Risky Business : Riots, Earthquakes, Hurricanes and Floods Have Weakened the Insurance Industry and Narrowed Policyholders’ Options
Wind, rain, earthquakes, hail, floods, fire--everything but pestilence--hit the property/casualty insurance industry in 1992, the worst year ever for catastrophes.
Things were so bad that even without Hurricane Andrew, the killer storm that caused more than $15 billion in insured losses in Florida and Louisiana, 1992 still would have been the second-worst year on record. That’s because the Los Angeles riots, Hawaii’s Hurricane Iniki and winter storms in the Northeast together caused more than $3 billion in havoc.
Several of California’s largest insurers were hard hit by the catastrophes. Two--Allstate Insurance Co. and the Fire Insurance Exchange, a Fireman’s Fund subsidiary--were weakened to the point that their financial stability was downgraded by major rating services.
For consumers of both homeowners and business insurance, the result may be higher prices in the year to come. And in some areas--Florida and Hawaii in particular--it may be harder to find coverage, as insurers cut back on their exposure to disasters.
The problems with risky real estate and junk bond investments that have caused failures in the life insurance industry--inviting comparisons with the savings and loan debacle--do not afflict the property/casualty companies, experts say.
Still, given the fearsome toll, perhaps the most surprising thing about 1992 is that the industry as a whole recorded a modest profit for the year, adding $3 billion to $4 billion to its surplus--that is, its cushion against losses.
But don’t count on it happening again.
What made 1992 profitable, despite the unprecedented cataclysm, was the industry’s ability to offset its underwriting losses with gains on its fat portfolio of stocks and bonds.
“It was a one-time ace in the hole,” said Martin Weiss, president of Weiss Research of North Palm Beach, Fla.
As interest rates fell to 20-year lows, many insurers realized big profits by selling bonds, whose prices rise as interest rates drop. Unless rates continue to plummet, however, that trick is not repeatable.
So with the industry’s safety net frayed, many companies will devote this year to repairing the damage.
Allstate, for example, announced Wednesday that it might reduce its homeowners business in Florida by one-third and apply for a 40% rate increase. Allstate said it could achieve the cuts by imposing caps on new business and applying tougher standards to policies coming up for renewal.
Three major rating agencies lowered Allstate’s financial stability rating as the Sears, Roebuck unit suffered pretax losses of $2.5 billion from Hurricane Andrew.
Several other large insurers--notably State Farm and Prudential--also have begun limiting the amount of new business they write in Florida and other hurricane-prone areas. Nine small insurance companies failed because of Andrew, a catastrophe three times the size of the second-worst disaster in history--Hurricane Hugo, which caused $4.2 billion of insured losses in South Carolina in 1989.
“The industry and certain companies were stunned by the losses last year and recognized that the coverage they were providing was not priced adequately,” said Bruce Ballentine, senior analyst for Moody’s Investors Service.
Andrew prompted the insurance industry to revise its thinking about worst-case scenarios. One immediate outcome was sharp price increases by reinsurers--the global community of firms, such as Lloyd’s of London, which absorb a share of insurance companies’ risk.
Higher reinsurance costs put pressure on insurers to raise their premiums, as well. But price increases--regulated state-by-state and affected by competition and the economy, not just loss experience--are not always easy to come by.
California Insurance Commissioner John Garamendi, for example, has refused to grant rate hikes to that vast majority of companies which has failed to refund money to policyholders under the Proposition 103 rollback initiative of 1988.
William J. Cavanagh of Standard & Poor’s rating agency expects more insurers to try to make their peace this year with Garamendi, whose stance has effectively frozen property/casualty prices for four years.
“It’s one thing to argue that no rebate is due,” Cavanagh said. “But what you give up by losing out on price increases may be even more.”
By weakening demand for insurance, meanwhile, the poor economy also is keeping a lid on prices. In California, which is experiencing a wrenching shift away from the defense industry, that holds especially true.
So what’s an insurance company to do?
Squeezed by higher reinsurance costs on one side and an inability to respond with price increases on the other, some California companies are tightening their underwriting standards--refusing to renew certain kinds of policies or write new coverage in some areas.
“If you’re stuck with a price, you’ve got to sort through your portfolio of risks and see which ones are going to be profitable at that price,” explained Joseph L. Petrelli, president of Demotech Inc., a Columbus, Ohio-based insurance rating agency.
Business Insurance
That process is underway, especially in the business insurance market in greater Los Angeles, where the effects of last spring’s riots are still not fully digested.
The riots caused $775 million in insured damage, nearly all of it claims by commercial policyholders. In the aftermath, some companies--especially smaller ones that had been marketing commercial insurance aggressively in Los Angeles--were forced to pull back.
One example is Woodland Hills-based Crusader Insurance Co., which suffered riot-related net losses of $10 million, making it proportionately one of the hardest hit insurers.
Crusader was well enough capitalized to survive the disaster. Less fortunate was Western International Insurance Co. of Huntington Beach, which failed last August after being swamped by $22.4 million in riot-related claims.
Although Crusader survived, it changed its ways. The company stopped writing riot coverage three weeks ago, according to Cary L. Cheldin, executive vice president. It continues to provide commercial insurance--but excludes riot damage from the policies.
The decision was personally painful for Crusader executives, who have made it something of a mission to provide insurance to inner-city businesses. Once non-renewals bring Crusader’s exposure in inner-city neighborhoods to one-quarter of its pre-riot level, the company will resume offering riot coverage, Cheldin said.
Mercedes Berriz, an independent agent with E.J. Berriz & Associates in La Canada, said large insurers today are taking “a very hard line” toward writing new business throughout the Los Angeles area.
“It has to be picture perfect or they just won’t take it,” she said.
Berriz said that of 30 policy applications that her agency has submitted to one major carrier recently, only three have been accepted. The applications were from all over Los Angeles--and from Orange County as well.
The chance of another riot isn’t the companies’ only concern, she said. Some carriers are trying to limit their coverage in cities, because urban congestion brings higher incidence of vandalism and theft. And since buildings in urban areas tend be older, Berriz added, they suffer more fire and storm damage than average.
Without government intervention, either at the state or federal level, Cheldin believes that small-business owners in the inner-city will be left with only one insurance choice: the California Fair Plan.
The plan, another program created in response to the Watts riots, acts as an industry-sponsored insurer of last resort for businesses and homeowners that can’t find coverage in the regular market.
Although the Fair Plan suffered riot losses of $43.6 million, it was criticized because it didn’t provide business-interruption insurance and limited its coverage to $1.5 million per policy--too low to adequately protect many businesses.
Last month, the plan doubled its policy limits to $3 million for ordinary commercial structures and $5 million for multi-occupancy commercial buildings such as swap meets. It also started offering business-interruption coverage, which compensates policyholders for lost revenue if they are forced to halt operations.
Stuart M. Wilkinson, general manager of the plan, said the changes have sparked a large number of applications--as many as 500 a week--to upgrade existing policies.
Wilkinson is puzzled, however, that the plan has not seen more rapid growth in its new commercial business since the riots. If regular carriers were pulling out of the inner city in droves, the plan would be expected to gain a much larger share of the market. But growth has been only moderate, he said.
Small-business owners who are rejected by big carriers or who think insurance is too expensive sometimes gravitate toward companies that are not licensed in California--but which offer very attractive rates.
Such “non-admitted” carriers--particularly those based in the Caribbean or other offshore locales--were blamed for defrauding Californians of more than $40 million in unpaid claims related to the Los Angeles riots.
The offshore companies hold only a small fraction of California’s commercial insurance market, but they cause a wildly disproportionate share of the problems.
Consumer advocates say the best rule is this old chestnut: If a deal seems too good to be true, it probably is.
Homeowners
For homeowners seeking insurance, the picture in California is far more stable than in Hawaii or the hurricane-prone East and Gulf coasts, where many insurers have announced pullbacks.
There are no signs that homeowners coverage is getting harder to find in California. As always, the toughest coverage to get is for homes in brushy, fire-prone areas and for multifamily urban dwellings that are not owner occupied. Those two categories make up the lion’s share of the Fair Plan’s 100,000 homeowners policies in California.
Still, it matters who your insurer is.
Petrelli, the Ohio insurance rater, makes this recommendation: If your homeowners insurance company has a strong financial score from at least two rating agencies--and if you are satisfied with its service--you should stay put, even if other coverage is available at a somewhat lower price. He reasons that insurers are less likely to cancel the coverage of policyholders with whom they have had a long relationship.
Rating services aren’t infallible, however. Two of the nine insurers that were seized by regulators after Hurricane Andrew had been rated in the “excellent” or “good” range by A.M. Best, for instance.
Robert J. Hunter, head of the National Insurance Consumers Organization, said consumers should be wary if a company has a financial strength rating lower than an A+ from Best or its equivalent from other rating agencies.
That, worrisomely, includes three of the top 10 homeowners insurers in California. The three together write nearly one-third of the business in the state; by Best standards, they still are within the “excellent” range.
“Obviously, everybody who has less than an ‘A+’ is not going to go down the tubes,” Hunter said. “It just raises a question about them, as compared to the other seven.”
In the worst case, state insurance guaranty funds stand ready to pay claims for policyholders whose insurance companies fail. But the Florida experience demonstrated that financial stability still should be a paramount concern for consumers.
After the string of failures in Andrew’s wake, the Florida fund ran out of cash, forcing policyholders to wait weeks or months for relief.
Weiss--whose research firm is located a little north of where the hurricane struck--was in a position to see some of the devastation first-hand. Yet one of the most chilling sights was in Tallahassee, he said, far from the storm damage: the mobs of policyholders banging on the doors and windows of the state guaranty fund office, demanding payment.
The fact that the standard California homeowners policy does not insure against the likeliest indigenous disaster--earthquake--lessens the risk that a string of property/casualty failures could pose similar problems for the California Insurance Guaranty Fund.
Year of Disasters
This chart, which ranks Southern California’s largest homeowners insurers by statewide premium volume, shows ratings for claims-paying ability from three major rating agencies. A listing with double asterisk indicates a ratings downgrade during 1992.
Rank Company Market Share Premium Volume Rating (percentage) (in millions) A.M. Best 1 State Farm Fire 19.7% $488.1 A+ & Casualty 2 Allstate Insurance 16.0% $396.7 A-** 3 Fire Ins. Exchange 12.1% $300.4 A (Farmer’s) 4 Safeco Ins. 2.7% $67.9 A++ of America 5 USAA 2.5% $60.9 A++ 6 20th Century 2.2% $55.6 A+ 7 Assoc’d. Indem. 1.8% $44.9 A (Fireman’s Fund) 8 Federal Ins. 1.8% $44.3 A++ (Chubb Group) 9 State Farm General 1.8% $$3.9 A+ 10 Calfarm Ins. 1.6% $40.0 A+ (Zenith)
Rank Moody’s S&P; 1 Aaa BBBq 2 Aa3** AA-** 3 Aa3* AA+ 4 Aa1 AAA 5 Aaa AAA 6 --- BBBq 7 Aa1 AA+** 8 Aaa AAA 9 Aaa BBBq 10 A2* AA-
Key to Ratings:
A.M. Best Co.: A++, A+ = Superior; A, A- = Excellent.
Moody’s Investors Service: Aaa = Exceptional; Aa1, Aa2, Aa3 = Excellent; A1, A2, A3 = Good; single asterisk indicates implied financial strength rating based on Moody’s rating of the company’s bonds.
Standard & Poor’s: AAA = Superior; AA+, AA, AA- = Excellent; BBBq = Adequate or better, a qualified solvency rating based on publicly available information but not interviews with company management.
Sources: California Department of Insurance, rating agencies.
Consumer Tips
Buying homeowners or business insurance? Experts say you should focus on financial strength, price and service. Here is some advice culled from interviews with consumer advocates, brokers and insurance analysts:
If a price looks too good to be true, it probably is. Cheap insurance may be worthless insurance.
You’re buying insurance for security, so buy it from a secure company. Make sure the insurer has a strong rating from at least two reputable rating agencies.
Too-fast growth may be a sign of financial weakness. Some insurers try to grow their way out of problems, which can compound the trouble once claims start arriving from the new business.
Poor service, especially slow claims-payment, can also be a sign of instability. Companies that find excuses to delay payment may lack the resources to pay on time.
If you’re happy with your insurer and the company is well rated, don’t switch just to save a few dollars. In an environment where insurers are trying to cut back on some kinds of coverage, a long-term customer may be less likely to get canceled.
