Allstate in the dock, insurance pools with negative equity and a federal catastrophe backstop in the offing. With election fever in the air, Ronald Gift Mullins looks at an increasingly politicised US insurance market.

A father, his son and their mule began a journey to a nearby village. The father rode the mule, the son walked next to him. A farmer resting beside the road observed: “How selfish of the father to ride, while his little son walks.” So the father dismounted and put the son on the mule. A while later, a wine merchant passing by remarked why was the father walking when the mule could easily carry both the father and son. The father got on the mule behind his son. Nearing the town, a rider on a fast horse reined in and said how terrible it was that the mule was overloaded with both the son and the father. “You should give the mule a rest by carrying him.” They dismounted. With difficulty they lifted the mule onto their shoulders and began walking to town. Shortly they came to a small bridge over a deep stream. Just then an eagle swooped down and spooked the mule. Frightened, he kicked the heads of the boy and his father. They dropped the mule onto the bridge’s railing which broke. The animal tumbled into the water and drowned.
A 13th Century Fabliau

Imposing political pressure in order to maintain low rates or expand coverage throws the precarious (at best) balance between the providers of insurance/reinsurance and the buyers out of kilter. It goes against the time-tested principles of insurance: the law of large numbers, adverse risk selection, geographic positioning, underwriting guidelines and catastrophe modelling. Sometimes this imbalance leads to the collapse of a specific market.

There are many examples of the negative consequences when politics interferes with the natural ebb and flow of an insurance market, but a prime example has been in the funding of workers’ compensation insurance in a number of states. Elected officials are torn between private insurers, who want adequate rates to pay claims, and business interests who say that high premiums interfere with competition and eat into profits.

With inadequate premiums and increasing losses, many state pools for workers’ compensation find they do not have sufficient funds and begin surcharging private insurers to cover the deficit. During the 1990s, workers’ compensation residual programmes in a number of states – Massachusetts, Rhode Island, Maine, Texas, California and others – became so heavily in debt, that private insurers began leaving in order to avoid paying the surcharges. Drastic action in various forms was taken to fix the problem and to bring the programme back in balance.

“During the 1990s, workers' compensation residual programmes in a number of states became so heavily in debt, that private insurers began leaving in order to avoid paying the surcharges

Meddling officials
A prime example of how significantly politicians can impact the business has unfolded in the last year in the homeowners’ insurance market in Florida. The turmoil in the state began in October 2005 when Hurricane Wilma tore across Florida. Although overwhelmed by the $40bn insured losses from Hurricane Katrina and the devastation it caused in Louisiana, Wilma left estimated insured losses of close to $10bn in Florida. The area of the largest losses was in high-end properties on the Atlantic coast of Florida between Miami and West Palm Beach. Adding to the losses from Wilma were Hurricanes Rita and Dennis. Following new models that predicted even larger losses for future hurricanes, insurers in the state began raising rates on homeowners’ and other property cover. Further, several insurance companies stopped issuing new homeowners policies, especially along the coastal areas.

Adding to the growing distrust of insurers and reinsurers was the record profits they reported in 2006. Disgruntled homeowners and commercial businesses complained to the insurance commissioner. Eventually Florida Governor Charlie Crist proclaimed he was going to do something about rocketing rates and the growing unavailability of homeowners insurance. In fact, most of his election campaign in 2006 was fought on this promise.

“Our mission has never been more clear: Solve problems, don’t politicise them”, said Crist in his inaugural speech after being voted in as governor on 2 January 2007. A month later he had passed legislation to socialise insurance in the state. In a special session he persuaded the state legislature to pass a law in February 2007 that increased the size of the Florida Hurricane Catastrophe Fund (FHCF) to $33bn from $16bn. This action was supposed to allow primary insurers to reinsure risks at lower costs and thus the savings would be passed onto property owners.

Embedded in the law was a provision that if losses from catastrophic hurricanes exceeded the pool’s assets, any deficit would be made up with a surcharge on all Florida policyholders. “This reform package transfers the cost of paying for future hurricanes to generations of taxpayers, mortgaging our economic future on the hope that a major storm won’t strike anytime soon,” accused the Property Casualty Insurers Association of America.

“Lawmakers and state regulators contend Allstate and other insurers did not pass on savings accrued when the Florida Hurricane Catastrophe Fund was expanded

Allstate versus Florida
To aggravate the situation, rate increases were limited or denied for private insurers and the state-run insurance company selling homeowners insurance. The state of affairs became further complicated when Allstate refused to hand over documents subpoenaed in October 2007 by the Florida Insurance Commissioner Kevin McCarty.

The commissioner responded by banning the insurer from selling new homeowners’ polices in the state. Allstate went to court, which stayed that ruling. Commissioner McCarty then ordered that Allstate and any of its subsidiary companies could not write new auto or homeowners insurance in the state. Governor Crist in a statement said, “It is clear to me that Allstate must have something to hide if they are unwilling to comply with the commissioner’s requests,” and said this type of behaviour is an “unconscionable disregard for this process and their consumers”.

Within days however, a Florida judge granted Allstate an emergency motion for immediate relief from suspension of its license to write new business in the state pending an appeal. Meanwhile, Allstate subsequently produced some 40,000 pages of documents. “It would appear at this point that the company is acting in good faith,” said the commissioner.

The state was seeking documents related to non-renewals, underwriting practices and claim-settlement practices, as well as Allstate’s relationships with risk-modelling companies, insurance rating organisations, trade associations and reinsurance companies. Allstate had requested rate increase of 28.3% and 41.9%. Previously, the company had been denied rate raises of 38.4% and 39.7%. Lawmakers and state regulators contend Allstate and other insurers did not pass on savings accrued when the FHCF was expanded. The two-day Senate hearing in February also took testimony from Nationwide Mutual Insurance, Florida Farm Bureau Insurance, The Hartford and American Strategic Insurance Corp.

“Florida is the new poster child of misguided political intervention into the re/insurance market

Florida poster child
Interestingly, some of Florida’s officials have come out in opposition against Governor Crist’s expansion of the state’s reinsurance pool. Florida chief financial officer Alex Sink and House speaker Marco Rubio have proposed changes that acknowledge that homeowners must pay more for the privilege of living in a state with a high risk of hurricanes. They are each pushing plans that would mean modest increases for some homeowners, but would reduce the citizens’ burden for paying losses if a major hurricane hits the state. Speaker Rubio’s plan would require homeowners insured by the state-backed Citizens Property Insurance Corporation to strengthen their homes against hurricane damage in order to keep their policies.

David Bradford, executive vice president, Advisen Ltd, observed that Florida is the new poster child of misguided political intervention into the re/insurance market. “In general, government intervention works against a free and competitive marketplace,” he said. “The question is whether the trade-offs – principally stability if regulation is wisely administered – are worth the inevitable lessening of competition. Pandering to short-term public sentiment, as is happening in a big way in Florida, leads to bad laws, bad regulation, and almost always exacerbates a bad situation.”

Rate suppression and arbitrary premium pricing can also increase the risk of insurer insolvency as premiums fail to properly capitalise potential loss payments, said David Siesko, principal with Siesko Partners. Such state programmes, if they fail to cover a catastrophic loss, are likely to be bailed out by the Federal government, he said. “Government reinsurance and subsidisation,” he continued, “leads to a reduced motivation to build hurricane-resistant structures, excessive coastal development, and a reduced supply of private insurance.”

Mixed signals
Unfortunately, the insurance industry sends mixed signals about the role of the federal government in insurance matters. Allstate’s support of a national catastrophe fund is a prime example. At an insurance conference in New York in January 2008, several insurance commissioners agreed that states should take a more active role in reducing the risk that insurers face from natural catastrophes. Scott Richardson, insurance commissioner of South Carolina, said that states should work on improving building codes and mitigation and grant programmes to help insureds lessen their risks. “I don’t think we should go to a federal solution,” Richardson said, “until we’re on our backs, bleeding to death and breathing our last breath.”

“Unfortunately, the insurance industry sends mixed signals about the role of the federal government in insurance matters

James Donelon, commissioner of the Louisiana Insurance Department, proposed a system of private insurance covering all perils with a backstop financed by the federal government. “A federal fix is the ultimate solution, but it has to be based in the private sector,” he said. He advocated dissolving the flood insurance programme and private insurers offering an all-perils policy covering earthquake, flood and wind. Backstopping losses above a certain level, Donelon promoted a federal reinsurance programme, similar to the one created to cover losses from terrorists acts, and/or a federal tax-free reserving programme.

Thomas Wilson, president and CEO of Allstate, at the same meeting, disagreed with Richardson. Wilson cautioned that the major writers of auto and homeowners are on the hook for tremendous losses from a hurricane or other catastrophes. “The risk is too great for the reward we’re getting,” he said. Further, he did not think the free market can deal with providing capital to cover catastrophes. “To let the price rise to where it needs to be is just not politically acceptable,” he said.

In February 2008, at a hearing of the Florida House Financial Services Committee’s subcommittee on oversight, several US congressmen testified that the state’s property insurance problems are spreading to other states and argued for federal intervention to shore up the marketplace. The congressmen included Ron Klein, a Democrat from Louisiana, who said the “insurance availability and affordability problems have become a national issue.” He cited states such as New York, New Jersey, Delaware, Massachusetts, Connecticut and Texas, which have seen insurance companies cancelling or stop issuing new policies in the past year. Klein and Tim Mahoney, a Democrat from Florida, proposed the Homeowners’ Defense Act, which was passed by the US House in November 2007.

Such a piece of legislation would authorise the appropriation of $120m over the 2008-2013 period to establish a National Catastrophe Risk Consortium to help coordinate the availability of reinsurance contracts between state reinsurance entities and the private market. The bill also would establish two new federal direct loan programmes within the Department of the Treasury for state reinsurance programmes facing certain levels of insured losses following a natural disaster. Loans could be made only if a reinsurer could not access capital in the private market and repayment was secured by the full faith and credit of the state. The bill passed the house in November 2007, but has not been considered by the Senate.

Too many cooks
Republican presidential candidate John McCain, who has been endorsed by Governor Crist, does not support the governor’s plan to create a national catastrophe insurance fund, but does support the development of a regional plan to lower homeowner insurance costs associated with hurricanes and other natural disasters. Governor Crist praised McCain and said Floridians are looking forward to a lot of good things related to insurance reform. Both Hillary Clinton and Barack Obama, Democratic candidates for president, have voiced support for a federal catastrophe insurance programme.

Whatever the outcome of the next election, the continuing influence of US politicians in setting the insurance agenda is likely to continue. That regulation in the US is done on a state and not federal level is one reason for the “politicisation” of the insurance industry. Too many cooks spoil the broth and elected officials who attempt to artificially manipulate insurance regulation for the benefit of their voters, listen to too many conflicting voices and end up with a dead mule.

Ronald Gift Mullins is an insurance journalist based in New York City.