Are Insurance Rates Legitimate?
I was talking to a friend with extensive insurance industry experience ranging from underwriting to actuarial to system design and he asked this question. "Are insurance rates legitimate?"
Subsequently I was talking to a carrier executive who expressed his frustration with a competitor who lost billions (yes -- literally billions) over the last ten years because his company insisted on pricing that at least makes a modicum of profit, but as a result lost business to another carrier that is willing to lose billions. Out of frustration, his question was "How can the competitor's rates be legitimate when they lose so much money every year?"
Another friend of mine who works outside the industry was offered a homeowners quote of around 40% less than any other quote he received. He called for advice. The carrier primarily writes (now wrote) business along the Gulf Coast and had expanded to the west. My impression was they expanded to show regulators and rating companies their concentration of risk was being diluted, but also, primarily, to put a bunch of premiums on the books to offset their losses on the Gulf Coast. When a single carrier's rates are 40% less than the market and is new to the market, rarely are they so smart that they can breakeven at such discounted rates.
Another example is when a consumer provides the capital (RRG's and reciprocals) but is insufficiently aware of what this really means. The insurance agreement allows the management team to keep a large percentage of the premium for managing the carrier even if the carrier goes insolvent. The numbers closely resemble the private equity model of 2%/20%.
The insurance industry is extremely competitive. According to A.M. Best, around 950 P&C carriers write business in the U.S. The number seems to fluctuate between 900 and 1,000 as so many new companies are created every year. This does not include all the subsidiary carriers, these are the mother ships so there is a lot of competition. Carriers do not charge 40% extra just because competition is lacking!
One of the most important reasons insurance regulation exists is because in bygone days, or maybe not bygone days, carriers would charge too little. Executives and shareholders might make plenty of money and when claims hit, the carrier would go bust leaving policyholders bare. Over time, consumer regulation has become more prominent whereby regulators have focused on keeping insurance rates down. This has resulted in allowing carriers to charge too little and so far, mainstream insolvency has not occurred, so a sense of confidence has arisen.
In 2021, by a rough count, the number of P&C insolvencies has increased along the Gulf Coast and West Coast. It is possible those companies charged enough but simply did not have the capital. Charging enough and then leaving the money in the bank, as surplus, is the boring and simple strategy to remaining solvent.
When a carrier does not go insolvent but continually loses money, are the regulators really looking out for the consumer or are they facilitating a marketplace whereby carriers that charge legitimate rates slowly lose market share? In this scenario, does the carrier become too big to fail?
A different angle is why should strong carriers write business in a state when that state allows weak carriers’ underpricing accounts to exist? The weak carriers lose business and then when they become insolvent, the admitted carriers are taxed extra to pay for those insolvencies.
Insurance is not like other products where loss leader strategy makes sense for the public. For public safety, rates need to generate enough profit to sustain surplus. When a carrier regularly loses so much money that their surplus deteriorates, are their rates legitimate? If the only thing keeping that carrier in the market is low rates because their products and claims services are marginal, it prevents other carriers with better products and claims services from being more substantive. Is the public really benefiting?
Neither I nor most of my clients can really do much about the regulators' perspective on this point, no matter how important. I know the executives from well capitalized carriers with whom I have spoken are quite frustrated on this point because they feel they are being punished for being prudent -- and they are. But it is what it is.
Many carrier executives express frustration at what can be done when agents and brokers do not even make a legitimate attempt to sell quality. An agent has a choice between two carriers. Carrier A is charging legitimate rates, has higher quality claims service, and better forms. Carrier B's rates are 15% less, claims service is poor, and the forms are average at best. Agents will sell that lower rate almost every time because it is the easier sale, not the better sale.
An old rule of thumb exists that agents should be able to sell a 10% higher price for quality if they are any good at sales. That is a good rule of thumb. 15% is a challenge and 20% may be insurmountable especially if the carriers are all A- rated or better. This is the crux of the matter. Is the job of insurance commissioners to find a way that claims are paid no matter the means or is it their job to ensure carriers' rates are reasonable and not underpriced to the point the carrier cannot establish the surplus required to see it through even moderate catastrophes? The damage to legitimate carriers trying to do right by society is material if that is the case, and ultimately their desire to write business in these states is diminished. They can deploy their capital elsewhere.
If the former is the case, keep allowing new carriers to form without adequate capital and pricing that is materially less than the market without legitimate justification of underwriting prowess that justifies lower rates, while acknowledging and telegraphing to the industry that either the state or the legitimate carriers will pick up the bill. If the latter is the case, regulate rates so that rates are legitimate to a profit.
To head off the argument that rates are legitimate and the carriers' underwriting is just incompetent, which happens too, then how is the public served by such incomparably horrible underwriting? It is not. The carrier must increase rates or otherwise raise capital, or best yet, fix their underwriting. If the rates are 20%-40% less than market, making the case that it is an underwriting problem becomes a difficult proposition bordering on inanity.
To head off the argument that scale is required, force the carrier to define, "scale." Next, establish the surplus. I saw that a few carriers had established $25 million in surplus for fires and floods on homeowners policies. The fires hit California. The average price of a home in California is in excess of $500,000. They have the surplus to insure 50 homes, hopefully geographically spread far and wide.
Surplus includes reinsurance. But $25 million is not scale when 50 or fewer homes can be insured (fewer than 50 homes because adding contents and additional living expenses at Coverage A's of $500,000, means total fire losses are likely close to $1 million and therefore, maybe only 25 houses can legitimately be insured).
Interestingly though, from what I have seen their rates are low.
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None of the materials in this article should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this article. Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations.