Homeowners Insurance Loss Ratio Chart

In reference to the following published by Florida Today newspaper, I received the following question. I’m no longer licensed as an insurance agent, so I can’t give personal advice on insurance, but I’ll go ahead and comment on the general issues if it might be helpful for those looking for some direction on these issues.

Here’s the original email I received:

The chart that appeared in FLORIDA TODAY last Sunday, 8/5/07, deserves some analysis. I am no expert. I wish one would step forward. Until one does, here are my observations:

1) This chart cuts to the chase. It simply shows the ratio of claims paid to premiums collected. It’s very basic and uncluttered with things like re-insurance (whatever that is) or overhead.

2) It shows that Florida is in line with the rest of the country when averaged over any 10 year period. Spreading risk over time is what insurance is supposed to do.

3) Insurance premiums started going up in 2006, but there was no hurricanes in 2006. This resulted in the lowest loss ratio on the chart (45.4%).

4) As premiums continue to spiral upward in 2007, and if we don’t have any hurricanes in 2007, the loss ratio may well be in a record 20-30% range due not to more claims paid but to more premiums collected.

5) This chart does not seem to support the multiple hundreds of percent increase in premiums being seen in Florida.

And here is my response:

1) This chart cuts to the chase. It simply shows the ratio of claims paid to premiums collected. It’s very basic and uncluttered with things like re-insurance (whatever that is) or overhead.

Reinsurance is just insurance for the insurance companies. In other words, there are companies whose sole purpose is to rate and evaluate personal lines companies (like Allstate, State Farm, Progressive, etc) to determine how well they handle their risks - and then sell them large amounts of insurance so that these companies can remain financially “solvent” according to state law. Sometimes, companies purchase reinsurance for other reasons too. So, while State Farm spends all its underwriting efforts focusing on small pools of risk (i.e. all male drivers aged 50-55 with 1 speeding ticket in Brevard County), a Reinsurer spends its time focusing on how well those companies like State Farm do managing their risks. Policies usually start at $10 million and up (of coverage). It’s always been around, but people hear about it more because of all the public whining our insurance companies do when they try to justify their rate increases. It is a real significant cost, however.

One warning: Loss ratio isn’t as simple as it might at first seem. I can’t tell from these numbers, but just like any accounting or corporate reporting, there are myriad adjustments “allowed” before reporting. I’m not saying that the numbers could be better (or worse), just that they aren’t exact as to what we might think. In other words, Florida Insurance Companies did not pay out exactly 58.6% in claims of all pre-taxed premiums in 1996. But for the purposes of comparison from year to year, this chart is sufficient.

2) It shows that Florida is in line with the rest of the country when averaged over any 10 year period. Spreading risk over time is what insurance is supposed to do.

Problems with this chart? I’d say go back another 10 years and see. 1992 was a horrific year, and 1993 wasn’t much better. The insurance companies don’t just look at this, so to be completely fair, we’d need to see if there were other factors to consider. Keep in mind that 13 companies went belly up after Andrew which is “recent memory” for many underwriters in the business.

3) Insurance premiums started going up in 2006, but there was no hurricanes in 2006. This resulted in the lowest loss ratio on the chart (45.4%).

This is because rate changes have to be filed for and approved before using in Florida. Thus, claims in September 2004 aren’t settled (on average) until early 2005. Then, they have to be compiled in the aggregate to justify a rate increase, which has to be filed for, then approved (at least a 2-3 month process, but usually longer if there is politics involved), and then the company can begin using the new rates — ONCE the homeowner’s policy renews. So, on annual policies, such as homeowners policies, 18-24 months from disaster until new rates come pouring in the company doors is typical. Unfortunately, the very thing you are mentioning here is something the companies want to change. They want a “Use and File” law on the books like some other states - where they can immediately adjust their rates, file for them later, and then justify the politics even later. Although an insurance commission would have the right to roll back rates, in practice, it hardly ever happens. We don’t want that!

4) As premiums continue to spiral upward in 2007, and if we don’t have any hurricanes in 2007, the loss ratio may well be in a record 20-30% range due not to more claims paid but to more premiums collected.

This isn’t likely. I’m not trying to sound too supportive of insurance companies - really! But the reality is that loss ratios are not the only factor in determining future rates: Value of potential losses (always increasing in Florida as of late), frequency and severity of future potential losses, and many other factors come into play. In other words, they don’t want to find themselves in a situation like 2004… and quite frankly, policyholders should desire that their insurance company not have negative loss ratios. In fact, if we could know beforehand that our company WOULD have negative loss ratios, most of us would likely shop elsewhere.

What might be more helpful to discuss would be how profits breakdown in the “good years”. In a stock company (like Allstate), profits go to the shareholders - just as they would any company. Yes, technically, reserves from prior year losses are filled back up first, but only to the guidelines required by the state, or rating firms like AM Best and Moody’s, to get a good enough rating, to sell more insurance, to be more competitive, and so on. In a Mutual company, like State Farm Mutual, profits go directly to the policyholders, who are essentially stock holders in a way. Personally, I see this as the best type of company, and I think the state ought to more strictly regulate reserves of Stock companies (who at times can border on profiteering). We can’t just get rid of Stock companies (they are the majority), but we could say that since they don’t return windfalls to their policyholders, they must have 1.3 times the reserve of a Mutual company the same size. Something like that.

5) This chart does not seem to support the multiple hundreds of percent increase in premiums being seen in Florida.

No, it doesn’t. Which is why F/T published it. Controversy breeds newspapers sales, right? It certainly isn’t a chart that anyone inside the industry is looking at… and by “inside” I’m including legislators who are **supposed** to be representing us.

One idea I’ve had for a while would be to require that homeowner’s insurance companies offer only 3-year policies on all standard HO-3 policies (home’s insured by the owner who lives in the home - which is most folks). Although businesses and landlord dwelling policies would still have to deal with the yearly hassle to find insurance, it is ridiculous the amount of time that good normal folk have had to go through every year. On the beachside, I know people who haven’t had the same company 2 years in a row for over a decade. Their time is worth something too. If a company won’t offer a renewable policy (short of bankruptcy or the policyholder’s failure to pay premiums and other normal lapse issues) for at least 3 years, I think we will have a hard time reintroducing stability back into the market.

Agents should go for this big time. HO3’s typically make up about 80% of premium of your average neighborhood agents property policies. They have to spend enormous amounts of time helping policyholders find new coverage (or lose them altogether) every year - at no increase in commission to them. New and Renewal Commissions on homeowner policies have been about the same (8 to 10 percent) for over a decade with most companies - since most companies don’t want to do anything to encourage new business.

Although the companies will initially balk, it is actually in their best interest. They have no underwriting costs other than the first year. As extensive as underwriting is, they will actually save real money every renewal - which can go back toward reserves and/or profits. They’ll probably be able to even downsize staff.

And three years is hardly a long-term risk. For this to work, we’d have to concede some stricter underwriting guidelines for most companies, but this could go a long way toward helping **freeze** rates (in effect) for about 95% (or more) of Florida homeowners.

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