Posts Tagged ‘insurance’

Running Naked

Wednesday, December 30th, 2009
I Photographed This Sign at the San Diego Border Crossing

My Photo of the San Diego Border Crossing

“Running naked” refers to the decision to forego insurance for known risks. It is an increasingly popular strategy among states experiencing budget constraints. But it is risky. Pre-financing a natural disaster through insurance is more cost-effective than financing recovery but for governments with falling tax receipts, the temptation to forego insurance arises if probability of a natural disaster is low. Funds spent on insurance premiums are not recoverable, which could lead to regret when funds are diverted from other programs for insurance coverage and the storm season proves mild. To save resources following the credit crisis, states are cutting public reinsurance programs to save premium expense. For example, less than one year after reinsurers paid $1.5 billion in claims related to Hurricane Ike, Texas opted out of its reinsurance program to save premium expense. California soon followed.

Governments typically fund emergency and relief efforts and rebuild public infrastructure after a disaster by issuing debt, raising taxes or reallocating funds from other budget items. These alternatives are considerably more expensive than pre-financing risks, but the states are presumably gambling that the federal government will bail them out in the event of a major natural disaster. European governments have also been cutting their pre-disaster risk bills to alleviate budget strains. But the gamble may not pay off. The U.K. this year experienced unexpected flooding in some parts of central and western England. In any given year, 30% of floods occur in regions that have no prior history of flooding, making the choice to forego insurance a risky one.

Ironically, developing countries are moving in the opposite direction. They face considerably greater challenges, such as the awful trade-off of limited resources and compelling needs to invest in education, health and other infrastructure. To resolve these competing interests, the World Bank structured its MultiCat Program to allow countries to purchase cost-effective coverage through the capital markets for various threats, including floods, earthquakes, hurricanes and windstorms. The first such program was structured in Mexico.

Will the bet pay off? Should a major disaster strike California or Texas, residents of those states will face onerous tax increases if they cannot persuade the federal government to bail them out. But even should the U.S. be lucky enough to avoid a major catastrophe, we are at risk of ceding the lead in financial innovation to other countries.

It Adds Up

Tuesday, December 29th, 2009


At a recent small business event, I had the pleasure of being seated next to a chapter director of the National Hispanic Chamber of Commerce. Over lunch she shared with me her own insurance disaster, which illustrates the importance of good record-keeping – a costly way of learning a lesson! She collects Lladro figurines. Over 30 years of marriage, her husband would give her gifts from Lladro for commemorating special events: their wedding anniversary, Valentine’s Day, her birthday and Christmas. Lladro figurines are handcrafted in Spain and cost several hundred dollars each. Some of the figurines she has collected are irreplaceable as they are models that are no longer in production. And of course, their sentimental value is incalculable as they represent precious memories with her husband, who passed away. She had the figurines prominently displayed in a glass curio cabinet in her living room. She lost her collection when her home was burglarized. Unfortunately, she did not calculate the value of her collection in her coverage limits for her homeowner’s insurance. Nor did she endorse the collection or document the assets with videotape or photography, for example, or sales receipts. Over 30 years, that collection had become quite valuable, so in addition to the emotional distress associated with its loss, there is a significant financial loss as well. It is an all too common mistake to neglect to update asset values or to underestimate the value of non-traditional assets. I chided Stefan, our IT guru, for this very oversight. He had purchased a state-of-the art stereo system at a retailer’s bankruptcy sale for a ridiculous price. But in the event of fire, theft or other loss, he would never be able to replace that asset for what he had paid for it. It is not covered in his insurance policy, yet he insures his automobile, which is worth far less. I use the New Year as an occasion to update my business and home records to ensure that my insurance records are up to date. Please do the same – it will give you peace of mind.

Without Precedent!

Wednesday, May 27th, 2009
Unusual Case

Unusual Case

In Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses (John Wiley & Sons Inc., second edition, 2008), I wrote that the cash flows of an insurance operating company could not be diverted for other corporate purposes, thus providing some security for the policyholders. Last week, lawyers representing a group of policyholders of American International Group Inc. (AIG) filed a lawsuit in California Superior Court against the company, its executives and its auditor, PricewaterhouseCoopers. The policyholders allege that AIG had improperly diverted capital from its insurance operating companies, thereby undermining the critical asset for claims payment. State insurance commissioners are supposed to prevent this from happening; specifically, holding companies cannot extract capital from their insurance subsidiaries, no matter how much pressure they are under. However, the policyholders who are plaintiffs in this lawsuit alleged that AIG had pledged the cashflows of its insurance subsidiaries to repay the Federal Reserve Bank for the government bailout funds. This is absolutely without precedent and raises some troubling questions with respect to the regulatory responsibilities of the state and federal governments.  I will be following this case with great interest.

Unintended Consequences

Friday, March 27th, 2009
Bureaucratic Interference

Bureaucratic Interference

In Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses (Wiley, second edition, 2008), I sought to explain the economics of the insurance cycle. Cash flow underwriting was, until recently, one of its defining features. Cash flow underwriting essentially involves pricing risks below the actuarially expected losses with the expectation that gains on the investment portfolio will bring the insurance operation to profitability. In essence, insurance companies collect premiums from underwriting risks and invest those premiums from which to pay claims and expenses. In the first edition of the book, I advanced the controversial argument that insurance premiums rose dramatically following 9/11, in part, because insurance premiums had been too low. High rates of return in the stock and bond market allowed insurance companies to underwrite business below the actual price of risk. The advantage of doing so was to preserve or gain market share in an environment where insurance was viewed as a commodity and providers competed almost exclusively on the basis of price. The downside to this practice of course, is that we have more volatility in the pricing of insurance risks, particularly commercial insurance and we have to think more carefully about the solvency of insurance companies with these pricing for market share strategies. Unlike the discount retail store, which closes a transaction with the sale of the product, the insurance company has to remain in business for years or decades to come to pay future claims.

Now with the federal government bailout of AIG, we have an interesting situation in respect of the cash flow underwriting dilemma. According to the Wall Street Journal, at a recent meeting with Federal Reserve Chairman Ben Bernanke, insurance executives complained that AIG was using its federal government money to cut prices and buy market share, thereby harming competitors and destabilizing the industry. Of course, as small business owners, we all want low prices, but we also want financially solvent insurance carriers. The federal government bail out of AIG introduced an element of moral hazard that our policymakers failed to anticipate. Of course, AIG may be responding to market pressure to retain business in the face of uncertainty about its future. But should their insurance premiums be inadequate to cover their insured risks, the stage is set for yet another bailout and a very vicious circle for taxpayers and policyholders alike. It is an insightful article and I commend the Wall Street Journal for its reporting.

Leveraging Strength for Ike Evacuees Returning to Galveston

Wednesday, September 24th, 2008
Welcome home

Welcome Home

Evacuees returning home to Galveston are just now seeing the devastation inflicted on their homes and businesses by Hurricane Ike. Undoubtedly, they are feeling overwhelmed by the recovery process ahead of them. Having been through a version of that process myself, I can offer words of hope and advice.

First, leverage the strength of your insurance company. Let me explain how that can work in your favor. I returned home to my apartment in the shadow of what used to be the World Trade Center after our neighborhood was closed and evacuated on 9-11-01. For several months I had been homeless as our neighborhood remained under the control of the National Guard, although during that time period, I was once allowed to return home for a half-hour, with a Guardman, to retrieve some personal effects. The Guardsman took neighbors into apartment buildings (once we produced our New York driver’s licenses proving our residency) in groups of five or six. When I came back for good, I contacted an environmental remediation company to remove the soot, ash and other contaminants from my home and my office. The project manager with whom I had spoken said that it would be “months” before he could send a staff person to my property to give me an estimate to perform the work, let alone actually start the work.

I asked if someone could come in the evening, after business hours. The answer was no. I asked about early mornings, before business hours, or on the weekend. The answer was no and no again. With relatively few companies certified to do this work and many thousands of people demanding these services, the queue was very long. And yet this was the critical task before I could safely return home. So I called my insurance company. I hoped that this would be the only major disaster that I would ever have to work through and I would never have to deal with an environmental remediation company again. But insurance companies deal with environmental remediation companies all of the time. They approve payment for these services for their policyholders. They can choose remediation companies as their preferred vendors for certain types of work. So the insurance company had the leverage that I did not.

I explained to the person who answered my insurance company’s CAT line (“CAT” is insurance speak for “catastrophe”) my situation and reminded her that the longer it would take to remediate my home, the longer I could remain in a hotel, which expense was covered by my homeowner’s insurance. She got the point. A few minutes after we concluded our conversation, my cell phone rang. It was the project manager from the environmental remediation company, the same man with whom I had spoken only minutes ago. He advised me to be at my apartment at 7:00 a.m. the next morning so that I could let his team in. At the time I was displaced, I was staying in Jersey City across the Hudson River from Manhattan. Most people commute to Lower Manhattan from Jersey City by the PATH train, but with the World Trade Center PATH train terminus destroyed, we had to take ferry routes that were put in place on an emergency basis. The routes and timetables changed from day to day, as the recovery was underway, so it could take some time to get from where I was staying to my home. Obviously, the project manager didn’t want to waste a trip to my apartment if I could not be there. “Oh,” I said, “you can have someone visit and give me an estimate tomorrow morning?” No, he answered, the insurance company called him on my behalf and he would have a team there to do the cleaning at 7:00 the very next morning.

Some of my neighbors spent months dealing with long waits and negotiating their spot in the queue. This is why you pay for insurance, so get full value for it. By the way, I recommended this tip to someone whose mother lived in Florida through the 2004 hurricane season when she was in the same situation (months and months to get an estimate before any work could be done). He reported that it worked for her as well. Another lesson I learned from 9-11 is that vendors often present the worst-case scenario in terms of service restoration because they would rather err on the side of caution. Then, of course, they look like heroes if they can restore service in a more reasonable time frame. I remember contacting my telecommunications provider to find out when landline service would be restored and was told that it could take months. It was back within two weeks. Bear this in mind when vendors are giving you bad news and don’t let it discourage you.

By the way, the photograph you see here is of the lobby of my apartment building upon our return home when civil authorities re-opened our building. It was quite an experience to return home after an absence to see what had happened to our neighborhood. This is undoubtedly the stress that residents in the footprint of Hurricane Ike are now experiencing.