Insurers' Right—and Duty—To Say "No!"
June 2007
Insurance, correctly understood and conducted,
is a long-term enterprise. Therefore, as risk management professionals, we recognize
that insurance can fulfill its basic purpose of providing funds to indemnify
policyholders for their individually unpredictable losses only if the enterprise
is firmly grounded on a foundation that includes: premiums which are equitable,
adequate, and reasonable; and efficient overall operations.
by George
L. Head, Ph.D.*
Properly managed, insurance generates reliable funding that efficiently stabilizes
the costs of restoring policyholders' losses from short-term crises. For long-term
crises, such as global warming or a famine, the variables within the insurance
mechanism still apply but may need to be adjusted. The ability to adjust—and
to recognize when adjustments are needed—are among the many strengths of the
private insurance enterprise.
Thus, insurers must take the long view, building—and then maintaining—the
stability of their enterprise when crises arise. These crises, especially ones
as devastating as Katrina, may alarm the public and stir politicians and other
leaders of public opinion to demand "quick-fix" changes that threaten these
foundational elements of our industry. Property-liability insurance professionals
have an ethical obligation to our industry, as well as to each policyholder
whose future we should protect, to resist political pressures that would erode
the time-tested practices through which insurance has proven its worth.
Saying "No" to unwise proposals for drastic overnight changes in our industry—whether
these proposals come from a panicked public, from opportunistic politicians
and clergymen, or from lawmakers and other public figures who generally have
no true grasp of the actuarial and financial principles of managing risk—takes
courage.
Keep or Restore Equitable, Adequate, and Reasonable Premiums
Basically, and except for differences in size, all the insureds in any given
rating class are presumed to be identical. Therefore, despite fluctuations over
the seasons and the years, the aggregate premium (plus investment earnings)
an insurer receives from the insureds in each class should, on the average over
time, be sufficient to pay the covered losses, the insurer's operating expenses,
dividends and additions to surplus, and any anticipated underwriting profits
for that class. This long-term model for insurance in a world that, despite
unpredictable daily and even yearly fluctuations and other events, is essentially
stable.
But occasionally, as with Hurricane Katrina or with the urban riots that
spawned FAIR plans in the 1960s, someone who lacks insurers' distant vision,
skills, and resources seizes the public's attention with cries of, "The sky
is falling! The sky is falling!" trying to convince the public that the fundamental
principles of insurance can no longer protect them in this tumultuously changing
world. In such troubled times, insurance professionals have a right, indeed
a duty, to object with a firm "NO!"
Nothing is suddenly fundamentally faulty with the core logic and time-tested
procedures of insurance. As risk management professionals, we have a right,
an ethical duty, to say this to anyone who would discard the fine underwriting,
rate classification, and loss-reserving mechanisms our predecessors have laid
down.
Promote Efficient Insuring Operations
Beyond speaking out in support of the essential wisdom of classical insurance,
risk management professionals need to demonstrate that our traditional insurance
techniques will still work when disasters strike. Given how our federal and
state governments have handled Katrina, this should not be difficult. But speaking
out clearly and confidently—whether to a panicked public whose yet-unrepaired
properties have been ravaged by a regionwide hurricane or to irate politicians
and preachers who understand all too well how to seize the public's attention—requires
courage.
Rather than trying to establish a uniform national rating system that would
have Midwestern farmers pay higher premiums to cover Gulf Coast's homeowners'
Katrina hurricane losses (as some have proposed), our industry's traditional
practice of adjusting local and regional premiums to accumulate funds to pay
for local and regional losses will still work. It would be a mistake to try
to restore insurers' Katrina-ravaged reserves in 1 or 2 years, but these reserves
can be rebuilt readily in 1 or 2 decades. Further, as some insurers are painfully
learning, insureds rightfully protest when insurers try to replenish these loss
reserves by ballooning the very next year's premium charges. Again, we professionals
need to bear in mind that insurance is a long-term enterprise.
Another way to demonstrate that traditional insurance procedures remain valid
and practical is to apply regular property-loss adjustment techniques to those
Gulf Coast properties which have yet to be rebuilt after Katrina. As an industry,
we have allowed our politicians and other leaders of public opinion to halt
in Louisiana and elsewhere, the same loss adjustment procedures that successfully
restored Florida after Hurricanes Andrew and Hugo. If the government would stand
down, remove the legal and physical barriers that keep insurance adjusters out
of the New Orleans Lower Ninth Ward, and let these adjusters access its damaged
properties, restoration might be largely possible as it was with Homestead,
Florida, after Hurricane Andrew in 1992.
If our industry's decision is not to rebuild the Lower Ninth Ward because
there is too great a risk that future hurricanes will destroy it repeatedly,
then we should offer to permanently relocate its residents to safer areas. For
those who insist on staying in the Lower Ninth Ward, we should agree to insure
any rebuilt structures only if the policyholders agree to pay the much higher
premium rates their extreme hazard justifies. Matching premiums with hazards
is part of the real genius of the insurance enterprise. True genius should be
persevered, not abandoned, not even to the federal government.
Conclusion
This future—like the past—will surely bring more disastrous storms, floods,
and earthquakes, each wreaking destruction comparable to Katrina, to various
parts of our nation. But regardless of the particular regional peril, we do
not want the future to leave Lower Ninth Wards sprinkled throughout our nation,
festering in their own rubble, unrepaired by FEMA. Our industry has the resources,
the experience, and the wisdom—and I believe the courage—to repair what FEMA
cannot.
Having the courage to move forward will silence many of the critics who protested
that the insurers were trying to evade legitimately insured hurricane claims
by labeling them as uninsured flood losses. In retrospect, these critics were
largely wrong; for the most part, our industry was functioning as it should,
once we were given time to explore the true nature of the loss. Remember property-liability
insurance is not the Red Cross or one of the other emergency-based first-responders
to regionwide disasters. Insurance will finance recovery, but it needs time
to apply its principles for assessing losses and for forecasting those likely
to come. Based on these forecasts, we can adjust the premiums and the loss reserves
these probable future losses require.
Securing the future may call for some adjustments within our private insurance
enterprise. Abandoning that enterprise, tying to replace it with governmental
mandates, threatens to endanger everyone's—especially our insureds'—future.
*Lisabeth A. Groller contributed significantly to the substance of this article.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author’s employer or IRMI. This article does not purport
to provide legal, accounting, or other professional advice or opinion. If such advice
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