Hint: Old-fashioned fiscal management and regulatory fiscal management are good places to start.
I recently analyzed the homeowners loss ratios for the top 60 writers of homeowners in one of the more difficult homeowners states. I note this is one of the "more" troubled states because reality is that quality homeowners insurance is becoming incredibly difficult to obtain and if obtained, the price is ridiculously high in probably at least half our states. I am not some consumer advocate with little knowledge of how hard it is for insurance companies to make money. Instead, I’m pretty happy to go head-to-head with any insurance carrier financial analysts relative to insurance carrier profitability, the lack of profitability, and how to fix the problem. The fact is that homeowners insurance has been one of the least profitable lines of insurance for the last 20 years and a good reason why is carrier mismanagement of the product.
But it is also a regulatory issue. In my analysis of the top 60 carriers in this particular state, the average unweighted adjusted loss ratio per A.M. Best over the last ten years is 87.7%. That is awful. However, the median loss ratio is only 38.8%, which is awesome. On a median basis, the carriers are making money hand over fist. The massive difference between the unweighted median and unweighted average loss ratios indicates large catastrophe losses. Large catastrophe losses have no meaning and really no value without looking at how profitable carriers are in non-catastrophe years. In non-catastrophe years, carriers in states like this should make a fortune, as the median loss ratio indicates they are doing. They need to make a fortune in those years, leave the money in the bank, and make extra investment income on that money to pay for the catastrophe years so that "on average" everything averages out, as the saying goes. In this case, for the top 60 carriers, the results do not average out and that is because some carriers don't make enough in the non-catastrophe years.
If I eliminate those carriers that did not even have $1 million in DWP in 2022, the overall results improve materially. Being brutally frank, an insurance company has no business being in the homeowners business in a catastrophe prone state if it does not even have $1 million of premium. This is one area in which regulators can assist and that is, don't allow carriers that are too small to provide stability. They are not going to have the resources or the ability to spread the risk when a large portion of agents have more premium than the carrier. I'll get to the surplus factor momentarily.
The results excluding those immaterial carriers improved the ten-year unweighted average loss ratio by eight full points to 80.7%. The median decreased to 33.1%. Manage whatever it is you are managing based on the material and eliminate incompetent players. Their incompetence should not be the tail wagging the dog.
The median results are truly enlightening because competence, or the lack thereof, is more obvious. There were 44 carriers with at least $1 million in homeowners premium in 2022. Of those 44, 11 had not written homeowners in the state for all ten years. A ten-year timeline is a good legitimate timeline for a catastrophe prone state. I see people analyzing and distributing quarterly loss ratios and that is just a waste of time except in dire scenarios. Insurance is based on the law of large numbers which not only means a wide distribution of risks, but a long range of time. At the least, pay attention to five-year results.
On a ten-year basis, the carriers with at least $1 million premium in this line and with material premium for all ten years, had an average unweighted loss ratios of 81.9% with a median of 35.5%. It still appears then that catastrophe losses outweigh the extra profits. But I'll return to competence.
There are seven carriers that can barely make a profit even on a median basis. In other words, their loss ratios are marginal even when catastrophes do not hit. Really interesting is that their loss ratios tend to be materially better than normal in the catastrophe years and yet their loss ratios in non-catastrophe years are so much worse than normal, they still end up losing more money. This is a competence issue, not a catastrophe issue. It is not a reinsurance issue either. They simply cannot underwrite and/or price correctly and it is probably some combination of the two.
The most competent carrier in the state actually has a ten-year unweighted average loss ratio of 44.5%. They have made a handsome profit. This particular carrier possesses some other important, old-fashioned characteristics. In the old days when the industry had periodic hard markets about every seven years, the carriers with the best balance sheets wrote a lot of business because they had the surplus available with which to write the business. A carrier that makes money in the good years, especially enough to more than offset the catastrophe years, provides far more stability to the market. This is good for consumers. It is good for agents. It is even good for shareholders (imagine a financial model that is good for all three!).
One of the reasons insurance company regulation evolved was because many insurance companies were run poorly so that executives and a few shareholders, often one in the same, made money leaving insureds holding the proverbial bag. If you read the origin story of A.M. Best on this subject, you'll learn just how bad it was. Over time, regulation has been diluted for the sake of more efficiency and the fact that the established insurance companies were managed better for their insureds. With these improvements has come complacency and now we have situations where many new carriers have insufficient resources and models that are again designed to guarantee the enrichment of specific originating parties.
I had a private equity backed new "carrier" call me to advise they had a license and $300,000 surplus. What a joke. Enough said that any regulator would issue a license for towing insurance for an entity with only $300,000 surplus. Take ten times that, $3 million, which is the minimum in some states. The average home market value in the U.S. is around $400,000. Replacement cost is likely higher, especially in a catastrophe prone state where stronger building codes have been enacted (forget the O&L coverage issue for now). $3,000,000 divided by $400,000 equals 7.5 houses. And given the data, those new carriers' loss ratios are so bad they need every dime.
The new carrier structure adds to the danger. Most of these structures are some form of assessable reciprocal whereby the founders set up a second company to provide administrative services to their own carrier. The charge is usually 20%-25% of premiums and they get this money without regards to performance. It is money off the top too. They get paid even if the carrier goes insolvent and if the carrier was initially thinly capitalized, especially if the initial surplus was borrowed, then they keep their money and everyone else loses.
Good, old-fashioned insurance carrier financial management and regulations supporting that good, old-fashioned model are the solutions. Insurance company financial management, like bank financial management should be boring. The idea of some bank president making millions and not realizing a maturity risk misalignment is happening is a joke. For some of these insurance companies, the founders have significant financial acumen, better than regulators and maybe not in a good way. Reading history and regaining an appreciation of why insurance companies need to be regulated is a good exercise.
Allowing exceptionally high profit margins in non-catastrophe years is another good idea in catastrophe prone states provided regulators insist carriers keep those profits in surplus so that the shareholders/executives use those profits wisely. Preventing thinly capitalized carriers and carriers using models that are somewhat questionable from entering the market is also beneficial because then the better carriers don't have to play the price game. It prevents too much market concentration happening too quickly with these carriers, which happens.
Another factor might be for regulators to look at the incompetent carriers and not allow them to charge inadequate rates. When the carrier complains they will then be at a competitive disadvantage for writing new business, tell them the truth that based on their performance, their actuarial rates need to be higher and since insurance premiums are supposed to be based on actuarial analysis, standing exists for this requirement. The results between the competent and incompetent are too stark to conclude luck is the major factor.
This solution will stabilize the market and while I'm generally not a fan of heavy regulation, some carrier executives need assistance from regulators in setting responsible rates that protect all stakeholders.
Does this mean that rates might go even higher? It might because stability has a price. But that might be offset by a decreased need for reinsurance and better underwriting. A carrier with plenty of surplus generally requires less reinsurance and less demand results in lower prices.
Better underwriting is important too. Carriers have largely abdicated old-fashioned underwriting. A topic for another article is how insurance carrier executives abdicate making hard decisions hoping technology solves the problem, but that is at the heart of the underwriting opportunity. Anecdotally (and only because I'm not privy to private claims analysis of the variables which carriers should be performing), homes that have that old-fashioned "pride of ownership" do not seem to suffer the same damage levels.
And finally, address risk mitigation correctly. Incentivize roofs that better withstand hail rather than refusing to write a hail proof roof because the building is in a hail zone like I saw a carrier do. The same goes for not writing in wildfire zones even when the building is fireproof and/or has a wide fire hazard clearance. In other words, use brains rather than blanket underwriting. The money is there for carriers who will use intelligence and you can afford that intelligence when your average loss ratio over ten years in a catastrophe prone state is 45% even after paying for two consecutive catastrophe years!
NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.
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.