Consumer Federation: Insurers Increase Profit Levels by Overpricing Policies

National consumer organizations joined the Consumer Federation of America (CFA) today in Washington D.C. to release a new study concluding that the property/casualty insurance industry (which includes the nation’s home and auto insurers) has dramatically increased profits and surplus in recent years, in part by systematically overcharging for insurance and shifting costs to consumers and taxpayers.

According to CFA, the report provides extensive data demonstrating that property/casualty insurance companies are paying out lower claims in relationship to the premiums they charge consumers
than at any time in decades. The combined ratio, the relationship of all paid claims and expenses to the premiums that insurers collect, appears to be the lowest on record in 50 years. This indicates the highest profit levels in recent history.

“Profits and a solid insurance industry are a good thing but unjustified profits and excessive capitalization harm consumers,” said J. Robert Hunter, the director of Insurance for the CFA and author of the study. Hunter is an actuary, former state insurance commissioner and former federal insurance administrator.

“We saw record profits in 2004 and 2005 despite significant hurricane activity. Profits in 2006 rose to unprecedented heights, with pre-tax profits likely to increase by over $30 billion for property/casualty insurers, a jump from the previous record of more than $100 for every man woman and child in America. Meanwhile, the amount that insurers paid in claims and expenses as a percentage of the premium collected in 2006 plummeted to a 50-year low,” he said. “Unfortunately, a major reason why insurers have reported record high profits and low losses in recent years is that they have been methodically overcharging consumers, cutting back on coverage, underpaying claims, and getting taxpayers to pick up some of the tab for higher risks,” said Hunter.

Industry Responds
However the Property Casualty Insurers Association of America (PCI)said that the CFA report mischaracterizes the facts involving the profitability of the insurance industry.

“Consumers are among the primary beneficiaries of a financially strong insurance industry,” said Genio Staranczak, chief economist for PCI. “Profits allow insurers to reinvest in the business so that there is sufficient capital available to pay claims when a major catastrophe occurs. Additionally, increased profitability spurs competition among companies, a trend we’re already seeing in many lines of insurance across the country. Increased competition means more dollars in the pockets of consumers.”

PCI referred to data compiled by MarketScout in Dallas, for example, where rates, as of December 2006, were down 8 percent on a composite basis for all business property and casualty coverage placed in the United States. In addition, the November 2006 consumer price index for personal auto insurance was up about 1 percent over last year – less than overall consumer inflation.

“2006 profits are in large part due to a year that has been absent of major catastrophe losses and only offset less than stellar returns achieved in previous years,” Staranczak said. “Despite, the financial health of the industry as a whole, it’s important to note that these figures are for all lines of business – from auto to workers compensation – in all parts of the country.”

Marc Racicot, president of the American Insurance Association (AIA) also responded to the Consumer Federation of America (CFA) study.

“Insurance is a business based on risk, and any risky business proposition must have a relatively high rate of return for investors from time to time, or the investors will take their capital elsewhere, and that business will cease to exist,” noted Racicot. “Fortunately for all Americans, the property-casualty industry had a much better year financially in 2006 than in 2005 or 2004, when we saw record losses from natural disasters. Last year was a fortunate anomaly given that in virtually every year over the past two decades, insurers lost money on their core business operations. In fact, the U.S. property-casualty industry as a whole has had only two underwriting gains at year’s end during the past 27 years. After record losses in 2004 and 2005, the respite provided by 2006 has meant that insurers could replenish the capital that they must have on hand in order to stand behind the policies they sell. Healthy balance sheets better prepare insurers to face future catastrophes, and greatly benefit consumers.”

Racicot also noted that, in fact, prices for auto insurance and other types of property-casualty insurance are falling around the country, with the major exception being coastal property insurance. “This makes sense, given that insurance rates are set according to the risk of loss in each state,” Racicot said. “Because insurance rates in each state must reflect the actual and expected loss experience within that one state, each line of insurance – such as homeowners – must stand on its own in terms of profitability.”

CFA countered saying that many insurers are sharply increasing premiums for homeowner’s and commercial insurance and reducing or eliminating coverage for tens of thousands of Americans in coastal areas of the country. Insurers are also urging Congress to continue taxpayer subsidies for terrorism losses and to create a federal catastrophe insurance program that could also involve taxpayer support.

Terrorism Insurance
Racicot refuted CFA comments about industry public policy positions related to terrorism and natural catastrophe risks.

“Unfortunately, CFA simply refuses to understand that terrorism risk today essentially is equivalent to war risk, making it wholly uninsurable by the private sector alone. A public-private partnership is needed to deal with terrorism losses that could be virtually infinite in scope, particularly if an attack involves chemical, nuclear, biological or radiological weapons,” Racicot stated. “There is broad, bipartisan agreement on Capitol Hill, and broad consensus among policyholders, that a long-term national terrorism insurance program is critical to the ongoing economic security of this country.”

The CFA study uses a number of common measures of financial health, the study finds that balance sheets for property/casualty insurers are in better condition overall than at almost any time in recent history. Representatives of the insurance industry often claim that high premiums and profits are necessary to compensate for the high risks they must bear. In fact, insurance is a low-risk investment. Using standard measures of stock market performance that assess financial safety and stock price stability, the property/casualty insurance industry represents a below-average risk compared to all stocks in the market, safer than investing in a diversified mutual fund.

In 2006, the study estimates that stock insurers will earn a return on equity (ROE) of about 20 percent, well in excess of what is required by investors. The lower industry-wide ROE that insurers report underestimates the industry’s actual ROE. The industry-wide ROE includes returns from mutual insurers, who tend to carry excess capital on their books. Insurers calculate their ROE using a method that understates returns, using mid-year capital rather than beginning of year capital. Moreover, since insurers are significantly overcapitalized by all historic measures, the income earned on swollen surpluses is lower that it would be if efficient capital
levels were maintained.

In addition the CFA study estimates that retained earnings, or surplus, for the entire industry is $600 billion as of the end of 2006. An adequate surplus guarantees a solid and safe insurance industry
but this amount is, by any measure, unprecedented. To assess the financial solidity of an insurance company, regulators examine the ratio of net premium written to surplus, which, at .73 to 1 (73 cents of premium written for every dollar of surplus) is less than half of the extremely safe 1.5 to 1 ratio that is recommended by many observers and far less than the famous “Kenny” rule of 2 to 1 as an efficient surplus level. The largest loss ever suffered by the insurance
industry, Hurricane Katrina, represented an after-tax loss of $26.3 billion, or 4.4 percent of current surplus. The $12.2 billion in after-tax losses experienced by insurers after the September 11th terrorist attacks amounts to about 2 percent of surplus. Many insurers are engaged in massive stock buy-back programs because of this excess capital situation.

In recent years, insurers have reduced their financial risk by making wise use of reinsurance and other risk spreading techniques, such as securitization. However, the study cites several tactics that insurers have also used to shift costs and risk onto consumers and taxpayers.

For a complete copy of the CFA study, including charts and proposals, go to www.consumerfed.org/