Insurance Insolvencies Soaring; Early ‘80s Price-Slashing Spree Blamed

When Mission Insurance fell into insolvency, victim of an ill-fated attempt to expand beyond its successful workers’ compensation business, benefit payments were jeopardized for thousands of beneficiaries, the victims of job-related injuries.

But by last March, the California Insurance Guarantee Assn., an industry-fed safety net created in 1969 by the state Legislature, was paying 13,000 beneficiaries of policies written in the state by the Los Angeles-based insurer. So were similar associations in Texas, Florida, Arizona and Oregon.

California’s fund has paid out a record $42 million in benefits in just the first seven months, said executive director John Gates, who added: “And we used to think $5 million was a big insolvency!”

However, insolvency in the insurance industry over the past few years has hardly been confined to such notable collapses as those of Mission and of Cincinnati-based Baldwin-United, which sold single-premium annuities. And while those huge failures appear to have been managed adequately, in terms of protecting policyholders, insolvencies are continuing at an abnormally high level. They are the continuing legacy of the frenzied price-slashing that marked the industry from 1979 until about 1983 as companies, attracted by high interest rates, took on bigger risks in the belief that high investment profits would cover any eventual insurance losses.

Dealing with that legacy--and finding ways to avoid a repeat of that experience--falls to state insurance commissioners, whose national association met in Pittsburgh last week to compare notes. What they found was that, masked by the record profits reported by the industry for the first half of the year, 16 insurance companies have failed so far this year, raising the toll since 1983 to 95.

For years, the failure rate averaged about four companies a year, but in 1983 the figure leaped to 15, and it has remained in double digits ever since. Some regulators expressed hope that the pace might slacken this year, but instead it has picked up over summer.

“There will be more insolvencies,” said Edward J. Muhl, Maryland’s insurance commissioner and president of the National Assn. of Insurance Commissioners. These, he said in an interview, will probably include other companies affiliated with Mission through risk-sharing agreements. Several such companies already have foundered.

“It’s hard to assess at this point the effect of Mission’s insolvency,” said Peter Gillies, Connecticut’s insurance commissioner. Gillies supervises NAIC’s work with state guaranty funds, such as California’s, which commissioners can tap to pay the claims left behind by failed insurers. While some of the funds, which are fed by assessments against insurers doing business in the state, are approaching their assessment limits, he said the network so far is coping with the challenge of paying claims.

NAIC is targeting an increasing number of potentially troubled companies for close regulatory scrutiny, indicating the likelihood of continued failures, although part of the increase stems from refinements made in the computerized screening system. Last year, the computer identified 10.8% of the 2,505 property-casualty companies for investigation, compared to 3.4% five years earlier. Among 2,052 life insurance companies, the proportion increased from 2% five years ago to 10.7% last year.

Nonetheless, these indications of continuing financial difficulty contrast with the record profits reported by property-casualty insurers for the first six months of 1987: Net income totaled $7.5 billion, up 29.7% from a year earlier. And while the industry continued to pay out more in claims than it received in income--paying out $4.20 for every $1 in income--it paid out $8.90 for every $1 taken in a year earlier.

Despite this general improvement in insurance operations, Muhl said, “overall, there are a lot of strains on the system.” There also are troubling signs that the market may already be starting to soften as companies trim rates to undercut competition for new business. The regulators worry that another punishing price-slashing cycle may be starting even before full recovery has been achieved from the last one.

Insurance commissioners are trying to find a way to control the wild swings in insurance prices that occur when plenty of money is available for coverage and investment opportunities look promising. Companies then are willing to cut premiums to increase their share of the market. The major price increases of the past few years continue to draw loud criticism despite the five years of rampant rate-cutting that had preceded it.

“We’ve learned some tough lessons,” Muhl said. One lesson is that if regulators could control the amount of insurance capacity available, they might be able to moderate the severity of the rise and fall in insurance prices.

One way of doing this might be to require insurers to value the bonds in which they typically invest much of their premium income at current market prices rather than at their face amount, which usually distorts actual value. If the value is inflated, companies may sell more insurance than they can safely handle.

NAIC officials are studying what effect such a regulatory change might have had in moderating the rampant rate-slashing that began in 1979. At that time insurers, attracted by high interest rates, cut prices wildly to attract new premium dollars to invest at the high interest rates then prevailing. In doing so, many lowered their risk standards, assuming that money lost through claims could be more than made up by profits from investment. And that was true for awhile--until interest rates fell and insurance claims skyrocketed.

At Pittsburgh, the commissioners unanimously voted a 150% increase in assessments against insurance companies to finance further improvements in NAIC’s computer program budget for data collection. The goal is to improve monitoring--both of individual companies and of the market place.

“We want to be able to see who is out there doing what, who is cutting prices, and who is trying to buy up market share,” Muhl said.