State Budget Deficits Could Harm the Insurance Industry

By | March 19, 2010

While 2009 was a tough year to do business, state and city leaders say 2010 and 2011 will be even tougher — the outcome of which could have negative implications for the insurance industry.

A number of states are struggling to keep their 2010 budgets in balance, and mid-year budget shortfalls have opened up in 41 states, according to the Center on Budget and Policy Priorities. Mid-year budget shortfalls currently total $38 billion, and fiscal year 2011 gaps are projected at $103 billion from 42 states, the Center noted in its report, “Recession Continues to Batter State Budgets; State Reponses Could Slow Recovery.”

“These totals are likely to grow as revenues continue to deteriorate, and may well exceed $180 billion,” the report indicates. And as states look to shore-up their budgets, it could lead to more taxes, less funding for insurance operations, and increased risks.

Looking to 2011 and beyond, even as the economy appears to be improving, “states’ fiscal prospects remain extremely weak,” the Center said. High unemployment and households’ diminished wealth due to fallen property values will decrease consumption and keep income tax receipts at low levels while increasing demand for services that states provide. States will face shortfalls of at least $120 billion in fiscal year 2012, the Center projects.

City Budgets Affected Too
On the municipal level, a fiscal shortfall of between $56 billion and $83 billion is expected from 2010-2012, driven by declining tax revenues, ongoing service demands and cuts in state revenues, the National League of Cities said. State governments are expected to make cuts in transfers to local governments, in the range of 10 percent to 15 percent.

“The low point for city fiscal conditions typically follows the low point of an economic downturn by at least two years, indicating that the low point for cities will come sometime in 2011,” NLC said. The common responses to such shortfalls are workforce reductions (67 percent); delaying or canceling capital infrastructure projects (62 percent); and cuts to public safety services such as police, fire and emergency (14 percent), NLC’s annual survey of city finance officers revealed.

Cuts Affect Safety Services
Public safety service cuts have already been made, and will inevitably rise, NLC said. For instance, Augusta, Maine’s mid-year budget shortfall and decreasing budget for the next fiscal year resulted in layoffs, reductions in police and fire overtime, and reductions in services. Bossier City, La., eliminated 80 police and fire positions as a result of the city’s $6.5 million deficit. And Little Rock, Ark.’s $2.8 million shortfall resulted in a $200,000 cut in police services and $450,000 cut in fire services.

One concern is that when essential emergency services are scaled back, it could increase risks.

When a workforce is cut, that could also mean there is less staff to handle services by state insurance departments. For instance, Arizona slashed the staff in its insurance fraud unit, and contemplated eliminating the fraud unit altogether. Similarly, Florida discussed eliminating state insurance fraud prosecutors.

While eliminating the fraud units never came to fruition in Arizona and Florida, the fact that the idea was floated is worrisome to the Coalition Against Insurance Fraud and others who aim to end malfeasance.

“There is fear within the anti-fraud community that this is what could happen,” said Howard Goldblatt, director of government affairs for the CAIF. If the idea is talked about enough, then there will be less urgency and concern about it if becomes reality, he said.

Furloughs Affecting Insurance Departments
Goldblatt noted that the Coalition is keeping an eye on whether states’ fraud fighting efforts have already been affected by draconian budget cuts. For instance, he said a number of states have implemented furloughs for state workers, and in some cases, insurance departments have been affected. This reduces the time a worker has to investigate insurance fraud, he said. Or as budget cuts are implemented, investigators that cover a broad territory might have less money to travel to investigate fraud.

“People might think an economic crime is not as heinous as a violent crime, but insurance fraud affects the economic well-being of a community,” Goldblatt said.

Funding from Healthy Enterprises
Entities that have built up a cushion to survive the lean times may find they’re not immune from states’ budget crises either. In 2009, California considered selling some assets of the State Compensation Insurance Fund to bring in $1 billion in revenue. The idea died when State Insurance Commissioner Steve Poizner filed a lawsuit blocking a sale.

In Colorado, Gov. Bill Ritter is currently studying the possible sale of the state’s interest in Pinnacol Assurance, a state-chartered workers’ compensation insurer, as it keeps an eye on a projected $1.8 billion budget deficit. In 2009, legislators debated taking $500 million from Pinnacol’s $700 million surplus to help balance the budget, although the proposal never passed. Pinnacol has more than $2 billion in assets.

In Oklahoma, a measure that would make the state Insurance Department a standalone entity passed the state Senate Appropriations Committee. Taking away appropriations from the agency and making it self-sufficient could save the state $2.5 million in funding that could be used for other services such as transportation, education and public safety, said Sen. David Myers, author of the bill.

In Hawaii, state legislators are evaluating a proposal to use $50 million from a Hurricane Relief Fund worth $180 million to pay teachers who are currently out on furloughs. While Insurance Commissioner J.P. Schmidt is against the idea of using the fund that’s been set aside to aid residents in a major hurricane, many think it’s not unreasonable to put education ahead of an unknown disaster.

The Direct Impact on Agents and Brokers
Yet perhaps the most worrisome aspect of increasing state budget deficits are the direct outcomes they are having on insurance agents’ and brokers’ livelihoods. As states find they have less funding available for infrastructure projects, construction will continue to slow. Agents who provide coverage for the construction industry will find their revenue stream shrinks as well.

“Those that do commercial lines, and especially anyone that has a large contractors’ book, has had a really tough time because a number of contractors have severely cut back on the number of buildings they’re involved with, if not gone out of business,” said Daniel Holst, executive vice president for the Independent Insurance Agents & Brokers of Washington. “It’s definitely a scary time for just about everybody in Washington and probably most other states because we’ve had budget shortfalls, because we’re basically bringing in less taxes than we were before, because less is being sold and more people are being laid off.”

As insurance agents and brokers discover that smaller state and municipal budgets lead to less revenue, they might also see states taking a bigger bite out of their profits. While spending cuts are often implemented first to relieve shortfalls, to date more than 30 states have raised taxes to at least some degree, the Center said.

Holst noted that as Washington struggles to balance the budget in 2010, state legislators are looking at extending a business and operating tax on professional services, which would include such professions as attorneys, stockbrokers, and insurance agents and brokers. While such a tax is not ideal, the bigger concern is how the tax is structured. If insurance agents and brokers are taxed but are restricted from passing along the tax to customers, then insurance agents’ and brokers’ livelihoods will be threatened, Holst said.

“If they’re taxing the very thin margins that we are making from commissions and fees, then that’s a real problem,” he added. “Because unlike attorneys and others who can just basically change their fee structure and start charging more to cover their additional cost of doing business, because we’re paid through commission that’s filed through the state and set by our companies, we don’t have the luxury of changing what we charge our customers. So that’s where it really is very scary for agents and brokers.”

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