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July 5, 2014

New Regulation After a Disaster: More Harm Than Good?

Summary:

Insurers can't do their job if they're told the game is football -- then it becomes lacrosse. Policyholders lose, too.

This business of insurance requires a certain level of clairvoyance, and no one owns a crystal-clear crystal ball. What we do own is historical data on the impact and aftermath of large-scale disasters – and like most of what’s in the rearview mirror, that image is sharp yet fleeting. Some may forget the lessons of the last disaster too soon, while others cast past events into stone as the basis for managing future catastrophes. What’s worse, however, is when a disaster prompts knee-jerk reactions that do more harm to the market than good.

Just like anyone else, insurers need certainty that the rules put in place to manage risk, pay claims and protect policyholders won’t change unexpectedly and immediately after Mother Nature plays her game.

After a natural disaster, “Monday morning quarterbacks” both proliferate and pontificate. Some of this can be positive. In fact, staring down disaster and deciding not to be a victim twice often triggers community conversations that lead to infrastructure improvements to help prevent such a scenario from ever getting a replay. However, not all hindsight is helpful, particularly when the rules going into the “game of risk” are not the same rules in the immediate aftermath. Think about it this way: You’ve got a team that runs drills, budgets for expenses and asks players to follow a certain game plan in preparation for the big football game. But on game day, the team arrived on the field to discover it’s not football they are playing, but lacrosse.

Of course, most rules have elasticity. Yet when the rules of insurance are changed after a hurricane, tornado, earthquake or flood, what sounds like a consumer-driven move often has unintended short- and long-range consequences that are truly not consumer friendly.

States make the rules

Contrary to public perception, insurance companies don’t set the rules. State legislators and regulators make the rules, which are codified within state statutes and the insurance contract. While the magnitude of recent disasters has made them game-changers, more often post-disaster moves result in actions that make it hard to figure out if anyone wins.

The most recent example is Superstorm Sandy. In New York, there were nearly 500,000 claims resulting from the October 2012 storm. Yet regulators mandated that claims adjusters needed to inspect properties within six days, rather than the 15 days that was in the rulebook before the storm. That may not sound like a big deal, but insurers weren’t handling Sandy claims in New York alone. There were almost as many claims in New Jersey and more than 60,000 claims in Connecticut. Getting to New York claimants faster made sense to New Yorkers, yet it sapped resources from deserving claimants in other states who also needed prompt attention.

Each state understandably, and admirably, wants to take care of its own. But in the immediate aftermath of a multi-state disaster, a stampede of mandates may be as disruptive as the disaster itself.

Policyholders pay the price

Unexpected requirements to hurry up the claims process puts speed at odds with thoroughness. That does not just mean the process is sloppy; rushing to close out a claim also raises costs. After Sandy, there were instances when insurers felt forced to pay out more in claims than what was warranted under the terms of the insurance contract. Insurers want to pay what they owe. No more, no less. Paying more than what is owed raises costs for everyone who was fortunate enough not to sustain damage. While getting more claims money sounds great from an individual claimant’s perspective, these additional, sometimes unwarranted, claims payouts are factored into determining surplus requirements for the next disaster. That makes all policyholders pay the price.

Insurance companies want to settle claims quickly. It’s in our DNA. There is little upside to drawing out the process when cause and effect are clear. But pushing speed over practicality is expensive for consumers and insurers alike.

Another program promulgated post-Sandy by both the New York Dept. of Financial Services and the New Jersey Dept. of Banking and Insurance was an emergency measure requiring mandatory participation by insurers in the mediation of non-flood claims if there was a claims dispute. Policyholders had to request mediation; insurers had to pay for it. It was a well-intentioned idea to keep litigation costs in check. The process was voluntary for policyholders, mandatory for insurance companies, and confusing for everyone. Because it was rolled out after the storm, there were a wide variety of interpretations of the process. Some people who were satisfied with their claim thought they had to attend a mediation. Storm survivors without flood insurance thought they had a chance of compensation with mediation. Don’t get me wrong: Mediation is a great option, and many other states have similar programs. However, quickly making a new program mandatory, without proper vetting and understanding by all parties involved, can make things more confusing than they need to be – particularly post-disaster when less confusion is what is needed.

Catastrophic events bring large losses, which causes insurers to review their underwriting performance. The only natural disaster that we can reasonably predict is a hurricane, and even before anyone knows exactly where a storm will make landfall, insurers review their portfolio of risk and determine how they’ll respond when the sky calms. Often, insurers will reevaluate their market position, which can lead to requests for rate increases, changes in coverage options, adjustments to terms and conditions and even making decisions to adjust their exposure in the market. These seemingly prudent moves aren’t easy to do and are made more complex after large-scale disaster.

After Sandy, New York regulators toyed with the idea (and rejected it) of restricting insurers from non-renewing no more than 2% of their book of business per territory. The current non-renewal limit is 4% on a statewide average. That’s not unlike forcing someone to put a purchase on their credit card that they know they can’t afford. Insurers decide to enter a market – or expand there – based on the rules and regulations currently in place. Where there is a pattern of restrictive, sudden rule changes post-disaster, few companies would choose to invest more capital there.

If an insurer decides to retreat from or exit a market, it’s not personal – it’s prudent. Restricting the ability to adapt to changes in risk exposure makes the market constrict. Florida’s experience is the test lab, if anyone is in need of proof.

The whole market suffers

The severity of losses following Hurricane Andrew in 1992 caught everyone by surprise. And, the resulting market crisis got worse when the insurance industry got bushwhacked. During a special session in 1993, the Florida Legislature imposed a six-month moratorium on cancellations and nonrenewal of personal property insurance policies. Then, things got worse. The moratorium was followed by a three-year phase-out plan that allowed an insurer to non-renew only up to 5% of its property policies within a 12-month period. That meant insurers were required to continue providing coverage at rates below what they needed. Yes, it was more than two decades ago, and we have long, painful memories and existing residual damage to show how those actions forced companies to remain strict on underwriting, even today. States that have imposed exit restrictions in the past may find that insurers do not want to enter or grow their business in the future.

It’s not only insurers that suffer financially from unanticipated actions. State resources suffer, too. In another special legislative session, the Florida Legislature changed the rules governing hurricane deductibles. Some people had the unfortunate experience of being hit by more than one storm during August and September 2004. To alleviate the financial hardship those storm victims were experiencing, the Legislature nixed the per event hurricane deductible and passed a law requiring only one annual hurricane season. The change cost the State of Florida money because reimbursements for multiple deductibles came from the Florida Hurricane Catastrophe Fund – the fund providing reinsurance for all insurers doing business in the state – reducing its assets by millions of dollars.** It cost all taxpayers dearly, including those who had no storm damage.

Unlike most other states, Florida’s largest insurance carrier is the state itself. Citizens Property Insurance Corp. was designed to be a state-run insurer of last resort; however, the company experienced tremendous growth following the 2004/2005 hurricane seasons when multiple storms hit and private insurers once again reevaluated their portfolios. The retreat was compounded by the fact that, in many areas of the state, Citizens was charging below market rates. The gap has been narrowed significantly in recent years, but it still exists.  The politicization of insurance in Florida is what made Citizens grow into the ninth largest insurer in the U.S. in 2012. Among the top 10 writers of insurers nationally, Citizens is the only insurer with all its business – and all its risk – in a single state.

Typically, insurers are expected to raise rates following a natural disaster if what happened seems to show that there is a greater chance for such an event to occur again. Florida’s hurricane history demonstrates it’s either boom or bust for insurers, and many carriers have posted losses even in the years that are hurricane-free.

Making sense out of chaos

Natural catastrophes are called disasters for a reason. It’s organized chaos – and sometimes, it’s unorganized chaos. To try to get their arms around the enormity of an event, regulators ask for claims data from carriers – and the thinking seems to be that more data is always better. The truth is that more data is expensive and time consuming to collect, especially when the requests entail delving into files that may not be catalogued in a format that insurance departments demand. Providing information for data reports is often not optional, and what regulators ask for after a major event is as changeable as the weather. Following Sandy, New York regulators made one-time data requests and gave insurers only a few hours to respond. Requests such as these could mean that the important work of handling claims gets delayed while employees have to divert their attention from taking care of people to taking care of paperwork.

Property insurance markets do benefit from regulation, but rules that change like the wind don’t help.

Natural disasters trigger emotional responses, and those responses are helpful in that they drive volunteers to show up to give both financially and physically to start the recovery process. But it’s the rational responses that bring the economic resources necessary to rebuild after disaster. The very rational action of paying claims that are owed is a responsible way to fulfill the parameters of the insurance contract in place at the time the disaster occurred.

What lawmakers and regulators should know is that working according to predictable outcomes is the key to balancing the needs of policyholders and businesses focused on recovery, and insurance is one of those businesses. There will always be multiple points of view, as well as numerous options. But disaster response and recovery should not be viewed as opposing forces protecting self-interest. Our collective focus should be on agreements in advance that serve everyone in the best way possible, knowing that the real risk and true costs of natural disasters remain unknown.

As we enter yet another hurricane season, it’s worthwhile to take a look at both market reaction and regulatory mandates that have proven to be, in effect, another disaster in the making.

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About the Author

Robert P. Hartwig is president of the Insurance Information Institute. Since joining the I.I.I. in 1998 as an economist and becoming chief economist in 1999, Dr. Hartwig has focused his work on improving understanding of key insurance issues across all industry stakeholders including media, consumers, insurers, producers, regulators, legislators and investors.

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