The WSJ did a story last week on the explosive growth of state-owned insurers of last resort. This is a fine story that makes an important point: the public has quietly been taking on massive liabilities, particularly since the 2004 and 2005 hurricane seasons— more than $600-billion from more than two million policies in 2006, up from $200 billion and less than one million policies in 2001—because private insurers increasingly won’t sell policies along the coast.
Fair Access to Insurance Requirements, or FAIR, plans cover people who can’t get homeowners insurance anywhere else, usually because they live in a place deemed risky. FAIR plan policies are usually more limited and—by law—more expensive than any competing private carrier in order not to undermine the private market, if there is one.
In insurance-industry paralance FAIR plans are known as the “residual market,” i.e., the crap.
These don’t operate like most insurance companies. They don’t build up reserves to pay claims. If the money runs out, they assess other policyholders in the state, either directly or indirectly through insurers, who pass along the costs.
The story quotes the articulate and knowledgeable Robert Hartwig, the executive director of the Insurance Information Institute, the industry’s research and public relations arm, who says:
The system “shifts the risk literally from those who are most at risk … to individuals who are at less risk or even at no risk.”
The problem—and yes, I’m very hard to please on the subject of insurance, particularly hurricane coverage—is that it misses the big picture.
The Journal misses the story, really.
Hartwig frames the story in a way that pits one group of insureds against another. It is the fault, in other words, of irresponsible people who insist on living near water. And while that’s his job, he’s basically wrong, and the Journal should stop falling for it.
What “the system shifts the risk from” is not coastal dwellers to inlanders, but from insurers to everybody else. And when it comes to paying for things the insurance industry doesn’t want to pay for, there are only two other candidates: taxpayers and policyholders. There is no third choice.
Think about it. If Allstate Insurance Co. and State Farm Insurance Co. are canceling or not writing policies south of Interstate 10 in Louisiana, which cuts through New Orleans, that leaves them with the profitable business—the not-risky homes inland and the incredibly lucrative auto business—and dumps the bad risks in the state’s lap.
Meanwhile, the state doesn’t get the benefit of the low-risk policies to pay for the risk on the coast.
Is this complicated?
This insurance “system” defeats the point of insurance, which is to spread risk as widely and efficiently as possibly. Not for nothing is insurance known to operate by the “the law of large numbers.” The more premiums you collect from the more people, the cheaper the whole system becomes. The more you chop up risk—separating sick people from healthy ones, for instance, or Louisiana homeowners from Mississippi homeowners from New York homeowners in a utterly stupid state-based system—the more expensive it becomes to cover the risky, the more lucrative to cover the unrisky and the more costly it becomes to administer all the separating that’s required. Saying “No” costs money.
And the premise underlying the story, that the private U.S. insurance system must leave the coast because it can’t handle another Katrina, is laughable. As I said in a previous post, the worst-ever insurance-loss year—2005—was the best-ever profit year in the history of insurance, $48 billion net income. On top of that, the industry added—not subtracted—added to its surplus that year, by $35 billion, pushing it to $495 billion, a record.
And that was a bad year.
How do they do it? Audit Readers, the U.S. pays $430 billion a year in property/casualty premiums every year. Forget health and life. That’s just auto, home, etc. That’s $1 trillion in less than three years. You don’t think we can handle a lousy hurricane, even a $45-billion one, every once in a while?
And while I’m at it, you probably think these government-owned companies are inefficient because they’re the government, right? You are wrong, seiche breath.
After Katrina, Louisiana Citizens Property Corp. was flooded with complaints by policyholders who couldn’t get through for weeks. All this prompted numerous calls for reform. Running the company on a contract with Citizens at the time, however, was Audubon Insurance Co., a unit of American International Group Inc., the global powerhouse then run by the now-deposed insurance titan M.R. “Hank” Greenberg.
Heck of a job, Greenie.
To solve the problem of super-high-priced policies, poor service and restricted coverage after the four hurricanes of 2004, the State of Florida took matters into its own hands and essentially allowed its state-owned company to dominate the homeowners’ market, spreading risk as widely as it could within its borders. The Journal writes about that like it’s a bad thing.
Florida offers a glimpse into what could happen down the road. In the wake of recent storms that prompted many insurers to limit their exposure, the state’s last-resort insurer is growing — and assuming more risk.
When the 2004 and 2005 hurricanes slammed its coast, the state’s insurer of last resort, Citizens Property Insurance Corp., suffered heavy losses. It hit its own policyholders — and eventually even those insured by other companies in the state — with $2.7 billion in premium surcharges. Florida legislators also allocated $715 million to hold down fees.
Since last year, Citizens has continued its massive expansion, writing roughly 15,000 to 20,000 new policies a week. As a result, it could be on the hook for significant losses if major storms roll in. A direct hit on Miami could cost tens of billions of dollars, much of which would be borne by Citizens — now the largest property insurer in the state.
Florida’s move could be a very bad thing, but the story at least could have pointed out that the state now will also collect new premiums to offset the added risks. I’m mean, they’re stupid in Florida, but they’re not crazy. And did I mention the governor down there is a Republican who went by the nickname of “Chain Gang Charlie?” Read the Journal and you’d think the system was designed by the Columbia School of Social Work.
Listen, this risk-shift idea, coined by Yale’s Jacob Hacker, is not a small issue. He writes about a shift from government onto the backs of American families. Less well-noted is the shift from the private insurance sector onto the government. You probably have heard of the Terrorism Risk Insurance Act and the National Flood Insurance Program, but you probably haven’t heard of insurance-related agencies in your state, the California Earthquake Authority, the Pennsylvania Medical Care Availability and Reduction of Error Fund and the like. Those are all basically mechanisms by which the government takes risk off insurers’ hands or subsidizes the industry in some other way.
What other industry gets this kind of treatment?
You don’t hear Ford saying, “Well, we’ll make everything but the air bags and catalytic converters; that’s the State of Michigan’s job.”
In fact, I could make a better case for giving Ford a government subsidy. After all, a big part its problem is the government’s failure to reign in the spiraling cost of health insura…health insh…heh….
Hmm. I think I’m starting to see a pattern.
As I’ve said elsewhere, I’ve also had the benefit of being off the daily newspaper treadmill, studying insurance for more than a year. And, like I said, the Journal’s story is fine.
But insurers hold $4.3 trillion in assets, stocks, bonds, real estate, etc. That ridiculous. The Gross Domestic Product—the market value of the nation’s output of goods and services—is $13 trillion, in case you were wondering.
Insurance isn’t supposed to be an “industry” at all; but something that spreads risk so people can do something productive, like buy a house, provide medical care or make things.
And yet, it’s every household’s third or fourth largest expense. We’ve got 47 million people without health insurance. The Gulf Coast recovery is a disgrace. Thousands still live in FEMA trailers; many are fighting insurance claims. And FAIR plans are being swamped with new risks they can’t handle.
Point is: Insurance is a great business story. The Journal’s fine. The Audit wants—the nation needs—more.Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014). Follow Dean on Twitter: @deanstarkman.