Insurers Didn’t Bring on Crisis : Free Enterprise, Not More Regulation, Will Restore the System

In both its scarcity and its cost, liability insurance is having a profound impact on public entities, businesses and professions.

Some insurance commissioners, legislators, consumer advocates and commentators have reached a fever pitch in criticizing the property and casualty insurance industry for its business practices. They argue that the “excessive competition” for premium dollars to invest at high interest rates from 1979 through 1984 created the liability crisis.

Should the insurance industry feel guilty for its past management decisions or its current marketing strategy?

Absolutely not.

Will public flogging of the industry lead to a useful prescription for the future?

No.

As with other competitive industries, insurance management decisions are based on real economic conditions. Just as commercial insurance consumers have benefited from the low prices produced by fierce competition, consumers will ultimately benefit from a recovering insurance industry that can provide coverage to its customers while rebuilding its resources for future economic needs.

When the Federal Reserve Board decided in 1979 to control inflation by increasing the interest rate on funds loaned to member banks, insurance industry investment portfolios were positioned in the bond market to take advantage of rising interest rates. Insurance companies were earning unprecedented levels of investment income, and consumers were able to find ample and relatively inexpensive coverage for their risks.

But insurance company managers were confronted with a dilemma: They could either continue to charge rates high enough to cover their underwriting losses, or they could heed the clamor of consumer advocates and some insurance regulators and cut premium prices by figuring the investment gains into their rate structures.

In the highly competitive insurance industry, the choice was really no choice at all. The search for premium dollars became the name of the game. Any insurer that tried to swim against the tide by keeping rates high enough to cover losses soon found that another company had undercut the price and taken the business.

The industry’s investment income rose steadily at an average 14% per year through 1984, when it reached an all-time high of $17.7 billion. Meanwhile, underwriting losses (the shortfall of premiums to cover losses) were rising--at an annual rate of 74%. Insurers had anticipated the greater underwriting losses because of the aggressive competition for business. What lower prices masked during this period, however, was a civil justice system embracing ever broader theories of liability.

The insurance industry has long recognized problems with the civil justice system. The sheer number of complex court cases has choked an overburdened court system; at the same time, judgments have grown larger and less predictable.

Even more important, however, is that tried-and-true ground rules of civil law changed rapidly. Judges and juries began awarding damages for actions that would not have been admissible in court a few years earlier. Right versus wrong and the balancing of the needs of society versus dangers to a few seem not as important in today’s court system as the public’s assumption that someone, preferably those with the deepest pockets, should pay for every injury.

We now face a shortage of capital to meet insurance needs--the legacy of huge underwriting losses and an unstable civil justice system. Like any major recovery, this one will be somewhat painful. Who feels it most? Certainly those types of businesses--public entities, child-care centers, the medical profession and manufacturers--with which the civil justice system has dealt most harshly.

Segments of the insurance industry also have suffered. In both 1984 and 1985, a record 20 insurers were declared insolvent, and another 215 companies are on the regulatory “watch list.” Other insurers, including some major companies, have retrenched by slashing operating costs and selling assets to remain solvent. This adversely affects their financial ability to write additional insurance.

The aggressive competition now maligned by our critics was caused by a unique conjunction of historic economic events. Free enterprise created the problem; free enterprise--and not more regulation--will bring the insurance system back. The industry is now working with consumers, regulators and policy-makers to address problems associated with current market conditions and the legal environment.

One thing is certain. Without civil justice reform, losses will grow, prices will climb and insurance protection will become more scarce for those who need it most.