TCAIS Insider

Texas Coalition for Affordable Insurance Solutions

March 9 , 2007

Insurance Financial Strength Good for Texans

Texans need to be able to count on the financial strength of the insurance company they’ve trusted to pay their claims in the event of a loss. Financial strength to cover claims is a by-product of a healthy marketplace where consumers have choices and stability and regulatory predictability are commonplace. In some years, like 2006, financial strength is bolstered by insurance profits and contrary to some insurance critics, that’s good news for Texas insurance customers.

The Texas insurance marketplace needs to be profitable to serve Texas consumers and ensure availability of insurance in our state. Historically, insurers earn a profit about once every ten years. Some people get uncomfortable when insurers have a profitable year, fearful that big insurance companies just “pocket the money” in years when Texas is fortunate enough to avoid a natural disaster for example. That notion is a misconception.

When insurance companies experience a profitable year, profits contribute to a company’s financial strength as companies set aside funds to prepare for their customers’ future losses. It’s important to remember that insurance premiums collected today are not used to pay for losses that have already happened. Instead, insurers set rates based on data that helps predict their customers’ future losses.

During an unprofitable year, or a year with high losses, insurers have no mechanism to make up the loss. They can only rely on existing surplus to maintain strength to pay claims. In fact, the law requires insurers to maintain a surplus to back their customers’ policies. The surplus must meet a standard ratio to the number of policies an insurer carries. The larger the surplus, the more risk an insurer can take on, and the more policies it can write, therefore expanding insurance availability for consumers.

During profitable years, insurers have several options. They can use profits to shore up the mandated surplus to be used in the event of a catastrophe. Insurers can expand their surplus, which allows them to write more insurance policies, or they can use the surplus to absorb costs associated with lowering rates.

When considering insurance profits, data must be considered over time. Insurance profitability is properly viewed over a period of several years, not a single year’s performance. To be prepared for extraordinary events, insurers spread risk over a large number of people and spread risk over time. To be responsible to its policyholders and the marketplace, insurers must price in a manner that recognizes the risk, realized or not, in each individual year. Over time, such careful pricing yields a more stable market with the financial strength to pay claims when risk inevitably becomes reality.

Since insurers don’t set rates to recoup losses of the past, it can take a decade to recover from a single catastrophe. For example, it took insurers 11 years (1993-2003) to erase the underwriting loss associated with Hurricane Andrew. The four hurricanes of 2004 erased the prior 7 years of profits. Homeowners insurance claim payments resulting from the 2005 hurricanes in Louisiana equaled all homeowners premiums paid in the state during the past 25 years and every bit of homeowners insurance profits ever earned in that state.

Without question, 2005 was by far the worst year ever for insured catastrophe losses in the U.S., with $62 billion in losses. The 2006 respite in hurricane activity allowed insurers to rebuild their claims paying resources.

The Texas reprieve from a hurricane in 2006 brings danger in other areas. The threat comes when a single year of profitability triggers misguided regulatory responses to short-term profits. Short-sighted reactions create the kind of insurance crisis Texas experienced before recent insurance reforms began to heal the marketplace and premiums began to come down. In fact, Texas history is replete with examples of unwise regulation and reactionary rate regulation, which all damaged the Texas market. Consumers have borne the burden of such public policy in the form of rate shock and severe availability problems. Jumping to regulatory reaction based on one year’s profit is not only bad for consumers and the marketplace, but also unnecessary. Texas has significant financial regulations and stringent consumer protections that specifically guard against unfair or unwarranted profits.

Indeed, insurance competition is emerging, but we still have a long way to go to strengthen the insurance climate in Texas. The marketplace needs a long-term balance of profit and loss to build a strong foundation. A good insurance climate is particularly important to Texas, precisely because of its difficult natural climate. Policymakers and experts agree that Texas is a high-risk weather state both on the coast and inland, and must improve its financial position to handle that risk.

Texas policymakers should continue to be wise and measured in their approach to the Texas insurance marketplace so that Texans have the kind of healthy insurance marketplace they need and deserve.

Sincerely,
Beaman Floyd
Executive Director, TCAIS