Regional and specialty insurers help to
stabilize insurance markets and contain the cost of insurable risk.
Most of these 3,100 insurers emphasize long term, trusting
relationships with policyholders. Many have existed since the late
1800s, and have obviously weathered terrible insurance markets and
stock markets conditions.
Overall, their numbers have increased since
1986. The overwhelming majority are financially sound. We need to be
reminded of this, when insurers one hundred or even a thousand times
their size falter.
My colleagues and I at Demotech know these
insurers. We have been evaluating their financial stability since
1988. We have seen the number of specialty insurers expand. Demotech,
Inc. is actually the leading rating service in some classes of
regional or specialty insurers. We publish studies of financial
stability trends among these insurers, including an analysis of
23,000 Financial Stability Ratings issued over the sixteen year
period from 1989 through 2004.
On the question of insolvency risk, many
insurance professionals and the media tend instinctively to favor
larger sized insurers that offer a broad array of insurance products
in several geographic markets. These individuals usually associate
large size, diversity of insurance and geographical dispersion with
a lower risk of insolvency. Intuitively, this makes sense because
the statistical laws of random events tell us that when losses occur
randomly, the larger the size of the insured pool of risks, the
greater the probability the insurer has of surviving bad loss
experience.
However, there is a practical limit to the
relevance of hypothetical statistical inferences. Insurers get into
trouble less due to size or diversity and more due to management
practices and the unrelenting emphasis on meeting earning
projections. Often, management may embrace marketing, underwriting
and claims practices that cause them to under-price, lose their
focus on competitive advantages, and under-reserve for losses so
that earnings projections can be met (on paper, not in reality).
The ambitious insurer may try -- perhaps to feed
management egos or tantalize external investors -- to expand market
share rapidly, or take on new lines of insurance, or grow its top
line. This is a potentially lethal game.
The cause of failure is poor financial decisions
that can happen to the large and small alike - it merely takes
longer to discern and correct in large insurers. A study
commissioned by the National Association of Mutual Insurance
Companies (NAMIC) indicated that larger insurers, not small ones,
have more volatile year to year operating results.
While there are exceptions, Demotech has found
that most regional and specialty insurers are self-disciplined. They
are not driven to new markets, they focus on their niche. They are
not over-leveraged. As a matter of fact, they often purchase
extremely conservative reinsurance treaties and design reinsurance
programs to protect surplus. Are these practices something new? Not
at all. It simply means that other insurance professionals need to
scrutinize these insurers with the same degree of attention as
Demotech.
Ratings of any insurer can be reliable so long
as the rating agency or rating service knows what it is doing. We
have found our ratings of these regional and specialty insurers to
be highly effective in predicting financial instability.
Their financial statements are usually simpler.
Their operations are transparent. Their reinsurance contracts, we
believe, are easier to evaluate. We have seen this thousands of
times. We can easily research this specialty market. Among these
insurers, we expect to find that the insurer, its agents and its
core customers value stable relationships. Neither the agent nor the
insurer is apt to cut and run from a specialty market.
We expect to find that management is
self-disciplined, avoids ruinous price wars and maintains consistent
underwriting guidelines, even at the cost of losing market share.
Among these insurers, management quality and incentives, down to the
individual executive, are transparent and focused. There is less
infrastructure, and thus less chance of conflict between outside
investors, board members and top management. This benefits both top
management and middle management in daily decisions on marketing,
underwriting and claims.
All told, in 2004, 1,800 regional and specialty
insurers accounted for 5% of the industry’s $470 billion of
P&C direct writings. That is approximately $25 billion. This
business is in the hands of specialists.
These 1,800 insurers include regional P&C
insurers - roughly 1,000 of them. Some of them were founded in the
19th century. They employ as many as a hundred or as few as four
employees. They participate in guaranty funds and are typically
heavy buyers of reinsurance. In addition to them, commercial
insurers may have been founded by business associations. In the
medical malpractice market, numerous regional monoline carriers have
been founded with the encouragement of medical practitioner
associations such as state medical societies.
Regional homeowners insurers have sprung to life
in Florida in the past ten years, with the encouragement of state
insurance regulators who had become wary of the volatile market
strategies of some national property insurers, and the state’s own
risk-bearing entity.
Are these regional and specialty insurers a
risky proposition? We provide Preliminary Financial Stability
Ratings® for most of them. One might expect that the 2004 and 2005
hurricane seasons would have wreaked havoc on these insurers. Quite
the contrary: only one of them was impaired by the hurricanes in
2004 and 2005, and that particular victim’s market took direct
hits by major hurricanes three times within a week.
Then, there are self insurance pools - about 600
in number. They are often founded under the auspices of a trade
association: local governments, health care, and manufacturing, for
the most part.
Since 1990s, hundreds of highly specialized
corporation-sponsored insurance ventures have been created. In
Vermont alone - by far the largest domestic captive base - there are
over 700 specialty insurance companies. These can be founded by a
single corporate sponsor or by a group of corporations. They include
pure captives controlled by one corporation and alternative
arrangements such as risk retention groups.
These many and varied regional and specialized
insurers serve vital functions. They can all be reviewed and rated.
Most will be found to be financially stable. They will be around
years from now, in the markets they are in today. Regardless, if one
is a corporate sponsor, policyholder, broker, regulator or supplier,
these insurers are very good bets.
In sum, insurance agents, brokers and consumers
should be comfortable using regional and specialty insurers. The
overwhelming majority of these regional insurance companies have an
opportunity to earn a Financial Stability Rating® of A or better.
This is because their loss and loss adjustment expense reserves are
reasonable, their reinsurance programs are based upon traditional
excess of loss reinsurance, and has been placed with respected
reinsurers, their focus is on niches where customer service and
underwriting expertise are more important than meeting an analyst’s
projection of quarterly earnings.
Bigger is not always better - ask an agent or a
claimant who was insured with Legion Insurance Company, Reliance
Insurance Company, Home Insurance Company, Mission Insurance,
Villanova or PHICO Insurance.
Joseph L. Petrelli is the founder and
president of Demotech, Inc., a Columbus, Ohio-based financial
analysis and actuarial services company. Demotech provides services
to regional insurance companies, title underwriters, and specialty insurance
markets. Petrelli is a member of the Casualty Actuarial Society,
American Academy of Actuaries, and the Conference of Consulting
Actuaries.
By Joseph L. Petrelli
