T H U R S D A Y ,   J U N E   8,   2 0 0 6

     Big "I" National News

P & C  T R E N D S
Insurers in Climate of Change

Is the insurance industry capitalizing on the weather and climate? According to the article "Insurers May Cash In on Climate Change" in this week’s U.S. World News & Report, "Climate change isn’t just a crisis. It’s a business opportunity---at least in the view of insurance industry leaders who are mapping out a strategy that could force the rest of the economy to grapple with global warming as never before." Is this the case?

Not exactly, according to Insurance Information Institute Senior Vice President and Chief Economist Robert Hartwig. "Almost by definition, a lot of what insurers do is---quote unquote---profiting off the weather," he says. "If, in fact, we sell insurance for a high price in Florida this year, and nothing happens, we win! There’s nothing new about that. The article, I think, is a little misplaced in terms of its title."

Hartwig says that some of the issues discussed in the article, such as derivatives and carbon trading, have been around for quite a while.

It’s a fact that, in the wake of 2004 and 2005’s string of devastating hurricanes, particularly Hurricane Katrina, many insurers are retreating from coastal regions. Is this related to climate changes? "Many attribute insurers’ new climate awareness to the record $55.3 billion in natural disaster losses they sustained in 2005…" the article says.

Hartwig is quick to point out that the recent increase in hurricane occurrences is not necessarily linked to global warming, but attributable to normal cycles observed over hundreds of years in the Atlantic basin.

"I think there’s a danger that people will mix the issue of global climate change and interpret what is happen in the Gulf or in the Atlantic with respect to hurricanes, as being directly the result of global climate change," he says, "when in fact leading meteorologists say ‘No such thing.’"

The larger issue at hand when it comes to climate change and insurers is how carriers will deal with the possibility of more frequent and intense storm activity. "How will they handle that increasing degree of risk?" Hartwig asks. "That has more to do with how reinsurers will operate in this environment. It has more to do with securitization of risk in order to gain greater capacity to handle volatility. It has very little to do with the issue of ‘profiting off of climate’ by selling weather derivatives. Those products have been around for a long time."

There could be several reasons the insurance perspective on climate-related issues is making headlines. For one, Al Gore’s new movie "The Inconvenient Truth" is shining a spotlight on global warming. Secondly, as the country enters the 2006 hurricane season, weather is top-of-mind. However, it’s important to not mix up the issues and to battle misconceptions that insurers are looking to profit off of climate changes, Hartwig says.

"There are some groups that believe that global warming led directly to Hurricane Katrina, which there is absolutely no evidence and no way to prove that whatsoever," he says. "And most leading meteorologists would not agree with that at all."

Jennifer Sikorski (jennifer.sikorski@iiaba.net) is IA’s associate editor.

F O R M S   &   S U B S T A N C E
Explain Coinsurance to Clients

One of the toughest tasks facing insurance agents is how to explain coinsurance...why it exists, its purpose and how it works. Here is an explanation that you might find valuable in discussing the purpose of coinsurance with your clients.

Although most commercial property policies provide examples of how coinsurance works (e.g., check out the Additional Conditions - Coinsurance in the CP 00 10), why policies have such a clause is a mystery to most insureds...and many agents. So, let's look at the purpose behind coinsurance.

The coinsurance condition was introduced as a standard clause by the Louisville Board of Fire Underwriters in 1885 for pork and tobacco risks and 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 that 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: (1) encourages them to carry adequate limits in the event of major losses, and (2) 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? Simple...because, 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 relatively small limits of insurance. Since that inclination depends, in part, on the structure and occupancy of the building, the amount of the incentive is largely determined by those factors.

To illustrate, according to one estimate, less than 2% of fire losses are total, and 86% of fire losses 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 that 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 you add windstorm and other potentially catastrophic perils, 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 nil. 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 (perhaps many) insureds would be inclined to do otherwise. In doing so, insureds can save significant amounts and they have the assurance that, in the unlikely event that they do have a major loss, they're covered.

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

O N   T H E   H I L L
Big “I” Works Toward Estate-Tax Reform
Despite expected failure of cloture vote, push will continue.

A bill to repeal the estate tax is expected to face a cloture vote Thursday in the Senate, and while the odds are against a successful outcome, the Big "I" appreciates the efforts of the bill’s backers and urges continued work toward a solution on this issue.

The bill, brought to the floor by Majority Leader Bill Frist (R-Tenn.), is expected to be blocked by the Senate’s procedural rule that requires 60 votes to end debate. Despite bipartisan support, the legislation probably will fall short of the total needed to bring it up for a floor vote.

In the event that the bill fails to move forward, Sen. Jon Kyl (R-Ariz.) and Sen. Max Baucus (D-Mont.) are working on a potential compromise that would raise the exemption amount and lower the tax rate. It is yet to be determined whether this solution will be acceptable to the 60 members needed to invoke cloture.

The Big "I" supports the elimination, or the significant reduction, of estate taxes to encourage investment and growth in small businesses. This is crucial to the 300,000 Big "I" members across America, many of whom own their own agencies and whose families face significant tax burdens when these businesses pass along to their heirs. The prospect of heavy estate taxes also diminish the value of small businesses that are sold. The temporary estate-tax relief enacted by Congress is set to expire in 2011. (See "L&H Trends" article below.)

"Regardless of what happens with the cloture vote, we will continue to advocate strongly for the best estate-tax relief bill possible," says Charles E. Symington Jr., Big "I" senior vice president for government affairs and federal relations. "This is a crucial issue for our members, and we will keep working toward a viable solution to this issue."

Cliston Brown (cliston.brown@iiaba.net) is Big "I" director of public affairs/government relations.

L & H   T R E N D S
Estate Tax’s Life Implications

This week the Senate is debating whether to permanently repeal the estate taxes. The House of Representatives already voted in favor of it, and the administration also supports making the repeal permanent. This is an especially important issue to monitor in the Senate because estate taxes are estimated to raise about $776 billion from 2012 to 2021, assuming that there is no permanent repeal. (See "On the Hill" article above.)

The estate tax debate’s outcome has several implications for independent insurance agents. The 2001 tax law that reduced and eventually eliminates the estate tax will sunset in 2010, resulting in estate taxes’ reestablishment in 2011. Why is the timing of the current Senate action of particular note? Under the estate tax rules, life insurance proceeds are includable in the decedent’s estate unless he or she did not retain any incidents of ownership of the policy for at least three years. So while the proceeds of a life insurance policy are income tax free to the recipient, if an individual has a sizable life insurance policy and meaningful assets at the time of his or her death, the life insurance proceeds could be subject to estate taxes beginning at 37%. Most people are unaware of this problem.

How can you avoid the estate taxation of life insurance proceeds? The answer is to establish an Irrevocable Life Insurance Trust (ILIT) and have the trust own the policy. Each year’s insurance premium can be gifted to the trust, and as long as the beneficiary of the trust is given the right to withdraw funds during a stipulated timeframe (typically 30 days), the premiums’ funding is considered a gift of a present interest and qualifies for the annual gift tax exclusion (currently $11,000 per person). This temporary power to receive funds is known as a "Crummey" power.

If the repeal is not made permanent in the Senate, independent insurance agents should remind customers that if the size of their estate subjects them to estate taxes, they should take the steps to set up an ILIT so that the entire life insurance policy proceeds will be paid to the beneficiary.

A related consideration is whether business owners will need to have sufficient liquidity to pay estate taxes based on the value of their business ownership. Life insurance is the most efficient way to fund a buy-sell arrangement and/or to provide adequate funds to pay for estate taxes. Again, given the three-year rule for removing life insurance policies from the decedent’s estate, if the repeal does not occur this year, then agents need to have a candid discussion with customers to ascertain whether estate taxes will be a relevant issue for their situation. Stay tuned.

Of course, even if the Senate votes in favor of permanent repeal and the president signs a resulting bill, there is always a possibility that Congress may revisit this issue given the federal deficit’s magnitude.

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

T E C H   U P D A T E
Consumers Worried about Online Security Breaches
Poll shows Americans not confident of Internet transactions.

Americans are becoming increasingly wary of online business transactions. According to a new survey by the Cyber Security Industry Alliance (CSIA), only 24% of Americans say that businesses are placing the right emphasis on protecting information systems and networks. That means more than 75% of Americans believe businesses are not doing enough to protect their information.

Do your clients feel safe handing over their personal information to your agency? Clients entrust agents and brokers with highly personal information. Are you doing what it takes to ensure it remains private? A preventable security breach of your systems that compromising their data will not only have a devastating affect on your agency’s immediate business, but also on its long-standing reputation and overall value.

Protecting agencies’ papers and the physical space are no longer the only security concerns. Today, most agencies’ information is digitized. Take steps to protect your business and your clients. Agency principals should conduct security assessments, establish appropriate policies, train existing and new employees on security procedures, develop ongoing monitoring systems to detect unusual activity and viruses and confirm employees are conforming to the agency standards.

Stress to your clients and prospective clients the steps your agency takes beyond basic security to provide confidence and build trust. Does your agency have a security policy that it continually reviews and modifies to change with agency and technology advancements? Has an outside expert performed a security audit on your agency? Have you worked to secure information available through laptops, portable electronic devices and smart phones? Studies shows that less than one in five Americans feel that existing laws are enough to protect them on the Internet.

With the development of real-time multiple company rating and other fast-developing technology in the insurance industry, it is critically important that Americans gain more confidence in the Internet. Go above and beyond—protect your agency, your clients and gain the trust of so many skeptical Americans.

For more information on agency security, including an agency assessment tool, download ACT’s "The Independent Agent’s Guide to Systems Security: What Every Agency Principal Needs to Know." For more information on the security of portable devices, download Jeff Yates’ article "Managing the Security Risks of Portable Devices."

Emily Crane (emily.crane@iiaba.net) is Big "I" manager of media relations.