Here we go again! Heavyweights Bob Hunter, insurance director of the Consumer Federation of America, is trading blows with Bob Hartwig, president of the Insurance Information Institute, over whether the industry is “methodically overcharging consumers” and shortchanging policyholders on coverage and claims. Who will win the latest round in "The Battle Of The Bobs"??? (Both Bobs responded to my blog over the weekend. Read on!)
(To read all about the CFA report and industry reaction to it, click here.)
If you recall, back in November, I refereed the first clash of these titans during NU's inaugural Virtual Conference. One of the "rounds" focused on industry profitability.
Armed with a new CFA report, Mr. Hunter hammered the industry for price-gouging and ripping off consumers on coverage and claims. He said his analysis indicates that “over the last four years, the typical American family has paid $870 too much” for their p-c insurance coverage.
Meanwhile, Mr. Hartwig led the counterattack, with a chorus of industry leaders behind him. He called the CFA allegations “misleading” and dismissed the report on which their charges are based as “fatally flawed.”
Who is right? I believe Mr. Hunter is overstating his case when it comes to pricing, but I lean towards his side on coverage and claims issues.
Mr. Hunter charged that with record profits in the past two years, insurers are pricing their products way too high. But I didn't hear him complain during the record hurricane years of 2004 and 2005, with tens of billions paid out in claims, that insurers had been undercharging homeowners in disaster-prone states, in part due to rate suppression by politically-motivated regulators, even though that was certainly the case.
Mr. Hunter claims that in 2007, publicly-traded insurers earned a return on equity of over 19 percent, compared to the 14 percent cited by the industry itself. The ROE was higher than normal for this industry, but certainly not stellar by other industry standards.
In any case, Mr. Hunter argued that the industry's return is well in excess of what is required by investors. Isn't that for the market to decide? The industry is overcapitalized now, and is returning funds to shareholders via dividends and share buybacks.
Mr. Hunter would probably prefer that the excess be plowed back into the market in the form of lower rates, but with premiums already falling, that could be a dangerous strategy indeed for the industry's long-term health.
Mr. Hunter also bases his charges on some faulty assumptions--looking at industry-wide profits, for example, rather than profitability in catastrophe-exposed states.
Mr. Hunter has a litany of other complaints, but the only one that really resonates with me is about industry claims-handling. I am no fan of the anti-concurrent-causation clause, which strikes me as fundamentally misleading in the way it is executed. The industry paid out billions for Katrina losses, but I think thousands of policyholders with both wind and flood damage probably got screwed by carriers conveniently blaming uncovered flood for the total loss in many cases.
There are also obvious problems in other claims areas, with some carriers believing all they are selling is the right to sue. I, for one, am eager to see Allstate forced to turn over its by now infamous McKinsey Company recommendations--which allegedly instruct the carrier on how to manhandle claimants. (If that's not what it says, why won't Allstate release it?)
In any case, once again the industry's already tarnished reputation is taking more of a beating. Give this round to Mr. Hunter, although the fight is far from over.
Comments (6)
The industry states that I overstate profits, but if profits were not too high, how did the following excesses happen?
The Insurance Information Institute says that the industry has "excess capital" of up to $100 billion. Four years ago the III said the capital was “a matter of concern.”
This $100 billion does not reflect the huge amounts of capital used by insurers in recent years to buy back their own stock (Allstate alone did more that $15 billion of that), buy businesses or pay higher and higher salaries to management.
Nor does the $100 billion in excess surplus take into account the $53 billion in reserves that the Insurance Services Office reports as "redundant."
Four years ago reserves were about right. Thus the amount of unwarranted funds collected from consumers that the industry itself has reported is as much as $153 billion. I estimate that these excess amounts are probably closer to $175 to $200 billion.
However, even using an ultra-conservative estimate of $100 billion in excessive surplus and reserves, Americans have been overcharged by the equivalent of $870 per household in the last four years.
Consider this: It would take more than five Hurricane Katrina-sized losses (after-taxes) to eliminate just these unwarranted reserves and surplus.
Even if such an unlikely series of losses occurred, the insurance industry would still be extremely safe financially and consumers would still be paying rates that were excessive.
The fact of excess profits is irrefutable and confirmed by the industry's own studies. Prices must come sharply down to undo these excesses.
By the way, Sam, when the insurers were paying out all that money in 2004 and 2005 that you mentioned, they were still setting record profits.
That startled me and is why I started studying why this was, which led to the sections in the report on underpaid claims and hollowed out policies.
Posted by Bob Hunter | January 19, 2008 7:42 AM
Posted on January 19, 2008 07:42
The CFA’s premise that excess capital in the industry is proof positive that consumers are being charged excessive rates is simply wrong. But let me first start at the beginning. In my analysis of the CFA’s recent error-strewn report (http://www.iii.org/media/updates/press.780633/), I found that the CFA’s calculation of the size of the industry’s capital base is way off.
As of 12/31/06, the CFA states that the industry’s policyholder surplus totaled some $621.8 billion. Indeed, you will find precisely that figure on p. 409 of the 2007 edition of A.M. Best’s Aggregates & Averages publication.
Too bad nobody at CFA bothered to read the footnotes at the bottom of the page, which clearly warn that the figures include state funds and (worse) double-count surplus in companies with interownership.
If that doesn’t sound like a big deal, it is. In fact, after correcting for the double-counting problem alone, the CFA’s 2006 figure drops to $501.2 billion (see p. 90 in Aggregates & Averages).
This colossal $120.6 billion error reduced the CFA’s estimate by about 20%. In case anybody at CFA cares to avoid the same error in the future, you can find the past 40 years worth of policyholder surplus data without duplications on p. 406 of Aggregates & Averages.
Mr. Hunter is scheduled to talk about his report at a hearing in Tallahassee on Tuesday, Jan. 22. I’d like to hear how this jumbo-sized error gets explained away.
The CFA also asserts that loss ratios have generally fallen over the past 20 years and this, too, is prima facie proof of overcharging.
The reality is that loss ratios are quite volatile, bouncing up and down with the underwriting cycle and the unpredictable sting of major catastrophic losses.
In fact, since 1987 the actual losses paid to policyholders have increased in 18 of the 21 years through 2007 (inclusive).
It also stands to reason that insurers must generally run lower loss ratios today than in the past because total investment returns measures relative to earned premiums are shrinking.
Insurers maintain very liquid portfolios, primarily in high-grade bonds that can be quickly liquidated in the event of a major catastrophe. Indeed, about two-thirds of the industry investment portfolio is held in the form of bonds.
In 1987, the first year studied in the CFA report, a 10-year Treasury note yielded 8.4%. That yield fell to 6.4% by 1997 and just 4.6% in 2007.
Therefore, to meet the same level of financial obligation in 2007, insurers need to run larger underwriting profits (i.e., lower loss ratios) than they did in 10 or 20 years ago.
The CFA never mentions the influence that investment return necessarily has on underwriting. The omission is clearly intentional, as it is an inconvenient truth that, combined with the jumbo arithmetic error, largely eviscerate the entire premise of the CFA study.
Posted by Bob Hartwig | January 20, 2008 8:45 PM
Posted on January 20, 2008 20:45
I just paid $9 a piece for movie tickets. I don't go that often, but decided that the new Nicholas Cage flick sounded like fun, so I went. It was OK. Nothing spectacular.
However, now that I think about how much money the studios might make and how much they paid Mr. Cage, I am upset. How dare they hope to profit from their enterprise!
It doesn't matter that some movies are utter bombs, from which the studio loses millions of dollars. What matters is that they do not make what I consider too much profit for the risk they take. Especially, if they bill a movie as being "exciting" and I don't find my blood racing like I think it should.
How dare they act like capitalists in a capitalistic society?
Maybe we should regulate the movie industry to be sure everyone receives exactly the same amount of pleasure from the movie-going experience. Maybe, we should have a federal entertainment czar. Maybe, if Mr Hunter is not too busy....
Posted by Jack J. Maniscalco | January 21, 2008 11:16 AM
Posted on January 21, 2008 11:16
Gentlemen,
There we are, confusing symptoms and pretexts with underlying problems.
First, the checks and balances on the insurance industry, and I say this as a Conservative-Republican, are a damn joke.
The revolving door between regulators and the industry might as well as have a conceirge holding it open.
McCarren-Ferguson is legalized price-fixing, and an invitation to lack of innovation (that the industry rationalizes as open architecture).
Furthermore, innovation--at the heart of an open market--is disenfranchised, as those who create really just educate the biggies in a cost shift without compensation, taking the second bite (and the market).
Third, risk-based capital and penalties for disclosure is supression of speech. Totalitarian if you ask me--by the so-called bastions of free enterprise.
Is it any wonder we have anti-concurrent clauses?
And worse, playing with numbers and back-dating options (please don't give the excuse a few bad apples or everyone is doing it, when the barrel is rotten).
A new class is forming cutting across old political boundaries: one might call it the 'poor vous riche' or even the fiscal flatliners. There use to be haves, have nots, and have a little, want some more.
Now there is this merging class of Silver Tsunamis (who vote), the I've Had It's.
But this class, watching private equity managers turn their managing income into capital gain rates, watching corporate (and insurance) leaders making 400-times the salary of the lowest paid while earnings go down, or surplus is 'managed' (MAI: made as instructed), who watch up to 50 percent of those bankrupt and find out 75 percent of those had health insurance-- are going to make health insurance first a utility.
And it will hit P&C as well.
So play numbers games, impeach character, say the study was done wrong, etc., but the industry is fundamentally, ethically challenged.
Did I say ethically challenged or that one would have to suspend disbelief? Let's use the real phrase--willful corruption, which has become normative.
Posted by Jim Schwartz | January 21, 2008 1:29 PM
Posted on January 21, 2008 13:29
I'm just an amateur, but...
The industry consensus seems to be that to at least some extent, it is "overcapitalized."
But, for the same premium and the same losses it would then seem that the ROE would be even greater if calculated against the essential capital rather the the combination of the essential the and the redundant capital (the surplus surplus).
Wouldn't that tend to validate Mr. Hunter's economic arguments, if not his arithmetic?
Posted by Confused | January 21, 2008 2:26 PM
Posted on January 21, 2008 14:26
Mr. Hartwig accuses CFA of three errors in our report on profits. He is dead wrong on two and partially right on the third.
In his most personal attack, Mr. Hartwig boldly declares: “The CFA never mentions the influence that investment return necessarily has on underwriting. The omission is clearly intentional, as it is an inconvenient truth that, combined with the jumbo arithmetic error, largely eviscerate the entire premise of the CFA study.”
Intent to leave something out is quite an accusation!
The problem with this charge is that it is based on Mr. Hartwig’s failure to read the CFA report.
On page 9, footnote 11, the CFA report states: “CFA tested this drop in benefits related to premiums to see if it could be attributed to a drop in investment income. Within the time frame studied, there was a 3 percent drop in investment income. Since insurers typically reflect about half of investment income in prices, CFA believes that the drop in investment income accounts for only 1.5 points of the 15-point drop. That is, investment income explains only about one-tenth of the drop in benefit payouts to consumers per dollar expended in insurance premiums.”
In his second point, Mr. Hartwig states: “The CFA also asserts that loss ratios have generally fallen over the past 20 years and this, too, is prima facie proof of overcharging. The reality is that loss ratios are quite volatile, bouncing up and down with the underwriting cycle and the unpredictable sting of major catastrophic losses. In fact, since 1987 the actual losses paid to policyholders have increased in 18 of the 21 years through 2007 (inclusive). It also stands to reason that insurers must generally run lower loss ratios today than in the past…”
The actual pure loss ratios we posted in our report for the last 20 years are:
YEAR PURE LOSS RATIO
1987 66.6%
1988 66.4%
1989 69.2%
1990 69.4%
1991 68.5%
1992 74.7%
1993 66.7%
1994 67.1%
1995 65.7%
1996 65.5%
1997 60.6%
1998 63.2%
1999 65.4%
2000 68.4%
2001 75.3%
2002 68.8%
2003 62.2%
2004 60.3%
2005 61.5%
2006 53.3%
2007 will be about the same as the 2006 result.
While volatile, I believe that the readers of your blog, Sam, will agree that the trend is down, which is our point. The data show that over half of the time the loss ratio drops, certainly not rising in 18 of 20 years, and is way down over the period.
Perhaps Mr. Hartwig made a clever shift from loss ratios to dollars (his phrase “actual losses” implies this) but that would be very deceptive in the midst of a discussion of declining loss ratios and loss of consumer value per dollar of premium. I will not comment on intent, since Mr. Hartwig is clearly more experienced in that area than I am.
Finally, Mr. Hartwig criticizes a single number in the report--the 2006 surplus figure of $621.8 billion--which he says includes state funds and includes overlap of company surplus.
He is right about the double count and I will fix that in future editions of our profit analysis. But he is wrong about any devastating effect of this number on our report’s findings.
The number in question appears in the report in a column of data at page 29. It identifies that the data includes state funds in the footnote on that page. The surplus of state funds is available in catastrophes, such as in terrorism attacks producing workers' compensation claims, and is therefore appropriately included.
The most important point about the surplus number is that the figure is not used in any way in the development of CFA’s four key findings, that:
(1) There is decreased consumer value in P&C insurance (as measured by declining loss ratios of only private insurers, with no double counting or state funds included),
(2) There are extremely excessive profits (as measured by declining loss ratios of only private insurers, with no double counting or state funds included),
(3) There is significantly excessive surplus today. (We did not use the number Mr. Hartwig attacks in making this claim. Indeed we used Mr. Hartwig’s own Earlybird Forecast Report, which admits: “At the same time, there is excess capital in the industry today—estimated by some analysts to be as much as $100 billion—that is driving down returns on equity.”) or
(4) There are excessive reserve levels today (which are based on ISO reported redundancies).
Posted by Bob Hunter | January 24, 2008 2:08 PM
Posted on January 24, 2008 14:08