Citizens Financial banks on 'not your typical' insurance agency sale

Not Your Typical Bank," the slogan used by Citizens Financial Group in its consumer ads, seems to apply to the bank's latest move, the selling off of its respected insurance agencies.

It is not a typical sale. The bank did not shop the agencies around to assure the best price, the agencies being sold were not performing poorly, and the bank is actually expanding its reach into insurance as a result of selling off.

Providence, R.I.-based Citizens Financial Group, the eighth-largest commercial bank holding company in the U.S. with $155 billion in assets, is selling its three well-known agencies with combined revenues near $45 million for the price of $80 million to Hub International Ltd., a Chicago-based network of agencies across the country and in Canada. The deal includes a strategic alliance between the two for future joint sales and marketing.

The three large insurance brokerages joining Hub are well-established with a combined 19 offices in Pennsylvania, Massachusetts, and Rhode Island.

With roots dating back to the 1920s, Citizens Clair Insurance Group is one of the largest insurance agencies in eastern Pennsylvania with annual revenue of $16.5 million. Founded in 1859, Boston-based Brewer & Lord has 11 offices throughout Massachusetts and Rhode Island with annual revenue of $19.7 million. Established in 1916, Feitelberg Insurance, based in Fall River, Mass., has six offices in eastern Massachusetts with annual revenue of $8.6 million.

This sale reflects the judgment of one bank and is not the start of a flight from insurance by other banks, according to experts.

"This is not necessarily a trend," said Michael White, president of Michael White Associates (www.bankinsurance.com), explaining that he thinks the Citizens decision might have come down to the relatively small contribution the agencies were making to the bank's overall revenues.

"These insurance agencies were good producers; it's not that they were performing poorly," he added. It's just that Citizens was expanding its banking reach and revenues much faster and apparently decided to focus there.

Another bank consultant, Gerald C. Vigneron, of North Bridge Advisors Inc. in Concord, Mass., said he was not totally surprised by the transaction because he has long felt agencies are not a good fit for larger banks. "I'd been predicting this. Like in any trend, some who jump in will look at insurance and see this isn't their real mission and doesn't fit."

Vigneron stopped short of suggesting that other banks will follow suit but thinks others could get some ideas from this. "This is not yet a trend but it could put in the mind of other brokers that maybe they could pick off some agencies now owned by banks."

Bruce Guthart, Hub chief operating officer, offered his own rationale. "Insurance operations were going well but it's tough to be a bank and grow an insurance operation also," he said, adding that the joint marketing agreement actually gives Citizens a quicker way to expand insurance offerings into new territories.

Banking expansion
In August 2004, Citizens acquired Charter One Financial, Inc., which extended Citizens' banking beyond southern New England and Pennsylvania into Ohio, Illinois, Indiana, Michigan, New York and Vermont. But Citizens' insurance operations are only in Massachusetts, Rhode Island and Pennsylvania, so its banking and insurance footprints no longer match. To expand its insurance operations to keep pace with its banking expansion would have required buying additional agencies, perhaps at inflated prices if any were even available, observers noted.

Citizens contacted Hub and no other buyers participated. Citizens "specifically chose us to partner with," according to Hub CEO and chairman, Martin Hughes.

Consultants Vigneron and White agreed Citizens got a good price at $80 million, despite having dealt with only Hub about the sale. Both also agreed that Hub was a good partner.

Joseph Feitelberg's agency Feitelberg Insurance, was bought by Citizens in 2003 and now becomes part of Hub. Feitelberg says the way Citizens went about this transaction might not be typical of other sellers but is typical of how Citizens operates under Chairman and CEO Lawrence K. Fish. The company's credo emphasizes the "Three Cs": customers, colleagues and community, and Feitelberg says that's what the bank did.

"They (Citizens) wanted to do the right thing for customers and colleagues, so they pre-selected a partner they knew the people on the insurance side would be comfortable with. HUB is the right partner," says Feitelberg.

Hub officials indicated that no major consolidation or expense savings are anticipated. Hub has another New England office in Wilmington, Mass., which is north of Boston. The two Massachusetts agencies purchased are closer to and south of Boston.

Wind vs. flood Katrina lawsuit sent back to state court

The Mississippi lawsuit to force insurance companies to pay for damage caused by storm surge has been remanded back to the state's Chancery Court of Hinds County. Since the state is seeking injunctive relief, the remand means the case will now be expedited, according to the State Attorney General's Office.

"As I stated when the insurance companies moved this to federal court, their attempt was nothing but a delay tactic," Jim Hood, Mississippi Attorney General said. "The insurance industry is using delay tactics in hopes that many Mississippians will give up on their claims and take whatever the insurance companies offer. I hope people will hold on just a little bit longer and let us get a decision on this case."

Hood filed a civil action in the Hinds County, First Judicial District on Sept. 15 against the insurance industry on behalf of Mississippi property owners without separate flood insurance policies who incurred damage from Hurricane Katrina but who have been denied coverage due to water exclusions in their homeowners policies. The Attorney General's office maintains insurers should pay for losses caused by water, whether or not driven by wind.

"The insurance companies have already caused a six-month delay by taking this to federal court under a false premise," Hood said. "I think it is shameful that the insurance industry would drag this out while people are living in limbo. I just want to know how much money they've saved themselves holding on to these people's money?"

Insurers said they were not surprised by the remand. "Although we would have liked for the Mississippi case to stay at the federal court level, the court's action is certainly not unexpected due to the legal issues involved," explained Julie Pulliam, American Insurance Association. "We are still confident that ultimately Mississippi state courts will uphold the water damage exclusion, although we have to acknowledge that there may be more pressure at the state court level to provide relief to fellow citizens."

But William Bailey, director of the Insurance Information Institute, was surprised. "It seemed to me that this was a clear-cut case of federal preemption. This case belongs in the federal court and I thought that was removed and I haven't seen anything to change my mind about that issue.

"If it is a federal preemption there may lie an appeal at some point that the judge should have not have sent the case back to the state," Bailey said. "There are several options. The defendant can decide to go to the Federal Court of Appeals and take an interlocutory appeal while the case is in its current posture they can go to the next level of Appellate Court and say, 'We think that judge was wrong we want you to rule that he was wrong and that this case belongs in federal court.'"

Atlantic Mutual ratings fall as surplus drops $100 million

Ratings analysts who downgraded personal lines insurer Atlantic Mutual earlier this month will be meeting with the company in the coming weeks to review results of the fourth quarter and all of 2005 before deciding what to do next.

"We have the 2005 information now but we haven't sat down and talked with them. We only talked very quickly," noted Antony Diodato just days after his firm, A.M. Best, placed the Atlantic Mutual Companies of New York under review with negative implications.

A.M. Best downgraded the debt rating to ccc from b+ of the $100 million 6.05% 30-year surplus notes issued by Atlantic Mutual Insurance Company. It also downgraded the financial strength ratings to B- (Fair) from B+ (Very Good) and the issuer credit ratings to bb- from bbb of the group's subsidiaries, Atlantic Mutual Insurance Company and Centennial Insurance Company.

Initial reaction
Those changes were the Oldwick, N.J., rating agency's initial response to the companies' $100 million drop in surplus at year-end 2005. At year-end 2005, surplus stood at $141 million, compared to $244 million in 2004, according to Joel Silverthorn, A.M. Best senior financial analyst.

Standard & Poor's Ratings Services took similar action, lowering and placing the insurer's credit ratings on CreditWatch with negative implications, while expressing concern over the company's fourth quarter loss and the fact that 80 percent of the companies' surplus is in surplus notes.

Atlantic Mutual declined to comment.

The larger than expected reduction in surplus is being blamed largely on the group's discontinued commercial lines business. Atlantic Mutual sold its specialty commercial lines business to One Beacon and its marine accounts to Travelers but adverse development in the commercial business that is in runoff has required more reserving than anticipated, according to Diodato and Silverthorn.

Dropped reinsurance
Diodato noted that the insurer unrolled the reinsurance it used to have on this commercial business during 2004 and 2005. More than 70 percent of its reserving is tied to this exited commercial lines business.

A.M. Best is concerned that even more reserving may be necessary. "The potential for continued adverse prior year development of the group's loss reserves remains present and fuels the uncertainty regarding its future financial strength, which remains dependent upon Atlantic's underwriting and operating profitability (having been weak in recent years) and remains an ongoing concern as the group attempts to improve its situation," A.M. Best said in releasing its downgrades.

Focus on personal lines
Since it exited commercial insurance lines, Atlantic Mutual has been focusing on the upscale personal lines marketplace. Its flagship product is The Atlantic Master Plan, which provides coverage to affluent individuals for homes, automobiles, valuables and watercraft, along with personal liability protection.

While the company faces the potential for continued losses on its legacy commercial lines business, it also now faces challenges in the ratings-sensitive personal homeowners business, where mortgage companies tend to require a B rating, the analysts noted.

A.M. Best analysts said they plan to sit down with executives and learn how the company's management plans to proceed with its current capitalization. They said an updated analysis is likely within three months.

S&P's concerns
Atlantic Mutual executives will also be meeting with representatives from Standard & Poor's Ratings Services. S&P lowered its counterparty credit rating on Atlantic Mutual Insurance Co. to B+ from BB+; lowered its rating on Atlantic Mutual's surplus notes to CCC from B+; and also placed the ratings on CreditWatch with negative implications.

"Because surplus notes have increased as a proportion of total surplus, the risk of default on the surplus notes has increased and for this reason the notching on the surplus notes was increased," explained S&P analyst, Jason Jones.

"Reported results and surplus were well below our expectations, resulting in the rating action," Jones added. "Atlantic Mutual's capital adequacy was materially weakened by its fourth-quarter loss, and quality of capital weakened because the $115 million of surplus notes now constitute about 80 percent of total surplus."

The insurer's state regulator approved an interest payment on the surplus notes in February 2006, according to Jones. The risk-based capital ratio for Atlantic Mutual was about 250 percent at year-end and the RBC of its subsidiary Centennial Insurance Co. was about 500 percent, both of which are more than the company action level.

Jones indicated that among the factors that could affect the rating outcome is the strategic alliance with Countrywide Financial Corp. that Atlantic Mutual penned in July last year to expand the availability of the Atlantic Master Plan insurance product nationwide.

The deal was designed to draw on Countrywide Insurance Group's A rating and its parent company's national presence. The deal allowed Atlantic Mutual's independent agents to leverage the higher rating of the P&C division of Countrywide Insurance Group while giving Countrywide access to a new distribution channel of independent agents.

The two insurers said they planned to extend their partnership to western states and Texas, where Countrywide Insurance Group operates but Atlantic Mutual does not.

Additional questions
In addition to questioning the Countrywide affiliation, S&P said it would look into whether the loss reserve deterioration can be remedied and whether there might be potential benefits from reinsurance.

S&P said it intends to discuss the reasons for the company's poor results in the fourth quarter of 2005 in the near term and resolve the CreditWatch shortly thereafter. The ratings could be affirmed or they could be lowered further.

Citizens not banking on insurance

Using June 30, 2005 figures from bank holding companies, Michael White, president of Michael White Associates (www.bankinsurance.com) in Radnor, Pa., shows how relatively little insurance meant to Citizens:

Citizens Financial Group, with assets of $148.5 billion, ranks 21st in the nation in insurance brokerage fee income. Its insurance fee income revenue represented only 3.18 percent of the Citizens' noninterest income.

In contrast, BancorpSouth Inc. (Miss.), with assets of $10.8 billion, ranked 18th in insurance brokerage fee income. That revenue represented 32.2 percent of BancorpSouth's noninterest income.

In the Northeast, Webster Financial Corp. (Conn.), with assets of $17.5 billion, ranked 24th in insurance brokerage fee income. That revenue represented 22.2 percent of Webster's noninterest income.

Also, in the Northeast, Eastern Bank Corporation (Mass.), with assets of $6.2 billion, ranked 27th in insurance brokerage fee income. That revenue represented 41.0 percent of Eastern's noninterest income.

Catching up with region's insurance politics

In the Northeastern and Atlantic states, elected politicians are in the thick of deciding on legislation that could affect insurers, insurance agents and their insureds.

New Jersey lawmakers are considering restoring coverage under the New Jersey Surplus Lines Insurance Guaranty Fund for claims involving liquor law liability. The fund currently pays the claims of bankrupt surplus lines insurers for only medical malpractice liability and property insurance for owner-occupied dwellings of less than four dwelling units. The Professional Insurance Agents of New Jersey told legislators that liquor law liability claims tend to involve substantial damage amounts and "it would benefit consumers to have access to these funds in the event that their insurer is unable to pay their claims."

Flexing ethics
The Connecticut Insurance and Real Estate Committee is weighing whether to move the state from prior approval of insurance rates to a "flex rating" system. The flex rating proposal would permit insurers to raise or lower rates by 12 percent without first obtaining regulatory approval. According to the Property Casualty Insurers Association of America, consumers stand to gain if flex rating is adopted. PCI said that on average, auto premiums are 10 percent lower in states with flex rating or open competition than in states with prior approval of rates.

The State Elections Enforcement Commission in Connecticut fined 16 members of Gov. M. Jodi Rell's administration for illegally giving subordinates invitations to a Rell campaign fundraiser. The officials, including Insurance Commissioner Susan Cogswell, have each agreed to pay a $500 penalty for violating an ethics law that bans them from soliciting political contributions.

New York Gov. George Pataki has proposed stricter safety and insurance requirements for commercial passenger boats in response to last fall's capsizing of the Ethan Allen tour boat on Lake George, an accident that killed 20 tourists. Pataki would mandate that operators of commercial boats involved in accidents undergo drug and alcohol tests. Pataki also wants a minimum level of marine insurance for all public vessels operating on state waters.

New York state senators, spurred by a woman whose son died at Playland amusement park in Rye, are considering a rating system for amusement park rides, along the lines of movies labeled G, PG and R. The guide could be in place by this summer if the bill passes.

Fire-safe smokes
Lawmakers in Annapolis are considering mandating that cigarettes sold in Maryland meet tough new fire safety requirements. The American Insurance Association says that cigarettes meeting this new code could save lives and significantly reduce property losses. All cigarettes in Maryland would have to demonstrate a reduced propensity to burn when left unattended. AIA told lawmakers that in 2004 there were 473 smoking-related fires in Maryland, resulting in 25 percent of all fire deaths in the state, and estimated property losses of $4.5 million. New York, Vermont and California have already adopted fire-safe cigarette requirements.

With the House and Senate at a stalemate over transportation funding, the Virginia General Assembly adjourned its regular 60-day session on March 11 without finishing work on a budget. That prompted Gov. Timothy M. Kaine to order a special session to begin on March 27. Setting the budget has become contingent upon settling differences over transportation funding. The Senate favors a package that requires $1.2 billion in new taxes, while the House has opposed raising taxes. Kaine, whose own proposal that included a hike in insurance premium taxes was rejected, has urged lawmakers to keep working until they come to an agreement.

Health assessments
Massachusetts Gov. Mitt Romney was undecided on whether he'll support a health care reform bill until he can determine if it would require a tax increase. Romney said he supports the provision requiring everyone in the state to obtain health insurance, much the way all car owners must have auto insurance. But Romney said he needs more information about the bill's section that would require businesses that don't offer insurance to their workers to pay a so-called health care assessment. Romney is opposed to new taxes, but has signed off on an array of fee increases. "An assessment can be a tax or it can could be something that's different from that. It depends on how it's applied," said Romney.

With eye on federal monies, more states adopting primary seat belt laws

Seventeen-year-old Brittney Hudson wasn't wearing her seat belt when it mattered most, the moment her 2004 Toyota Celica rolled over along a rural stretch in western Colorado and ejected her from the vehicle.

The crash happened a day before Thanksgiving and months later, her parents can only speculate on why she wasn't buckled up. Brittney, a straight-A student, normally wore her seat belt and state troopers told family members it probably would have saved her life.

"It was pretty violent but I think that seat belt would've kept her in," said her stepfather, Wayne Burton of Delta, Colo.

Still grieving, her family has pressed state lawmakers in Colorado to enact a primary seat belt law, which would give police the ability to stop motorists for failing to wear their seat belts.

Twenty-four states, including Michigan, have primary enforcement laws. Others, including Georgia, Kentucky, Massachu-setts, and Missouri, have bills pending amid concerns about auto safety, mounting health care bills for people injured in traffic crashes and new federal grant money available to states with such laws.

Opponents contend the laws will infringe upon the personal freedoms of motorists and amount to nothing more than a revenue-generating scheme by government. Others wonder if they will lead to racial profiling.

Belt use reached a record high of 82 percent last year, but the government and auto safety groups have viewed stronger seat belt laws as a way to get the holdouts to buckle up and reduce the number of people, which is about 42,000, killed in traffic crashes every year.

As an enticement, Congress has offered nearly $500 million to states that have passed the law or have maintained a seat belt use rate of 85 percent or better for two straight years.

The incentive grants were part of the reason the measure passed in Mississippi, supporters said. The state, which is recovering from Hurricane Katrina, is eligible for $8.7 million because it passed the law.

After signing the bill, Mississippi Gov. Haley Barbour said he received calls to veto the measure because it would limit personal freedoms. But he noted: "Individual freedom has to be combined with personal responsibility."

Twenty-five states have secondary laws, which allow police to ticket a driver for failing to wear a seat belt only if the motorist is stopped for another infraction. New Hampshire does not have an adult safety belt law.

The government estimates that states with primary laws have use rates about 11 percent higher than those with secondary laws. Transportation Secretary Norman Y. Mineta has said 2,200 lives could be saved annually if 90 percent of motorists buckled up.

In Michigan, where the primary law took effect in March 2000, belt use has increased from about 70 percent before passage to about 93 percent last year. Traffic deaths have dropped from nearly 1,400 in 1999 to just over 1,150 in 2004, according to the state's Office of Highway Safety Planning.

Lawmakers in Colorado have failed to approve a primary belt law in past sessions, but the measure cleared the House and the Senate is expected to consider it later this month. Colorado could qualify for about $12 million in federal grants if it's signed into law.

Proponents there say more than half of the 502 people killed in vehicle crashes in Colorado in 2004 were unbelted. They also point to the Medicaid costs, estimating motor vehicle injuries cost the state more than $60 million for the first year and $15 million in successive years.

"A vehicle is a lethal weapon if it's not used responsibly," said state Rep. Fran Coleman.

The ACLU of Colorado isn't opposing the bill, but the group's executive director, Cathryn Hazouri, said they have concerns about potential racial and ethnic profiling.

"We certainly don't want to have law enforcement use primary seat belts as a means of stopping people for driving while black or driving while Latino," she said.

Hazouri noted that many minorities are killed in traffic crashes because they aren't wearing seat belts. Federal statistics show that motor vehicle crashes are the leading cause of death for blacks from birth to age 14 and for Hispanics from 1- to 44- years-old.

Burton said he and his wife told safety groups that they would do anything to help pass the law as a tribute to their daughter and to prevent more deaths. In an e-mail to The Associated Press, he noted that some of Brittney's friends pulled up to the family's home for a memorial service without wearing their seat belts.

"When they left our home that day in tears, every one of them buckled up," he wrote.

Copyright 2006 Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

Insurers back in court over World Trade Center

Insurance companies asked a federal appeals court in New York earlier this month to reject a jury verdict that would enable developer Larry Silverstein to obtain an extra $1.1 billion to rebuild the World Trade Center complex.

Meanwhile, Silverstein's lawyers asked the 2nd U.S. Circuit Court of Appeals to order a new trial so he can try to recover more money from the largest insurers of the trade center, which was destroyed by terrorists on Sept. 11, 2001.

Lawyers on both sides asked the appeals panel to take a fresh look at the outcomes of two trials stemming from disputes over nearly two dozen insurance policies.

Before Sept. 11, 2001, Silverstein bought $3.5 billion in insurance, but he sought to recover double that amount, saying the trade center's twin towers were victimized by two hijacked airplanes which amounted to two attacks.

In a trial that ended in April 2004, a federal jury found the majority of the insurers, holding more than $1.8 billion of the policy, were bound by a form that defined the destruction of the twin towers as one event.

In a second trial, which ended in December 2004, another jury concluded that nine insurance companies were bound by insurance form language that defined the destruction as two events. The verdict meant Silverstein will get another $1.1 billion to rebuild.

Fighting the verdict in the first trial, Silverstein attorney Herbert Wachtell said the developer would have won against more insurance companies if the jury had been allowed to hear evidence that was excluded.

Attorneys for some of the nine insurance companies that lost in the second trial argued that information about a California case was unfairly permitted to be put before the jury.

The three-judge appeals panel reserved decision in both cases, but the judges' questioning showed a reluctance to disturb the decisions.

Copyright 2006 Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

Few homeowners buy flood insurance when not required, RAND study says

Only about half of homeowners living in some of the most flood-prone areas of the United States buy federal flood insurance, leaving millions of families at risk for severe financial losses when floods strike, according to a recent RAND Corporation study.

Most homeowners buying flood insurance do so only because it is required in areas considered most vulnerable to flooding, the study found. Just 20 percent of homeowners living in the most flood-prone areas buy federal flood insurance when they are not required to do so, the study says.

"Substantial flood damage from Hurricane Katrina was suffered by homes located in flood zones whose owners were not required to purchase flood insurance," said Lloyd Dixon, lead author of the report.

Only about 1 percent of Americans living outside flood zones buy federal flood insurance, according to the study, even though they sometimes become flood victims as well.

Fifty to 60 percent of the 3.6 million single-family homes in the most flood-prone areas are required by law to buy federal flood insurance. But the owners of the remaining homes in the most flood-prone areas and the roughly 76 million single-family homes in the nation outside these areas are not required to buy flood insurance.

The study is part of a wide-ranging evaluation of the nation's flood insurance system that was requested by the FEMA and coordinated by American Institutes for Research (AIR).

"The findings represent important new information that contributes to the larger effort to improve the flood insurance program," said Marc Shapiro, AIR's director of evaluation. Additional studies and the final AIR report will be released this year.

The RAND study also found little evidence to suggest that increasing the number of homeowners who buy flood insurance would lower FEMA disaster assistance to individuals following floods. The lack of relationship is partly because flood insurance does not cover temporary housing assistance, which accounts for roughly 60 percent of FEMA individual assistance following flooding disasters. The FEMA individual disaster assistance program is one of many forms of federal disaster assistance available to individuals, businesses, and governments following floods.

Extending the National Flood Insurance Program to include temporary housing could help reduce FEMA individual disaster assistance payments, according to the report, although such a policy change would require a broader examination of potential impacts.

The RAND study also explores the number, location and characteristics of homeowners who purchase federal flood insurance. In addition, it outlines what motivates people to buy insurance and assesses the implications of increasing sales of flood insurance.

The analysis provides a solid basis for policymakers to determine the National Flood Insurance Program's impact, assess costs and benefits, and evaluate proposed reforms, Dixon said. For example, the findings provide the data needed to better estimate the effects of recent proposals to extend the mandatory purchase requirement to all homes in Special Flood Hazard Areas.

The RAND study also found that flood insurance purchase rates are much lower in communities that have a relatively small number of homes in a floodplain or that have a low proportion of homes in a floodplain. The disparity may be because insurers market flood insurance less aggressively in communities with fewer homes in the floodplain or because there are fewer insurance agents familiar with the program and enthusiastic about writing policies in such communities.

Also, in communities subject to coastal flooding, about 63 percent of homeowners purchase flood insurance, compared with 35 percent of homeowners in areas subject only to river flooding. The disparity may be due to a lower perception of risk or the limited insurance coverage available for basements, which are more common in inland areas.

Within Special Flood Hazard Areas nationwide, about 75 to 80 percent of those who are required to purchase flood insurance have done so. However, communities with lightly populated flood zones or a small percentage of homes in flood zones present a growth opportunity for the National Flood Insurance Program.

The study also found that overall market penetration for flood insurance in Special Flood Hazard Areas is approximately 60 percent in the South and West regions of the United States, compared with 20 to 30 percent in the Northeast and Midwest. In the South, 75 percent of homes with flood insurance policies also have contents coverage, compared with 16 percent in the Midwest and 49 percent in the Northeast. And nearly 60 percent of single-family homes in Special Flood Hazard Areas nationwide are in the South, although less than 25 percent of the nation's single-family homes are in the South.

The study also found that that the decision to purchase flood insurance is not particularly sensitive to the price of flood insurance, at least over the range of flood insurance prices currently observed. Consequently, the study concludes that when developing strategies to increase participation in the flood insurance program, program managers do not have to be greatly concerned about moderate changes in policy premiums.

The other authors of the report are Noreen Clancy, Seth Seabury, and Adrian Overton of RAND. The study was conducted jointly by the Institute for Civil Justice and the RAND Infrastructure, Safety and Environment division. The full report can be downloaded at: www.rand.org.

Berkshire's Buffett still high on insurance despite catastrophe risk

Warren E. Buffett, the billionaire chairman of giant Berkshire Hathaway, praises the performance of his primary insurance units, particularly Geico, in his annual letter to shareholders and acknowledges that concern over hurricanes has prompted his insurance subsidiaries to raise prices and underwrite more carefully.

Even with his concerns over catastrophe losses from future storms, Buffett appears confident in his insurance operations.

He suggests that auto insurer Geico is prepared to spend even more than its current $500 million annually on advertising to further increase its market share, and he hails the reentry of Geico into New Jersey as a success.

He also reports on the late-2005 acquisitions of a medical malpractice writer and a workers' compensation firm.

But Buffet makes no mention of the legal and regulatory problems that have dogged his General Reinsurance unit because of allegedly inappropriate reinsurance deals with American International Group, although he does apologize for problems General Re is having exiting the derivatives business.

"Berkshire had a decent year in 2005," Buffett writes, citing a gain in net worth for 2005 of $5.6 billion, which increased the per-share book value of its stock by 6.4 percent. Over the last 41 years since Buffett took over, book value has grown from $19 to $59,377, a rate of 21.5 percent compounded annually, according to his letter.

Berkshire posted net income for all of 2005 of $8.5 billion, up from $7.3 billion in 2004. Revenue for the year was $81.7 billion, compared to $74.4 billion in 2004.

General Re reported a $334 million underwriting loss while other Berkshire reinsurers' losses topped $1 billion. But that result was overcome, thanks to Geico's performance, and the insurance group posted an overall profit.

In his letter, Buffett forecasts that in order to deliver better gains in the future, Berkshire will need to make major acquisitions.

Insurance
Despite $3.4 billion in losses from hurricanes Katrina, Rita and Wilma for General Re and National Indemnity, Berkshire Hathaway companies in the aggregate had an underwriting profit of $324 million on $1,270 million of volume, thanks to the performance of giant auto writer Geico and some of the smaller insurers in the Berkshire family.

"Credit Geico--and its brilliant CEO, Tony Nicely--for our stellar insurance results in a disaster-ridden year. One statistic stands out: In just two years, GEICO improved its productivity by 32 percent. Remarkably, employment fell by 4 percent even as policy count grew by 26 percent--and more gains are in store," he said.

Hurricane season's effects
In addition to causing financial damage, the 2005 hurricane season has raised questions at General Re and National Indemnity. "It's an open question whether atmospheric, oceanic or other causal factors have dramatically changed the frequency or intensity of hurricanes. Recent experience is worrisome," Buffett acknowledges.

He maintains that the outlook is uncertain. "Was this onslaught of more frequent and more intense storms merely an anomaly? Or was it caused by changes in climate, water temperature or other variables we don't fully understand? And could these factors be developing in a manner that will soon produce disasters dwarfing Katrina?" Buffett asks.

Buffett admits that neither he nor his reinsurers knows the answers but he advises that in the absence of answers, insurers must proceed with caution, meaning higher prices and more selective underwriting.

"So guided, we've concluded that we should now write mega-cat policies only at prices far higher than prevailed last year--and then only with an aggregate exposure that would not cause us distress if shifts in some important variable produce far more costly storms in the near future.

"If prices seem appropriate, however, we continue to have both the ability and the appetite to be the largest writer of mega-cat coverage in the world," the chairman wrote.

More acquisitions
Berkshire acquired five companies in 2005. Among them was the June 30 acquisition of Medical Protective Company (MedPro), a 106-year-old medical malpractice insurer based in Fort Wayne, Ind. Immediately after the purchase, Berkshire increased MedPro's loss reserves by about $125 million to avoid any surprises in coming months and years. Buffet explains why:

"No one knows with any precision what amount will be required to pay the claims we inherited. Medical malpractice insurance is a 'long-tail' line, meaning that claims often take many years to settle."

In December Buffet also agreed to buy 81 percent of Applied Underwriters, a company that offers a combination of payroll services and workers' compensation insurance to small businesses. A majority of Applied's customers are located in California.

Praise for Geico
Auto policies in force grew by 12.1 percent at Geico, increasing its market share of U.S. private passenger auto business from about 5.6 percent to about 6.1 percent. According to Buffett, each share point equates to $1.6 billion in sales.

Buffett believes the Geico brand has grown significantly, although he says it is hard to quantify. In 1996, Geico spent $31 million on advertising, whereas last year it spent $502 million. "And I can't wait to spend more," Buffett writes, proclaiming that the advertising works "because we have a great story to tell: More people can save money by insuring with us than is the case with any other national carrier offering policies to all comers." Last year Geico achieved by far the highest conversion rate--the percentage of Internet and phone quotes turned into sales--in its history.

Geico's reentry into the New Jersey auto market in August 2004 has been a success, according to the chairman. He claims that Geico is poised to become that state's third largest auto insurer by 2007.

Gen Re derivatives
Berkshire lost $104 million pre-tax last year in its continuing attempt to exit Gen Re's derivative operation. Its aggregate losses since it began trying to exit this business total $404 million. Buffett has little good to say about this Gen Re venture and he blames himself for not acting quickly to exit the line.

Originally Gen Re had 23,218 contracts outstanding. By the start of 2005 that number was down to 2,890 but "the blood has kept flowing." According to Buffett, one of the contracts liquidated in 2005 had a term of 100 years. "It's difficult to imagine what 'need' such a contract could fulfill except, perhaps, the need of a compensation conscious trader to have a long-dated contract on his books."

"The hard fact is that I have cost you a lot of money by not moving immediately to close down Gen Re's trading operation," Buffett confesses to shareholders. Instead, he adds, he wasted several years trying to sell it.

He adds that when he finally winds up the Gen Re derivatives, his feelings about its departure will be akin to those expressed in a country song, "My wife ran away with my best friend, and I sure miss him a lot."