I had an interesting conversation the other day with a freelance journalist who writes about parenting topics for a national magazine. We were discussing disability insurance. According to the Society of Actuaries, working Americans between the ages of 25 and 65 years old have a 1-in-5 chance of becoming disabled for a year. Experts recommend having coverage to replace 60% of your income. But what about the value of the work performed by someone who has no income? Imagine that a full-time homemaker becomes temporarily disabled. Her family would incur the expense of replacing the services she provides for free: caring for children, cooking, housekeeping, etc. Many families don’t take the value of those services into consideration when they make their financial plans. Don’t make that mistake. Ensure that your savings plan contemplates the value that both parents bring to the family, not just the parent with earned income.



California Governor Arnold Schwarzenegger signed into law the California Low Cost Automobile Insurance Program, which provides affordable liability coverage for low-income drivers with good safety records. The intent behind the program is to facilitate compliance with California law requiring that all drivers be insured. The California Legislature concluded that low-income drivers violate the law as the cost of compliance is prohibitive.  The California Automobile Assigned Risk Plan administers the program, but private insurers underwrite policies.  As with most initiatives, the intent is good, but we are rapidly crowding out the private sector at a time when California is broke. Remember the Robert Plan and other such insurance ventures from the 1990’s? They figured out how to insure non-standard motorists in the private market. We need some private sector innovation.

It Doesn't Add Up

USA Today completed an analysis demonstrating that insurance markets in the states most vulnerable to natural disasters are on dangerously shaky ground. More than half of our states have state-sponsored insurance plans, dating back to the 1970’s when private insurers stopped underwriting properties in high-risk areas, such as inner cities. After Hurricane Katrina inflicted unprecedented losses in 2005, private insurers reduced their market exposure in the affected states. Abandoned policyholders then fell into the state plans, which began to assume unprecedented liabilities. Since Katrina struck in 2005, the value of property covered under the eight coastal state insurance plans from North Carolina to Texas has doubled from $316 billion to $632 billion. But while private companies are required to maintain reserves sufficient to pay expected losses, the states exempt their own plans from such laws. The result is that the state plans have inadequate reinsurance (third-party capital to backstop their risks) and unfunded liabilities. The eight coastal state plans from North Carolina to Texas have only $6 billion in cash reserves and $11 billion in reinsurance coverage. Should a major hurricane strike, the state plans would have to raise assessments, which are effectively taxes on private policyholders to subsidize the policyholders in the state plans. But even under the most aggressive assumptions, the assessments would not be sufficient to pay claims.

Consider that Citizens Property Insurance, Florida’s state plan, reported that it insures property worth $433 billion. For losses in excess of $15 billion, it would have to levy assessments against state residents carrying any type of policy, from auto to liability insurance, that add 16% to the costs of their premiums, which are already quite high. Texas isn’t in much better shape. Its state plan insures property worth $73 billion along the Gulf Coast (remember, that is just a tiny geographic sliver covering Galveston), but has only $150 million in cash and no reinsurance. Surcharges can generate an additional $2.5 billion to pay claims, but that is it.  Last week, I blogged about the temporary extension of the National Flood Insurance Program, which had expired three times this year. Our liabilities are simply too massive for us to continue this self-deception. We must stop the short-term fixes, Band-Aids and wishful thinking and start serious planning for our financial future.

A whistle blower lawsuit filed against the Allstate Insurance Company alleges that the company inflated the amount of flood losses sustained by three clients in connection with Katrina-related homeowners’ insurance claims that Allstate had disputed. The whistle blower is an attorney who represented the homeowners and reports direct knowledge of the allegations, asserting that Allstate fabricated insurance documents to shift its own claims obligations to the federal government. Flood losses are not covered by a standard homeowners policy, but instead are covered when the government’s National Flood Insurance Program provides insurance. Although the whistle blower lawsuit was filed more than three years ago, Allstate was just informed of the matter last week. The whistle blower filed the suit of the government for which he seeks three times the amount of fraud losses plus civil fines and legal expenses. The case will be heard in New Orleans. While the facts of the case have yet to be determined by the court, it is clear that the existence of a government-funded program provides incentives for cost-shifting at taxpayer expense.

Moody’s Weekly Credit Report took an in-depth look at the U.S. insurance market. Catastrophe losses for the first six months of this year remained stable at $7.9 billion as compared with $7.7 billion for the same period last year, but still above the $6 billion average over the past ten years. Moody’s writes that while there has not been a severe natural catastrophe in 2009 and 2010 to date, “the underwriting margins of many industry players, particularly those with property coverage concentrations, have suffered significant aggregate losses because of a sharp upswing in the frequency of low-severity perils including tornados, winter storms, hail and covered floods.” In 2010, we have seen epic floods in Tennessee, severe hailstorms in Oklahoma and diverse tornadoes, including those in low-risk areas such as Southern California and New York City.

“In the past, losses from non-hurricane weather-related events were less volatile, allowing insurers to charge sufficient premium to offset exposure to these perils,” Moody’s wrote. “But this recent uptick in volatility is problematic for insurers given the thin underwriting margins in what is largely a commodity business, particularly in the homeowners segment.”  Insurers are also assuming more of these losses on their own balance sheets, Moody’s noted. “Although insurers typically purchase reinsurance protection for hurricanes and earthquakes, these small-scale weather-related losses tend not to trigger reinsurance protections.” As the cumulative effect of these low-severity events is catching up with insurers, it is not surprising that they should respond by filing for rate increases on their homeowners’ coverage. Expect them to follow suit for commercial rates. If you can renew your coverage before rates increase, you would be wise to do so.

Future Vision

In the first six months of this year, the State of Vermont licensed 17 new captives. The strongest interest comes from the financial services sector, with five captives formed by insurance companies and two by banking companies. Captive insurers offer a cost-effective means to self-insure the risks of their corporate parents. By insuring the risks themselves, large corporations benefit from more favorable tax treatment as well as the possibility to retain better risks rather than pay premiums to cede the risks to a third-party insurer. Vermont is the largest captive insurance domicile in the United States, offering foreign companies the ability to use their local rules in accounting for their captive insurers, as well as a streamlined formation and approval process. Last year, more than $75 billion of captive insurance premiums were written in Vermont, which volume seems likely to increase this year.

So what does this mean for the small business community? Increases in captive formation typically signal expectations of insurance rate increases. Significantly financial institutions represent most of the Vermont captive formations. With the litigation around the financial crisis, directors’ and officers’ coverage is expected to rise in cost. Small businesses should prepare for future rate increases and, if possible, negotiate renewals now.

A rare treat will be offered to those who happen to be in London this Saturday, the 18^th of September: the opportunity to visit the Lloyd’s building. This year Lloyd’s is participating in Open House, London’s celebration of architecture to welcome the general public to visit over 600 buildings across the city, many of which are ordinarily closed to the public. The tours are offered free of charge.  I had the fun of seeing the building when the head of one of the largest managing general agents at Lloyd’s took me on a one-on-one tour to see the Underwriting Room, the Nelson Collection and the Adam Room. I also enjoyed a fantastic view of London from the external glass elevators. Then I observed the process of running a slip to bind an insurance cover, which illustrates the speed and flexibility of what is not only the world’s largest and most entrepreneurial insurance market.

Lloyd’s began in a 17^th century coffee house and grew rapidly to meet the increasing demand for ship and cargo insurance required for global trade. Today Lloyd’s is the leading global provider of specialty cover, such as marine and aviation insurance. On one of my recent trips to New Orleans, I met business owners who were insured by Lloyd’s when Katrina struck. Those of us who won’t be in London on Saturday can take the online virtual tour at the Lloyds website.

A Peek Into the Future

In the first edition of Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses (Wiley, second edition paperback, 2009), titled Contingency Planning and Disaster Recovery: a Small Business Guide (Wiley, 2002), I wrote to explain how, in the aftermath of a major disaster, insurance premiums rise. However, large corporations eventually reach their threshold for pain and adopt self-insurance, captive and other programs to reduce their costs (p. 171):

Large corporations will become increasingly unwilling to pay such steep insurance premiums and will develop innovative means of insuring their risks. We have seen this phenomenon before, beginning in the 1980’s with the development of the so-called alternative risk transfer market (ART). ART offered a portfolio of tools by which corporations could transfer their risks by means other than standard commercial insurance programs. One such tool is a captive insurance program whereby large corporations insure their own risks through wholly owned insurance companies. They were typically domiciled offshore, in places such as Bermuda and the Cayman Islands, to benefit from the favorable tax treatment and fewer regulations. Captives allow corporations the benefit of tax-deductible premiums to cover their risks while ensuring that profits on the program remain in-house.

Now, some interesting news from Vermont, the leading jurisdiction with laws friendly to establishing U.S. captive insurers. In the first six months of this year, Vermont licensed 17 new captives, with a great deal of interest reported by hospital groups seeking coverage for their professional medical liabilities and financial services companies that face premium increases for their directors and officers liability coverage.

Many market analysts believe that this is a defensive measure in anticipation of further premium increases, in which case the insurance market, where small businesses have relatively little bargaining power, is about to get tougher for us. As I am an optimist, I would like to believe that as demand declines in the traditional market, as large corporations self-insure through captives, we will benefit from declining premium rates. Indeed, that it what I had argued in the first edition of the book. Unfortunately, the world changed with the 2008 banking crisis. I am with the market analysts on this one; I predict rising insurance rates, so if you have an opportunity to lock in coverage now for a multi-year period, it would probably pay to do so.

Massachusetts Congressman Richard Neal would like to impose taxes on foreign reinsurance companies and that means scarcer and more expensive risk capital for small businesses. Reinsurance companies are the ultimate providers of risk capital as they back-stop the risks of primary insurance companies. Consider what happens when a hurricane strikes Florida, for example, causing $10 billion in insured losses. The insurance company likely has reinsurance protection in place to spread the risk, thereby increasing capacity and lowering costs. If the insurer had to bear the losses itself, it would have less risk capital to underwrite policies. Imposing a special tax on reinsurance raises its cost, making insurance less affordable to small businesses. Any reduction in reinsurance capacity increases the vulnerability of communities particularly prone to catastrophic risks, such as coastal communities and large cities. Foreign reinsurance providers are of particular concern to the small business community as they provide two-thirds of the reinsurance coverage purchased by U.S. property-casualty insurance companies. We rely on foreign capital to make our economy hum. Imposing a discriminatory tax on reinsurers is counterproductive for the U.S. economy and its small businesses.

Better Numbers, But...

This week the property-casualty industry reported some good news and some bad news. According to the ISO and the Property Casualty Insurers Association of America, the industry returned to profitability, reporting a 6.7% return on policyholder surplus for the first quarter this year, a marked improvement from the 1.2% loss from the first quarter of 2009. The industry-wide results would have been even better, but for steep losses reported by mortgage and financial guaranty insurers.

“This is further proof that home, auto, and business insurers are fiscally sound, that we have been strong and stable throughout the economic downturn of the last two years, and that we are able to pay claims to policyholders during their times of need,” said David Sampson, PCI’s president and CEO. “With experts forecasting an active hurricane season, the $102.9 billion increase in policyholders’ surplus from $437.8 billion at the end of first-quarter 2009 to $540.7 billion at the end of first-quarter 2010 provides us all with an extra measure of confidence that insurers will be able to fulfill their obligations to policyholders when the wind blows. Nonetheless, it only takes one storm like Hurricane Ike in 2008, Hurricane Katrina in 2005, or Hurricane Andrew in 1992 to disrupt millions of lives and cause tens of billions of dollars in property damage. And this means now is the time for all of us — insurers, businesses, public safety officials, elected leaders, and the general public — to prepare for hurricane season to minimize the human hardship and economic loss in the event of a natural catastrophe this year.”

But the news isn’t all good, either for the industry or the businesses they insure. The property-casualty insurance industry returned to profitability, despite continuing declines in premium volume. Premium volumes have declined for twelve consecutive quarters.

“The 1.3 percent decline in net written premiums in first-quarter 2010 reflects the ongoing consequences of a once-in-a-generation economic storm. In first-quarter 2010, seasonally adjusted total private-sector employment fell 2.7 percent compared with its level a year earlier, private-sector wages and salaries dropped 1.4 percent, and the average unemployment rate rose to 9.7 percent from 8.2 percent in first-quarter 2009,” said Sampson. “This challenging economic environment reduces demand for insurance. Nonetheless, our industry remains stable and is financially well positioned.”

I am concerned about declining premium volumes. Understandably, businesses and consumers are looking for ways to reduce expenses in this difficult economy. But foregoing insurance coverage may be shortsighted. I have met homeowners in Rhode Island who stopped their flood insurance once their mortgages were paid off, only to suffer major financial losses when the record floods struck the state earlier this year. If you are buying insurance only to satisfy a lender’s requirements, you need to seriously reconsider your risk management strategy. An uninsured loss will only increase financial stress and it will be too late to go back and reinstate insurance coverage retroactively.