building contractor negligently installed a sewer line to a house it constructed on uncompacted fill. The sewer ruptured and flowed water into the fill, which settled under the house, cracking the foundation. The insurer denied coverage due to an earth movement exclusion. The court found that because the "efficient moving cause" (builder's negligence) was covered, the loss or damage was covered, even though an intervening cause (earth movement) was expressly excluded, because the efficient moving cause set in motion the intervening cause.
Partridge established that a different approach must be used when two entirely independent causes combined to result in loss or damage, but neither set into motion the other. In such a case, "coverage under a ... policy is equally available to an insured whenever an insured risk constitutes simply a concurrent proximate cause of the injuries."
On September 10, 1976, Hurricane Kathleen dropped heavy rains in California, overwhelming the old levees that protected the community of Palm Desert in the Coachella Valley, flooding it. The community had historically been subject to flooding that had been controlled for decades by levees built by government authorities. Insurers denied claims by homeowners for damage due to flooding and a lawsuit followed.
Safeco's policies included industry standard language designed to cover "all risks" not excluded by the contract language. The contracts included, in bold letters:
"THIS POLICY DOES NOT INSURE AGAINST LOSS:
1. CAUSED BY, RESULTING FROM, CONTRIBUTED TO OR AGGRAVATED BY ANY OF THE FOLLOWING:
a. FLOOD, SURFACE WATER, WAVES, TIDAL WATER OR TIDAL WAVE OVERFLOW OF STREAMS OR OTHER BODIES OF WATER, OR SPRAY FROM ANY OF THE FOREGOING, ALL WHETHER DRIVEN BY WIND OR NOT."
In the lawsuit, policyholders pointed out that although the cause or hazard of flooding was excluded by the policy, there was no exclusion for the independent concurrent cause of negligence in design or maintainance of levees. They successfully argued that because the loss resulted from the concurrence of an excluded hazard and a covered hazard, it was covered under California law. Although it ruled that Safeco had to pay the loss, the court did find that Safeco had not acted in bad faith in denying the claims, because the issue had been legally uncertain before its decision. Safeco Ins. Co. v. Guyton, 692 F.2d 551 (9th Cir. 1982).
Following Guyton, the California state courts criticized the federal court decision and further developed the law of concurrent causation in that state. In 1986, applying the Sabella and Partridge cases, a California Court of Appeal decided it was a question of fact whether or not two concurring causes were independent or dependent causes of a homeowner's injury. This left to a jury the decision whether the loss was covered or not. Garvey v. State Farm, 227 Cal.Rptr. 209 (Cal.App. 1986).
Other states reached similar conclusions in similar situations. Legislation was introduced to clarify the law, for example, California Ins. Code §530. "An insurer is liable for a loss of which a peril insured against was the proximate cause, although a peril not contemplated by the contract may have been a remote cause of the loss; but he is not liable for a loss of which the peril insured against was only a remote cause."
At the same time, insurance companies scrambled to draft, file and get state approval of policy language to avoid the unexpected consequences of decisions like Sabella and Partridge. This included language excluding loss due to certain perils (such as flood and earth movement) "whether other causes acted concurrently or in any sequence with the excluded event to produce the loss."
In 1989, a federal court upheld the effectiveness of this "concurrent causation exclusion" in the face of a insured's argument that it violated §530. The United States Court of Appeals said that "an insurance company has the right to limit the coverage of a policy issued by it and when it has done so, the plain language of the limitation must be respected. * * * California Insurance Code §530 provides guidance when a policy is silent on concurrent causation; it does not prohibit inclusion of a provision similar to the concurrent causation provision in the State Farm policy." State Farm v. Martin, 872 F.2d 319 at 321 (9th Cir. 1989).
Similar results have been reached elsewhere in cases involving floods resulting from the failure of dams due to alleged government negligence. On July 15, 1982, the Lawn Lake Dam in Rocky Mountain National Park failed, and the released water destroyed commercial property downstream. The property owners' "all risk" insurance policies included a provision that "The Company shall not be liable for loss * * * caused by, resulting from, contributed to, or aggravated by any of the following: * * * flood, surface water, waves, tidal water or tidal waves, overflow of streams or other bodies of water, or spray from any of the foregoing, all whether driven by wind or not." The Supreme Court of Colorado rejected policyholder's claims that the "efficient moving cause" of the loss was third party negligence leading to the failure of the dam, finding that the rule regarding such causes "must yield to the language of the insurance policy in question." Kane v. Royal Ins. Co. of America, 768 P.2d 678, 78 A.L.R.4th 797 (Colo, 1989).
Mississippi was particularly hard hit by Hurricane Katrina, and has an instructive precedent regarding flood exclusions, resulting from Hurricane Georges in 1998, Eaker v. State Farm, 216 F.Supp.2d 606, 2001 WL 1900617 (S.D. Miss. 2001).
Eaker resolved claims against State Farm by a homeowner whose property was insured under both a National Flood Insurance Program Standard Flood Insurance Policy (SFIP) and under a commercial homeowners policy form HO-3. Both policies were written by State Farm, which wrote the SFIP as a "write your own" (WYO) fiscal agent of the United States government's NFIP. The insured failed to file within 60 days of loss a written, sworn Proof of Loss form as strictly required by the NFIP laws and regulations. In its opinion, the United States District Court for the Southern District of Mississippi discussed at length the purpose, provisions and requirements of the NFIP and the SFIP, and applied Mississippi state law to the following facts.
Following Hurricane Georges, the Eaker's home developed settlement and foundation problems that their expert witness, an architect, estimated would cost almost $90 thousand to fix and which he attributed to flood water from Hurricane Georges. The District Court discussed the National Flood Insurance Program's purpose "to provide previously unavailable flood insurance protection to property owners in flood-prone areas at rates that are at or below actuarial levels." As guarantor of the program, the United States government pays all flood insurance claims and the terms of the SFIP must be strictly complied with, said the court. The WYO insurer, a mere fiscal agent of the government, is powerless to alter, vary or waive any provision of the policy, including the requirement that the policyholder must file a written, sworn Proof of Loss within 60 days after the loss. The United States Supreme Court has affirmed that in such situations, the courts are powerless to uphold assertions that the insurer is estopped from insisting on compliance with the requirement, like those made by the Eakers. OPM v. Richmond, 496 U.S. 414 (1990).
The fact that the Eakers were unaware of the requirement of filing a written, sworn Proof of Loss within 60 days did not make a difference, according to the court, because the requirement was clearly set forth in the words of the policy. As a result, in the absence of compliance with the requirement, "all claims presented under the flood policy are barred." Eaker, 216 F.Supp.2d at 618.
The Eaker court also addressed the policyholder's claim that State Farm wrongly denied coverage under their homeowners policy. "The policy language clearly and unequivocally excludes coverage for the settlement of the foundation, the claim which the Plaintiffs are asserting." Ibid at 621. The court pointed to the "earth movement" exclusion, the "water damage" exclusion and the "settling/cracking exclusion," all of which were set out in detail in the court's opinion. The court also declined to apply the doctrine of "efficient proximate cause" asserted by the Eakers, because "the Mississippi courts have not specifically adopted the efficient proximate cause doctrine." Id. at 623.
There will be many tragic stories coming out of Hurricane Katrina. Many things will be learned, and some of those learnings will result in changed behavior. Let’s hope that some of the learning is about the realities of flood insurance and flood exclusions in homeowners policies.
You can find out about coverage from the National Flood Insurance Program through your local insurance agent or emergency management office. There is normally a 30-day waiting period before a new policy becomes effective.
For more information about protecting your life and property from floods, visit FEMA's "FloodSmart.gov" website.
Katrina may cost insurers $60 bln - Yahoo! News
Reuters reports that Risk Management Solutions, a private risk-modelling vendor, has raised its modeled loss estimate for Hurricane Katrina from $20-$35 billion up to $40-$60 billion, out of a total damage of $125 billion. About half of the total damage will be in the New Orleans flood. RMS Increases Insured Loss Estimate for Hurricane Katrina to $20-$35 Billion
Although flood is not covered by private insurers, it will be problematic to apportion the covered damage from wind versus the excluded damage from flood, especially with regulators, media and policyholder advocates watching closely.
It remains to be seen how much liability the National Flood Insurance Program (NFIP), a division of FEMA (i.e. the U.S. taxpayer) will have due to the flooding. The program sells flood insurance below cost, with flood insurance rates deliberately set below the actuarial level in order to encourage people to build and live on flood plains, but many don't buy it anyway. The magnitude of this disaster and the locus of the flooding in a major industrialized urban region almost assures that extraordinary NFIP deficits will be booked because of Katrina. One wonders how much of the $50 billion just appropriated for FEMA will be consumed by NFIP allocated and unallocated claims expense.
Bob Sargent at Specialty Insurance Blog points to the Mississippi Insurance Department's early guidance on insurance claims for Katrina damage.
Commissioner George Dale's letter (pdf) states that he has been "contacted by Mississipians who advise that their adjusters allegedly denied their homeowner's claims without inspecting the damaged property." Commissioner Dale states that when water and wind combined to produce a loss, "the insurance company must be able to clearly demonstrate the cause of the loss." He expects insurers to resolve doubt in favor of a covered loss. Specialty Insurance Blog: Katrina Coverage: Wind or Water?
As Bob Sargent rightly points out, reinsurers are not likely to be as responsive as locally regulated primary carriers to local insurance regulatory "jawboning." Reinsurers are expected to "follow the fortunes" of the primary carriers. They may (and often do) insist that the primary carriers clearly resolve legal issues before paying claims if they expect reinsurance participation. This may lead to extensive and politically painful litigation with large numbers of Katrina victims unless both the primary and reinsurance market leaders step up to the plate and do their part in relief.
This may prove very difficult, as the insurance industry is a business, not a charity. They have an obligation to their shareholders and other policyholders to construe policies both fairly and consistently in accordance with many decades of precedent and legal principles. This will be difficult times for their decision makers. Some will fare better than others. Adversity brings out both the best and the worst in people and organizations, and the insurance industry is no exception.
On the wall in a conference room of The Hartford hangs an oil painting of a legendary event in the company's history. Following the Great Fire of 1835 in New York City, many insurers failed and closed their doors. Eliphalet Terry, then president of The Hartford reacted differently, in a way reminiscent of "unauthorized" aid we see today. He borrowed cash on his personal credit, loaded it into a horse-drawn sleigh and personally drove it 100 miles through bitter winter weather to the disaster area and began paying claims. Although records of policies had also been destroyed in the great fire, he was able to reconstruct some information and relied a lot on the faith and good will of the people who made claims.
As victims of other insurers received reports that their companies had failed and would be unable to pay a dime, the stand-up insurers began selling policies to those failed by the competition. By the time he and his people finished in New York, Terry had paid the claims and also signed up enough new customers to provide the cash to pay off the temporary loans and establish the reputation of his company as one you could count on.
I retell this story not because The Hartford is alone in such behavior, but because I happen to be familiar with it from several decades working there and looking at that oil painting. Many other stand-up insurers did the right thing in that disaster, and will do the right thing in this disaster. We will learn in the coming months which insurers and reinsurers are able to figure out what is the right thing.
Wharton professors assess the impact of what is clearly the costliest natural disaster ever to strike the U.S.
Picking Up the Pieces from Katrina: What Lies Ahead - Knowledge@Wharton
This feature piece at Wharton's free "Knowledge @ Wharton" e-zine compares the impact of Katrina to that from Andrew and other disasters. Its authors suggest a $200 billion damage estimate, with still uncertain impact on the oil and gas industry.
Wharton professor Howard Kunreuther points out that private insurers will not be as hard hit as they were by Andrew. Insurance for flood is borne by the National Flood Insurance Program, which may outstrip its ability to pay until tax money is added. The mix of windstorm and flood damage in many instances will lead to "many lawsuits," according to Kunreuther.
Real estate professor Witold Rybczynski predicted that like most cities, New Orleans will rebuild due to "an inertia built into cities," that makes the investment more than the destruction. He points to the destruction of Warsaw, Poland during World War II and its reconstruction afterwards. Another professor cited the rebuilding of Woodland Hills, California after wildfires in 1991.
The authors also provide a perspective from a Madrid professor who was visiting Guatemala in 1998 when Hurricane Mitch hit Central America. 10,500 died and some 10,000 simply disappeared.
Joe Coppleman at Workers Comp Insider is aggregating info resources from the perspective of workers compensation and workers saftey in the face of the Katrina Disaster. He points out the challenges of those injured at work to process claims, let alone get medical attention. The hospital, hotel and emergency service workers trapped in the cesspool of New Orleans come to mind. He addresses some of the safety and compensation issues of those now employed or retasked as emergency workers. He closes with a personal plea for a dose of much-needed humility before the forces of nature and our own revealed limitations:
"It is eerie to watch these third world images of despair and dysfunction rolling out in our own country. It's something we are used to seeing in remote corners of the world, not on our own shores. But this is all too real: the total disintegration of civil society, the uselessness of the usual management "best practices." This is a crisis where the most rudimentary needs -- food, clothing, water and shelter -- cannot be provided. Between the Christmas tsunami and Katrina, two things have become all too clear: when confronted with the full brunt of nature's power, we are defenseless against the blow and pitifully ineffective in response. Let's keep that in mind when we position our species -- and our country -- in the forefront of all things civilized."
Workers Comp Insider - Katrina
Risk Management Solutions estimates over $100 billion in economic loss from Katrina, according to Insurance Journal, which said: "Hurricanes of category 4 or 5 strength are well-understood to occur in this region of the country, yet the levee system in New Orleans was designed only to protect against a category 3 strength storm. The insufficient level of flood protection offered by the city's levees has been exacerbated by shortcomings in preparedness."
RMS Totals Economic Loss for Katrina at $100 Billion
One insurance question is how many events are involved in this disaster. Is the levee break part of the same event or occurrence as the windstorm? Following 9/11, the extent of property insurance coverage on the World Trade Center itself depended on the interpretation of policy language that determined the number of occurrences. The decision went to the Court of Appeals and took years to resolve.
In the end, some policies were interpreted to cover each of the two airstrikes as a separate occurrence, with a separate amount of coverage for each. Other policies with slightly different language were interpreted so that the coordinated attack on two towers was one occurrence. The decision had a $2.2 billion impact on the insurers that used the different language. See: Unintended Consequences: WTC Coverage Dispute - Phase Two (November 30, 2004) and Unintended Consequences: "Occurrence" under WTC v. HFIC (December 13, 2004) and WTC v. Hartford Fire, 345 F.3d 154 (2d Cir. 2003).
Insurers, reinsurers and courts will be examining the commercial property policies of businesses, apartments, hotels and public buildings for a long time, resolving these issues.
Fitch ratings points to multiple factors that may combine to make Katrina the worst insured loss in history. The levee break, business interruption controversies, looting impact, delays in adjusting losses due to extended flooding, coverage disputes and political sensitivity of denying claims under flood exclusions, the complication of interpreting environmental loss exclusions, all add to the likelihood that reserves will be underestimated initially and "develop" in subsequent years.
As Fitch points out, reinsurers are less regulated, so can increase prices faster than heavily regulated property insurers. Overall, the impact on insurance pricing is likely to be significant, long-term and unevenly distributed.
Fitch: Katrina May be Most Costly U.S. Insured Loss Ever
Thanks for this link to our friends at Specialty Insurance Blog: Katrina & Insurance Prices
Meanwhile, we are not yet past the midpoint of the Atlantic hurricane season. As Floridians can attest, the first hurricane to hit you may not be the last.
Colorado State University hurricane researcher William Gray predicts above-average activity for the coming two months. According to Reuters on September 2, "Gray and his colleagues calculated there was a 43 percent chance another major hurricane with top winds over 110 mph (177 kph) would strike somewhere along the U.S. coast in September." Strong chance another big hurricane will hit US - Yahoo! News
The rising outrage at the unfunded mandate for New Orleans' poor and infirm to evacuate the city must cause changes in the federal and state response to real homeland security needs. If this had been a terrorist bio-warfare attack, or a "dirty bomb" set off in a major city, would the homeland security response have been different?
Responsible government requires more than telling several hundred thousand people with no autos, no savings and no credit cards, with sick and infirm elders and babies to "Evacuate to somewhere else! You figure out where to go, how to get there and where you'll sleep and get food, shelter and medicine when you find it."
The exodus of Oklahomans during the Dust Bowl was the source of untold human misery and human nobility as those with nothing struggled to find a place that would accept a huge influx of refugees. They were met with resistance, sometimes armed and organized by the local government who didn't want "those Okies" in their community. John Steinbeck immortalized the human response to such conditions in "The Grapes of Wrath."
We look to the words he put in the mouth of Tom Joad, pushed to the limit of human endurance by a combination of natural disaster and social failure:
“Whenever they’s a fight so hungry people can eat, I’ll be there. Whenever they’s a cop beatin’ up a guy, I’ll be there . . . . I’ll be in the way guys yell when they’re mad an’—I’ll be in the way kids laugh when they’re hungry an’ they know supper’s ready. An’ when our folks eat the stuff they raise an’ live in the houses they build—why, I’ll be there.”
We're seeing Tom Joads emerge in the chaos of New Orleans. We need many more, and we need to get more of them in the government, because there are not enough in evidence there now.
RiskProf notes that Katrina will have impacts on insurance prices, though they will be more subtle than the recent sudden spikes in gasoline prices seen across the country. Katrina will take a significant amount of capital out of the whole insurance system. Most of it will initially come from reinsurers, but reinsurers always operate on a long-term relationship with the companies they reinsure. They pay you this year, and recoup the losses next year, and the year after, and the year after that.
Property loss reserves in the whole system will be immediately increased, immediately wiping out taxable income for the quarter (and the year for insurers concentrated in Gulf windstorm exposures). This is a big hit, but it is one that is in the range of forseeable 100 - 250 year windstorm losses. Insurers and reinsurers know that the "reversion to the mean" allows the survivors to earn back their losses in future years.
Katrina will "thin the herd" of insurers that were insufficiently capitalized or reinsured, and those who took a risk on under-insurance. Those who passed on flood insurance will suffer. Those owning property in the heavily impacted area will have to think long and hard whether or not they want to reinvest what insurance proceeds they get in the below-sea-level bowl that man created by "flood management" in the New Orleans metro area. Vindicated will be those engineers and other experts who long warned that New Orleans could not survive a storm like this. See Business Week Special Report Let Katrina Be a Warning (September 1, 2005) and Budget cuts delayed New Orleans flood control work - Yahoo! News
Reinsurers will increase their rates, some marginal insurers may fail and their capacity exit the market, some insurers that were "on the fence" about windstorm exposures on the beach will retire from the market. Residential flood losses will be absorbed into the federal tax and deficit base through the flood insurance program, but commercial property writers may be hit on flood losses to apartments, offices and industrial property. Many windstorm losses will be spread through "wind pools" and government subsidized pools whose solvency will be tested and financing re-evaluated. Commercial writers that got aggressive in the energy markets may find themselves paying disproportionate losses. All these market forces combine and point to an inevitable hardening of the market in property insurance, particularly in the Gulf and Florida.
The effects on insurance prices are subtle and complex. Count on politicians to make them seem simple and controllable with hasty legislation that will have unintended consequences.
The greater effects will be on those losses not covered by any insurance, such as the immense human suffering of those trapped in the chaos of New Orleans.
See: RiskProf : Katrina and Florida Insurance Prices
Those who bemoaned a "medical malpractice crisis" in Maryland were surprised when a major mutual stopped raising rates.
Insurance Journal reports that the news comes "after an emergency session of the General Assembly and dire warnings from Gov. Robert Ehrlich that doctors would be driven out of the state because of high insurance costs."
A state subsidy is now in question. Why do politicians always seem surprised when the market works like it should, despite their best efforts? Med-Mal Rates in Maryland Dropping
Specialty Insurance Blog points us to a New York decision holding an excess lines broker liable for placing an insured with Legion Insurance Company, which failed and was liquidated in 2003, leaving claims unpaid. The court believed undisputed testimony indicating that the broker may have skipped and papered-over the statutorily required search for an admitted insurer before placing coverage with the doomed Legion. Specialty Insurance Blog: Insurance Broker Insolvency Liability
Most courts agree that an agent takes on a professional duty of care simply by taking on the role of an agent. That ordinary duty usually does not include a duty to give advice or explain coverages to insureds, who are expected to read the policy. But it often includes liability for failure to procure insurance as promised.
In the presence of special circumstances, such as express assumption of additional responsibilities or the agent representing that she has special skills, additional duties may be found. Some courts are even recognizing that some circumstances raise an especially high “fiduciary duty” standard, even though that standard has rarely been applied to agents in the past. See Daniel Gregory Sakall, Note, “Can the Public Really Count on Insurance Agents to Advise Them? A Critique of the ‘Special Circumstances’ Test,” 42 Ariz. L. Rev. 991 (2000).
Insureds have also sought to hold agents and brokers responsible if the company with which they were placed becomes insolvent and unable to fund a defense and pay claims. Though agents are not held to be guarantors of the solvency of an insurer, courts have found them liable if they fail to use reasonable care in choosing an insurer. See Michael F. Skinner, “Liability of Insurance Agent or Broker for Placing Insurance With Insolvent Carrier,” 42 A.L.R.5th 199 (1996).
When companies are licensed by the state, agents are generally protected if the insurer fails, because state licensure comes with oversight of solvency. See, e.g., Wilson v. All Service Ins. Corp., 153 Cal.Rptr. 121 (Cal. App. 1979). Some companies are “unauthorized” insurers, for which special procedures are called for in order to place business using “surplus lines” agents and brokers. For such insurers, there may be a higher standard to inquire into the financial status of the company and to observe all of the statutory formalities. This recent New York decision highlighted by Specialty Insurance Blog is one example of application of such a standard. East Coast Mgt. Ltd. v. Ganatt Assoc., Inc, 2005 NY Slip Op 25313 (Supreme Court 2005).
Risk Prof spurred a bit of a debate over the use of credit scores as a rating tool, as recently approved by the Louisiana Ins. Commission. Commentators repeat the usual objections, usually with a minimal background in the science, logic and economics of insurance pricing and risk selection. Risk Prof quotes and criticizes arguments from objectors that attempt to apply standards from civil rights cases to commercial insurance pricing.
One commentator, Joe Rotger, volunteers to "sacrifice and pay higher premiums" to avoid "blatant discrimination." All we need is a market filled with buyers who make decisions based on other than their economic best interest. Last I heard, those were hard to find. Hard enough to make it unprofitable to depend on it in a competitive world. And the various GEICO and Progressive ads offering lower rates would be a waste of money. My guess is they are more practical than Joe.
Another is willing to let "Joe" pay extra, but opposed to forcing that choice on everyone.
The key element is that credit scores do in fact correlate with claim ratios. Why? Hard to say, but its not important to the rating decision. If a positive correlation can be shown, making the discrimination not unfair, the law is satisfied. If the legislature wants to outlaw a scientifically demonstrated predictor of claim costs, let it be their call, not the insurance commissioner's.
I'm with Risk Prof and the Louisiana Ins. Commissioner on this one.
To join in the debate, visit: RiskProf : The Civil Rights-ing of Risk
The Financial Risks of Terrorism: Balancing Public and Private Roles - Knowledge@Wharton
From the abstract:
"This week, the Wharton Risk Management and Decision Processes Center publishes TRIA and Beyond, an analysis of the Terrorism Risk Insurance Act of 2002 (TRIA), which will expire December 31, 2005, if not renewed. The Risk Center's report offers policymakers, key industry representatives and other interested parties an analysis of what roles the public and private sectors should play with respect to terrorism risk coverage in the United States. The report was produced by a nine-person team, led by Howard Kunreuther, co-director of the Center, and Erwann Michel-Kerjan, a senior research fellow at the Center. The other authors include Neil Doherty, Wharton professor of insurance and risk management; Paul Kleindorfer, Wharton professor of operations and information management; Mark V. Pauly, Wharton professor of health care systems and business and public policy; Scott Harrington, Wharton professor of health care systems; Center research associate Esther Goldsmith, and senior fellows Irv Rosenthal and Peter Schmeidler."
RiskProf : More Simplistic Tort Reform Research examines recent writings by Bob Hunter about the medmal marketplace and tort reform, and rightly criticizes the lack of decent standards for statistical comparison and claims, saying: "The standards for analysis in this debate are too low. Every group has their favorite whipping boy and their statistics to back it up. However, just looking at point estimates and saying this estimate is bigger than another to make a conclusion ... is so 1930s. I don’t think these reports would even get an average grade as an undergraduate term paper. Shouldn't we expect more?"
Claimants against insolvent insurer Legion will be able to recover directly from captive reinsurers for which Legion served as a fronting company. Koken v. Legion Ins. Co. et al, NO. 218 MAP 2003 (July 19, 2005)
The decision came over a dissent by Madame Justice Newman, in which the Justice said: "Because Section 534 of the Insurance Department Act explicitly prohibits an insured from obtaining direct access to reinsurance funds absent express language in the provisions of the reinsurance contract, I believe that we must reverse the Orders of the Commonwealth Court to the extent that they permit such erroneous direct access.
See also the decision below: Koken v. Legion Ins. Co., 831 A.2d 1196 (Pa. Commw. 2003)
(Commissioner’s decision to liquidate insolvent insurers and trigger guaranty funds contested by principal shareholder. Insolvents acted either as “fronting companies” on numerous corporate insurance programs reinsured by captives or wrote large deductible policies on corporate risks and were reimbursed by affiliate that wrote a Deductible Reimbursement Policy. Corporate insureds that had such contracts with Legion were granted direct access to the reinsurance proceeds, and did not have to accept a delayed and reduced dividend from the insolvent estate of Legion.)
Insolvency Briefing (PDF) is a publication of the National Conference of Insurance Guaranty Funds (NCIGF).
This year, they quietly began publishing an online newsletter with news of legal decisions and procedural developments in the liquidation of insurance companies that affect the various state insurance guaranty funds. State insurance guaranty funds are provided for by statute and are obliged to pay many of the ordinary insurance claims made against property-casualty insurance companies that have been placed in liquidation due to insolvency.
The current issue includes an update on Reciprocal of America, PHICO, Frontier, The Home, CRE/EMIC, and the latest financial reports from Legion Insurance Company. It includes a short report by Kevin Harris of transactions at the recent meeting of the National Conference of Insurance Legislators (NCOIL).
A listing of back issues (unfortunately without TOC or squibs of their contents) could be easier to find.
Property Casualty Insurers Association of America (PCI), a large association of property-casualty insurance companies, has proposed to Congress an alternative to the scheme set forth in the Terrorism Risk Insurance Act (TRIA) which is expiring. In its press release, PCI says:
"PCI’s market-based approach focuses on bringing additional capacity to the terrorism insurance marketplace by employing private market tools coupled with the certainty that can only be provided by high level federal government financial backing. The solution would spur insurers to enter the market, enable insurers to share or “buy down” their risk, and allow for the development of a catastrophe bonds market and similar facilities that would encourage greater private capital participation in the market."
"Csiszar Urges Congress to Adopt a Market-Based Terrorism Insurance Solution" (July 27, 2005).
A three-page outline of their proposal can be found in a " Key elements" PDF
The U.S. Treasury has also argued for significant changes in TRIA. See Unintended Consequences: Treasury Assesses TRIA: Revisions, Limits Needed
In "Who Bears the Risks of Terror," New York Times July 10, 2005, Edmund L. Andrews' provides a concise and readable "fly-over" of the principal issues in the debate over the future of TRIA. He notes a developing red state / blue state divide and the positions of Rep. Delay and Sen. Frist that the role of federal help "had run its course."Unintended Consequences: NYTimes on distributing risks of terror
Underpricing and under-reserving by well-meaning new players in the medical malpractice insurance marketplace often ends in financial disaster for the company, its policyholders and claimants. It is politically popular for regulators to play to those wanting to keep premiums down and to encourage self-insurers, physician-owned mutuals, reciprocals and risk retention groups. To often, those groups face an inherent conflict of interest between their mandate to "make affordable coverage available" and their obligation to obtain enough premium to cover all claims and contingencies.
That conflict becomes most acute during "crises" in which commercial insurers withdraw from markets that have become losing propositions for any financially responsible provider. It is economically vital that those that regulate insurance providers and the insurance coverages of health care providers also enforce the less popular legal requirements forbidding premiums that are "inadequate," to avoid melt-downs like MIIX Insurance, presently operating in "solvent runoff". N.J.'s Med-Mal Writer MIIX Continues in Runoff Without Guaranty Fund (Insurance Journal, July 21, 2005). The regulatory euphemism "solvent" runoff is ironic, considering that less than a year ago, MIIX had a negative surplus of some $300 million.
The story of MIIX Insurance could be added to a list of case studies in dysfunctional insurance management and regulation, joining the list with Reciprocal of America and many others.
Other online resources providing a timeline of the decline and fall of MIIX Insurance:
MIIX Group Reports Fourth Quarter Results, Announces Quarterly Dividend and Sets Record Date for 2001 Annual Meeting Investor's News at MIIX.com Website (2/22/01), in which management stated:
"Our written premium declined over $30 million in 2000 and we expect further reduction in 2001 as a result of our ongoing re-underwriting and re-pricing efforts. During 2000, we aggressively sought to eliminate unprofitable business and we will continue to focus on retaining and intelligently growing our business prudently and where opportunities exist. We believe that this bottom line focus will result in greater long term profitability, particularly in the current very hostile market climate."
"Our book value at December 31, 2000 exceeded $21 per share and we believe that the current trading range represents a significant opportunity for long term investors. We believe that reserve adequacy, debt leverage and management are key considerations when looking at MIIX as an investment. Our reserves continue to be carried at Company best estimate levels and at year end our gross loss reserves approximated $1.142 billion, of which incurred but not reported (IBNR) reserves represented $690 million, or 60.3% of the total, up from 58.1% at September 30, 2000 and 57.6% at June 30, 2000. Debt leverage at the Holding Company level approximated 2% and is not expected to increase in the near future. Lastly, the new MIIX management team has demonstrated its commitment to take the appropriate, often difficult actions to ensure the Company's long-term success."
MIIX Group Reports Third Quarter Results (reporting book value of over $23.00 per share) Investor's News at MIIX.com Website (11/1/01).
MIIX Announces Decision of Chief Financial Officer to Leave in March 2002 Investor's New, MIIX.com Website (12/21/01).
MIIX Group Reports Fourth Quarter Results Investors News, MIIX.com Website (Reporting reserve increases, $12/share net operating loss and book value below $10 per share) (2/28/02)
MIIX Group Reports Fourth Quarter Results Investor's News, MIIX.com Website (2/26/03). This year-end report blamed the sudden downturn on the necessity of increasing reserves for past policy years:
"For the twelve months ended December 31, 2002, the Company incurred a net operating loss of $107.5 million, or $8.03 per share, compared with a net operating loss of $149.6 million, or $11.06 per share, during the twelve months ended December 31, 2001."
"The Company's losses in 2002 are reflective of the turbulent legal and medical economic environments in the states where the Company wrote the majority of its business," stated Chairman and CEO Patricia A. Costante. "Results reflect fourth quarter gross reserve adjustments of $85.1 million, which are directly attributable to the continuing upward trend of loss severities to unprecedented levels. The reserve adjustments associated with the New Jersey physician market primarily relate to accident years prior to 1999 when the Company undertook an effort to restructure its New Jersey program. The continuing rise in loss severities in the fourth quarter to historically high levels follows loss and ALAE reserve adjustments made by the Company in the first quarter of $35.6 million and in the third quarter of $30.7 million."
The MIIX Group Announces Court Places Insurance Subsidiary in Rehabilitation. Investor's News at MIIX.com Website (9/30/04)
The MIIX Group announces bankruptcy filing. Investor's News at MIIX.com Website (12/20/04)
There's a graduate level case study in here somewhere.
Risk Prof Martin Grace suggested on Monday that TRIA support is a blue state issue, particularly for urban centers like New York City, explaining the outcries of NY senators in reaction to the Treasury Department recommendations against renewing TRIA in its present form. He suggests an objective analysis of the economics, including the external costs and benefits of subsidizing construction projects in NYC. RiskProf : TRIA--A Blue State Problem?
One of the considerations to keep in mind is the reaction of those that fund construction in NYC. According to the Congressional Budget Office, Federal Terrorism Reinsurance: An Update (January 2005) [hereinafter “CBO Terrorism Study”], following 9/11, banks did not tighten commercial lending requirements, even though the market for terror coverage dried up. Builders and developers were able to distribute risk through the use of REITs and mortgage-backed securities, plus requiring more developer equity in properties. All without terror insurance. Banks still loaned money on construction, according to the CBO study, which found no significant impact on construction hiring or construction loans. True, properties and securities that did not take such financial diversification measures suffered credit rating downgrades because of the lack of terror coverage.
If that is the case, the source of New York's concerns may be from small and medium sized businesses and construction interests who may not have access to the more sophisticated financial tools like mortgage-backed securities and REIT investment.
Should we continue the present approach, in which federal reinsurance is free? Expecting private reinsurance (from which the capacity for terror catastrophe coverage must come) to compete with a free federal product seems just silly to me. As long as the feds give away reinsurance, small and medium sized businesses will be dependent on the kindness of strangers in Washington. And those strangers will be dependent on their votes and campaign contributions.
"Who Bears the Risks of Terror" leads the Sunday Businss section of the Times today. Edmund L. Andrews' piece provides a concise and readable "fly-over" of the principal issues in the debate over the future of TRIA. He notes a developing red state / blue state divide and the positions of Rep. Delay and Sen. Frist that the role of federal help "had run its course."
Andrews compares impact of 9/11 on the insurance industry ($31 billion) with that of 1992 Hurricane Andrew ($20 billion). He also cites insurance industry funded reports by R. Glenn Hubbard (Columbia Univ.) and Kent Smetters (Wharton School). He also points to the debate over the impact on private markets of the presently "free" federal coverage, and also notes the possible negative impact on private security "hardening" that such subsidized protection may have.
An excellent article for the busy novice to this complex economic controversy.
Who Bears the Risks of Terror? - New York Times (Sunday Business page one, July 10, 2005).
For another perspective on terror risk distribution, see also this view:
"The administration seems comfortable with transferring risk away from taxpayers and into the private sector. Private insurers, in turn, will ask their actuaries to calculate the potential exposures (no easy task) and will then try to pass the added costs along to their customers. But which customers will be willing to pay? For insureds living in high risk areas, business owners are very likely to opt for terrorism coverage. But what about the machine shop in Leominster MA? Or the Midas Muffler franchise in LaGrange GA? The fact is, the vast majority of businesses are likely to decline coverage, because we all seem to think that most of the risk resides in the big coastal cities. That leaves the burden for coverage on a relatively small number of businesss: their costs will go through the roof, while the costs for everyone else will stay pretty much the same."
Found at: Workers Comp Insider - TRIA: Terror and Risk Transfer (July 7, 2005)
The Supreme Court's decision in Grokster left Sony in intact, but found it did not shield those who promote and encourage use of a product to infringe intellectual property. Euclid Managers Blog points out that "the case raised new concerns and considerations for some technology companies, particularly those whose product or service can be used for making unauthorized copies."
They go on to relate this to insurance costs for technology companies, saying:
"Companies may face a more fact-intensive examination of intent and objectives. That kind of lawsuit can make discovery more expensive, it can lead to more cases being filed for the purpose of going through the discovery process to see what’s there, and such a suit can be more difficult to defend. And summary adjudications may be more difficult to achieve in such cases.
Tech companies should be aware that someday a court may perform a balancing test of the product’s legitimate and illegitimate uses, and the standards that will be applied in that test are not entirely clear.
Predictability has gone down for developers, and their insurers, meaning that risk has gone up."
Source: Euclid Managers Blog - Home - Grokster, the Supreme Court and the Impact on Risk (June 30, 2005).
Insurance blogmeisters George Wallace and Bob Sargent have an ongoing discussion over the ethics and legality of duties and responsibilities of agents and brokers. This arises in the current controversy over undisclosed contingent commissions and other revelations in the insurance intermediary business. George himself acknowledges that the discussion has reached a level of dryness and complexity that one might think could frustrate the average state legislator. (See: Declarations and Exclusions: In Answer to Bob Sargent's Question . . .)
Perhaps this debate (and others like it) best demonstrates that this issue is too complex for the average lay person who is buying personal or commercial insurance to follow, even if they wanted to. The issue becomes much like insurance rates and forms. Decades ago, insurance regulators decided that rates and forms were too complex and variable for consumers to be expected to follow, and imposed regulations requiring that they be filed. Some states require them to be approved by a regulator before use, or subject to review after use. Some may also require affirmative non-waivable disclosures to insurance purchasers before or at the time of sale.
Has the time come to make similar provisions for the compensation terms of insurance agents and brokers? Or would such regulation stifle the creativity in the field that may be necessary to make a market? Perhaps in consumer lines a different argument could be made than in standard commercial or in specialty lines (such as those Bob Sargent focuses on)?
Connecticut AG Blumenthal recently slammed medical malpractice insurers for raising rates faster than current payouts are rising. According to Specialty Insurance Blog: Insurers are to Blame, he's citing a recent advocacy piece written by Jay Angoff, former Missouri insurance commissioner, a lawyer who represents trial lawyers and consumer advocacy groups. See: Illinois Civil Justice League: Will the REAL 'conflict of interest' be raised?
See: Attorney General Calls For Immediate Review Of Medical Malpractice Insurance Rates; Cites Troubling Consumer Report (Press Release from Conn. Attorney General July 7, 2005).
Advocacy pieces often overlook the sorts of long-range statistics that show that the insurance cycle lags the med mal expense cycle for many complex reasons. Advocates will frequently select a relatively small time frame to compare data, without referencing long periods in which insurance prices and profitability fell year after year until large insurers collapsed leaving hundreds of millions in claims unpaid.
Following such market collapses, reinsurers and surviving companies must rebuild reserves in order to gain enough strength to survive the next round of price wars, often initiated by government-subsidized insurance pools, JUAs and patient compensation funds. The key roles of below-cost providers (often physician owned) in aggravating the insurance cycle is well documented. Some of the objective, scientific studies are referenced in a recent working paper available on this website at: Unintended Consequences: Causes of the Medical Malpractice Crisis? (March 17, 2005.
Insurers have long made a convenient whipping boy for advocates seeking to avoid dealing with the complex issues of markets in long-tail lines in which governments periodically introduce below-cost competition. Its complicated by the special legal and accounting rules allowed (required) for insurers. Prof. Martin (author of the RiskProf blog comments on these regularly, such as in his guest post in: Evan Schaeffer's Legal Underground: Continuing the Med-Mal Debate: Insurance as a Whipping Boy? (Jan. 12, 2005)
Let us hope that Attorney General Blumenthal maintains his objectivity and reads more than one side of a complicated story in which the last four years' experience is only a small part of a much larger economic story.
Thanks to Specialty Insurance Blog: Insurers are to Blame
The Organisation for Economic Co-operation and Development has released an extensive report on the availability of insurance coverage against terrorism. According to its abstract, the report finds that private sector insurance capacity is still limited and what is offered is not widely taken up by insurnce buyers. It cites estimates of $50 billion to $250 billion as potential maximum losses from a "mega terror" attack like that of September 11. It suggests possible changes in tax and accounting laws may be helpful, as well as public-private partnerships.
The report is offered for sale as a printed document or e-book, but journalists are invited to request copies.
OECD countries warn of continuing shortfalls in insurance coverage against terrorism
Treasury Releases Report on Terrorism Risk Insurance Act of 2002
From the letter of transmittal to Rep. Oxley:
"The attached report, based in part on surveys of the insurers and policyholders that were developed after extensive consultations with the National Association of Insurance Commissioners, policyholders, the insurance industry, and other experts in the insurance field, evaluates the effectiveness of TRIA in the context of the purpose of the legislation. The report finds that TRIA has achieved its goals of supporting the industry during a transitional period and stabilizing the private insurance market."
* * *
"It is our view that continuation of the program in its current form is likely to hinder the further development of the insurance market by crowding out innovation and capacity building. Consistent with its original purpose as a temporary program scheduled to end on December 31, 2005, and the need to encourage further development of the private market, the Administration opposes extension of TRIA in its current form."
"Any extension of the program should recognize several key principles, including the temporary nature of the program, the rapid expansion of private market development (particularly for insurers and reinsurers to grow capacity), and the need to significantly reduce taxpayer exposure. The Administration would accept an extension only if it includes a significant increase to $500 million of the event size that triggers coverage, increases the dollar deductibles and percentage co-payments, and eliminates from the program certain lines of insurance, such as Commercial Auto, General Liability, and other smaller lines, that are far less subject to aggregation risks and should be left to the private market."
"It is also important to keep in mind that the program would cover damages awarded in litigation against policyholders following a terrorist attack. Current litigation rules would allow unscrupulous trial lawyers to profit from a terrorist attack and would expose the American taxpayer to excessive and inappropriate costs. The Administration supports reasonable reforms to ensure that injured plaintiffs can recover against negligent defendants, but that no person is able to exploit the litigation system."
Assessment: Terrorism Risk Insurance Act of 2002 (PDF - 142 pages)
Not long ago, I did some research into the recent history of the struggle between state and federal regulators, each of which want to have the big job (and big budget and headcount) of regulating the largely self-organized global insurance network. As we have seen in recent scandals, there are plenty of opportunities for the unscrupulous to take advantage of the complexities of this byzantine industry, yet somehow it runs, grows, absorbs horrendous losses from earthquakes, hurricanes and terrorist attacks and still survives and attracts new capital. Would it be as robust if its regulation became less diverse, more interconnected, more of a monoculture? If it were federalized, as proposed by some and opposed by others? A new chapter in the saga of federalization proposals was written this month in the committee rooms of the U.S. Congress, under Rep. Oxley.
(read more)
Those who think that the solution to any thorny economic problem is to have the United States Government run it should think first about 1) the Postal Service 2) the War in Iraq and 3) government handling of intelligence prior to September 11. With that firmly in mind, let's review some of the thrust and parry that has been going on in the last few years over who gets to make sure the insurance industry is regulated "efficiently." As we do, let's not forget that someone should make sure that it is also robust, and able to absorb financial shocks like September 11 and Hurricane Andrew.
The rhetorical record grew this month with testimony in hearings and a presentation by the National Association of Insurance Commissioners (NAIC) before the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises. "Impact of SMART Act on State Insurance Regulation" (June 16, 2005) (PDF). Keep in mind that since the McCarran-Ferguson Act was passed decades ago, the federal government has left insurance regulation to state law, with only minor reservations, as reviewed in Hartford Fire Ins. Co. v. California, 509 U.S. 764 (1993).
For the acronymically challenged, here is a lexicon of some of the dueling manifestos floated over the past few years.
Optional Federal Charter for Insurers ("OFC"). The OFC champions propose to create a federal insurance charter like the existing federal bank charter. Those insurance companies that got a federal charter could elect to be regulated by the federal government instead of by every state where it sells insurance. Insiders sometimes refer to this as being regulated by "One giant gorilla instead of 50 chimpanzees." The organization of insurance legislators in the various states (NCOIL) opposes OFC, concerned that states would be unable to shape insurance regulation to local needs, like making insurance companies subsidize bad drivers in metropolitan areas or purchasers of expensive homes right on the beach. A new federal regulatory regime would create thousands of jobs both in the government and private industry to provide and comply with the new federal regulation, which would be competing with the existing state regulation. Some state insurance regulators may be concerned that their roles will diminish in importance, and that if enough big insurers (such as those operating in all fifty states) switch to federal charters, state revenues for insurance department budgets (based on premium taxes) would plummet.
Oxley “Road Map” and “SMART” Bill. Early in 2004 speech, (see: New Momentum for Letting U.S. Help Regulate Nation's Insurers (March 14, 2004)) House Financial Services Committee Chair Michael G. Oxley of Ohio unveiled what he called a “Road Map” of changes he says are needed in state insurance law, to get more uniformity and efficiency. Feeling a breeze, the NAIC (which has no legislative authority) came back with a draft for implementing some of Rep. Oxley's proposals in state law, and called it a “Framework.” In 2004, Rep. Richard H. Baker of Louisiana joined Rep. Oxley to sponsor the State Modernization And Regulatory Transparency Act ("SMART"). Its purpose would be to make the Road Map into law. If it became law, SMART would leave state regulators in place, but override some of the state rules that Baker/Oxley see as inefficient (like state rate approval). They would also require the state insurance commissioners to agree on standard regulations, and put a federal overseer in place to knock heads ("mediation and enforcement") in case of disagreement. Some think that without such a federal referee, states will never agree on standard regulations. A long history shows even agreeing on model insurance laws and regulations has been slow going and often leaves major states refusing to enact the model laws agreed to by their own insurance commissioners. SMART seems like a stalking horse or trial balloon intended to motivate state legislatures to hurry up and agree or see the feds stepping in with the classic line: "We're from Washington and we're here to help you."
NAIC Responses to Federal Initiatives ("Interstate Compact"). Sure enough, the NAIC blinked and came up with an improved proposal, their “Framework” of modernization plans, including uniform standards for licensing agents and brokers, supervising insurer's conduct in the marketplace and handling the mundane but bread-and-butter work of regulating insurance policy language, premium rates and company financial solvency. To move their cooperation along, the NAIC members created an Interstate Insurance Product Regulation Compact (“Interstate Compact”) that included many of the reforms called for by Baker/Oxley. They have since been working to get major states to become signatories to the Interstate Compact, by which they would voluntarily agree to implement the regulatory reforms.
Many key states have a poor history of following, and a tendency to want to lead. This can be a disaster on the dance floor and also in "voluntary" organizations of proud players who are nominally peers but who know that some are more equal than others. In late 2003, for example, California, Florida and Texas agreed to work together to standardize approval procedures for certain life and annuity products. Illinois, Pennsylvania and New York also have a history of going their own way in insurance regulation. Getting these heavies to cooperate could take longer than Baker/Oxley are willing to wait.
The latest episode in the circling of these sumo wrestlers was a hearing on June 16 before the Baker Subcommittee (clearly a more wieldy title than "The Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises") In the announcement of the hearing ("Baker Subcommittee to Continue Oversight of Insurance Markets"), Rep. Baker said: “Of all areas of regulation which our Committee has examined, insurance regulation is easily one of the most in need of modernization and uniformity. Price controls and patchwork regulation benefit neither consumers nor providers. I look forward to hearing from our panel of commissioners their views on the SMART proposal and our efforts to bring insurance regulation into the 21st Century."
Rep. Oxley said, “As a former State legislator and member of NCOIL, I have been one of the strongest proponents of the NAIC and its efforts. But as we have demonstrated throughout the hearings in this Committee over the past three years and the numerous hearings held previously in the old Commerce and Banking Committees, the States cannot get the job done by themselves. The collective action barrier to getting legislatures and regulators to act in complete unison is, and will always be, insurmountable, absent Congressional legislation.”
The usual cast of characters at these hearings again appeared last week, represented by six present or former insurance commissioners from states (Illinois, Pennsylvania, New York, Ohio and Arkansas) that have been active in the NAIC's movement to preserve its member's authority.
NAIC President, Hon. M. Diane Koken (Insurance Commissioner of the Commonwealth of Pennsylvania) declared the NAIC's public service orientation and timeliness at achieving modernization without sacrificing consumer protection. She then went on to tell Congress what they really felt about SMART: "Third, the draft SMART Act incorporates unacceptable levels of federal preemption that would create both legal and practical problems for the insurance industry and its customers. A thorough analysis of the SMART Act by 117 insurance regulatory experts from your home states identifies concerns where the bill would preempt many important state laws that protect consumers from unfair or discriminatory marketing, inadequate or excessive rates, and unsound products. Federal preemption of state insurance regulation denies your Congressional constituents the benefits of important state services and protections, as has already been proven in existing federal programs, such as FEMA in its administration of the National Flood Insurance Program, and ERISA through its taking away state authority to assist your constituents. The states believe it is constructive to point out basic constitutional, legal, and operational problems that would undermine the SMART Act’s stated purposes." Her full testimony is online, including the reports of seven teams of regulatory officials and staff. (51 pages in PDF)
One of the strengths of complex systems is the capacity of its components to interact independently because of the existence of diversity. That independence has repeatedly been shown to protect the overall system from vunerability to unexpected consequences that lead to cascading failures in "monoculture" systems that are highly interlinked. (See: Unintended Consequences: Reading: Barabasi, Linked: The New Science of Networks (2003))
The vulnerability of monoculture systems to catastrophic results of otherwise survivable errors or attacks has been observed again and again, from the Irish Potato Famine (Fraser, "Conservation Ecology: Social vulnerability and ecological fragility: building bridges between social and natural sciences using the Irish Potato Famine as a case study" (2003) to the recent New England electrical blackout (Unintended Consequences: Blackout Report: Maintenance, Training and Communication Errors (2003). During the Blackout of 2003, only the systems that were able to independently decide to disconnect from the "efficiency" of the centralized, unified controls avoided being sucked into the collapse of the highly connected network.
Looking back on decades of ill-conceived centralized government "solutions" to insurance availability and affordability "crises" in state after state, in automobile insurance, workers compensation insurance, medical malpractice insurance and product liability insurance, we see a record of attempts to solve political problems with price controls and lock-ins that caused long-term damage to the whole economic system. If our decentralized insurance system gets federalized, mistakes that would have an impact on only one state may impact every insurance transaction in the entire nation. Time will tell if the game of "chicken" going on between state and federal regulators has a net positive or negative effect. Whatever happens, I'm counting on unintended consequences.
Abstract:
The Terrorism Risk Insurance Act (TRIA) requires insurers to offer commercial insurance that will pay on claims that occur from a terrorist attack, and for losses on the scale of 9/11, TRIA provides a "backstop" in the form of free reinsurance. The authors describe the evolving terrorist threat with the goal of comparing the underlying risk of attack to the architecture of financial protection that has been facilitated by TRIA.
RAND Corporation has made a PDF version of this 92-page peer-reviewed paper, "Trends in Terrorism: Threats to the United States and the Future of the Terrorism Risk Insurance Act" (ISBN: 0-8330-3822-2), available free online at this time.
Thanks to Insurance Journal for pointing to this resource.
See also: Unintended Consequences: Terror Insurance Market Overview (Dec. 18, 2004)
Recent investigations by state and federal regulators have led the insurance industry to turn away from the use of controversial "contingent commissions" that compensated insurance brokers for bringing to insurers risks meeting certain volume or profitability goals.
At a recent Standard & Poor's conference, brokerage executives were quoted as expecting greater transparency coming as a result of the recent investigations. That transparency will include the disclosure of the higher commissions brokers are negotiating. Source: S&P Conference: With End of Contingent Commissions, Brokers Find Ways to Plug the Hole Insurance Journal, June 14, 2005.
Increased disclosure to insurance purchasers of all compensation received from insurance companies by agents and brokers is a key goal of model laws proposed by the National Association of Insurance Commissioners (NAIC). Any such law and implementing regulation would have to be enacted by each state's legislative and regulatory authority individually. The NAIC has no power beyond persuasion.
The NAIC model law is not without controversy. In November of 2004, Connecticut Attorney General Richard Blumenthal called the model law "a shadow of what it should be," that "fails to address the key defects in the current system." See: Unintended Consequences: NAIC Model Law on Broker Disclosures Criticized by CT A.G. Blumenthal (November 17, 2004). See also: Unintended Consequences: Testimony to Senate Panel on Insurance Brokers (November 17, 2005).
Risk Retention Reporter has reported 2004 premium for risk retention groups (RRGs) neared $2.2 billion, up from $1.7 billion for 2003. During the three soft market years (98, 99 and 00) RRG premiums were essentially flat. Source: Insurance Journal, June 15, 2005 Risk Retention Group Premium Soars Above $2 Billion.
Under the federal Liability Risk Retention Act, RRGs licensed in one state can write liability insurance on a variety of property-casualty risks in other states without having to comply with the usual licensing requirements imposed on "foreign" insurers. During hard markets, RRGs tend to expand the geographical scope of their writings and take on risks "commercial" insurers decline. Unfortunately for their insureds, insureds in RRGs are not eligible for coverage from their state insurance guaranty funds that pay claims against insolvent insurers. As a result, if a RRG fails (as they sometimes do in soft markets), the policyholders (and claimants against them) may find payment of their claims to be delayed, heavily discounted or unavailable.
Such problems have come to light recently in connection with the insolvency of several RRGs associated with Reciprocal of America (ROA). ROA and its RRGs recently were declared insolvent, leaving thousands of hospitals and physicians suddenly without insurance and without assurance that claims already made against those companies would be paid in full.
See also: Unintended Consequences: Impact of Reciprocal of America on Mainstreet Professionals (April 17, 2005).
A new study from Wharton, funded by the AIA, concludes that while contingent commissions can be the subject of abuse, they may also benefit policyholders in some ways, especially if they involve profit-based contingencies. Aligning the intermediaries interests with the insurers may relieve the spector of adverse selection and the "winners curse," by providing insurers with more confidence in the quality of the risk being placed. This may encourage more competitive bidding for business.
This Wharton study was funded by the American Insurance Association (AIA), and is available in full text online at Insurance Journal's website. Cummins & Doherty, "The Economics of Insurance Intermediaries," Wharton School, May 20, 2005.
Source: Insurance Journal. Wharton Study Finds Agents, Brokers Play Critical Role in Buying Process
See also: Unintended Consequences: Testimony to Senate Panel on Insurance Brokers
And: Unintended Consequences: NAIC Model Law on Broker Disclosures Criticized by CT A.G. Blumenthal
As Congress considers arguments for and against the extension of the Terrorism Risk Insurance Act (TRIA), one that recurs is that the insurance industry could not absorb a $100 billion loss from terrorism. Yet, without federal reinsurance, the insurance industry is already exposed to comparable shock losses of similar magnitude, in the form of hundred-year or 200-year killer windstorms or earthquakes striking key population centers in the developed world.
See, e.g., an earlier Unintended Consequences post on May 6: Unintended Consequences: Useful sources on terror risk "super catastrophes"
For possible terror attacks, one exposure not often discussed is that to workers compensation insurers. A Towers Perrin/Tillinghast study saw a $90 billion comp loss in a worst-case scenario. RMS studies reportedly found potential for $4 billion from a major truck bomb attack and $32 billion from a large-scale anthrax attack. The total capital in the workers comp market is said to be about $30 billion, so these would be major hits. Some speculate that the anticipation of this might cause a crisis in workers compensation insurance as employers with urban concentrations are non-renewed and left to get comp insurance from the residual market or assigned risk plans, if TRIA is not extended. The article, with links to more detailed studies, is at International Risk Management Institute, "TRIA's Sunset: The Dawn of a New Workers Compensation Crisis?" (May 2004)
To further put a $100 billion exposure in perspective, consider the unfunded liabilities in existing corporate pension programs. According to a recent release by Wharton, the Pension Benefit Guaranty Corporation (PBGC) estimates a projected liablity of $450 billion, almost $100 billion of that in plans sponsored by financially troubled companies. The recent default by United Airlines on $6.6 billion in pension liabilities is just one instance of such a call on PBGC. Retirement Programs Face an "Aging-Population Tsunami" - Knowledge@Wharton
Wharton Professor Grace Wong analyzed transaction volumes and other factors potentially contributing to speculative bubbles, focusing on the fluctuation of prices in Hong Kong real estate. Her study suggests possible tools to detect speculative activities in cyclical markets, in time for regulators to act before damaging collapses.
Her study looked at and discounted the influence of various fundamental factors (e.g. interest rates, inflation, population growth, tax changes) sometimes offered to explain price spikes. She also considered historical bubbles, including the Tulip Craze of the 17th century and the tech stock bubble of more recent years. She derives some of her tools from work done by Scheinkman and Xiong in "Overconfidence and Speculative Bubbles." (2003) and "Speculative Trading and Stock Prices: An Analysis of China's A-B Share Premia." (2004).
Question: might Wong's studies be of value in understanding insurance price cycles and "crises" such as that in the medical malpractice sector? Can such recurring "crises" be seen as the analog of the inevitable "crash" following a speculative bubble in a real estate market, fueled by overconfidence? In insurance markets, the "crash" phase is manifested in suddenly rising prices as markets over-react to the excesses of the bubble of "exuberance," instead of the falling prices that evidence a "crash" in other financial markets? Is the regulatory attention better aimed at preventing the exuberent speculation or the over-reaction that naturally follows?
Attention, Speculators: Here's a Lesson from Hong Kong's Housing Bubble - Knowledge@Wharton
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Abstract: The Hong Kong residential housing market index (CentaCity Index) experienced a real increase of 50 percent from 1995 to 1997, followed by a real decrease of 57 percent from 1997 to 2002. Using a panel data set of over 200 large-scale housing complexes (estates), increases in transaction volume and considerable cross-sectional variation in the size of price upswings are documented. Movements in fundamentals cannot fully justify the dramatic price upswing, the changes in turnover rate or the crosssectional variation. The non-fundamental price component is explored. Evidence consistent with overconfidence-generated speculation is provided, based on the model in Scheinkman & Xiong (2003), which predicts both a cross-sectional variation in the speculative price component, and co-movements in turnover rates.
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.
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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.
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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
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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.
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.
Based on Fla. Population Growth, Duke Research Calls Med-Mal Claims Stable
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.
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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.
Accounting for the Abuses at AIG - Knowledge@Wharton
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.
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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.
DougSimpson.com/blog
Wharton examines the possible consequences of ongoing investigations at AIG and the fate of "Hank" Greenberg, CEO of American International Group, in an article available online. Can AIG Stay on Top? - Knowledge@Wharton
AIG is under scrutiny now for at least one "finite reinsurance" transation with GenRe several years ago. Questions have arisen as to the propriety of treating it as a transfer of risk instead of a loan. Finite reinsurance can be used as a means of "smoothing" earnings, but are controversial. If the transaction in question is undone, it could reflect on the propriety of past earnings reports by AIG.
The Wharton article points to renewed corporate concerns following recent scandals (e.g. Enron and WorldCom) and responsive legislation, such as Sarbanes Oxley.
See also: "Finite Risk Reinsurance" background online" Unintended Consequences, Nov. 24, 2004.
“Behind Those Medical Malpractice Rates” (New York Times, 2/22/05) included a statement that “legal costs do not seem to be at the root of the recent increase in malpractice insurance premiums.” Testing this assertion requires examination of the complex dynamics of the insurance network and is complicated by a lack of appropriately segmented data and contradictory assertions. Alternative views can be found in a review of selected literature that is attached as a RTF file. TypeKey verified comments are welcome.
(Abstract follows -- Read more)
Abstract: A review of selected studies of the causes of insurance cost crises in medical malpractice liability.
The author adds a perspective on the insurance cycle, comparing the participants’ situation to an iterated prisoner’s dilemma complicated by non-commercial risk bearers that provide explicit or implicit subsidies. The author suggests study of insurance market crises using tools of network theory including “phase transitions” and “cascade effects.” He also suggests consideration of an “imputed premium cost,” being the differential between real aggregate premiums and the aggregate premium that would apply in the absence of subsidized market makers offering insurance below actuarial cost.
Link to "Causes of the Medical Malpractice Crisis?" (working paper) in Rich Text Format (RTF).
Insurance market forces, not rising tort costs, drive recent medical malpractice premium increases, according to a new study released March 10, 2005 by the The Center on Lawyers, Civil Justice, and the Media at University of Texas
Examining records on 150,000 closed claim files over a period from 1988-2002, the authors found that claim costs were stable, except for a rise of about 4% annually in defense costs. The authors attributed recent rises in malpractice premiums to market forces, because "no changes occurred in the tort system that could possibly account for them," according to a press release. The study's authors are Professors Bernard S. Black (University of Texas), Charles Silver (University of Texas), David A. Hyman (University of Illinois), and William M. Sage (Columbia University).
A summary of their findings and link to the full paper is available here.
Comments welcome with TypeKey authentication.
Erik Banks, "Alternative Risk Markets: Integrated Risk Management through Insurance, Reinsurance and the Capital Markets," (Wiley Finance 2004)
Banks' work turned up while searching for a text for an insurance law course I'm co-teaching in Hartford. Apart from a CPCU text we've found little to cement our case readings for our course focused on Surplus Insurance Lines and Alternative Risk Transfer ("ART"). Large deductibles, self-insurance, risk retention groups, captives, catastrophe bonds and other insurance linked securities, derivatives and other alternatives to traditional insurance are a controversial and cutting-edge topic, especially in light of recent disasters and investigations. Banks brings his experience as a senior risk manager at global institutions including XL Capital (the Bermuda reinsurer), Merrill Lynch, and a record of a dozen books already published in the field.
An online look at the Table of Contents of Banks' text looked promising, but after a full read, the text left much to be desired as a law school source. It was organized into four parts, which I’ll follow below with a few observations of my own.
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Risk and the ART Market
The first two chapters open with an examination of management approaches to risk management. They include a discussion of the insurance price cycle and the influence of capital availability and investment return on the dynamic cycling between "hard" and "soft" markets. The author writes about the credit risk of "intermediaries," including in that category a broader spectrum of players than does much of the insurance sector, to include global insurers, reinsurers, and commercial and investment banks. He points out that traditional insurance, while simple to get (when available) is not ideal for addressing more "intricate or comprehensive solutions," such as multi-year structures and non-traditional covers such as terrorism and financial risk. He speaks of "regulatory arbitrage," in which differential regulatory treatment of banks and insurers may motivate them to lay off different types of risk, and the effects of continuing deregulation and "convergence" on those influences.
Closing the first part, his third chapter becomes more specific, defining the ART market as the "combined risk management marketplace for innovative insurance and capital market solutions," and ART itself as "a product, channel or solution that transfers risk exposures between the insurance and capital markets to achieve stated risk management goals." Banks, p. 49.
Insurance and Reinsurance
Banks opens the second part of his text with a primer on primary insurance and reinsurance contracts commonly used in ART situations. In 25 pages, he reviews basic insurance concepts and the tools used to manage risk in the spectrum from risk retention (e.g. self-insurance, captives and finite risk programs) to risk transfer (e.g. full insurance with low deductibles and coinsurance). He concisely explains the features of various types of loss-sensitive contracts, including those that are experience-rated, and programs employing large deductible, retrospectively rated (both paid loss and incurred loss), and investment credit methods.
He continues exploring the risk retention end of the spectrum with a useful introduction to finite risk programs, organizing them by retrospective (e.g. loss portfolio transfer, adverse development cover and retrospective aggregate loss cover) and prospective polices. He finishes with a capsule lesson about layering of insurance programs.
His introduction to reinsurance and retrocession provides concise explanations of the financial and balance sheet effects of reinsurance, and the difference between facultative and treaty reinsurance. He also provides an overview of the varying effects of excess of loss, quota share, and surplus share agreements, and illustrates the possibilities of both vertical and horizontal layering of coverage. He closes with additional information on spread loss and finite quota share versions of finite reinsurance arrangements that provide substantial financing benefits with minimal risk transfer.
Banks provides a chapter dedicated to captive insurers, opening with a cash flow table illustrating the cost-benefit analysis that goes into evaluating the business justification for forming a captive. He provides some easily understood diagrams supporting his brief explanation of the role of a “fronting company” and the different forms of captives, including pure captives, sister captives, group captives, rent-a-captives and protected cell companies. He includes a short introduction to Risk Retention Groups, which are vehicles that are similar to captives, but that are organized and regulated in a different fashion. He closes with a very brief sketch of the tax consequences of employing a captive for risk management.
Banks’ chapter on multi-risk products extends the concept of a multi-line or package policy to the more complex products that are used in the energy industry. For example, a “dual trigger” policy might pay if and only if both of two triggers exists, say interruption of the insured power supplier and a market price for replacement power price over a certain level. Banks describes such multiple trigger products as a way to more precisely manage the outside risk of both events coinciding. He notes that multiple trigger products tend to be individually negotiated and structured, so that they need to include a charge for the cost of such custom development. In addition, such structure may not fall within all definitions of insurance for accounting, legal and tax treatment.
Capital Markets
Banks’ third part concentrates on capital market instruments and securitization, opening with an overview of insurance-linked securities, including catastrophe bonds. He goes on to explain contingent capital structures that (unlike the insurance-linked securities) have no characteristics of insurance and are subject to different regulatory, tax and accounting issues. Both contingent debt and contingent equity financing are arranged prior to a particular class of loss or adverse event, but provide for financing to be provided only after the occurrence of the adverse event. The capital can be less expensive than post-loss arrangements because it is arranged in advance and is not available at will.
Banks closes his third part with an examination of derivatives used to manage insurance-related risks. Those instruments include futures, options, futures options, forwards and swaps. Because derivatives are not based on insurable interest and demonstrated loss, they do not qualify as insurance, and may be subject to basis risk (a term describing the disconnect between the trigger of the derivative and the exposure from which protection is sought).
Exchange-traded derivatives have been developed for catastrophe risks, which were introduced in 1992, but failed to generate interest or a critical mass of participants and were abandoned in 2000, according to Banks. Temperature derivatives have been better received by energy suppliers and have led to active trading environments in some financial exchanges. Banks makes an observation that has applicability beyond this field when he notes that temperature derivatives “are heavily reliant on very robust historical data for accurate modeling, valuation and risk management. In the absence of 30-50 years of high-quality daily temperature data, the pricing exercise becomes difficult and subjective, which can lead to erroneous risk management choices. Given this minimum requirement, most activity remains concentrated in locations that have good data records under the quality control of a national weather or meteorological agency (e.g., US, Canada, Europe, Japan, Australia). Expansion into other countries without this minimum requirement will be slow.” Banks p. 162.
Over-the-Counter (OTC) traded insurance derivatives have been more successful, according to Banks. He describes OTC-traded catastrophe reinsurance swaps, pure catastrophe swaps, temperature and other weather derivatives (e.g. precipitation, stream flow and wind) and credit derivatives. Through swaps, reinsurers exchange exposures to un-correlated risks (e.g. Japanese earthquake and North Atlantic hurricane) to achieve greater portfolio diversification.
“Transformer” companies are those created to address the regulatory obstacles barring banks from writing primary insurance or reinsurance. A transformer bridges the gap between banking and insurance by dealing with its bank clients using derivatives, and transferring the same risk to the insurance market through reinsurance. Banks suggests that the need for transformers may diminish as regulatory changes allow more “bancassurance” platforms to develop.
ART of the Future
Banks fourth and final section addresses his vision of “ART of the future.” He argues for combinations of various financial and insurance risks into a single, multi-year Enterprise Risk Management (ERM) program. Such requires elimination of “silo” approaches to risk management, restructuring of the risk management organization and an extensive analysis of the total risk profile of an enterprise. Banks sketches two case studies and states that “demand for ERM programs by corporate end-users appears to be strong and growing,” citing “industry surveys and actual corporate experience. He does not, however, identify the surveys or experiential data on which he bases this conclusion, and acknowledges that several “pioneers” in the ERM process found their ERM program dismantled following corporate reorganizations in which the pioneers were acquired and displaced.
Prospects for growth in the ART market face both drivers and obstacles, as sketched in Bank’s final chapter. He cites “stronger demand for risk capacity” as the likely driver for future growth, aggravated by future catastrophes that stress available risk capacity. As an additional driver, he points to lower regulatory barriers to entry of new capacity. He briefly acknowledges organizational and cultural obstacles to the elimination of the “silos” and “incremental decision making” that he sees as impeding ART solutions.
Banks closes with subjective forecasts for the future of various ART tools (ranging from “moderate” to “strong”), and an observation that deregulation will encourage convergence of banking, insurance and other financial service industries.
Banks’ work contains little in the way of statistical support for many of his observations and conclusions. While the book includes a bibliography, it does not include legal references, texts or articles. Many of the author’s conclusions are couched in general and broad terms and read much like those one would expect from a visiting consultant providing a backgrounder on his field of expertise, in preparation for a possible retention to assist in an ERM design project.
While the text provided a useful overview of the various risk-retention tools common in the specialty risk market, the absence of meaningful legal references and citations makes it of doubtful value as a supplement to an advanced insurance law course.
Douglas Simpson, J.D.
Wethersfield CT
DougSimpson.com/blog
Connected through LinkedIn
The 2003 collapse of a Virginia-based professional liability insurer has led to racketeering suits, guilty pleas to insurance fraud charges, and multi-million dollar assessments upon state insurance guaranty funds. Recently, according to Insurance Journal, Berkshire Hathaway has reported that U.S. Attorney in Richmond subpoenaed General Reinsurance for information about Reciprocal of America and its offshore reinsurer, First Virginia Reinsurance, Ltd. General Re Under Scrutiny for Reinsurance Dealings with Failed Virginia Liability Reciprocal (3/2/05). The same article reports that two senior officers of the collapsed Reciprocal of America expect sentencing in a few months.
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The Reciprocal Group (In Liquidation) is a management company for four affiliates: Reciprocal of America, American National Lawyers Insurance Reciprocal, Doctors Insurance Reciprocal, and The Reciprocal Alliance.
In February, former ROA officers Kenneth R. Patterson and Carolyn B. Hudgins pleaded guilty to conspiracy to commit insurance fraud, and Patterson pleaded guilty to two counts of mail fraud. The federal judge in Richmond has scheduled sentencing for June, according to the Richmond Times-Dispatch, "Ex-insurance officers plead guilty" (2/9/05)
Their companies were formed in the 1970's to address a shortage of insurance coverage for health care providers and attorneys in Virginia, and insured some 7,000 professionals when they were declared insolvent and ordered liquidated in June of 2003.
At the time, the Virginia Lawyers Weekly reported (6/30/03) that the various affiliates were all reinsured 100% by ROA and lost the ability to pay their claims when that company collapsed. The company reportedly had a $200 million negative surplus at the time. That report included indications that Gen Re's reinsurance of ROA was replaced by a Bermuda reinsurer managed by some of the same directors as ROA itself, First Virginia Reinsurance. But the Virginia Insurance Department was not informed of that change, according to the VLW article.
Claims against the hospital policyholders were picked up by state guaranty funds, managed by Guaranty Fund Management Services in Boston. The lawyer policyholders were insured by ROA affiliates organized as Risk Retention Groups (RRG) under the federal Liability Risk Retention Act of 1986, 15 USC 3901 et seq. By federal law, risk retention groups are barred from enjoying insurance guaranty fund coverage. The thousands of lawyers affected by that filed legal actions in Virginia, Alabama and Tennessee, according to the 2003 Virginia Lawyers Weekly story.
The Practicing Attorneys Liability Management Society, Ltd. ("PALMS") maintains a webpage with updates and links to reports and materials on the case. ANLIR/Reciprocal of America Status Report.
See also:
Baird Webel, "The Risk Retention Acts : Background and Issues" (Congressional Research Service, December 2003) (Excellent background and introduction. 11 pages plus summary in PDF.)
And:
Nicole Williams Noviak, as reporter of speech by Robert W. Mulcahey, "The Medical Malpractice Crisis: Federal Efforts, States' Roles and Private Responses," 13 Annals of Health Law 607 (2004) identifies recent state mandates that health care providers purchase malpractice liability coverage from authorized insurers. These mandates have led to the termination of more affordable Risk Retention Group coverage by many health care provider programs and legal challenges that these state mandates are pre-empted by the federal law in the Liability Risk Retention Act (LRRA).
Further reading:
Maureen Sanders, "Risk Retention Groups : Who's Sorry Now?" 17 S.Ill.U.L.J. 531 (1993) (piercing the corporate veil following failure of RRG)
Karen Gantt, "Federal Tax Treatment of Medical Malpractice Insurance Alternatives for Nonprofits," 52 Drake L.Rev. 495 (2004). Professor Gantt (of the University of Hartford) addresses tax consequences of various insurance alternatives for nonprofit organizations. Among them are self-insurance, reciprocal insurers, and the Risk Retention Group approach, including captives and "protected cell captives." Prof. Gantt's article cites creation of many RRGs in last two years to deal with "the medical malpractice insurance crisis."
DougSimpson.com/blog
Doug Simpson is LinkedIn
Settlement was announced in the civil action by the State of Pennsylvania against former directors of Reliance Insurance Company who were charged with responsibility for the company's failure in 2001. The State of Pennsylvania took control of Reliance in that year, beginning a sequence of precedent-setting legal proceedings involving the largest insurance company insolvency in history. In the process, the activities contributing to Reliance's troubles became part of the public record and a valuable source of study for insurance regulatory law and practice professionals.
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At the time the state's Insurance Commissioner stepped in, Reliance wrote a large volume of workers compensation, general liability, commercial auto and personal auto insurance all over the U.S. Much of its business had been written through Managing General Agents (MGAs) and many of its claims were being handled by Third Party Administrators (TPAs).
Efforts to rehabilitate Reliance were frustrated by negative surplus of $1 billion and the events of September 11, 2001, following which the state declared Reliance insolvent and ordered it liquidated. That order triggered statutory obligations of insurance guaranty funds all over the United States. Due to the widespread "outsourcing" of the claim handling to multiple TPAs, the transition to guaranty fund management was challenging as files were retrieved from multiple sites and reviewed by guaranty fund claim units.
It was found at the time that a great deal of Reliance's commercial business was written on a "large deductible" basis, with insured companies bearing up to $250,000 (and sometimes more) of each individual loss. Under a large deductible program for workers compensation, the insurer pays the claim within the deductible then gets reimbursed from the insured employer. To secure that right, a well-advised insurance company gets financial security in the form of cash, letters of credit or surety bonds. For a portfolio of commercial policies, the insurance company can hold hundreds of millions of dollars of financial security for those deductible reimbursement obligations. Reliance was in just such a circumstance.
A controversy arose between the insurance liquidator and the guaranty funds over which was entitled to the benefit of those security deposits, and when. The dispute was resolved and details are in the Commissioner's Petition to Approve Agreement between Pennsylvania Ins. Commissioner and various state guaranty funds regarding large deductible programs of Reliance Ins. Co. (April 2002)
The Commissioner filed a civil action in June 2002 against various officers and directors of Reliance, alleging breach of fiduciary duties, professional negligence and the recovery of preferential transfers. The settlement announced last week resolves that action.
The Commissioner's press release reported that this settlement brings to approximately $100 million the amount recovered for policyholders of Reliance Insurance Company as a result of regulatory action in the case. Another $31 million goes to benefit the creditors of the parent corporation of Reliance Insurance.
A copy of the full text of the Settlement Agreement and the Petition to Approve Settlement Agreement (162 pages in PDF) are now online and together detail the case and controversy and the financial terms of its resolution.
Other materials regarding the Reliance case are available at the Reliance Documents website maintained by the State of Pennsylvania Insurance Commissioner. The legal challenges of large deductible programs have been a subject of study and private reports by the NAIC and other insurance industry organizations.
Thanks to Insurance Journal's online newsletter for the source of this information: Pa. Officials Reach $85 Million Settlement with Former Reliance Insurance Directors
Citizens Property Ins. Co. was created in 2002 as a stop-gap insurer for property owners unable to get insurance in the "voluntary" marketplace. During the four-hurricane onslaught of 2004, it was severely tested, and may now be short of capital. In the event of need, Citizens has power to assess all Florida property owners, but does not have access to the Florida Hurricane Catastrophe Fund (FHCF). Questions have been raised about the quality of its claim handling and payments during the 2004 season. A state senator has now called for an audit by Florida authorities. Senator Klein Asks Fla. Auditor General to Review Citizens Books
See also: Unintended Consequences: Andrew Remembered After Charley
and: Unintended Consequences: FL Hurricane CAT Fund Tapped
A task force of the International Association of Insurance Supervisors released in December its first "Global Reinsurance Market Report 2003" (IAIS Dec. 2004). It discusses aggregated data from 43 "significant reinsurance entities" from 7 major jurisdictions. It is based on fiscal year 2003 data, and appraises industry ability to absorb the results of 2004, including controversial impacts on the Florida windstorm residual market system. It examines the degree of market concentration and diversification of risk in the global reinsurance marketplace, and makes recommendations regarding global standardization of accounting and regulation.
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In addition to 2003 data, the report includes information about events in 2004, including the impact of the series of hurricanes that struck Florida in the summer and fall of 2004. It cites current estimates of total losses from Hurricanes Charley, Frances, Ivan and Jeanne to range from US$15 bn to US$25 bn. According to the report, much of the loss in Florida will be absorbed by State Farm and Allstate (together writing 35% of the homeowners risk in Florida), and by the residual market mechanisms created after Hurricane Andrew, the Florida Hurricane Catastrophe Fund (FHCF) and Citizens Property Insurance Corporation (Citizens).
The report's tables of estimated hurricane losses for 2004 indicate that Citizen's loss is approximately 99% of its surplus, and that assessments of policyholders will be necessary. Except for one regional insurer concentrated in southeast Florida, most of those insurers impacted by the 2004 hurricanes had surplus hits in the single digit percentages. Despite their significant share of the Florida market and substantial retention, the losses for Allstate (US$1.1 bn) and State Farm (US$1.3 bn) are below 5% of surplus .
The report includes discussion of aggregate statistics of the size of the reinsurance market, the structure and profile of risk assumed, use and impact of derivatives and credit risk transfer activity, counterparty risks, capital adequacy and other areas of potential interest.
The need to tap the FHCF due to the 2004 hurricanes has already raised substantial controversy in Florida over the impact on FHCF, as has the impact upon Citizens.
The International Association of Insurance Supervisors (IAIS) offers for public comment a draft proposal "Towards a common structure and common standards for the assessment of insurer solvency," (IAIS 2005). It builds upon existing IAIS papers on solvency, in particular "A New Framework for Insurance Supervision," (IAIS 2004).
The February draft "outlines a more precise view on a number of key elements or ‘cornerstones’ for the formulation of regulatory financial requirements for insurers worldwide," according to an IAIS press release on 2/15/05.
Both papers are now available on the IAIS website at www.iaisweb.org. The IAIS invites comments to to the IAIS Secretariat by 15 April 2005, via e-mail to: iais "at" bis.org, or by fax to: +41 61 280 9151, or by post to: IAIS Secretariat, c/o Bank for International Settlements, CH-4002 Basel, Switzerland.
Thanks to Risk Center Risk Alert for word of this paper and organization.
On January 7, New York Attorney General Eliot Spitzer told his state's legislature that in his expanding investigation into the insurance industry, "[w]e have also begun to look at other troubling areas of the insurance industry beyond steering and bid rigging, such as conflicts of interest that arise between brokers and captive insurance and reinsurance companies that are operated or owned by brokers."
Attorney Spitzer attributed to a 2002 Swiss Re study a statement that a majority market share was concentrated in two or three insurance brokerages, saying that "the threat of collusion has become a reality. We found that a small group of brokers and insurance companies have created a network of interlocking connections and secret payments which ensure that the bulk of business goes to certain insurers and that profits remain high."
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Although he did not provide a precise citation to the Swiss Re study, a web search at Swiss Re's website found a 2004 research paper with the indicated data. From the executive summary "Commercial insurance and reinsurance brokerage -- love thy middleman," Sigma No. 2/2004 (Swiss Re, March 2004):
"In 2002, global commercial brokerage revenues were estimated at about USD 27 billion. The broker industry is highly concentrated, with Marsh and Aon accounting for 54% of revenues. As a subset of that market, the 2002 global revenues from reinsurance brokerage are estimated at USD 3 billion. This market segment is highly concentrated, with the four companies accounting for 78% of the total market."
"The growth of offshore markets -- particularly the Bermuda market -- has increased the share of brokered business in commercial lines and reinsurance, and is responsible for the recent decline or [sic] brokered commercial business in US insurance market statistics. Brokers have played a very active role in setting up some of the new Bermuda players and serve as the sole distribution channel for offshore reinsurance carriers." Swiss Re, Sigma No. 2/2004 (March 2004).
Attorney Spitzer acknowledged the challenges of investigating operations such as captive insurers that are located outside the jurisdiction of the United States, and called for greater federal involvement in insurance industry accountability.
His remarks were during testimony to the State Assembly Standing Committee on Insurance on January 7, 2005. insurance_assembly_testimony.pdf (application/pdf Object)
The Attorney General's statements open up the issues of potential antitrust exposures of brokers and reinsurers operating outside of the United States but impacting trade and commerce within the United States. As the ultimate risk bearers for the global insurance network, reinsurers have a significant impact on the pricing and availability of insurance at all levels of distribution.
In the 1980's, decisions by international reinsurers had a substantial impact on the availability of commercial liability insurance in the U.S. and became the subject of major antitrust action by state attorney generals. In its decision, the Supreme Court reaffirmed that "the Sherman Act applies to foreign conduct tha was meant to produce, and did in fact produce, some substantial effect in the United States." Hartford Fire Ins. Co. v. California, 509 U.S. 764 (1993).
Massachusetts Bankers Assoc. Reports Favorable Federal Court Decision on Bank Insurance Sales
The U.S. District Court's memorandum of decision in Massachusetts Bankers Association, Inc. v. Bowler, Civ. Action No. 03-11522-RWZ. (January 10, 2005) found that certain provisions of the Mass. Consumer Protection Act (Mass.Gen.Laws ch. 167F, Sec.2A), dealing with sales of insurance by banks, were preempted by the Gramm-Leach-Bliley Act. The contested provisions included the Referral Prohibition, the Referral Fee Prohibition, the Waiting Period Prohibition and the Separation Provision.
Last year, the First Circuit Court of Appeals dismissed an attempt by the Massachusetts Commisioner of Insurance and Banks to contest a 2002 opinion to similar effect that had been issued by the Office of the Comptroller of the Currency of the United States (OCC). Bowler v. Hawke, 320 F.3d 59 (1st Cir. 2003).
In December 2004, a Connecticut jury awarded $2.3 million to an insurance agency terminated by Nationwide, despite a provision in the agency agreement allowing termination "without cause," according to press reports. The decision was based in part on a finding that the action was governed by the Connecticut Franchise Act ("CFA"), C.G.S. §§42-133e, et seq. Atty. Ray Garcia of Garcia & Milas, P.C. represents the plaintiff in this case and told Insurance Journal: "This jury decision is groundbreaking in that it is the first in the United States to apply Franchise rules to the Insurance business, in effect invalidating the 'without cause' provision."
According to Atty. Garcia, "The jury's decision ... opens up the possibility of future class action suits against major insurance companies from independent agents terminated in the last few years without cause, or those who were not given reasons for their termination even when accused of illegal conduct." Jury Backs $2.3 Million Award to Terminated Independent Agent; Nationwide to Challenge Verdict
In September 2003, the U.S. District Court denied summary judgment sought by Nationwide. Charts v. Nationwide, D.Conn., Civil Action No. 3:97CV1621(CFD) (1993)). Nationwide has indicated it may appeal if the court allows the jury verdict to stand, according to Insurance Journal.
The events of September 11, 2001 constituted the largest catastrophe in the history of insurance. Despite the shock of estimated combined claims of over $32 billion, the global insurance network held and adapted. Before that date, the market for terrorism insurance was small and specialized. After that date, the demand exploded and prices rose as many insurers excluded terrrorism coverage.
Some corporate insurance buyers found the resulting prices to be unaffordable, or were unable to purchase terrorism coverage at any price. In response, the United States Congress passed the Terrorism Risk Insurance Act of 2002 ("TRIA") which provided $100 billion in federal reinsurance, nullified terrorism exclusions, and required insurers to "make available" terrorism coverage.
TRIA expires at the end of 2005, and may or may not be extended. The continuing need for TRIA, or a measure like it, has been a topic of intense political and economic debate as corporate risk managers and insurance providers plan their 2006 insurance and reinsurance programs.
Released on December 15, 2004, a new study, "Terrorism Risk Management & Risk Transfer Market Overview" is now available (free registration required) from the global insurance brokerage firm Aon. According to its Executive Summary, the report "summarizes the salient features of the central components of today's global marketplace for terrorism insurance," and is "designed and intended to provide a current snapshot of the state of the terrorism insurance marketplace and to describe metrics, risk control, and other issues surrounding it." Ibid.
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Aon reported on its examination of data regarding 500 of its corporate accounts that renewed coverage in the previous 12-month period. The report includes detailed graphs and tables of data regarding "take up" rates and pricing for terrorism coverage broken down by variables including account size, industry segment, total insured values ("TIV") and geographical location. Aon concluded that the presence of TRIA increased availability and affordability of terrorism coverage, and that the percentage of insureds that purchase or "take up" terror coverage has increased substantially in the past year.
Aon also examined the upsides and downsides of the use of single-owner captive insurers to handle terrorism exposures. It also examines U.S. Treasury Department interpretive letters addressing concerns over potential use of captives to "game" the TRIA system, and suggests ways of styling a captive program to satisfy the concerns of Treasury.
"Fire following" an event is a hazard that must be covered under the 1943 New York Standard Fire Policy ("SFP") language required by statute in 29 jurisdictions. Fire following the terrorist attack played a key role in the destruction at the World Trade Center on September 11. Aon notes 9 states that amended their statutes to allow insurers to exclude from such SFP coverage "fire following" an otherwise uninsured terrorist event.
The study examines arguments for and against extension of TRIA beyond 2005, and bills pending that would continue its "back stop" provisions. It also offers hypotheses on what the market would look like if TRIA were not extended, and raises doubts that satisfactory alternatives can evolve before the end of 2005. It also provides a view of how TRIA coverage would "unwind" if not renewed or extended, predicting a "clear potential for significant confusion and disruption in the market as TRIA expires." Id., page 40.
Available capacity for "Stand-Alone" terror coverage is also presented in tables in the Aon study, based upon information obtained by Aon in the course of placing coverages for its customers. It also provides information about Stand-Alone coverage form language and the definition of terrorism, generally based upon the London market "T3" definition: "an act of terrorism means an act, including the use of force or violence, of any person or group(s) of persons, whether acting alone or on behalf of or in connection with any organization(s), committed for political, religious or ideological purposes including the intention to influence any government and/or to put the public in fear for such purposes."
The study report closes with an analysis of the challenge and importance of corporate management of the terrorism risk.
Appendices include summaries of recent U.S.Treasury Regulations, a listing of international terrorism risk programs and a list of some officially recognized terrorist organizations and examples of potential methods of attack.
Although Aon clearly discloses its support for the continuation of the TRIA provisions, its report provides substantial information of interest to objective students of the issue.
Other Unintended Consequences postings about TRIA resources available online:
AIK Comp, the troubled Kentucky workers compensation self-insurance group, was paying members advance discounts to attract business, when rates were inadequate to fund reserves, according to press reports about of the contents of a private consulting firm's audit. Insurance Journal reported that $38.6 million in discounts over a three-year period led to a $59 million shortfall at AIK Comp, forcing it to assess 3,700 member employers.
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According to the Kentucky Post, the Office of Workers' Claims received a report from a private consulting firm, York Consulting, on the status of AIK Comp. "Giving discounted premiums to members before loss reserves can be reasonably established appears to be a key factor in the current financial distress of the fund," said the York Consulting report, according to the Post. "The current deficiency could have been partially or completely offset had the trustees allowed for time to see losses develop over a reasonable time prior to returning any potential excess premiums to members," the York report added, according to the Post.
A "lack of appropriate oversight" by the Kentucky Office of Workers' Claims allowed the situation to continue until a cash crisis forced the situation to the surface, according to a F.A.Q. on the website of the Office of Workers' Claims.
Following the discovery of AIK Comp's financial status, on August 3, 2004, the Governor of Kentucky signed an order relieving OWC of authority over self-insurance funds, including AIK Comp, placing it under the supervision of the Department of Insurance. By August 5, the Department of Insurance placed AIK in rehabilitation. As explained by the DOI in its own FAQ on the action:
"Rehabilitation is a first step to reform and revitalize an insurer. The rehabilitator assumes control, but not ownership, of assets and property owned by the insurer. Under court supervision, the rehabilitator assumes the power of the board and trustees, has the power to direct and manage, can hire and fire employees and can plan and carry out a reorganization of the company. After successful rehabilitation, the court may terminate the proceeding and return control to the insurer. Liquidation begins when rehabilitation is seen as failing or futile. The liquidator assumes title to all assets and property and asks the court to declare the entity insolvent. In a liquidation proceeding, the Court determines the rights and liabilities of the insurer, its creditors, policyholders, shareholders, members and all others interested in the estate."
Within the month, five senior officers of AIK Comp were fired, according to a D.O.I. press release.
According to the various news stories, FAQs and press releases, 100% collection of the assessed funds is considered doubtful. Many former members of AIK Comp have gone out of business or do not have the ability to pay their assessment. The membership in the fund has declined dramatically since it stopped discounting its premiums in advance and began charging an actuarially sound rate.
The Kentucky Department of Labor provides material from a public hearing on AIK Comp's status, including an actuarial report of financial dealings over the period of concern.
More information is available at AIK Comp's website.
See also: Unintended Consequences: Member Assessment : Dangers of Under-reserved S/I Plans
Under-reserving for workers compensation claims since 1999 has caught up with a group self-insurance plan in Kentucky. Member employers (and former members) are being assessed to shore up inadequate reserves that allowed underpricing for years.
The assessments provide a hard example of the hazards of "pay as you go" financing in insurance programs designed to cover "long tail" exposures. Such financing allows managers of such funds to charge premiums that are lower up front than that charged by competitors that do reserve adequately. As a result, such plans can take business away from more responsible providers. But some day, the bills will come due, as 4,000 employers in Kentucky are learning today. 4,000 Businesses In Group Comp Fund Owe $51 Million In Ky. Self-Insurance Claims
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Assuring sound reserving and financial management is one of the roles of the insurance regulatory authority. That role is sometimes opposed by those whose prime goal is offering insurance cheaper than the competition, in order to grow its market share. For a current example on a scale larger than that in Kentucky, see the ongoing struggle between California Insurance Commissioner Garamendi and the management of the State Compensation Insurance Fund (State Fund). See, e.g. "Judge's Key Ruling Favors California Department of Insurance in Trial Concerning Regulatory Authority Over State Compensation Insurance Fund," (Calif. Ins. Dept. Press Release, December 13, 2004).
This dispute has been ongoing for over a year, and raises memories of similar controversies in states such as Texas. In 2002, the California Commission on Health and Safety and Workers’ Compensation released a comprehensive white paper "State of the Workers’ Compensation Insurance Industry in California" that is worthwhile reading on this subject. See Unintended Consequences: Drive Down Comp Costs, not Premiums, says Garamendi (September 4, 2003).
American Agents Alliance, an association of independent insurance agents in Arizona and California, opposes the "incentive commission" disclosure regulations recently proposed by California Insurance Commissioner Garamendi. The Alliance has released a position paper written by the Los Angeles law firm of Barger & Wolen, LLP, now available on the Alliance's website.
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In November, Robert W. Hogeboom of Barger & Wolen provided "Broker Fiduciary Regulations -- Legal Questions and Answers" and has since written and edited a "Position Paper on Broker Fiduciary Obligations" (Rev. Dec. 7, 2004).
Atty. Hogeboom's position paper includes a summary of the factual circumstances of enforcement actions and lawsuits initiated in the fall of 2004 in California, New York and elsewhere, challenging "incentive commission" practices of certain insurance agents and brokers. He provides an analysis of the proposed regulations and criticizes them on the grounds that they mistate the current law in California regarding the duties of agent and brokers and attempt to expand it beyond the authority afforded the Commissioner. The eleven-page paper cites decisions of the California courts in support of its position.
Predictions of rate increases emerged from some insurance industry sectors immediately following the 12/6/04 jury verdict that certain of the World Trade Center insurers must pay two limits of insurance, a decision with an impact exceeding $1 billion. While that may be true for some, the decision of the Second Circuit in 2003 offers a clear alternative for coverage written today: define “occurrence” as did the Willis policy form known as “WilProp.” In WTC v. Hartford Fire, 345 F.3d 154 (2d Cir. 2003), the “WilProp” definition was found to be unambiguous. Applying it, the destruction of the WTC was one, not two occurrences, as a matter of law.
Some notes on the case follow below.
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World Trade Center Properties v. Hartford Fire Ins. Co.,
345 F.3d 154 (2d Cir. 2003)
Holders of interests in the World Trade Center (WTC) (the "Silverstein Parties") and various insurers sought delaratory judgments whether the events of September 11, 2001 constituted one or two "occurrences" under first party insurance coverage on the WTC property. At stake was about $3.5 billion in coverage, the total of the insurer's combined "per occurrence" policy limits . If the events constituted two separate "occurrences," the Silverstein Parties could recover about $7 billion; if they constituted only one "occurrence," the total recovery would be only about $3.5 billion. Both sides sought summary judgment. The court affirmed that the defined term "occurrence" used by some of the insurers was not ambiguous and meant that the events of September 11 were one occurrence. It also affirmed that the undefined term "occurrence" used by another insurer was ambigous, so that whether there was one occurrence or two must be decided by a jury or other trier of fact.
The factual situation was complicated by the fact that at the time of the attack on the WTC, the insurers had issued binders, but not final insurance policies. As starting points for negotiation, the binders issued by the first three of the insurers included references to the "WilProp" policy form and the binder issued by Travelers referred to Travelers' own commercial property form.
The court of appeals recognized that insurance binders are necessarily incomplete in some respects and that New York courts have long recognized that terms must be implied in them, citing Hicks v. British Am. Assurance. Co., 56 N.E. 743, 744 (N.Y.1900). One way of implying terms is by examining the terms that are used in the usual policy issued by the company. The court also allowed reliance upon extrinsic evidence of the parties' pre-binder negotiations to determine which terms are to be implied in the binder. It disqualified as of "no import to this case" proferred evidence of post-binder negotiations over what language would be used in the final policy to be issued. It relied in part on New York law that the binder and the policy to be issued are "two separate contracts of insurance, containing two separate sets of terms," citing Springer v. Allstate Life Ins. Co., 731 N.E.2d 110 (N.Y. 2000) and Rosenblatt v. Washington County Coop. Ins. Co., 594 N.Y.S.2d 456 (App.Div. 1993)
Regarding three of the insurers (Hartford Fire, Royal and St. Paul), the court of appeals upheld an award of summary judgment against the Silverstein Parties, based on the finding that the binders the three insurers issued before the disaster were governed by the "WilProp" policy form. Those binders referenced the WilProp form as a starting point. The court upheld the finding that the definition of "occurrence" in that form was not ambiguous and ruled that under its terms, the destruction of the WTC was one occurrence as a matter of law. This was the definition in the "WilProp" form:
"'Occurrence' shall mean all losses or damages that are attributable directly or indirectly to one cause or to one series of similar causes. All such losses will be added together and the total amount of such losses will be treated as one occurrence irrespective of the period of time or area over which such losses occur."
The court of appeals agreed with the district court that "no finder of fact could reasonably fail to find that the intentional crashes into the WTC of two hijacked airplanes sixteen minutes apart as a result of a single, coordinated plan of attack was, at the least, a 'series of similar causes.' Accordingly, we agree with the district court that under the WilProp definition, the events of September 11th constitute a single occurrence as a matter of law."
Regarding the fourth insurer (Travelers), the court of appeals dealt with a binder referencing a form in which the term "occurrence" was not defined. The Silverstein Parties had argued that as a matter of New York law, the term was not ambiguous and its meaning was legally established by various precedents. Further, they had argued that the legally established definition meant that the September 11th events were only one occurrence as a matter of law. The district court had disagreed, applying a test found in Curry Road Ltd. v. K Mart Corp., 893 F.2d 509 (2d Cir. 1990). Accordingly, the district court denied summary judgment and decided that the interpretation of "occurrence" had to be determined by extrinsic evidence, to be considered by the trier of fact. See SR Int'l Bus. Ins. Co. v. World Trade Ctr. Props. LLC, 2002 WL 1163577 (S.D.N.Y. June 3, 2002)("Travelers Dec.").
As it did for the first three insurers, the court of appeals allowed consideration of extrinsic evidence of the parties' intentions with respect to the incomplete binder terms, citing Underwood v. Greenwich Ins. Co., 55 N.E. 936 (N.Y. 1900), even though extrinsic evidence would not be allowed to contradict language that was clearly unambiguous, citing Am. Sur. Co. v. Patriotic Assurance Co., 150 N.E. 599 (N.Y. 1926).
The Silverstein Parties argued that under New York law, "occurrence" means the direct, physical cause of a loss and not more remote causes; because the WTC destruction was the result of two impacts from two planes, there were two occurrences as matter of law. They relied on Arthur A. Johnson Corp. v. Indem. Ins. Co., 164 N.E.2d 704 (N.Y. 1959) and other cases involving third-party liability insurance.
The court of appeals decided that the construction used in such cases is not necessarily applicable in cases involving first-party property insurance, such as that covering the Silverstein Parties. For such cases, the court of appeals found most applicable Newmont Mines Ltd. v. Hanover Ins. Co., 784 F.2d 127 (2d Cir. 1986). In Newmont Mines, the court of appeals found that "occurrence" had no special meaning in the context of property insurance, and that its meaning must be interpreted in the context of the specific policy and facts of the case.
In reaching this conclusion, the court of appeals looked at the fundamental differences between liability policies (that protect an insured against liability for causing loss) and first-party policies (that protect an insured against loss resulting from events). The court pointed out that the Johnson line of cases follow a New York rule for determining the number of occurrences that was expressed in Stonewall Ins.v. Asbestos Claim Mgmt. Corp., 73 F.3d 1178 (2d Cir. 1995) : “[A]lthough a single ‘occurrence’ may give rise to multiple claims, courts should look to the event for which the insured is held liable, not some point further back in the causal chain.” 73 F.3d at 1213.
Unlike in cases of third-party coverage, in which the trigger of coverage “event” is the insured’s negligence, in the case of the WTC first-party coverage the trigger of coverage is “direct physical loss or damage to Covered Property at premises … caused by or resulting from a Covered Cause of Loss. Covered Cause of Loss means risks of direct physical loss unless the loss is excluded … or limited [in other policy language].” (as quoted by the court from the Travelers policy form).
“A jury,” said the court, “could find that the words ‘direct physical loss or damage’ does not refer to the ‘event’ that triggers coverage at all, but rather sets forth the scope of damage resulting from the ‘event’ that the insurer will pay for, namely, direct physical damage as distinct from remote or incidental damage.”
As a result, the court of appeals affirmed the district court's ruling that the definition of "occurrence" under the Travelers policy was ambiguous, and that its interpretation would be left to the fact finder. "To be sure, a jury could find two occurrences in this case, as it did in Newmont Mines, or it could find that the terrorist attack, although manifested in two separate airplane crashes, was a single, continuous, planned event causing a continuum of damage that resulted in the total destruction of the WTC, and, thus, was a single occurrence."
On December 6, 2004, a jury found that under versions of “occurrence" not used by the "WilProp" form, the destruction of the WTC was two separate occurrences, triggering two separate limits of insurance. Subject to the results of any appeal, the insurers affected by the verdict face obligations totaling $2.2 billion instead of $1.1 billion. See "Silverstein Wins Two-Occurrence Verdict in Second World Trade Center Trial," Insurance News Network (Dec. 7, 2004).
Increased disclosure and transparency will result from the Spitzer investigation of the insurance industry, and that will be good for it in the long run, suggests Therese Rutkowski, Managing Editor of Insurance Networking News, in "Spitzer Probe Pushes For More Disclosure" Insurance Networking News, December 1, 2004.
The Spitzer probe, according to Rutkowski, "is pushing the entire industry-even those who have nothing to hide-toward process and technology improvements that enable companies to track and manage compensation more effectively-as well as to disclose those processes and data to regulators when required." The availability of that information will ultimately enable insurers to provide better products at lower prices, she suggests.
She also points to the treasure trove of indiscrete statements that Spitzer's staff seems to have found in the e-mail archives produced by subpoenaed insurers and brokers. Similar gems found in the investigation of investment bankers and the antitrust actions against Microsoft.
The article quotes Robert H. "Skip" Myers Jr., partner in the Washington, D.C. office of law firm Morris, Manning & Martin LLP: "E-mail creates an electronic trail of information, and if you're Eliot Spitzer, once you get into the database and you've got the time to look at it, you can follow the clues and get all the information," Myers told Rutkowski. "As we've seen in any number of recent investigations, e-mail can be a terribly obvious form of information, which-for whatever reason-people don't seem to manage with the same scrutiny as they do their written communications."
All this is enough to make a company consider updating their policy regarding management of email. See, e.g. Atty. Chip Rainey's "Trying to Exorcise the Ghosts, Nightmares and Demons Alive in your E-mail Server: The Need for A Virtual Document Retention Policy," (PDF) a presentation to a local chapter of American Corporate Counsel Association (ACCA). Mr. Rainey is a partner in Locke Liddell & Sapp LLP.
Because two jets struck the two towers at the World Trade Center, insurers must pay developer Larry A. Silverstein for two policy limits, not one, according to a jury verdict rendered December 6, 2004. The decision represents a $2.2 billion blow to the nine insurers directly affected by the jury verdict. Insurance experts predict it will have ripple effects throughout the insurance industry as others take the decision into account in pricing other commercial property exposures. "Towers' Insurers Must Pay Double" (The New York Times, December 7, 2004).
See earlier posting of online resources regarding the case at Unintended Consequences: WTC Coverage Dispute - Phase Two
WTC lessee Larry Silverstein and several insurers disagree on whether the events of 9/11 at the World Trade Center Properties (WTC) were one "event" or "occurrence" (with one deductible and policy limit) or two (with two deductibles and policy limits). At stake in the dispute is several billion dollars in insurance coverage ... and the dispute is over the meaning of policies that had not been issued at the time of the disaster. The case has been to the Second Circuit and back, and is likely to make that trip, or higher, again. In the interim, the facts have been described as presenting a law school case study that has to be real, because it would not be credible if a professor made it up.
Online resources on the dispute include those linked below. Please let me know of other resources you might recommend:
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Silverstein, Insurers Face Off In Round Two $2.264 billion at stake as nine carriers seek to limit 9/11 coverage to one event InsuranceNewsNet.com 10/14/2004, republishing National Underwriter 10/11/2004.
"Words worth billions: ..." Risk & Insurance, June 2004.
"Silverstein hit by Swiss Re setback; prepares for new phase of litigation", Business Insurance 5/10/2004.
WTC Leaseholder Loses Insurance Battle LexisOne.com April 30, 2004 (jury verdict that the attacks represented a single event)
"Revisiting the Number of Occurrences Issue -- An Examination of the Case Law on 'Number of Occurrences' In Light of the New York Federal Court's Recent Ruling that the Terrorist Attack on the World Trade Center is a Single Occurrence." Nixon PeabodyLLP, 10/8/2002.
"Double Indemnity", The American Lawyer, 9/3/2002.
"Twin Towers: The 3.6 Billion Question Arising from the World Trade Center Attacks" Defense Counsel Journal, April 2002.
Blogs following the case include:
See also, Robert P. Hartwig, "September 11, 2001: The First Year -- One Hundred Minutes of Terror that Changed the Global Insurance Industry Forever" Insurance Information Institute, circa 2002.
The law and science of insurance is the law and science of disaster and its causes. An expert analysis report on the sequence of events and likely causes for the collapse of each WTC Tower is available from the National Institute of Standards and Technology (NIST), released October 19, 2004. Founded in 1901, NIST is a non-regulatory federal agency within the U.S. Commerce Department's Technology Administration. A NIST announcement summarizes its extensive report of findings. )
Reports are surfacing about state and federal investigations and allegations that well-known industrial companies and insurers may have used "finite risk reinsurance" to distort financial statements. The legality of the "finite risk" or "loss mitigation" transaction does not appear to be in question. What is in controversy is whether or not it was improperly used by the companies purchasing it. Purchasers of such loss mitigation policies include major insurance companies. As early as 2002, some legal analysts expressed concern that it may be used to disguise underreserving for shocks such as 9/11 and was becoming a target for legal and regulatory challenges.
Below are listed some professional analyses available online that provide more detailed information on this arrangement that was developed in the 1990's and surged in popularity after 9/11/2001.
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Swiss Re: ""Finite Risk Insurance -- Alternative risk transfer via finite risk reinsurance: an effective contribution to the stability of the insurance industry"
" (1997) Abstract: "The study concentrates on the needs and interests of primary insurance companies in the non-life area. The first section sheds light on the circumstances which gave rise to the development of finite solutions. This is followed by the study's main focus, ie description and discussion of the most important forms and functions of finite risk reinsurance, and recent developments which have blurred the distinction with traditional forms of reinsurance. The study also assesses the market potential of finite products in the United States, Europe and Asia."
Munich Re: "MUNICH RE ART SOLUTIONS – FINITE RISK REINSURANCE" (2000). From Abstract: "This publication defines the so-called alternative risk transfer methods in a concise manner and describes their origins and development, existing products and solutions and Munich Re’s philosophy in this market segment."
Guy Carpenter: Interview with head of Finite Risk Specialty Unit (date uncertain -- Google cache version)
David Kroegel, "Finite Risk in 2003," PPT Presentation to Casualty Actuarial Society (CAS).
Various authors, various dates, "About ART: Finite Risk," Artemis, "The Alternative Risk Transfer Portal".
ACE Group, "ACE Global Re Expands its Financial Reinsurance Capabilities," (July 2004).
As early as 2002, industry writers wrote about increased demand for finite risk insurance following the shocks of 9/11, contributing to the formation of new entities in Bermuda. Such writers also warned of increasing regultory scrutiny of finite risk insurance following indications that such products may have been used to disguise financial weakness in insurers and underreserving for 9/11 losses. Attys. Geoffery Etherington and Thomas F.X. Hodson, Edwards & Angell LLP, "The tail that wags the dog: Developments in finite reinsurance," Risk Transfer Magazine (2002) (Free registration required for access).
Standard & Poors reported that four insurers "distorted their financial statements by using 'financial risk reinsurance.'" according to Reuters 11/16/04. Latest News and Financial Information | Reuters.com
On November 24, Reuters and the New York Times also reported that American International Group (A.I.G.) agreed to settle federal inquiries into its participation on similar financial transactions. AIG agree to pay about $80 million and accept an independent monitor. While this is expected to resolve the subject of the grand jury investigation pending in Indiana, the presence of an independent monitor inside A.I.G. could turn up other issues.
See "AIG targeted by US Grand Jury, AP reports" Unintended Consequences 10/22/04
Finite insurance has also been a recent subject of inquiry by New York Attorney General Eliot Spitzer. See "Spitzer and SEC investigate "'finite insurance'" Unintended Consequences 11/16/04
Continuing a series of legal actions against insurance brokers and insurers, New York Attorney General Spitzer and California Insurance Commissioner Garamendi have filed separate suits against Universal Life Resources (U.L.R.), a broker specializing in employee benefits programs for businesses. Links to the complaints and settlement documents are provided below.
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Mr. Spitzer's suit was filed Friday, November 12 in state court in Manhattan, and alleges that U.L.R. steered business to insurers in exchange for lucrative payoffs and that this practice raised premiums for individual employees.
In Mr. Garamendi's suit, according to a November 18 story in the New York Times, "Mr. Garamendi accuses Universal Life Resources, a broker specializing in employee benefits, of receiving kickbacks from the insurance companies in exchange for steering to the insurers the business of corporations seeking group life, disability and other coverages. The kickbacks, the lawsuit says, led to higher insurance costs for the corporations and their workers." The suit also names four insurance companies allegedly involved in the practices described in the complaint.
Commissioner Garamendi has announced that a settlement with U.L.R. has been settled simultaneously with its filing. To prepare his suit, Mr. Garamendi hired Lerach Coughlin Stoia Geller Rudman & Robbins, the same private law firm that brought a private lawsuit on similar grounds in October. It does not appear that a settlement has been reached with the four insurers.
According to the San Diego Union-Tribune, Mr. Garamendi told a news conference at the Superior Court: "We will be moving very vigorously against the four insurance companies using the information in the Universal Life files," The Union-Tribune also quoted a partner in Lerach Coughlin as saying: "Now that Universal Life Resources has agreed to cooperate, the state can focus more specifically on the illegal practices of the insurance firms, with full assistance from the insiders at Universal Life. * * * This is the tip of the iceberg."
Links to the New York Complaint are available in Mr. Spitzer's press release.
Links to the California complaint and settlement documents are available in Mr. Garamendi's press release.
During 2003 and 2004, fifty states and the District of Columbia joined in a market conduct exam of three life insurers that have now agreed to pay $15 million in fines and to change disability benefits claims practices. The U.S. Dept. of Labor, which conducted a parallel investigation of employee benefit plan practices under authority of ERISA, joined the settlement announced November 18.
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Lead signatories of the agreement include Maine, Massachusetts, Tennessee and New York. "This action is one of the most significant multistate insurance regulatory actions in history, providing a uniform, verifiable and effective state-based settlement for the benefit of UnumProvident policyholders nationwide," said Maine Superintendent Iuppa in an press release Nov. 18.
The Maine Bureau of Insurance has a "UNUMProvident Multistate Examination/Settlement Agreements" page online containing links to a Q&A, the Multistate Exam Report, the Settlement Agreements with Unum Life, Provident Life, Paul Revere Life and First Unum Life with supporting exhibits.
Recent N.Y. A.G. lawsuits alleging kickbacks and bid-rigging and Senate oversight hearings on insurance broker practices have raised an issue whether current state regulation of insurance is adequate, or whether more federal oversight is necessary.
Thanks to the email bulletin from the NAIC Pressroom for the pointer to this news.
A collection of materials about Terrorism and the Terrorism Risk Insurance Act (TRIA) is available on the website of GE Insurance Solutions Institute: Terror / TRIA Updates. That includes an article titled "Terrorism Risk Insurance Act of 2002: A Reinsurer's Perspective" that goes into some depth as to the legal, policy and business issues of concern to a reinsurer in light of the TRIA statute.
The United States Treasury is charged with implementing the provisions of TRIA that provide a $100 billion reinsurance program standing behind the law's mandated offer of terrorism coverage and temporary federal pre-emption of state approvals of terror exclusions in insurance policies. Materials about TRIA are available on the Treasury's website: Terrorism Risk Insurance Program.
BNA's Web Watch has a page of links to more information about Terrorism Insurance than most care to know.
November 16 witness testimony in the "Oversight Hearing on Insurance Brokerage Practices, Including Potential Conflicts of Interest and the Adequacy of the Current Regulatory Framework" before the Senate Committee on Governmental Affairs is available online and includes:
Member Statements by:
Witness Statements by:
The hearing focused on on insurance brokerage practices, such as contingent commissions, that raise conflict of interest questions, and whether these practices harm consumers or suggest changes to the existing regulatory framework.
The Committee website on this hearing includes an archive of the webcast in Real Player format.
The National Association of Insurance Commissioners (NAIC) formed an Executive Task Force on Broker Activities, following legal action launched by New York Attorney General Eliot Spitzer and others into allegations of kickbacks and bid-rigging involving leading insurance broker Marsh & McLennan and multiple insurance companies.
On November 15, NAIC's Task Force released draft model legislation that would implement new disclosure requirements. The requirements are designed to ensure consumers are provided the information necessary to understand the manner in which brokers are compensated for the sale of insurance products. According to an NAIC Press Release , "the draft model legislation would amend the NAIC’s current Producer Licensing Model Act. The draft is part of ongoing efforts by state insurance regulators to address issues surrounding the use of compensation arrangements by insurance brokers."
Connecticut Attorney General Richard Blumenthal called it "a shadow of what it should be," according to an article by Dan Haar, "Model Broker Rules Drafted," Hartford Courant, Business Section, page 1 (November 17, 2004). Blumenthal, Spitzer and others testified on November 16 before a U.S. Senate panel, and also said that "This model simply fails to address the key defects in the current system," according to the Courant. Id.
The full text of the draft model legislation follows.
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For Public Review and Comment
November 15, 2004
Proposed
Broker Disclosure Amendment
To The Producer Licensing Model Act
Section __
Any insurance producer or any business entity related to such producer who is permitted by [statute] to receive any compensation, including commissions, from the insured, shall not accept or receive any compensation, including commissions, from an insurer unless the producer has, prior to insured’s purchase of insurance, (1) obtained the insured’s written consent that such compensation will be received by the producer or business entity related to the producer and (2) disclosed the amount of compensation from the insurer; and the method for calculating such compensation, including any contingent compensation. If the amount of contingent compensation is not known at the time of disclosure, the producer shall disclose a reasonable estimate of the amount and method for calculating such compensation.
Drafting Note: States that are considering the licensing of business entities should reference subsection 6B of the NAIC’s Producer Licensing Model Act and the Uniform Application for Business Entity License/Registration, which address the licensing of a business entity acting as an insurance producer.
Drafting Note: The provisions of this section shall not apply to an insurance producer or any business entity related to such producer that accepts or receives only a nominal fee from the insured.
Section __
An insurance producer must disclose the following, if applicable, to an insured or prospective insured, prior to the purchase of insurance:
1. That the producer will receive compensation from the insurer for the sale;
2. That the compensation received by the producer may differ depending upon the product and insurer; and
3. That the producer may receive additional compensation from the insurer based upon other factors, such as premium volume placed with a particular insurer and loss or claims experience.
Drafting Note: States that are considering the licensing of business entities should reference subsection 6B of the NAIC’s Producer Licensing Model Act and the Uniform Application for Business Entity License/Registration, which address the licensing of a business entity acting as an insurance producer.
Source: NAIC Press Office
Do contracts designed to smooth out earnings at publicly held companies qualify as insurance? New York Attorney General Eliot Spitzer has joined forces with the SEC to investigate such "finite insurance" or "loss-mitigation insurance" agreements, according to the The New York Times today. "Bermuda Firm Is Subpoenaed in Inquiry Into Insurers"
The new subpoena seeks information from ACE, Ltd., based in Bermuda. Previous inquiries by the SEC and the state of Indiana had focused on finite insurance contracts written by American International Group (A.I.G.). The investigation adds to the focus on the adequacy of state regulation of the business of insurance, reserved to the states by the WWII-era McCarran Ferguson Act.
The Times notes: "The investigation has also raised questions about the quality and breadth of insurance regulation, which has been the responsibility of the states. The current regulatory framework will be the subject of a hearing in Washington today being convened by Senator Peter G. Fitzgerald, Republican of Illinois."
Sen. Fitzgerald is the Chair of the U.S. Senate Governmental Affairs Subcommittee on Financial Management, the Budget, and International Security. According to his website, the Subcommittee "will hold a public hearing on Tuesday, November 16, 2004 at 10:30 a.m. in Room SD-342 of the Dirksen Senate Office Building entitled, 'Oversight Hearing on Insurance Brokerage Practices, Including Potential Conflicts of Interest and the Adequacy of the Current Regulatory Framework.' This oversight hearing will focus on insurance brokerage practices, such as contingent commissions, that raise conflict of interest questions, and whether these practices harm consumers or suggest changes to the existing regulatory framework. "
Aon, the #2 insurance brokerage, may be Eliot Spitzer's next target in his investigation of contingent commission payments from insurers to insurance brokers, according to the New York Times.
An article in the Sunday Times, "Spitzer Goes Hunting for His Next Trophy," by Timothy L. O'Brien and Joseph B. Treaster, focuses on the career of Patrick Ryan, Aon's CEO, who built the present day global insurance brokerage through acquisitions and creative business practices. The article provides a readable introduction to the practices and regulation of insurance relevant to the investigation and the role of Marsh & McLennan and Aon, which together handle 70% of the corporate insurance market in the United States, according to the Times.
The CEO of Marsh resigned a few days ago in response to charges by Attorney General Spitzer. According to the Times, Mr. Spitzer has further evidence that may involve practices by Aon, but has not filed legal action, as he has with respect to Marsh. The New York Times > Business > Your Money > Spitzer Goes Hunting for His Next Trophy
Jeffrey W. Greenberg, CEO and Chairman of Marsh & McLennan, the world's largest insurance broker, resigned Monday, according to the New York Times, to avoid an indictment of the corporation. Criminal prosecutions of individuals are still expected from New York Attorney General Eliot Spitzer. He and other state authorities are probing "contingency fees," and "placement service agreements" that have been controversial but commonplace between insurance brokers and insurance companies. Allegations of bid-rigging in commercial insurance have also surfaced, involving the state antitrust laws. Insurance Chief Quits in Inquiry Led by Spitzer (New York Times, October 26, 2004)
AIG (American International Group) says it is the target of a U.S. grand jury probe into "nontraditional" insurance products, according to A.P., the Seattle Times and the New York Times.
In September of 2003, AIG paid $10 million to settle (without admitting) S.E.C. charges that it had aided Brightpoint (Nasdaq CELL), a cell-phone distributor based in Indiana, in falsifying earnings by issuing an "income smoothing" contract.
Sources: Insurer AIG says it's target of federal grand-jury probe (Seattle Times, Oct. 22, 2004). See also: A.I.G. Says It Is Target of Midwest Inquiry (New York Times, Oct. 22, 2004).
California's insurance commissioner has proposed new regulations to require agents and brokers to disclose any financial incentive they would receive for selling certain insurance products and steering business to specific companies. A press release by Commissioner Garamendi reports he ordered the regs drafted in March, after criticism of incentive commissions surfaced.
The practice came to national attention recently due to legal action taken by New York Attorney General Eliot Spitzer, focused on Marsh & McLennan and several leading insurers, alleging conflicts of interest and bid-rigging in violation of state antitrust laws.
The Florida Hurricane Catastrophe Fund is expected to pay about $3 billion towards the estimated $21.9 billion in combined damage from the four 2004 hurricanes, according to the state's CFO Tom Gallagher. Insurers expected to tap Florida catastrophe fund for $3 billion (A.P. Wire Oct. 18, 2004). The state's cat fund works as catastrophe reinsurance for the state's windstorm insurers, with each storm having a separate $4.5 billion deductible to be absorbed by the covered companies. The first of the two hurricanes (Frances and Ivan) may not qualify because their estimated damage is below the deductible, but Charley and Jeanne are expected to breach the threshold.
The state-subsidized fund is designed to encourage insurers to offer windstorm coverage in Florida. In 1992, Hurricane Andrew's $16 billion in losses drove several companies into insolvency and also wiped out the cash reserves of the state's guaranty fund, which stands behind insolvent insurers. Gallagher is quoted as seeking legislative changes to the deductible levels in a special legislative session. In April, 2004, Gallagher was quoted by the Insurance Journal: "Expanding the Cat Fund will promote needed competition in the marketplace by encouraging insurance companies to write more coverage for homeowners."
In a September, 2004 commentary by Gallagher comparing Charley v. Andrew, he compared the "too low" premium rates of 1992 to rates he today regards as adequate to provide sufficient reserves for insurers to weather catastrophic storms. He contrasted his view to that in consumer letters, published this fall, arguing that windstorm insurance rates should be reduced "because it has been 12 years since Hurricane Andrew: A week later Charley hit."
New York AG Spitzer's press release on lawsuit against Marsh & McLennan Companies, naming several insurers and alleging fraud and antitrust violations for price-fixing, includes a link to the Complaint (PDF), setting forth the allegations.
Emilio Colagiovanni, a Vatican contact of Marvin Frankel, will be sentenced in New Haven, according to the Williamson County Review Appel. In 2002, Colagiovanni pled guilty to conspiracy to commit wire fraud and money laundering in connection with Frankel's looting of Franklin American Life Insurance Co. and several other insurance companies of $200 million. Others involved in the scheme included John Hackney, Gary Atnip, and attorney John Jordan. Atnip is serving a 10-year term. Jordan was sentenced to five years. Hackney and Frankel have yet to be sentenced, all according to the Review Appeal.
Frankel's Vatican contact to be sentenced Thursday on The Review Appeal
DougSimpson.com/blog
The "one-two" punch of Hurricanes Charley and Frances will test technology used by insurers to forecast insured losses from catastrophic storms. Some recent commentary and information about such technology includes the following links. If you know of additional technology that's proven useful or is promising, or critical analyses of such technology, please comment, trackback or email me at: doug "at" dougsimpson.com. This implies no endorsement of any product or report mentioned below, and I have no affiliation or relationship with the vendor of any product mentioned. Comments will be closed soon to reduce spam.
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"While nobody can eliminate natural or market forces, insurers are turning to business geographics to minimize their impacts in underwriting, ratemaking, risk concentration analysis, marketing and disaster recovery."
This 2002 article mentions:
"StormCenter Communications, Inc. and Accurate Environmental Forecasting, Inc. have teamed up to deliver a new hurricane forecast model that has been used at the National Hurricane Center and in some selected private industry locations for more than 5 years. * * * A key differentiator with the RealTrack(TM) Hurricane Model is the production of combined AEF/AIR real-time loss estimates which provide the most accurate assessment of potential risks for all landfalling hurricanes along the U.S. coastline."
"Experts Team Up to Deliver the RealTrackTM System via the Web" (Envirocast 2003).
"[S]kilful long-range forecasts of seasonal US hurricane activity could be used either to create an additional profit margin for a seller of reinsurance coverage or to reduce costs for buyers of coverage. * * * Several ideas and developments have been combined to demonstrate the business relevance of seasonal US hurricane forecasts for the first time."
Niklaus Hilti, Mark Saunders and Benjamin Lloyd-Hughes, "Forecasting Stronger Profits" (GlobalRe, 2004)(PDF).
"Founded in 1987, AIR pioneered the probabilistic catastrophe modeling technology that revolutionized the way insurers, reinsurers and financial institutions manage their catastrophe risk. Our leading edge models of global natural hazards, which form the basis of our software systems, enable companies to identify, quantify, and plan for the financial consequences of catastrophic events."
"About AIR," a subsidiary of Insurance Services Office (ISO).
"The AHC [Atlantic Hurricane Catalog] is a new hurricane event set that brings unparalleled technological sophistication to the science of hurricane risk assessment."
"Incorporating Climate Variability and Numerical Weather Prediction Technology into Hurricane Risk Assessment" (Accurate Environmental Forecasting, Inc., 2004)
"AEF's sophisticated modeling technology is coupled with intuitive interactive visualization software to allow rapid and effective use of our forecasts. "
"Hurricane Modeling > Overview" (Ibid)
Hurricane Andrew was a Cat4, causing "catastrophic" damage ... if Hurricane Frances gains another 15 mph in its wind speed, it will be a Cat 5, according to recent news of this south Atlantic storm headed for the East Coast.
AOML's page of information about Hurricane forecast computer models
Consumer misunderstanding of the various flavors of "replacement cost" homeowners insurance can mean a natural disaster is a financial disaster, according to a story in The New York Times > Business > "Homeowners Come Up Short on Insurance".
Most insurance claims are not for the total loss of a home, which is where "replacement cost" coverage is most important. When wildfires strike in the West, or a Hurricane like Charley or Andrew hits in the East, folks learn far more about the technicalities of their insurance coverage. A total loss of house and contents tests the extent to which coverage applies.
The problem can be aggravated by a rise in the cost of labor and materials following a major disaster. Despite calls to prevent "price gouging," the law of supply and demand means that the need for massive amounts of lumber, shingles, siding and skilled labor after a disaster will naturally drive prices above "normal." This may leave consumers underinsured. Part of this is due to insurance marketers efforts to keep premiums "competitive" by underestimating replacement costs, and by consumer choice for the less expensive version of homeowners coverage.
The article includes sources to further information about the different types of "replacement cost" homeowners insurance coverage, and highlights the potential exposure if an agent fails to get "full coverage" when such is requested by a consumer.
A new GAO report calls for improved insurance regulator access to FBI nationwide criminal data, cross-industry sharing of regulatory enforcement data to prevent "the migration of undesireable people, or rogues, from one industry to another" and assesses oversight structures for sharing of consumer complaint data among multiple regulators. The 26 page report, titled "Better Information Sharing Among Financial Services Regulators Could Improve Protections for Consumers," is available at the GAO's website.
Thanks to:beSpacific: GAO Report Calls for Improved Info Resource Sharing in Financial Community
As damage estimates from Hurricane Charley are added up, a look back at Hurricane Andrew (Category 5 - 1992) provides some perspective. Insure.com notes that Andrew took 23 lives, destroyed almost 30,000 homes and damaged over 100,000 others. with aggregate loss over $15 billion, only surpassed by September 11 on the list of insured disasters. Source: Insure.com - home insurance - "10 years later, Hurricane Andrew would cost twice as much".
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As the impact of Hurricane Charley becomes better known, we will see how the insurance industry will react. Following Hurricane Andrew in 1992, while most insurers were able to pay claims and draw on reinsurance, several insurers with concentrations of insureds in the path of the storm became insolvent, and their losses fell on the guaranty fund. That fund had to borrow money to pay the flood of claims in order to stay afloat itself.
Since Hurricane Andrew, coverage provisions for windstorms have changed in Florida. We'll be seeing in coming months how those respond to Hurricane Charley as the loss statistics are added up. We'll also probably get some new cases to chew on, as we did following Hurricane Andrew in 1992.
The Insurance Information Institute provides a "Hot Topics" page with information on Hurricane Charley, which includes information about the Citizens Property Insurance Corporation, a Florida-regulated association offering full coverage and windstorm-only coverage in that state. CPIC replaced the former high risk pools, the Florida Windstorm Underwriting Association and the Florida Residential Property & Casualty Joint Underwriting Association.
The III's page includes summary data on the ten most damaging hurricanes (with dollar loss figures adjusted to 2003 dollars) and data on hurricane and hurricane-related deaths for the last twenty years.
Company payments to employee benefit insurance brokers has become a focus of the Attorney General of New York, as his investigation expands to include subpoenae to Aetna, Cigna, MetLife and Hartford Life, according to the New York Times. "Contingency payments" reward commercial insurance brokers for achieving sales goals, but not all brokers disclose details of the payments to their customers. Several major brokers received subpoenae this spring as part of A.G. Eliot Spitzer's investigation. "Spitzer Inquiry Expands to Employee-Benefit Insurers" (New York Times, June 12, 2004).
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A related story mentioning similar inquiries by California Attorney General John Garamendi and indicating that the inquiry was prompted by the nonprofit Washington Legal Foundation was in the June 11 Times: "3 Insurers Say New York State Is Investigating Fees to Brokers" (New York Times, June 11, 2004).
A May 2004 backgrounder by the Insurance Information Institute (III) is available at: "Contingent Compensation and Service Agreements Between Insurance Brokers and Insurers"
Wharton has a continuing focus on insurance and terrorism reflected in the research of its faculty. A February 2004 working paper by Prof. Kent Smetters, "Insuring Against Terrorism: The Policy Challenge" is at his listing of Working Papers.
Read more ...
In it, Prof. Smetters compares the increasing government role in providing back-stop insurance against natural catastrophes such as massive hurricanes or earthquakes to the developing government role in insurance against terrorist acts. He argues that government must take some blame for the challenges facing private insurers considering another catastrophic terrrorist event such as that of September 11, 2001.
His paper includes:
James Grimmelmann comments in LawMeme - Great Ideas Dept.: Open Source Insurance about news that Open Source Risk Management may counsel companies about managing the risk of being sued by SCO. Below are some comments I added to his posting. (Read more ... )
James, I took a look at OSRM's site, and thought about your comment that
it would not be likely to have sufficient capital to respond if many SCO
suits came in at once.
OSRM, from all I can see on their site, does not hold itself out as an insurer or even an insurance broker. Rather, it is a provider of fee-based risk management, consulting and training. Such companies take a fee from the ultimate customer in order to independently evaluate and advise regarding the management of risk, but do not sell or provide insurance coverage. I know of no real capital requirements to operate as a risk manager.
A risk manager may advise their clients about available insurance and introduce them to licensed brokers representing companies that offer such. A risk manager may advise a client to self-insure, or join with others similarly situated to form a risk pool, perhaps set up an offshore captive insurer owned by the pool members to which the risk may be transferred. They might even administer such a pool, acting as a third party administrator or "TPA". State regulation of TPAs varies.
If actual insurance were to be available, it would have to come from an actual insurer, which would need to have capital and/or reinsurance. I did not find anything on the OSRM site that indicated that any particular insurer was offering this type of coverage. That does not surprise me, because coverage like this is quite unusual, and there are very few players in the market.
This sort of coverage is *not* likely to be offered by a standard, licensed insurer with offices and agents in the prospective insured's state. Its the sort of non-standard coverage that would typically come from a "surplus lines" insurer licensed out-of-state or outside of the U.S. Most folks are familiar with the unusual types of insurance written by Lloyds of London, whose underwriters are an example of a S/L carrier. There are many others less well known, some that are subsidiaries of famous companies.
S/L carriers are not licensed or regulated by states (other than the state where they may be domiciled) so that buyers need to do due diligence. Risk managers are useful in that due diligence, because they are (usually) not compensated by the insurers with which the risk may eventually get placed.
Purchase of S/L coverage is typically through a specially licensed surplus lines broker, an insurance intermediary that takes a commission from the insurance company for the service of arranging insurance coverage for particular insureds with an insurer not licensed in the insured's state.
You've put your finger on the main challenge for any underwriter thinking about putting out a line on this type of risk ... lack of distribution of the potential hazard. If SCO starts a suit campaign, and only one or two insurers cover the whole waterfront, they will be hit hard.
Such can be handled much like "retroactive" coverage ... which is sometimes purchased *after* a disaster. In essence, the insured, who has already been sued or expects to be sued because of some known event, pays a premium that the insurer figures will cover the costs of defense, indemnity, its administrative costs and a margin for profit. The transaction may be beneficial to both parties because the insured can take a business expense deduction in the year the premium is paid (rather than over the ensuing years of defense and ultimate payout).
Unlike the insured, the insurer *is* allowed to deduct its actuarially justifiable reserve for all that anticipated expense and indemnification, in the year the premium is paid. If the likely main pay-out is several years away, the insurer may also be able to generate investment income on the premium paid by the insured over the years of defense. So, there are tax advantages for the customer in placing the risk into an insurer.
Either way, the coverage is likely to be expensive, if available at all. The more likely the coming lawsuits, the more expensive it will be. In some cases, the premium will equal the limits of coverage, so that it may be somewhat like a banking transaction. Under IRS rules, there must be sufficient transfer of risk to the insurer for the premium to be deductible, however.
One may ask: "but isn't the real value of such a policy in the insurer's coverage of defense expenses?" Good question. Many surplus lines policies provide that defense is "within the limits," so that payouts for defense costs reduce the remaining limit for indemnity. If one has a million dollar limit, and the insurer pays out $750k to defend, there may only be $250k left for any indemnity or settlement. Careful analysis of the policy language by an expert may reveal similar limitations.
Surplus lines coverage prices are also volatile, because they are not regulated. So, if a flurry of lawsuits hits the cover, the renewal may be *dramatically* more expensive. And, if the management of the insurer changes and decides it no longer has an appetite for that type of risk, the coverage may get prohibitively expensive or simply unavailable. It is not unusual to find that there are no other sources of the coverage at such times.
Insurers sometimes fail, become insolvent. In the US, all insurance insolvencies are handled under state insurance insolvency law, not federal bankruptcy law. Also, except in one or two states, surplus lines insurers are *not* covered by insurance guaranty funds, which act in a way like FDIC or FSLIC to pay some claims of insolvent insurance companies. Purchasers of insurance from a surplus lines carrier that becomes insolvent may have little recourse except to wait for their share in the insolvency proceeding in the insurer's home jurisdiction. If the insurer is domiciled in a jurisdiction outside the U.S., the insolvency laws may be less favorable to creditors (policyholders) than is the case in the U.S.
Even in the U.S., insurance insolvencies often take decades to liquidate, if the principal liabilities are disputed "long-tail" claims and the principal assets are reinsurance policies with reinsurers that are financially strained, insolvent or just plain stubborn. Reinsurers may be particularly stubborn about paying claims of insolvent insurance companies, because they cannot produce future business for the reinsurer.
When caveat emptor is the word of the day, independent advice is most valuable, so that a good risk manager may be worth the investment.
Douglas Simpson, J.D. "Unintended Consequences" at DougSimpson.com
Seattle Post-Intelligencer reports that Ex-Tenn. lawyer sentenced to 5 years in Frankel case by a Mississippi court. He will serve the sentence concurrently with the 5.5 years he received in a Connecticut court in September for a related charge.
In 2002, after some time as an international fugitive, Martin Frankel was caught and pleaded guilty to defrauding an insurance company under his control of over $200 million. His elaborate Ponzi scheme involved an international cast and triggered Congressional hearings, inter-governmental accusations and GAO studies. Not to mention the indictments. Frankel is awaiting sentencing as his alleged cohorts are prosecuted.
(Read more ...)
The GAO Report: Scandal Highlights Need for Strengthened Regulatory Oversight .
From the "Results in Brief":
"Throughout the 1990s, Martin Frankel, with assistance from others,
allegedly obtained secret control of entities in both the insurance and
securities industries. He is alleged to have anonymously acquired and
controlled insurance companies in several states and, despite being barred
from the securities industry, to have exercised secret control over a small
securities firm. Using the name of this securities firm, Mr. Frankel
allegedly took custody of insurance company assets and provided false
documents on investment activity to disguise his actual purpose. Instead
of managing these assets in a prudent manner, he allegedly diverted them
to other accounts he controlled and used them to support the ongoing
scam and his lifestyle. The scam was finally exposed after insurance
regulators in Mississippi took enforcement action against three of the
Frankel-connected insurers by placing them under regulatory supervision.
At the time this report was being written, a federal criminal probe against
Mr. Frankel was still ongoing."
"This report includes recommendations to help prevent or detect similar
investment scams in insurance companies by proposing the adoption of
appropriate asset custody arrangements, improved asset verification
procedures, and the sharing of confidential regulatory information across
industries and agencies. In addition to the above recommendations
emanating from the Frankel matter, this report contains a
recommendation designed to broaden and help sustain cooperation among
regulators of different financial services sectors."
A September 18, 2000 letter from U.S. Congressman Dingell to NAIC Commissioner Nichols
included: "I am greatly concerned by the U.S. General Accounting Office’s (GAO) report to me about the insurance investment scam of Martin Frankel ("INSURANCE REGULATION: Scandal Highlights Need for Strengthened Regulatory Oversight" GAO/GGD-00-198). The GAO’s report shows this travesty occurred because state insurance regulators were either too blind to see, or too unwilling to acknowledge, the scam Mr. Frankel perpetrated, openly and fearlessly, over a period of eight years. This fraud went on far too long, not because Mr. Frankel was clever and deceptive, but because he was operating in an environment where the regulators lacked the skill, authority, access to basic information, resources, and "healthy skepticism" needed to protect insurance consumers."
Court TV's Crime Library Article on the Frankel Fraud (10 segments)
Ellen Pollack, The Pretender: How Martin Frankel Fooled the Financial World and Led the Feds on One of the Most Publicized Manhunts in History. A reviewer at Amazon.com says: "Ellen Joan Pollock's The Pretender is a biography of Martin Frankel, an unsavory financial savant whose vast illicit empire reached into very high places on two continents before collapsing with thundering suddenness. By the time of his arrest in 1999, Frankel had bilked various insurance companies out of $200 million via an elaborate (and oddly haphazard) Ponzi scheme. Pollock chronicles not only Frankel's phantom stock trades, fictional portfolios, asset skimming, and money laundering, but his mind-boggling personal extravagances--both financial and sexual. (His Greenwich, Connecticut, headquarters served both as business office and home to a shifting harem devoted to Frankel's sadomasochistic interests.)"
Testimony of the National Association of Insurance Commissioners
Before the Subcommittee on Oversight and Investigations And the Subcommittee on Financial Institutions and Consumer Credit Committee on Financial Services United States House of Representatives Regarding: Information Sharing Among State and Federal Financial Regulators. Quoting: "In particular, we want to move very quickly on closing the information gaps that prevented state regulators from checking on securities violations committed by Martin Frankel before he got involved in the insurance industry."
In 1974, when Fred Carr took the helm of First Executive Life, the life insurance industry was at the threshold of drastic change, and Carr was one of those who took it over that threshold. Reading Schulte, The Fall of First Executive: The House That Fred Carr Built provides an insider's view into how a financial services company can fall victim to the actions of a few individuals acting either from greed, hubris or both. Gary Schulte's inside account provides important lessons in regulation of financial services. (Read more ... )
Fred Carr took over the management of First Executive Life in 1974, at a time when it was near bankruptcy due to lack of capital. The life insurance industry was then a wealth creation machine that few outside of the industry understood, and which faced little competition, despite the hundreds of companies in the market. It was shaken up in 1978 with a FTC report that claimed that the savings component of life insurance produced a rate of return far below that of other safe investments available to the public. The press picked up on the report, shaking public confidence in life insurance as a savings vehicle.
Into this situation, ripe with opportunity for change, stepped Fred Carr, a stock broker who had earned a reputation as a "gunslinger" in the explosion of the mutual funds markets during the "Go-Go Sixties." His was the opening story in the 1972 book "The Young Millionaires" by Lawrence A. Armour.
Author Benjamin J. Stein included Carr among the ranks of what he called a network of junk bond financiers in his "License to Steal" (Simon & Schuster 1992). Besides Michael Milken and others the list also included Saul Steinberg of Reliance, which would eventually fail also, but not until after the disaster of 9/11/01.
First Executive pulled itself from the brink of bankruptcy through the sales of interest-sensitive life insurance products. Agents showed prospects projections of investment returns dramatically superior to competing products. Carr made the returns plausible by heavy investment in "high yield" or "junk bonds" bought from Michael Milken, and erroneous assumptions that high returns would continue indefinitely. First Executive provided Milken a ready market for his bonds, propelling both businesses into rapid growth, in a reciprocity strategy commented on by Forbes in a 1984 cover story.
Schulte criticizes Executive Life (and those that followed it into the hot money trance of the 1980's) for failing to consider the unknowns of the future, and for taking risks that were not its to take ... risking the long-term promise to the policyholder for short-term performance. Without old portfolios or existing policyholders to consider, Executive Life was able to offer products based upon an investment portfolio with yields as much as double those of the established companies with established portfolios invested in conservative bonds and mortgages.
He also saw Executive Life succumb to what he calls "psychomedia risk" -- "the risk that even though you do everything right, something unexpected will happen, which creates the perception of failure although the facts don't support it." Schulte, page 56.
One element of Carr's eventual downfall was his self-imposed isolation of First Executive from both the insurance establishment and the press. First Executive and its managers avoided participation in industry associations and the network of industry support. He operated the expanding company like a sole proprietorship, making all the decisions and sharing little information with his own executive staff.
His agents suffered similar isolation from the established industry network. By joining Executive Life and aggressively converting old-line policies, they rejected the rest of the industry and put other agents on the defensive about their products. Other agents looked upon Executive Life agents as pariahs, associated with junk bonds, junk policies and junk agency practices.
What made Executive Life grow so fast, was the competitive advantage from the exceptionally high yield of its portfolio of junk bonds. According to Schulte, by 1987, First Executive Life had the largest portfolio of junk bonds in the world. In 1990, he was called before Congressman Dingell's subcommittee investigating problems in the insurance industry and defended his portfolio strategy. Those hearings resulted in a report "Failed Promises: Insurance Company Insolvencies" which was critical of state insurance regulation. As junk bonds and the Milken activities began to break down and come under increasing criticism from the media and commentators such as Benjamin Stein and Joseph Belth's Insurance Forum, he declined to respond.
What undid the company was its eventual inability to raise sufficient capital to support the rapidly expanding volume of business. The nature of the life insurance business is that due to heavy up-front expenses (mostly for agent's commissions), policies do not become profitable until several years of renewals. In the early years, every dollar of new premium is an actual drain on capital. Fast growing companies need more and more capital, and Carr took greater and greater risks to raise that capital, while projecting the continuation of high yields into the indefinite future.
Of course, the future turned out to be quite different than the projections.
When the junk bond market collapsed and policyholders became frightened for their investments, redemptions of his policies began and the company was forced to announce a dramatic writedown in 1990, increasing the policyholder panic.
His competitors and the press had been predicting the downfall of Carr's practices for some time, and in light of the new revelations, fed the collapse of confidence in the company. Carr found himself without allies or friends in the industry or media. Agents converted the company's policies to other writers, and in a very short time, Executive Life went from a fast growing business to a company in liquidation, a victim of the "psychomedia risk" and its lack of support and allies within the industry and media.
As the crisis deepened, Carr's pattern of centralized, autocratic management resulted in paralysis as he was buried in defensive issues. As organizational scholars such as Columbia Professor Duncan Watts would later predict, without a network of informed executives within the company and sympathetic allies outside the company, he was unable to effectively respond to the rapid change and challenges.
Although the base company reserves were sufficient to cover the remaining liabilities, they were seized by the insurance departments and placed into liquidation, and the holding company was forced into bankruptcy on May 13, 1991. The policyholders were covered, eventually, but the shareholders who had not cashed out early (as did Peter Lynch) lost their investments.
Stories like this are invaluable studies, because cases like those of First Executive continue to play out today. Such as those told in the February 2002 issue of The Actuary, "Deja Vu All Over Again - a roundtable discussion of insurance solvency and insurance fraud."
In Declarations and Exclusions, California Atty. George Wallace is tracking two new lawsuits arising out of the 9/11 tragedy. One is by some of the major insurers and reinsurers who paid over $2.7 billion in losses, naming some 500 individual and corporate defendants, including some government entities. The other lawsuit is by survivors against the airlines, the Port Authority and Boeing for negligence or product liability contributing to their loss of loved ones. September 11 -- The Litigation Expands
He has noted articles in Business Insurance and the New Republic regarding these cases, which will expand the discovery of facts and may redistribute the losses.
DougSimpson.com/blog
George Wallace's Decs and Excs follows California's turmoil in workers comp insurance: Insurance Commissioner Seeks Reduction in Workers' Compensation Cost Factors. In a press release linked by Decs and Excs, Department of Insurance (DOI) Commissioner Garamendi anticipates a legislative attempt to force lower premiums. The Commissioner asserts that the better solution is to control claim costs, and that capping premiums below cost will only drive for-profit insurers out of the marketplace.
That sort of exodus would increase the stress on the California State Fund, the controversial writer of "last resort." State Fund has been increasing its market share and premium/surplus ratio dramatically in recent years. The Commissioner of the Department of Insurance (DOI) has questioned the adequacy of State Fund's rates and capital base, but State Fund has bristled at DOI's attempts at control. This past May, State Fund filed suit against the Commissioner, arguing that it was not subject to the Insurance Department's control, or the Risk Based Capital (RBS) Statutes, and was not near insolvency.
In a recent press release, State Fund disclosed and dismissed advice from its own accountants that it is underreserved by over $1 billion. As of last month, the lawsuit continued, with State Fund disclosing that it has requested approval of a reinsurance transaction to improve its financial position by moving $4 billion in premiums off of its books.
The situation sounds sadly like those in past years in other states, such as Texas in the 1980's, where a state-controlled "market of last resort" sold workers comp insurance below cost, running large deficits until it was shut down and put into run-off. Is that happening now in California? Time will tell. (More ... )
About 18 months ago, California Commission on Health and Safety and Workers’ Compensation released a comprehensive white paper "State of the Workers’ Compensation Insurance Industry in California" that is worthwhile reading on this subject.
The well-documented experience of Texas may be informative to those considering the best moves for California. The Texas Research and Oversight Council on Workers Compensation maintains a comprehensive library of studies of the Texas workers compensation market and effects of legislative changes over the past years there, including the impact of the residual market programs upon prices, competitiveness and solvency. The articles are offered by mail for free and many of the more recent reports are online for immediate download, including the December 2002 Biennial Report which reports on the current effects upon insurance prices resulting from past legislative change, medical costs and insurance industry insolvencies, including that of Reliance.
DougSimpson.com/blog
Insurance Defense Blog editor Dave Stratton points us to online white papers relating to toxic tort defense and other material of interest to insurance people in his post: Independent Insurance Brokers of America Virtual University
DougSimpson.com/blog
Sealed Indictment Is Said to Charge Bank With Fraud (New York Times, August 28, 2003). The reported federal indictment of Credit Lyonnais in Los Angeles is the latest chapter in the 1991 collapse of Executive Life, a California insurance company that failed as the value of its junk bond portfolio dropped. The company was acquired by investors, the bond portfolio by Credit Lyonnais. At the time, the bank was owned by the French government, said the Times. Allegations later surfaced that the investors who bought the company were actually straw men for the bank, which could buy the bonds, but could not acquire the insurer due state law and the federal Glass-Steagall Act (partly repealed in 1999 by the Graham-Leach-Bliley Act). A federal investigation and a civil suit by the California Insurance Department ensued, and the indictment by the United States is the latest step in the process, indicated the Times. (more ... )
An Feb. 25, 2002 Insurance Journal article, "Decision Nears for Credit Lyonnais in Executive Life Case" includes more details about the case. In 1991, Executive Life, says the Insurance Journal, was the largest life insurer based in California, covering 340,000 insureds with $10.1 billion in assets. It also had enormous debts and went broke, in part because much of its capital was invested in "junk bonds" whose value crashed with the stock market in 1987.
On behalf of its creditors, the California Insurance Department (the statutory liquidator then under Commissioner Garamendi) accepted a bid for the company by a French firm that later turned out to be controlled through undisclosed intermediaries by French financier François Pinault. Later, some thought the price inadequate and criticized Garamendi. Garamendi failed re-election and his successor, Chuck Quackenbush, launched an investigation and lawsuit based on state law. Federal investigations also began for violation of the Glass-Steagall Act, said the Insurance Journal.
(Quackenbush resigned effective July 10, 2000, following a California Assembly investigation triggered by staff attorney disclosures that also led to changes in the California bar rules about in-house counsel's role as whistle blowers. Garamendi is once again the Insurance Commissioner of the State of California.)
Coincidentally, what book did I get from the West Hartford library yesterday? Yes, correct: Shulte, "The Fall of First Executive - An Insider's Account of the Biggest Insurance Failure in History." (1991) So much to read, so little time ...
DougSimpson.com/blog
Atty. George Wallace in Pasadena is following John Garamendi's latest maneuvers to control homeowners insurance underwriting in California in his weblawg "Declarations and Exclusions:" Department of Insurance in Court Over Emergency Homeowners Insurance Regs. Garamendi has been enjoined by a state court from taking actions without following the A.P.A., which he has chosen to publicly characterize as barring him from enforcing state law. The story, reminiscent of insurance struggles in past years in North Carolina, Massachusetts and Maine, continues.
DougSimpson.com/blog
Aon has published the report of a 2003 study by Oxford Metrica, analyzing the performance of the global (re)insurance market over the year following the World Trade Center catastrophe, using published data from the year-end 2001 annual statements. OM analyzed market value and premium writings of 484 publicly reporting insurance firms, with a combined market value of over US$1,061.3 billion. They found that 80% of the market value of the global general insurers and reinsurers lies in 20% of such companies. Shareholder Value Analysis of the Global (Re)insurance Industry (More follows)
The 53 companies that wrote global non-life insurance had a combined market value of US$542.4 billion (51% of the total value of the 484). OM focused on the 25 (with their subsidiaries) that accounted for 97% of the total value of the 53. OM's published data, for each of the 25 focus companies included:
1) Market Cap
2) Gross Written Premium
3) Total Net Premiums
4) Assets & Liabilities
5) Estimated Claims Relating to Cat 9/11
6) Cash available at 12/31/01
OM's table of market capitalization data showed, as of February 2003:
* 19% of the 53 global insurers had 83% of their combined market value;
* AIG had 28.9%, and Berkshire Hathaway had 20.4% of the combined market value of the 53.
* Number three's value was dramatically less at 6.4% of the share.
The top 25's premiums, assets and liabilities showed less market concentration:
* 20% had about 50% of the premiums
* 20% had about 70% of the assets
* 20% had about 70% of the liabilities.
(These percentages are based upon visual estimates from OM's graphical data.)
OM looked at the stock market reaction to each of the 25 following the 9/11 catastrophe, separating them into "recoverers" and "non-recoverers." OM noted that the larger firms tended to dominate the "nonrecoverers" group, compared to the smaller, "newer" firms with lower exposure to substantial historic liability claims such as asbestos.
The study provided some numerical data and views regarding insurance industry issues relating to asbestos and environmental liabilities, Enron and the expensing of stock options. It described the creation of almost 100 new (re)insurance companies in the insurance regulatory haven of Bermuda, funded with about US$13 billion of new capital since 9/11. OM also sketched Catastrophe 9/11 impacts on Lloyds of London and the Japanese insurance market, which reacted with insurance bankruptcies, mergers and alliances. OM noted that mergers of large firms in Japan have reduced 23 non-life companies to "6 mega insurance groups that would control collectively over 80% of the (Japanese) insurance industry's total premiums. * * * [T]he three top companies * * * hold 65% of the Japanese market."
The study was commissioned by Aon Limited, London and performed by Oxford Metrica, Oxford.
Contact information is in the full report: Shareholder Value Analysis of the Global (Re)insurance Industry
DougSimpson.com/blog
California's HVIRA, aggressively pressed by Insurance Commissioner Garamendi, interferes with POTUS' conduct of foreign policy and the McCarran-Ferguson Act does not save it from preemption. Reversing the Ninth Circuit Court of Appeals. AMERICAN INS. ASSN. V. GARAMENDI.
4 dissents, for whom J. Ginsburg wrote an opinion.
From the syllabus of the June 23, 2003 decision:
"The Court rejects the State’s submission that even if HVIRA does interfere with Executive Branch foreign policy, Congress authorized state law of this sort in the McCarran-Ferguson Act and the U.S. Holocaust Assets Commission Act of 1998." * * * Pp. 29—31."
Obtaining business method patents on insurance operational processes or new products is a new trend in the marketplace. Walker Digital, L.L.C. in Stamford, CT holds over 200 patents, including some related to financial services and negotiations. Walker's most famous business method is the "name your own price" method used by Priceline.com.
Two consultants, Tom Bakos and Mark Nowotarski, have publicly posted insights into the trend toward patenting of new insurance business methods. A series of their articles in National Underwriter and elsewhere are listed and linked from Mr. Nowotarski's company website . Mr. Nowotarski is a patent agent and inventor based in Stamford, Connecticut. Mr. Bakos, a consulting actuary based in Ridgway, Colorado, offers a digital copy of an article summarizing patent, copyright and trademark principles relevant to insurance. It was published in the July/August 2002 issue of Contingencies, a publication of the American Academy of Actuaries.
I'll be doing additional exploring of the intellectual property realm in relation to insurance and other financial services and noting observations here in Unintended Consequences. If you have some areas of interest to suggest exploring, please let me know via email: douginhartford "at" earthlink.net