Another Day, Another Insurance Regulator Failure

As I am writing this article, AM Best reported another property/casualty insolvency this morning. If I am not mistaken, more P/C insolvencies and P/C carriers have become nonfunctioning over the past 12 months than in the last five years combined.

Blame is being placed on hurricanes and other natural catastrophes that are easy scapegoats, and most people will not look any further. However, the industry will benefit if people delve deeper because the industry is being damaged by entities taking advantage of lax insurance regulations and enforcement.

The damage is not yet evident at the highest levels where insurance commissioners have far too much to do. Perhaps a direct correlation between the entities that take advantage of the situation and the damage done is too obscure to recognize at the highest levels.

At the ground level though, the issues are plainly obvious.

Property in Duress

Some of the carriers were running marginal to high loss ratios without natural catastrophes. It is completely obvious what happens when a catastrophe hits and the carrier’s non-catastrophe loss ratios are already elevated. Clearly, the pricing model was insufficient.

The industry, however, is not primarily regulated to guarantee that carriers breakeven or make a profit. Regulations should address the need of carriers to generate enough profit to support surplus. Adequate surplus is critical — the most important variable — to ensure that claims are paid, and the state does not have to make payments out of its guarantee funds. This is especially true if a state’s guarantee fund must assess money from other carriers that are more prudent or simply smarter than their peers and makes that state a less appealing place to do business and as a result limits consumer choice.

Another factor I am seeing, especially with start-up “insurtech” carriers, is the amount of surplus with which they start is so tiny as to not be relevant. While $25 million is a lot of money in most scenarios, a $25 million surplus is peanuts.

If writing in a catastrophe prone state where the average Coverage A is $500,000, that surplus will only cover 50 homes, maximum. If you look at the homes that burned in Colorado in 2022, the average Coverage A was around $500,000. Add Coverage C, additional living expenses, guaranteed replacement cost, debris removal, etc., and the average claim is close to $1 million, but let’s use $750,000. At that figure only 33 homes are covered.

If a carrier is not profitable and there really is no future for it, giving agents and their insureds the expectation that they are safe is not fair or smart.

In catastrophe zones, property loss ratios should be exceptionally good except when a catastrophe hits. This is because in non-catastrophe years, the extra rate for catastrophes will go to profit. Therefore, if the loss ratios are not exceptionally good in non-catastrophe years, it should be pretty easy to identify the problem and force the carriers to act while they still have time.

I saw one property carrier focused on catastrophe areas recently advise they needed about an 85% rate increase. If they need an 85% rate increase, they needed a 40% rate increase last year. Whether they asked for it and were denied is one issue. If they failed to ask, as insurance carriers are apt to do, for regular rate increases every year rather than one large increase every five years, is another issue. However, that 85% increase request is key to understanding what is happening by permitting an environment in which insolvencies happen.

The property market in much of the country is in duress. The rates required for a prudent business model are so high that many people simply cannot afford coverage. Carriers are then developing and promising all kinds of innovations. Whether it is a financial engineering innovation, or a mapping innovation, or using a RRG or a reciprocal model that relieves pressure on regulators for an open market solution — they get approval. Then everyone keeps their fingers crossed.

This “hope and prayer” approach damages the talented players and consumers. The carriers that have the right models and pricing are prevented from capitalizing on their hard work. Consumers are hurt more by staying with carriers that are inadequately stable than by paying higher rates. Agents who emphasize the right coverages with strong carriers lose sales to purveyors of snake oil.

On the Ground

On the ground, the damage is obvious. Insurance is, in so many ways, a simple industry. The rates charged need to be reasonable and adequately profitable enough to give a carrier a reason to write the account and generate enough profit to build surplus. Anything less than this scenario will eventually fail. That is not to say that people will not get rich along the way, and many are. Rates are supposed to be regulated to fall within the range of reasonably profitable so that shareholders are happy, and surplus is created without over-charging. Inadequate rates and excessive rates both lead to market instability.

An example of the on the ground problems involves an agency having to address 150 clients whose carrier had become insolvent.

Who is going to pay their claims? Who is going to take their policies? Have you ever tried to move an account mid-term? How do you explain to a customer that they may have to pay their homeowners premium twice because the carrier with whom you placed them is insolvent? How much time is spent putting out this fire rather than helping insureds get the protection they need?

The situation is preventable if insurance regulators insist on carriers charging adequate premiums from day one. Adequate means not taking the carrier’s word for it, either.

For example, one of these carriers that recently quit existing started writing business in a non-catastrophe state so they could acquire more premium to quickly offset their losses and to appease regulatory/rating people with greater geographic diversity. The rates they offered were 30% to 50% below the rates offered by any established carrier in that market.

Seriously? If all the other carriers were overcharging by 30% to 50%, their loss ratios should have been averaging around 25% to 40%, which was not the case. I analyzed the numbers. Even if it was the case, then the regulators were at fault for allowing such over-charging, or they were at fault for allowing under-charging. That kind of rate disparity is impossible for standard lines like homeowners within a strong regulatory environment.

I know regulators must go through a strict actuarial analysis to determine rate adequacy, but sometimes the math is so obvious the actuarial analysis is perfunctory.

By a strong regulatory environment, I do not mean insisting carriers provide coverage that is not in the policy. I do not mean to insist carriers write business in areas where they do not want to write. Those are headline grabbers, but ineffective in building a better consumer market. Those actions do not support the carriers and agencies working to build sustainable rating models or help consumers get the coverages they truly need.

Stepping up protects consumers, and leadership is required. The industry has been down this path before, especially with auto insurance and it led to excessive rates and few consumer choices. That was about a generation ago so maybe the industry must repeat the lesson again. I hope not.