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Big “I” National News

P&C Trends

Lingering Shadows: I.I.I. Releases Annual Groundhog Report
Analysts predict slow p-c growth, underwriting profit in 2007.

Punxsatawney Phil, the legendary Pennsylvania groundhog, didn’t see his shadow last week when he was pulled from his hole, so (supposedly) spring is fast approaching. However, a panel of Wall Street stock analysts and insurance industry professionals don’t have as temperate a forecast for the p-c industry, according to the Insurance Information Institute’s annual Groundhog Forecast.

The I.I.I. polled several industry analysts on their predictions for the upcoming year and survey results indicate a slower p-c growth for 2007. However, the respite in catastrophe losses in 2006, coupled with a strong performance in nearly all other major lines of p-c insurance, will most likely provide the industry with its best underwriting performance since 1936.

The average forecast calls for an increase in net written premiums of 1.8% in 2007, a substantial decrease from the 3.3% estimated for 2006, according to the report. The increase in premium growth forecasted for 2007 is the third slowest rate of growth for p-c insurers since the last soft market in 1998. The decline in premium growth is a result of softening in the p-c lines pricing environment, with the major exception being in hurricane-exposed costal property insurance coverages, according to Bob Hartwig, president and chief economist for the I.I.I.

“The primary cause for the drop in premium growth is a decreased price for most types of insurance, particularly commercial types of insurance…homeowners insurance, outside of coastal areas, is pretty much flat,” Hartwig says. “Insurers are reducing exposures in catastrophe states, so the private insurers are going to see a lower growth rate there as well. For those properties that remain in private companies, that is where we’re seeing significant increases.

“For agents and brokers, what this means is that commission revenues are going to be sluggish for the net couple years,” he continues. “Agents and brokers can use performance-based contingencies to make up for some of this slack. Even though most of the prices are falling, performance is expected to remain strong for next couple years.”

For insurers, the current premium growth pattern is a reminder of the soft market of the late 1990s when the industry saw a recorded growth of 2.9% in 1997 and 1.8% in 1998. While those years were some of the worst in industry history, with combined ratios rising from 102 in 1997 to almost 116 in 2001, the expected combined ratio for 2007 is 96.6 making it too early to tell if the periods will mirror each other, according to the report.

Analysts are expecting the industry’s profitability to continue this year, although underwriting performance will likely generate a much smaller underwriting profit than in 2006. The I.I.I. report also forecasts this trend continuing into 2008. The expected profitability, paired with the deceleration in premium growth, may seem like a paradox, but the lack of catastrophe losses in 2006 and continued industry discipline have offset the slowdown, according to Hartwig.

“This indicates that the industry is remaining disciplined and the forecast for 2007 and 2008, even though they will be at slowest rate in decade, the industry is remaining profitable,” he says. “This would be reaching from the pattern in the ’80s and ’90s when the industry entered a slow growth period...some of this discipline comes about because of relatively low interest rates and a less volatile stock market.”

In addition to 2007 predictions, this year’s Groundhog Forecast also includes projected combined ratio projections for 2008 and beyond. The combined ratio for 2008 is predicted to be 98.6, a number that the I.I.I. feels is respectable, “but one that, nonetheless, represents an additional two-point deterioration from this year and a 5.4 point deterioration relative to 2006.” This projection is unsettling in the sense that as the ratio climbs to 100, returns will become less competitive with the Fortune 500 group. The 2005 combined ratio of 100.7 is a sobering reminder of the ROE of just 10.4 percent that year.

Michelle Payne (michelle.payne@iiaba.net) is Big “I” writer/editor.

L&H Trends

Don’t Make a Decision Without Context

How many times have sports commentators argued about which athlete or which team is the best of all times? A commentator might argue whether Bill Russell was better than Shaquille O’Neal. (To provide some background, Russell was listed at 6’10” and weighed 220 pounds when he played and O’Neal is listed as 7’1 and 325 pounds.) Russell won two NCAA championships (56 games in a row) and 11 NBA titles in 13 years and was the NBA MVP five times. O’Neal has won four NBA titles and been NBA MVP once. In absolute terms, O’Neal would be a tough match-up for Russell given the size and weight difference, but in relative terms, judging them based on their careers during the era when they played (O’Neal is still playing of course), Russell was immensely more successful in a time when it was easier to keep team personnel together.

In providing financial advice, agents also need to resist the temptation to answer a customer’s query put to them in absolute terms. For example: “Is the ABC company variable annuity better than the XYZ mutual fund?” The answer is that it depends on the customer’s income, tax bracket, years to retirement, risk tolerance and current investments to name a few considerations. Also, keep in mind that people can and should have more than one investment vehicle. Take, for example, a case where an individual is considering whether to put a portion of their savings in an international mutual fund investment. If that investment comprises a significant portion of the person’s assets, then it’s fair to say that type of investment brings a higher degree of risk and volatility. However, for a portfolio consisting of domestic stocks and bonds, adding an international component to the overall portfolio can actually lower the volatility of the returns since international stocks will bring a lower degree of volatility, versus adding more of the same type of investments with a high positive correlation such as adding an S&P 500 index mutual fund.

Customers frequently confront their agents, looking for absolute answers. A common question is: “Should I have a high medical deductible for my health insurance to lower my premium costs?” Again, the answer will depend on other savings resources. Or, “At what age should I start taking Social Security benefits?” The answer to this depends on the person’s health, financial resources and targeted standard of living in retirement.

Agent may not be able to give quick answers to absolute questions because answers require time to learn the customer’s personal situation and objectives. It also takes time to educate customers on the considerations to take into account when looking for an answer based on an understanding of reality and not just customers’ perception.

The next time a customer tries to press for a quick, absolute answer, explain to them the value of having an agent. Agents develop a relationship with their customers so that they can help them arrive at the best solution for their personal and business insurance. And, for the record, the greatest running back of all time was Jim Brown.

Dave Evans (dave.evans@iiaba.net) is a certified financial planner and an IA l-h contributing editor.

Forms & Substance

Explaining Coinsurance to Clients

Although most commercial property policies provide examples of how coinsurance works, why policies have such a clause is a mystery to most insureds and many agents.

The Louisville Board of Fire Underwriters introduced the coinsurance condition as a standard clause back in 1885 for pork and tobacco risks, and it was expanded to other property in 1890. However, individual insurer use of this condition dates back to at least 1877 (Continental Insurance Company), if not earlier.

Coinsurance is a contractual requirement the insured carry agreed upon insurance-to-value, as specified by a percentage (usually 80%, 90% or 100%) entry on the declarations page. If, at the time of loss, the limit of insurance is less than the value of the property times the coinsurance percentage, the insured will become a ”co-insurer,” along with the insurance company, when a loss occurs.

The purpose of coinsurance is not to punish an insured for carrying inadequate insurance-to-value, but rather to provide a financial incentive that encourages them to carry adequate limits in the event of major losses and rewards them, in many instances, with a significant premium reduction for doing so.

Why do insureds need an incentive to carry limits of insurance approaching the value of their property? In the aggregate, most losses are partial and don’t result in a total or even substantial loss. Without a financial incentive, insureds who are not risk aversive might be inclined to purchase relative small limits of insurance. Since that inclination depends, in part, on the structure and occupancy of the building, those factors largely determine the amount of the incentive.

To illustrate, according to one estimate, less than 2% of fire losses are total, and 86% result in damages of 20% or less of the building value. That is, if a building is worth $500,000 and a fire occurs (which isn't that likely to begin with), there is an 86% chance the damage will be $100,000 or less. So, if the insured is a risk taker, why not insure the building for $100,000 or less? Of course, the statistics above are just for the peril of fire. If windstorm and other potentially catastrophic perils are added, the numbers may change.

These numbers are averages. Statistically, a reinforced concrete office building is much less likely to experience a major loss than a wood frame woodworking shop. So, the owner of the office building could be less inclined to carry full insurance to value because the probability of a serious loss is virtually nothing. On the other hand, the owner of the woodworking shop is much more likely to insure to value because it is easy to conceive of a major loss occurring.

Coinsurance provides an incentive for adequate insurance-to-value by providing a rate credit for carrying relatively high limits to value. The credit is much larger for a fire-resistive office building because the owner needs a larger incentive and the rate credit reflects the lower probability of loss. In contrast, the credit is much smaller for a woodworker in a wood frame building because the owner is better able to visualize a complete loss.

Thus, coinsurance provides an incentive to purchase higher insurance to value than some insureds are inclined to do otherwise. In doing so, insureds can save significant amounts and they have the assurance that, in the unlikely event they do have a major loss, they're covered.

For premium examples and a deposition excerpt from an agent who was unable to explain coinsurance, click here.

Bill Wilson (bill.wilson@iiaba.net) is the Big “I” director of Virtual University.

Agency Management

The State of the (Business) Union

Finding, retaining quality workers tops list of small business challenges.

Small and mid-sized business owners are optimistic about their business outlook for 2007, with many planning to expand their companies and grow their workforces, according to a recent study.

AllBusiness.com, Inc., an online resource for small and mid-sized businesses, recently released its quarterly SMB (small and mid-sized businesses) State of the Union. It polled 1,000 small and mid-sized business leaders across the country on their business plans for this year, 10% of which were financial/insurance professionals.

According to the Small Business Association, small businesses currently employ half the private workforce (50.1%) and provide approximately 75 % of the new jobs added to the economy each year. This year that number is expected to grow as more businesses add to their staffs.

Fifty percent of survey respondents say they plan to hire more employees this year, compared to the 44% reported during AllBusiness’s last State of the Union study. As a result, finding and keeping quality employees has surfaced as the biggest concern among the business leaders polled (45%), surpassing managing cash flow, the cost of employee health insurance and managing business growth, which were the former top concerns.

Many independent agencies are also listing staffing as a growing concern as finding qualified employees becomes more of a challenge. “Hiring qualified people (is my main concern),” says Andrew Theodore of the Goldsmith-Theodore Agency, Inc. in Columbia, S.C. “There is a small pool of experienced insurance professionals in our area. We either have to take employees from a competitor or train people with no insurance knowledge.”

The Goldsmith-Theodore Agency has a 12% growth goal for the year, but is expecting flat profits compared to 2006. Despite these projections, the agency still intends to grow its staff by at least four people (two in sales and two or more in support) in order to keep up with the evolving market.

“We are fortunate that we have many markets which requires us to continue to grow to meet our goals with them,” Theodore says. “As insurance agencies are sold or merged, they seem to lose the service and relationship philosophy and are geared more toward marketing. This gives us the opportunity to sell our continued relationship strategy.”

Conversely, Rick Dinger of Crescenta Valley Insurance in Glendale, Calif., doesn’t plan on adding anyone to his payroll this year; instead, he’s concentrating using the staff he has to propel the agency to a successful year.

“We have been adjusting our staff over the past 12 months,” he says. “We had been in growth-mode for so long that I would hire anyone I could because it was a matter of time before I needed them. Once our growth leveled off, I needed to make adjustments. As people moved on, they were not replaced. We are properly staffed now and I do not anticipate adding anyone else this year. I do not see huge growth in the future, but I do see the potential to have one of our most profitable years. Now that we are staffed correctly, we are focusing on writing quality business.”

The focus on attracting new hires and employee longevity is not a newcomer to the list of business concerns, according to Kathy Yates, CEO of AllBusiness. The challenge of finding quality workers has been at the forefront of owners’ concern since 2004.

“We have found that hiring and retaining quality employees is always among the top three or four concerns of our audience,” she says. “Back in Q4 (quarter four) of 2005, it was the third highest concern, behind managing cash flow and managing business growth. But, just a year later in Q4 2006, we saw this issue of finding and keeping talent spike significantly to the highest concern. In fact, it moved by a net 14 percentage points, significantly more than any other measure of concern in our study.”

While business owners’ emphasis on staffing is no surprise to Yates, what owners aren’t focused on this year was unexpected:

“Two things jumped out of last quarter’s study of particular interest. Both of them showed up in the category of ‘least concerned.’ First, we noticed that our respondents were not at all concerned about changes to the minimum wage. We were particularly surprised about this given the large amount of press and political activity focused on minimum wage hikes in states like California and also nationally as part of the new Democratic congress’ first 100 hours of activity,” she says. “Right behind minimum wage hikes was the issue of estate taxes, also a minimal concern to our respondents, yet a topic that garners a great deal of public debate in terms of importance.”

Michelle Payne (michelle.payne@iiaba.net) is Big “I” writer/editor.

Forms & Substance

Company Cars and the ISO Personal Auto Policy

What coverage does the ISO personal auto policy provide for an employee assigned a company car? Liability.

Under the PAP, an exclusion states there is no coverage for the use of an auto furnished or available for regular use. It sounds like this employee fits this exact situation. Thus, when he drives the employer-owned auto (for business or personal use), his PAP does not protect him. It is the same for his spouse or other family members who drives the car. Normally the policy written in the name of the business would protect the employee but, in this case, the employer told the employee he was not protected off duty.

This being the case, the employee faces a huge gap in coverage. The solution is easy: simply add extended, non-owned coverage for named individuals (PP 03 06) to the policy for about $20 per six months and the exclusion disappears. Make sure to add each person, by name, to the endorsement, including the spouse and/or other family members if they ever drive the employer-owned auto. PAP 2005 gives the option to add the whole family.

As for medical payments, it’s exactly the same as liability, with the same exclusion and same solution--- add the PP 03 06, this time for about $3 per person named.

There are no coverage issues for Uninsured Motorists, but check with the state’s UM law. The employee and his family members can get their own UM in the employer-owned auto when using it for business or personal purposes, anywhere in the policy territory, whether the UM is stacked or non-stacked (stacking is not permitted in all states).

Physical Damage causes the biggest problem with coverage. The same ”furnished or available for your regular use“ exclusion pops up under physical damage and the bad news is that there is no endorsement to fix the gap. This means if a client takes the car to the store at night to pick up milk and wrecks the car, his PAP does not pay for the damage. Coverage lies solely with the business auto policy, which can cause problems if the BAP carrier seeks a subrogation claim against the employee.

This situation is very common today, so whenever an employee is furnished an auto for his regular use (or even has one available for his regular use), the PP 03 06 can be used to fix two gaps in coverage.

However, what happens if a PAP carrier won’t add the extended non-owned endorsement to a personal auto policy? If the company won’t (or can’t) add the PP 03 06 endorsement (or a similar one if they are a non-ISO company), there is a huge coverage gap. If this is the case, the best option---and maybe only option---is to write the client a named non-owner policy to fill the gap. In general, that policy provides options to include liability, medical payments and uninsured motorist coverage, but not PIP or physical damage coverage. It, in effect, accomplishes about the same thing as the PP 03 06 extended non-owned endorsement does, but at a more expensive price.

Whereas the extended non-owned is going to cost about $50 in most cases, the named non-owner can run into the hundreds of dollars; it is typically about 50% of the owned premium. With the named non-owner policy, make sure to name every person to be insured. That means everybody: dad, mom and each child to be covered. It’s not enough to name just one parent. (PAP 2005 allows for covering the whole family via checking that box. The policyholder must also indicate on the endorsement if he/she wants coverage for a vehicle furnished or available for regular use.) Such a named non-owner policy may be included in a specialty auto insurance market or the residual market in many cases.

So first try the extended non-owned route and if that doesn’t work, fall back on the named non-owner route. Either way, it’s very important to fix the gap in coverage.

For the online version of this article click here.

Bill Wilson (bill.wilson@iiaba.net) is the Big “I” director of Virtual University.