General Hood Speaks Out

Mississippi AG James Hood has a NY Times (reg. req’d) op-ed on the Katrina lawsuits.  He states…

It's true that many of these policies exclude specific types of water damage unrelated to hurricane winds, like the damage caused by tidal waves or windblown rain. But to extend such exclusions to the damage caused by a storm surge, which is the direct consequence of hurricane winds, is unconscionable and illegal, at least here in Mississippi.

Unconscionability is bandied about when someone doesn’t like a particular outcome.  It is claimed ex post – after a dispute has arisen as a rationale for changing terms and conditions of a contract.  One would like to see some objective evidence of unconscionability before concluding it exists.  Perhaps excess profits, while not definitive evidence of unconscionability, would at least allow one to ask follow up questions. Thus, one would expect if insurers were acting unconscionable they’d be at least making above normal economic profits on their insurance transactions. 

If we look at the National Ass’n of Insurance Commissioner’s Profitability Report which makes an estimate of insurer's profits by line by state, we see that for the southeastern states, only South Carolina has a positive 10 year average profit rate. The rest are negative with Florida having a bad year in 1992 (Andrew) which overcomes all subsequent profitable years.  In 2003 the industry earned 5.4% on insurance transactions which is approximately what the average South Carolina profit was over the period.

Thus, if there were unconscionable profits, we’d not likely see the numerous yearly losses in Mississippi. We’d see profits instead. If insurers priced a risk and then never covered losses for it, we'd see a profit.  Because there are losses across most of the southeast, it is obvious that this flood risk is not charged for in the homeowner's policy.  Thus, can there be unconscionability if the insurer is not benefiting in any way? 

A second question this lawsuit brings up is whether an insurer can ever absolutely avoid a risk.  The language which purports to do so can always be questioned, but if one looks at the attempt to avoid the risk, it is clear that the insurer is trying to do so. 

Finally,  Mr. Hood states:

Nor will honoring the contracts they've signed with policyholders send insurance companies into bankruptcy, as some companies have misleadingly claimed. Reputable credit and insurance industry analysts have found that the financial stability of these companies is not at risk. One insurance analyst estimated that covering damage from Hurricane Katrina's storm surge would cost insurers an additional $2 billion to $4 billion. To put that in context, consider that the industry's net income for 2004, when Florida suffered extensive damage from four hurricanes, was $38.7 billion.

So, Mr. Hood says the industry should pay just because it has money and will only cost the insurance industry $2–4 billion.  (When was that ever a just basis for liability?)  Further, the industry is made up of thousands of companies and many don’t sell homeowners insurance at all.  If we are going to put profit numbers into our rationale -- why don't we include Google's too?

Presumably shareholders will pay for this in the short run in terms of a loss in shareholder equity, but consumers in Mississippi will pay higher prices in the long run.  Shareholders are not going to put their money in jeopardy a second time.  AM Best and other rating agencies will look carefully at Mississippi exposures and firms with higher exposures will be rated lower.  The lower rating increases the costs of both capital and reinsurance and will lower Mississippi insurance profitability.  Over time firms will leave the market or ask to charge significantly more for their policies.  If regulators won’t allow increased prices for the increased coverage, then the industry will atrophy and end up like the State of Florida with the taxpayers bearing all of the risk and insurers rushing toward the exit.  The bankruptcy risk that Mr. Hood disputes may well be over stated, but the lack of insurers willing to write homeowners risks in Mississippi may not be.

Update:  AM Best (11/22) just reevaluated its rating of the Florida only Nationwide subsidiary.  Even after a contribution of capital by the parent the company is rated a B with a negative outlook.

Comments

[Bob Detlefsen]

Congratulations, Martin, on a typically brilliant evisceration of Hood's NYT op-ed and the rationale behind his lawsuit.

[chris robertson]

Riskprof, you completely mischarcterized Hood's point in the passage below. He was rebutting an opponent's argument that forcing insurance companies to pay would lead them into bankruptcy. He says that's not true, and gives some decent evidence for that point. You then create a complete strawman argument when you say, "Mr. Hood says the industry should pay just because it has money." Of course, that is not what Mr. Hood said at all.

"Finally, Mr. Hood states:

'Nor will honoring the contracts they've signed with policyholders send insurance companies into bankruptcy, as some companies have misleadingly claimed. ...Hurricane Katrina's storm surge would cost insurers an additional $2 billion to $4 billion. To put that in context, ...the industry's net income for 2004, ... was $38.7 billion.'

So, Mr. Hood says the industry should pay just because it has money and will only cost the insurance industry $2–4 billion."

[Martin]

Chris--I don't think I mischaracterize what he is saying. He said insurers are profitable so they afford to pay these claims. I agree that the bankruptcy claims may be overstated, but already one firm is gone--Miss Farm Bureau Mutual. It does not have the money to pay claims even without the flood claims added in. The point is, one can not say that the industry won't miss the money because not all of that money supports homeowners insurance. In fact, home owners insurers writing business in the southeast have a cumulative negative profit since 1992. However, saying an industry is rich and can afford to pay claims is a common argument used to "tax" just because of ability to pay --irrespective of responsibility.