Recently, a carrier’s representatives walked into one of my client’s offices. This carrier announced they needed a 25% rate increase because of the carriers’ poor loss ratios. My top clients are well informed about their carriers’ profitability thanks to my consulting with them, so my client showed the carrier their five-year average loss ratio of 40% in that state and asked, “Why in the world do you so desperately need a 25% rate increase?
Are your expenses so high that your loss ratio can’t exceed 15% (40% minus 25%)?”
Facts were not those marketing reps’ friends. Marketing reps never research their own companies’ results. They simply repeat whatever message their boss told them to deliver and odds are high their boss did not research the results either. I’ve seen many instances where CFOs did not understand their own results either. This industry runs by myth, assumption, hope, and tremendous amounts of wishful thinking, but rarely quality thinking.
I read an excerpt from the most recent Berkshire-Hathaway shareholders’ meeting where Charlie Munger was asked if he and Warren Buffet ever make bad decisions. His response is something every business leader should live by. He said that of course they sometimes make bad decisions, but “they never make emotional decisions.”
Frequently, when I show an agency owner the extremely weak financial facts of some carrier, they will continue to place business with that carrier because they like them. I have seen carriers bald face lie and the agency owner continue to trust the carrier more than the facts. Many a carrier depends heavily on agents not knowing the facts, not making decisions based on facts, and playing the ostrich by putting their head in the sand so they don’t hear the facts. Most agents are being taken advantage of, quite purposely. And with your head in the sand, another part of your anatomy is ripe for a whipping.
A Universal ‘Bad’ Market?
Many carriers are trying to sell agents, consumers, and insurance commissioners on how horrible the market is. Indeed, this is an awful market, but the reason it is bad and how universal the “bad” is a different matter. A key reason the market is bad for many carriers is because they lost so much money in their investments, not their claims. I’ve yet to read this in a press release and I actually check press releases against carrier financials. Facts are interesting.
Another blame is reinsurance, reinsurance, reinsurance. Well, reinsurance is an issue if the company is purchasing a lot of third-party reinsurance. However, many quality carriers buy little reinsurance. They might reinsure 5% or even as little as 2% of their premiums. Even if reinsurance prices increase significantly on 5% of their premiums, the increase in the overall scheme is minor and sometimes not even material. The increase might be less than one tenth of one percent of the carrier’s premiums.
When a carrier blames reinsurance, one of three factors is happening. The first is they are too dependent on reinsurance to begin with. That should be a red flag anyway. In this case, they want everyone to believe every carrier is too dependent on reinsurance and they hope no one checks. The second is they have no idea what they’re saying, and they are simply parroting what they’ve heard. They are effectively clueless. Third, they know what they’re saying and they are not dependent on reinsurance, and they also know everyone is too lazy to check the facts.
Another consideration exists and that is where the carrier buys reinsurance from themselves. If the price of reinsurance is increasing significantly, but the carrier is buying reinsurance from themselves, what difference does the price make? Some carriers buy the vast majority of their reinsurance from themselves. (I know this sounds oxymoronic.)
Get the Facts and Move Forward
Whether I am consulting for insurance carriers or agents, my clients who deal with facts best (and not by their own judgment because the most emotional ones always think they’re the most logical ones), achieve greater success. Hands down they achieve more success if for no other reason than that they get to the point 10 times more quickly.
Carriers have a fairly logical decision to make relative to agent and network compensation. Currently, they are paying most agents too much money and their best distributors too little. This is what you get in a socialistic compensation system, considerable inefficiency because merit is not rewarded. Emotion is all that is truly holding carrier executives from making the decision to reward distributors more efficiently on merit. The two carriers, and one in particular, that made that decision several years ago is outperforming most every company and never looking back. Take Charlie Munger’s advice and quit making emotional decisions, because even when you don’t make any decision, you’re making an emotional decision.
Facts vs. Emotions
Here is a really, really good example of how facts tell a different story than emotions. This is an insurance company story showing how carriers’ narratives don’t match the facts (because I have audited facts for carriers whereas with agencies and distributors, this level of detail on an audited basis does not exist).
The narrative is that homeowners loss ratios are horrible, awful, no one can make money, so on and so forth. The five-year unweighted average loss ratio for homeowners in the U.S. is 67.4% per AM Best. Carriers won’t make much money at a 67.4% loss ratio, but if the carrier is well managed, it won’t go broke either. A carrier that advises they’ll go broke at a 69% loss ratio is a poorly managed carrier — fact.
But the results really are not even that bad. There are two states with five-year averages exceeding 100% (Iowa and Louisiana). Carriers are racing to the exits in Florida and California, but Florida’s five-year loss ratio is “only” 86.5%, still horrible but almost 27 percentage points better than Iowa’s!
California’s loss ratio is just barely higher than the national average. (Louisiana, unfortunately, probably needs a wholesale innovative approach to homeowners involving the coverage forms to fix their truly severe problem.) Carriers are not exiting Iowa in droves, so the issue is not being driven by a profit analysis.
Take it further and the states with loss ratios exceeding 80% over the last five years include Colorado, Florida, Minnesota, Oregon and South Dakota. Notice that California is not on the list? Most of these states have bad results almost every year (Oregon is the exception). Treating all states equal, meaning taking an unweighted average and eliminating U.S. territories, the average five-year loss ratio of any given state is 65.0%. Removing those states with loss ratios exceeding 80%, the average loss ratio of any given state is a very respectful and profitable 58.9%. The industry does not have a homeowners loss ratio problem.
To get into a tiny bit of statistical detail, this is a great example of how this industry is run by people that know nothing about statistics. If you map out the loss ratios by state relative to how many states have good or bad loss ratios, the result is not a normal curve. The narrative the carriers are telling about homeowners assumes a normal distribution of loss ratios. As with almost everything in this industry except maybe to actuaries, is that normal distribution curves have no application. Catastrophes cannot by definition be catastrophes unless they are exceptions and exceptions don’t fit normal frequency curves (this is actually a huge problem for actuarial analysis and property claims).
The majority of states have good loss ratios. The issue is that a few states have really horrible loss ratios. Therefore, the solution lies in fixing those states’ loss ratios specifically.
The industry does not have a homeowners loss ratio problem. It has seven states with severe loss ratio problems. Taking actions by restricting writing in the other 43 states is not the solution.
Taking severe actions in states with okay loss ratios like Texas, a state with the most average loss ratios of any state, makes little sense.
If a carrier or agency was to deal with the facts, they would take advantage of those carriers incapable of making logical decisions, who believe their own stories. There is a lot of money to be made in these situations where the results are so skewed but the carrier executives will not deal with the actual data.
Take Charlie Munger’s advice and make fully considered decisions, but do not make emotional decisions and absolutely quit believing the narrative without checking the facts.
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