The Commerce Insurance Company, a wholly owned subsidiary of The Commerce Group, Inc. (NYSE: CGI), and the largest writer of private passenger auto insurance in Massachusetts, has updated its estimate of the financial impact of the proposed reform of the residual market system in Massachusetts to reflect changes in the rules being proposed.
Its revised numbers indicate that additional expenses would be lower than originally thought and that the financial impact of any increased share of the residual market deficit would be more than offset by a few other components of the new plan.
Noting that the initial proposal containing a six month transition period has not been approved, the insurer now estimates that the proposed reform will not result in $3.6 million of additional total expense before taxes for the 18 month period ended Dec. 31, 2005, as previously disclosed.
Rather, if Commissioner Julianne Bowler approves the revised proposal entirely as recommended by Commonwealth Auto Reinsurers (CAR) effective Dec. 1, 2004, company officials estimate that their additional expense, if any, for the next 15 months would be approximately $600,000 before taxes.
The latest proposal calls for the current residual market pool to be divided into two components – the first comprising high loss ratio exclusive representative producers or ERPs and the second comprising other than high loss ratio ERP business and business ceded to the residual market from voluntary agents.
The proposal is to be the subject of a public hearing on Oct. 29.
Commerce officials made other estimates of how proposed changes in the new plan would affect their operations.
While CAR has proposed different utilization formulas and credit values going forward, Commerce said it expects that those changes will have no material net impact on its overall participation ratio for this second pool.
The proposal would also require, for the period beginning Jan. 1, 2005, that each company with a 2003 market share of 7 percent or more service the business written by high loss ratio ERPs. In exchange, those servicing carriers would receive an increased expense reimbursement fee and an opportunity to earn bonuses for improvements in the loss ratio of those ERPs. CAR estimates that Commerce’s share of the high loss ratio ERP pool will be approximately 39.8 percent, given that Commerce and five other insurers will service the 2005 business of high loss ratio ERPs. If there are more than six carriers servicing the high loss ratio ERP business, the percentage of this pool that Commerce services will be reduced. Lastly, the proposal contemplates the introduction of an assigned risk plan beginning in 2006 for a segment of the business and for all business by 2008.
Commerce officials say they believe that it is premature to estimate the impact of the proposal on the company’s future financial results because of uncertainties relating to the rates approved for 2005, and the unpredictability of the strategies that Commerce and other companies may pursue in the proposed residual market system that could have a material impact on the residual market deficit, the voluntary agent marketplace, insurers’ participation ratios, and other important factors.
CAR, however, has provided some guidance as to what effect the revised proposal would have had if it had been in effect for the 2003 policy year. Based on information made available by CAR, the revised residual market would have realized a favorable impact in the amount of $3 million before taxes for Commerce’s fiscal year ended Dec. 31, 2003.
Based on the information made available by CAR, had the revised system been in effect for the 2003 policy year, the total CAR deficit would have been approximately $424 million, of which $295 million would have been attributable to high loss ratio ERPs, Commerce has calculated. CAR’s current projected policy year 2003 deficit is $322 million. The increase in the deficit is caused by both the expected mandatory cession of all high loss ratio ERP business and an increase in the expense allowance for servicing this business. Using its own year end 2002 voluntary agent market share of 26.4 percent, Commerce estimates that its share of the total 2003 CAR deficit of $424 million would increase to $105 million versus its actual share of the CAR deficit, which amounted to $67 million. Approximately $78 million of that $105 million would be attributable to the insurer’s share of the proposed high loss ratio pool, and the remainder would represent its participation in the non-high loss ratio pool’s deficit.
Commerce anticipates that its increased share of the residual market deficit would be more than offset by a few other components of the new plan. First, CAR proposes to increase the expense allowance for servicing the high loss ratio ERPs from 28.8 percent to 46.2 percent, which would have generated an estimated additional $10 million income before taxes for the high loss ratio ERPs that Commerce serviced in 2003, plus an estimated additional $19 million, after incremental costs and before taxes, for servicing additional high loss ratio ERPs that would be assigned to Commerce as one of the six proposed designated servicing carriers.
Second, Commerce said it would have realized in the 2003 policy year an estimated additional savings of $12 million before taxes as a result of the expected requirement that it cede all business written by high loss ratio ERPs, as compared to writing that business voluntarily.
“For the reasons described previously, the actual impact that the revised reform proposal may have on our operating results in 2005 or any future year may differ significantly from the pro forma impact on our 2003 results,” the company said in its statement. “We intend to review and, if necessary, revise our business strategies in response to these initiatives as they are implemented. We cannot predict whether our efforts will be successful or whether the initiatives as implemented will affect our competitive position or financial performance other than as described above.”
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