Insurers’ Profitability Clouded by Unknowns : Industry’s Fuzziness Proves a Major Stumbling Block to Voters Trying to Weigh the Pros, Cons
Insurance companies took in $9.7 billion in auto insurance premiums from California’s car owners in 1987. That much everyone involved in the state’s insurance initiative wars can agree upon.
But the question of how much of that $9.7 billion the insurance companies are able to keep as profit has become a major stumbling block to voters trying to weigh the pros and cons of the five measures on the Nov. 8 ballot.
The insurance companies, trying to defeat two initiatives that would allow regulation of the rates they charge, contend their profits are low or nonexistent. The insurers say that slapping a regulatory lid on premiums without also limiting claims and lawsuits could force many companies to withdraw from the California auto insurance market.
Profits Said to Be High
Advocates of insurance rate regulation--like consumer activist Ralph Nader, who is backing Proposition 103, and the California Trial Lawyers Assn., which is supporting Proposition 100--insist that profits are high or, at the very least, adequate.
Even unbiased observers give hedged and sometimes contradictory responses when asked to assess the industry’s profitability in California. This is due in part to the complexity of insurance industry accounting and in part to the inherent uncertainty involved in setting aside funds for settlements or awards whose ultimate size will not be known for many years.
In addition, some insurers, citing competitive reasons, refuse to disclose certain detailed line-by-line and state-by-state data that critics contend would shed light on the question of industry profitability.
“They issue a blizzard of numbers that don’t tell you what you need to know,” said Harvey Rosenfield, chairman of the campaign to pass Proposition 103, the most sweeping rate regulation proposal on the Nov. 8 ballot. Insurers say they provide more than enough information.
What can be said with certainty is that despite the insurance industry’s assertion that it is losing money on auto insurance business in the state, every major national insurer continues to do business here. What is also clear is that California’s current regulatory climate is one of the least restrictive in the nation. Insurers enjoy exemptions from antitrust laws that allow companies to swap data and prohibit agents from giving rebates to their customers.
Still, insurers, who are spending more than $43 million to promote Proposition 104, the no-fault initiative, and defeat rival initiatives, insist that they are losing money on automobile policies. They say skyrocketing legal and medical expenses have outstripped the hefty premium increases of recent years, while income on their huge investment portfolios has sagged.
“The bottom line is that the insurance industry is not making any money writing automobile insurance in the state of California,” argued Patty Lombard, director of communication of the Western Insurance Information Service. She pegs the industry’s loss at $77 million last year.
Not so, say the industry’s opponents. “This is the only industry in the world that can plead poverty at a time it is reaping record profits,” Rosenfield said.
According to Rosenfield, complicated insurance industry accounting procedures and inadequate disclosure by the companies allow them to obfuscate the true picture.
“The industry can select from one of three or four accounting methods to come up with its numbers,” said Steven Miller, president of the Insurance Consumer Action Network, sponsor of Proposition 100, the so-called Good Driver initiative, which is backed by the state’s trial lawyers.
State Insurance Commissioner Roxani Gillespie takes a moderate position. Asked in an interview whether the state’s auto insurers are earning an adequate profit, Gillespie replied: “It is not outstanding, but it is fine.”
The commissioner said the industry posted an average return on net worth of 10.3% during the last five years and 11.7% in 1987.
Some Not Making Much
But at the same time, Gillespie goes on to warn that at least half the state’s top insurers are making such low profits that her department would not require them to comply with rate rollback provisions in Propositions 100 and 103.
Who is right? In some respects, all of them are. There are several commonly accepted methods of calculating insurer profits. Depending on which one is used, the state’s auto insurers are either solidly profitable, moderately profitable, or slightly in the red.
When insurance company executives speak of losses, they are generally talking about underwriting losses--that is, their losses before adding gains from investing funds that must be held in reserve to pay claims and for other purposes.
Thus, a company like State Farm Mutual, the state’s largest auto insurer with nearly 16% of the market, can truthfully say it posted a $207-million underwriting loss on its California auto business last year.
State Farm’s “loss” equaled 12.8% of its premium income, says State Farm spokesman Jim Stahly, reflecting the cost of paying claims, the cost of handling claims, and overhead expenses.
Investment Income?
But State Farm was less forthcoming when asked to disclose its investment income on California automobile operations. State Farm pools investment funds from around the country, and “we do not allocate investment income to individual states,” Stahly said.
Even if the company could devise a formula to calculate investment gains attributable to California, the company would have lost an undetermined sum from auto operations in the state, he added.
State Farm, according to Stahly, has lost money in California for “the past four or five years.” Why then does State Farm--along with every other national insurance company--continue to do business in the state?
“We have 3 million customers, 2,000 agents, 6,000 employees, three regional offices, plus claims offices throughout the state,” he said. “We can’t just shut the door.”
Clearer Profit Picture
The California State Automobile Assn. Inter-Insurance Bureau presents a clearer profit picture because its operations are restricted to California. The company posted a $29.7-million underwriting loss last year--but investment income of $120.8 million more than offset the operating loss, yielding a net profit of $91.1 million.
Consumer advocates note that industry accounting methods can be seriously misleading. The insurers, they point out, can deliberately manipulate the size of their profits by arbitrarily raising or lowering the sums they set aside to pay off claims that may not be settled for several years.
“They can create the appearance of a loss by boosting reserves--by, in effect, moving money from one pocket to another,” said Miller, who heads the campaign to pass Proposition 100. “And though they’ve created a loss on paper, they get to hold on to the cash and to continue to earn interest on it.”
Although reserves created to pay off collision claims are closed out very quickly, “reserves for personal injuries can remain open for years and years,” acknowledged J. Michael Siebert, an assistant vice president of the automobile association.
Legal Requirement
Still, “the law is very clear: That money has got to be set aside for the payment of the claim.” In general, Siebert says, the amount of money companies set aside is determined by their experience with similar claims in the past.
“It is determined by the averages. If we were to talk to an actuary (for a fuller explanation), there would be so many ‘buts’ and ‘ands’ and ‘ifs’ that we would both be thoroughly confused,” Siebert said.
On that point, Siebert and William Shernoff, a lawyer and longtime legal foe of the insurance industry, agree. “There are not many people who understand this stuff,” the Claremont-based lawyer said.
One person who does understand the complexities of insurance industry accounting is J. Robert Hunter, president of the National Insurance Consumer Organization in Alexandria, Va., and a former federal insurance administrator under Presidents Gerald Ford and Jimmy Carter.
Hunter, who supports Proposition 100 and is an actuary himself, has devised a method for calculating insurance industry profitability. This technique, called the “discounted statutory method,” is similar to the one required by state regulators except that it takes into consideration the time value of the money that insurance companies hold as reserves.
Using his formula, Hunter calculates that the California industry posted a 17% return, or total profits of $868 million, on its auto insurance business. “That is my best estimate.”
The industry disputes Hunter’s calculations and assumptions, standing firm on its own estimate of a $77-million statewide loss. “The more confusing it gets, the more opportunity there is for people who would twist the facts to do so,” said Siebert of the California State Automobile Assn.
