Carrier solvency is on the tip of everyone’s tongue. It is the one issue everyone in the industry has to be concerned about. It isn’t just the staggering record losses sustained by the industry from the 9/11 tragedy but the long price war of the last 15 years or more. The market was starting to harden before 9/11. The World Trade Center tragedy pushed the industry off the cliff and created a hard market overnight. Unfortunately, there are more questions than there are answers when it comes to assessing carrier solvency.
Rates are starting to level off. Some property rates are actually decreasing. Yet, there remains a concern that carriers haven’t had enough good times to repair damage to their balance sheets caused by fierce price competition in the last 15 plus years. Carriers need more capital to bolster their balance sheets but have failed to show money markets that they can earn a respectable Return on Investment, which is needed to obtain capital. Also, there is a lot of concern about reinsurance recoverables. Can the primary carriers depend on their reinsurers to pay claims the carriers have submitted? Just how solvent are the reinsurers?
So where can we turn to get the answers we need about carrier solvency? Obviously, it’s the job of the various state regulators to monitor the financial health of carriers doing business in their states. But most industry analysts don’t pay any attention to regulators’ carrier audits. They turn instead to the rating agencies and the financial analysts at various investment houses charged with tracking the industry.
In California, the department of insurance (DOI) is supposed to audit a carrier not less than every three years. In reality, once a year is barely adequate. I’m not sure what other states are required to do. Many industry observers maintain the states have abdicated their audit responsibilities to the rating agencies. I don’t think that’s the case. The states still do their audits. It’s just that no one pays any attention to them. I assume the audits are pubic information but maybe not.
The problem with the DOI audit is credibility. Company presidents, in off-the-record conversations, have told me what a dilemma the DOI audit is. Each carrier is required to pay an hourly fee, supply the auditor with office space, office supplies, phone service and any clerical help he or she may need. The audit takes three months when it should take three weeks. Some auditors abuse the facilities provided by talking to friends and family on the phone and buying outrageous amounts of supplies they have no need for. Of course, all home office employees are walking around on egg shells scared to death they might somehow offend the auditor. While I know for a fact that there are many hardworking, very intelligent and experienced people in the California DOI, many DOI staffers can’t be categorized as hardworking, intelligent and experienced.
Then we have to ask the age-old question: could the private sector do it cheaper, better or faster? Who has the better people, the better software and analytical tools? Are the private sector accountants who work for the carriers so far ahead of the public sector auditors that it’s just not a fair match? Recent revelations about the auditors of Enron, et.al., will quickly eliminate that option for most of us.
So, maybe the regulators should leave the audit function to the rating agencies. Who has a better handle on carrier financial health than A.M Best, Standard & Poor’s, Demotech and others? Should the carrier ratings be used as the benchmark for regulatory action? And how much does it cost the taxpayer to have the staff of auditors needed to audit 1,000 insurance companies? Does each state audit all of the carriers doing business in their state? So, are they repeating the same audit 50 times? That doesn’t seem possible, but then again?
Certainly, one of the regulator’s primary mandates is to assure the consumer that the carriers doing business in that state are able to pay claims. Shouldn’t the foundation of that mandate be rate adequacy rather than a three-year-old audit? While most insurance commissioners focus on not letting the carriers charge too high a rate, I would submit that an even more important function is to make sure the carriers don’t charge too low a rate.
The biggest threat to the insurance consumer is carrier insolvency; not being over charged. Look at the record. Over the past 30 years the industry has made an underwriting profit in only one out of the last 30 years. Consider the California workers’ comp market. Twelve workers’ comp carriers have become insolvent since the elimination of the minimum rate law. The industry has been and continues to be its own worst enemy. It’s not that underwriters can’t underwrite; it’s that they can’t price properly. I’m going to get some flack on that statement. The biggest problem facing the carriers when it comes to pricing is that they won’t know what their costs are for three to five years. Price competition has been and continues to be the bane of the industry. The industry can’t stand prosperity. How many times have you heard that statement over the last 30 years?
So, if state regulators relied on the rating agencies to determine carrier solvency and did away with their audit departments, would the consumer and the industry be better off? Or would chaos ensue? If that were to happen, it wouldn’t make a damn bit of difference to the financial markets around the world. If the regulators really want to know what’s going on with a certain carrier, their best bet is to call up the insurance industry analyst at Morgan Stanley. They shouldn’t ask their auditors.
I believe in free markets. I believe competition should ‘regulate’ markets with regulators providing a level playing field and making sure everyone follows the rules. I believe the private sector can do things better, cheaper and faster than the government can. I think state insurance commissioners should be appointed not elected. Politicians have a different agenda than regulators. Politicians don’t regulate; they campaign. They need money to run for the next election or the next vacant Senate seat or the Governor’s office. All of this is grist for future columns.
Obviously, this is an opinion piece and, as you can see, I have a lot of opinions. Please let me know what you think, especially if you disagree.
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