T H U R S D A Y ,  S E P T E M B E R   2 7 ,  2 0 0 7 

Big “I” National News

P&C Trends

A Pulse on P-C: By the Numbers
An in-depth look at how industry fairing in 2007. 

After the first three quarters of the year, paradoxes are abounding in the property-casualty industry. The market is performing extremely well when it comes to income, but slipping in overall profitability. It lacks growth in premiums, but the combined ratio for the first half of the year is the second highest in years. And contradictions are equally as plentiful when it comes to how the market looks heading into fourth quarter 2007.

“There are two views (on how the industry is doing). One is retrospective, looking back and comparing current result to those in the past and in that respect the industry is doing well,” says Michael Murray, ISO’s assistant vice president for financial analysis. “But the other view, looking forward, sends a different message and that view is one that focuses on the rather weak 0.1% increase in premiums for the first half of 2007, well below industry norms.”

Written premium growth did slow to 0.1% in the first half of the year compared to 2.9% in 2006. However, the p-c industry’s net income after taxes increased 10.7% to $32.5 billion in the first half of the year, up from $29.4 billion for first quarter last year, according to statistics released by ISO this week. Net written premiums also grew $0.3 billion to $223.4 billion in the first six months of 2007 from $223.1 billion in 2006.

Yet, despite a rise in income for 2007, profitability is still below expectations, according to ISO and Insurance Information Institute President Bob Hartwig.

“There are some paradoxes in the results; here we have the industry on track to earn record profits in dollar terms, but at the same time one of the lowest growth rates on record in the last 40 years,” Hartwig says. “That suggests that we are going to see continued deterioration of underwriting performance.”

The deterioration of underwriting has caused the industry’s overall profitability, as measured by its annualized rate of return on average policyholders’ surplus, to fall 13.1% in the first half of this year from 13.5% in the first half of 2006.

On a positive note, policyholders’ surplus increased $26.5 billion to $512.8 billion as of June 30, up from $486.2 billion at the end of 2006. The increase could lead to a healthier marketplace, according to Murray.

“Demand for insurance is a stable thing,” he says. “The people who need insurance…need it year in and year out, so changes in the insurance are determined by the supply of insurance. In a very real sense, the surplus of the p-c industry is determined by the supply of insurance and with surplus being at record high in first half of 2007. This is driving competition for insurance.”

The overall net loss and loss adjustment expenses for the first quarter increased $15.9 billion (1.1%) to $142.9 billion in the first half of 2007 from $141.4 billion in the first half of 2006 and, excluding catastrophe losses, ISO estimates net loss and loss adjustment expenses increased $6.6 billion (5%) to $139.1 billion in 2007 in comparison to $132.5 billion last year. So far, catastrophes in the first half of the year account for $3.6 billion in direct insured losses to property, according to ISO’s Property Claims Services unit. This is a decline from the $6.5 billion in 2006.

Net gains from underwriting were down 4.1% to $14.4 billion in the first half of the year, compared to $15 billion this time last year. However, the combined ratio of 92.7% in the first half of this year is the best in years, according to Murray.

“Despite the deterioration in underwriting results, the 92.7% combined ratio for first-half 2007 is the second best for any first half since 1986, when ISO’s quarterly records begin,” Murray says. “Even so, underwriting results weren’t good enough for insurers to achieve the rate of return typically earned by firms in other industries. With first-half 2007 investment results, financial leverage and tax rates, ISO estimates that the combined ratio would have had to improve to 91.5% in order for insurers to have earned the 13.9% long-term average rate of return for the Fortune 500. Moreover, with today’s low interest rates and investment yields, insurers must now post significantly better underwriting results just to be as profitable as they once were.”

Editor’s note: This is the first installment in a series of articles examining the state of the property-casualty industry. Next week, IN&V will look at how personal lines are shaping up in 2007.

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

Producer Compensation Issue Update

N.Y. State Appellate Court Rules Contingent Commissions Legal
Decision is vindication for many in agent/broker community.

The insurance world was turned upside down three years ago when then-New York Attorney General Eliot Spitzer uncovered a bid-rigging scheme involving Marsh Inc., AIG and other prominent names in the industry. Every agent and broker in the industry at the time remembers how the attorney general and others used those allegations to somehow suggest that the receipt of contingent commissions by main street producers created an inherent conflict of interest and were improper in many instances. In a recent decision that received far less publicity than Spitzer’s initial attacks on incentive compensation, the nation’s insurance agents received a small measure of satisfaction and vindication when a New York State appellate court ruled that contingent commissions are legal.

The case, Hersch v. DeWitt Stern Group, Inc., involved an insurance brokerage firm that had allegedly failed to procure adequate insurance coverage for a relatively longstanding client whose property was later damaged by fire. The plaintiff argued that the broker had a fiduciary duty to the client and further maintained that the incentive commission agreement between the broker and insurer should have been disclosed. The New York Supreme Court, Appellate Division, First Department, disagreed and ruled that the lower court should have dismissed these claims altogether. 

The appellate court --- pointing to previous rulings of the state’s highest court --- clearly and succinctly asserted what the Big “I” and countless agents have been saying for three years. The court stated that "contingent commission agreements between brokers and insurers are not illegal ... and, in the absence of a special relationship between the parties, (the) defendant had no duty to disclose the existence of the contingent commission agreement." In addition to confirming the legality of contingent commissions, the ruling suggests that disclosure of such arrangements is not mandatory or necessary in most cases. 

The decision would not free agents and brokers from any compensation disclosure mandates that might be properly established through the legislative or regulatory process, but the vast majority of jurisdictions have elected not to impose such mandates. Even New York has not yet altered the requirements that existed prior to the Spitzer inquiry. 

The true effects of this important decision may not be known for weeks or months to come, but, in the meantime, in the words of Ray Donovan, who served as President Reagan’s secretary of labor and was acquitted of corruption charges after a lengthy and highly publicized trial: “Where do I go to get my reputation back?” In the wake of this recent decision, many insurance agents --- whose reputations were unfairly tarnished in recent years and who were never afforded the opportunity to fight back --- are probably wondering the same thing. 

Wes Bisset (wes.bisset@iiaba.net) is Big “I” senior counsel for state government affairs.

On the Hill

House Committee Acts on National Disaster Legislation
Klein/Mahoney bill will help spur debate on growing issue.

After several hours of deliberation this week, the House Financial Services Committee approved important and much-needed catastrophe insurance legislation. The Homeowners' Defense Act of 2007, which has had the support of the leadership in the House of Representatives, could now come to a vote in the full House before the end of the year.

The bill --- introduced by Reps. Ron Klein (D-Fla.) and Tim Mahoney (D-Fla.) in August --- contains two titles, one to create a National Catastrophe Risk Consortium and one to create a National Homeowners Insurance Stabilization Program. Both programs are intended to help prevent potential insolvencies and make the private insurance market more stable, ultimately making catastrophe insurance more available before and after a major disaster. The consortium program would allow multiple states to pool their catastrophic risk, thereby hopefully achieving an economy of scale and risk diversity that will lead to a lower cost of reinsurance than states could achieve independently. The stabilization program would allow the treasury department to make loans to states and their reinsurance plans to ensure their continued liquidity in the result of a natural catastrophe.

“The Big ‘I’ is pleased that the committee has approved this natural disaster legislation,” says Charles Symington Jr., Big “I” senior vice president of government affairs and federal relations. “Natural disasters require a national solution, and we applaud the leadership shown by the committee in advancing solutions to this problem. The legislation introduced by Reps. Klein and Mahoney and approved today is a great first step towards a comprehensive solution.”

The Big “I” has been a leader in advocating for natural disaster solutions, testifying on several occasions before the House Financial Services Committee and the Senate Banking Committee on the need for Congress to consider legislation to stabilize the insurance market for natural disaster risk.

“As the representatives of the independent insurance agents who sell homeowners’ insurance, we feel it is important that Congress encourages both a healthy and vibrant private market as well as secure state and regional reinsurance programs, and it is our view that this legislation does both” says John Prible, Big “I” assistant vice president for federal government affairs. “Specifically, the creation of a National Catastrophe Risk Consortium could offer both states and private market participants an opportunity to benefit from a pooling of catastrophic risk diversified by type of peril and geographic region. The creation of a National Homeowners’ Insurance Stabilization Program, meanwhile, could provide for a level of stability for state and regional reinsurance programs that is absent at this time.“

The Big “I” is not alone in calling on Congress to act, and an increasing number of federal, state and local officials are coming to the conclusion that a comprehensive national solution is necessary. In February of this year, the bipartisan Southern Governors Association adopted a resolution urging Congress to create a “reasonably priced national reinsurance program supported by actuarially sound premiums.” More recently, the U.S. Conference of Mayors adopted a similar resolution supporting the establishment of a national disaster plan and financial backstop.

Further support for Congressional involvement in resolving the catastrophe insurance crisis was also expressed this week during a natural disaster hearing conducted in Mobile, Ala., by seven insurance commissioners from the Southeastern United States. The session featured presentations by Rep. Mahoney and Rep. Jo Bonner (R-Ala.), highlighted the need for quick and meaningful action and recognized the benefits that strong building codes and mitigation measures can have in reducing the risks and costs associated with natural disasters.

In a follow-up to the Mobile hearing, the National Association of Insurance Commissioners is scheduled to discuss catastrophe insurance issues during its Fall National Meeting this weekend in Washington, D.C.

Patrick Royal (patrick.royal@iiaba.net) is Big “I” director of public affairs.

L&H Trends

Committing to Customers
Agents take away lessons from leading retailer.

This past week the Independent Insurance Agents & Brokers of Washington had its annual convention and curiously, the keynote speaker was not an insurance company CEO, insurance sales guru or other insurance luminary. Rather, it was Blake Nordstrom, president of Nordstrom, Inc. Less anyone think he was just handed the reins, the 40-something president made it clear he had to work his way up --- beginning at age 10.

The department store enjoys a hard-earned reputation for superior customer service. Nordstrom’s success derives from its sales associates’ unparallel commitment to serving the customer’s needs. During his presentation, Nordstrom discussed the 100-plus-year history that catapulted a humble shoe store into one of the premier retail brands in the country. However, the success was not without bumps in the road. In fact, Nordstrom explained that the store ran into operating problems in the 1990s.

In the 1990s, Nordstrom got caught up in a “top-down” approach that involved teams of consultants producing directives that stores adopted, leaving many store personnel feeling that their input was no longer valued. As a result, senior management was insulated from customers’ direct feedback and the shopping experience was being negatively impacted.

Fortunately, management realized that it needed to get back to Nordstrom’s formula, which involved “tipping” the organizational structure of a pyramid with senior management at the top and turning the pyramid upside down with senior management on the bottom with the broad base of store personnel at the top. Based on this approach, management focused once again on reinforcing the tools that were necessary to support the personnel directly serving customers’ needs. After making this adjustment, store sales again increased and Nordstrom has since not strayed from this strategy.

Another lesson independent agents can learn from Nordstrom’s is that its commitment to serving customers is well-defined and communicated. Its mission statement is as follows:

Our commitment to an extraordinary shopping experience

Even if you're making an exchange or a return, we make it easy. A pre-paid return label is included with every order. Only the minimum return postage fee will be deducted from your return. And exchanges are totally free --- by mail, by phone or in the store.

Do your customers know about your agency’s commitment to customer service? One of the foundations of the consumer brand, Trusted Choice^®, is that there is a pledge of performance that can and should be communicated to customers so they understand the value Trusted Choice^® independent agents deliver to their customers. Take the time to make sure the agency focuses on supporting the agency personnel directly dealing with customers and that customers know about that commitment.

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

Forms & Substance

Profit and Overhead: When Insureds Repair Their Own Damage
Are do-it-yourself-ers covered?

Your insured is a contractor. He wants to repair insured damage to his own building to ensure that the job is done right. Or, let's say he negligently causes damage to a customer's property that is covered by his CGL policy and wants to make repairs himself. Is the insurer obligated to pay an amount that includes profit and overhead for the work done by its insured or only materials and labor?

It's not unusual for a company to initially balk at paying profit and overhead. However, absent fraud, there’s a question whether this is a legitimate claim denial. The main reason against paying for profit is that it theoretically violates the principle of indemnity in that that an insured should be indemnified for actual loss sustained and not profit from a loss.

But, the insured does not technically profit since he would otherwise suffer an opportunity cost because he could have invested that time in doing work for a customer who does pay profit and overhead. Another reason for not paying for profit is that it potentially encourages fraud.

A number of courts have held that an insured undertaking its own repairs is entitled to include overhead and profit in its claim for reimbursement from its insurer. For example, the Sixth Circuit opines in Parkway Associates, L.L.C. v. Harleysville Mut. Ins. Co., 129 Fed. Appx. 955, 963 (6th Cir. 2005):

“Parkway's policy provides that it is entitled to recover the actual cash value of its loss. The actual cash value of a loss is equal to the repair or replacement costs less depreciation. The Tennessee courts have not determined what repair or replacements costs include.

“Other courts, however, have held that 'repair or replacement costs logically and necessarily include any costs that an insured reasonably would be expected to incur in repairing or replacing the covered loss.' Gilderman v. State Farm Ins. Co., 437 Pa. Super. 217, 649 A.2d 941, 945 (Pa. Super. Ct. 1994); Salesin v. State Farm Fire & Cas. Co., 229 Mich. App. 346, 581 N.W.2d 781, 790-91 (Mich. Ct. App. 1998); Ghoman v. N.H. Ins. Co., 159 F. Supp. 2d 928, 934 (N.D. Tex. 2001).

“Parkway would reasonably be expected to hire a contractor to repair its property. Since the actual cash value of a loss is the repair or replacement costs less depreciation and since the cost of a contractor would reasonably be incurred in repairing Parkway's damaged property, then the costs of contractor's overhead and profit would be included in the actual cash value of Parkway's loss.

“The statute relied upon by the district court says nothing to the issue of whether an insured who contracts to receive the actual cash value of its loss must deduct overhead and profit because it plans to hire an unlicensed contractor. The fact that Jeff Fisher, if he ultimately repairs Parkway's property, would not be entitled to profit does not mean that Parkway is not entitled to what it bargained from Harleysville, which is the actual cash value of its loss.

“In essence, Harleysville complains that Parkway would receive a windfall if it paid Parkway contractor's overhead and profit where Parkway hires a contractor that is not entitled to earn a profit. The same general argument was raised in both Salesin and Ghoman. In those cases, the insurers argued that they were entitled to deduct contractor's overhead and profit from the actual cash value awards since the insureds, who repaired their damaged property themselves, did not incur the costs of contractor's overhead and profit.

“Both courts concluded that the fact that the insureds did not incur the costs for contractor's overhead and profit was irrelevant because the insureds contracted to receive the actual cash value of their losses, which included contractor's overhead and profit since, in light of the damages the insureds incurred, it would have reasonably been necessary to utilize a contractor to make their repairs.

“Similarly, in this case. Parkway contracted to receive the actual cash value of its loss. It is irrelevant to the determination of the actual cash value of its loss that Parkway might employ an unlicensed contractor who is not entitled to earn a profit. What Parkway actually spends to repair its property does not affect its right to recover the actual cash value of its loss, as the actual cash value is not calculated based upon what the insured ultimately pays to repair its property. We set aside the district court's order deducting overhead and profit from the actual cash value of Parkway's loss."

Fore more on this topic, click here.

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