Insurers explain skyrocketing rates
9/11 just one factor driving increases

by Christopher Key

 

 

If there is one recurring theme I hear in my interviews with business people, it is the howls of anguish over sharp increases in insurance premiums. The cost of employee health plans, already stratospheric, has gone into orbit. Property and casualty insurance rates are not far behind. Economists point to these rates as a factor in the sluggish economic recovery. Media coverage has pointed the finger of blame at the terrorist attacks of 9/11. That is certainly a factor, but there’s a lot more to the story.

Insurance rates are cyclical. When they’re on the upswing, it’s known as a hard market. When they’re headed down it’s called a soft market. The decade of the 1990s was characterized primarily by a soft market. That is, the premium increases each year were low when calculated on a percentage basis. Major increases starting in 2001 were part of the cyclical upswing and still haven’t reached the heights of the last hard market in the 1980s.

Keith Wallace has been in the insurance industry since 1990 and specializes in employee benefits. He runs a two person office that is a subsidiary of Rice Insurance.

“Employee health insurance used to be just a major medical policy,” Wallace said. “In 1992, a monthly premium of $175 for a family was huge. Now, it’s around $650 up to $1100 for a Cadillac plan.”

According to Wallace, there are two levels of risk tolerance involved: the employer and the employee. Employers tend to have higher tolerance.

“The driving forces behind the increases,” Wallace said, “are the cost of medical technology, prescription drugs, and the shift toward preventive medicine. In the long term, preventive medicine will help drive costs down.”

He notes that drug prices cause both profit and loss.

“People who have pharmaceutical stocks are making a lot of money,” Wallace said, “but it’s not so good for the people who have to buy the drugs. I think we’ll have to control the costs of drugs sooner or later. The companies should make some return on their investment, but what is fair? There’s one Multiple Sclerosis drug out there that costs $1500 a month.”

He believes that the cyclical nature of insurance premiums will eventually see them level out or even drop.

“There is a lot of bureaucracy involved in insurance claims and processing,” Wallace said. “Insurers need to streamline their administrative processes so that they just deal with risk.”

Health Management Organizations (HMOs) have seen a steep drop in popularity and Wallace points to administrative costs as a big factor.

“Co-pay plans help keep usage from getting out of whack,” said Wallace. “They cut down on people using the emergency room as a doctor’s office by encouraging preventive care.”

While there are no reliable statistics, Wallace believes that some people are taking jobs based solely on the benefits that are offered.

“Health benefit costs for a family can run to $8,000 a year,” Wallace said. “That’s a significant chunk of employee compensation. Eighty to ninety percent of employers now require employee contributions to benefit plans.”

One relatively new wrinkle for controlling costs is the “cafeteria” approach wherein the employer pays a flat amount for benefits and lets the employees choose what they want or need.

“There are more plans available now,” Wallace said, “more competition. There are nine sources now whereas not long ago we were down to three. That means that insurance companies are more eager to work with people. Agents, in turn, can bid more aggressively and the industry becomes more responsive to the consumer.”

Not all rate increases are running at 40-50 percent, Wallace noted. Some are now back at five percent, which may herald the end of the hard market.

“Association plans like those offered by the Chamber of Commerce or the Farm Bureau,” said Wallace, “help spread the risk and keep costs down. It’s really a much more positive market than it was three years ago.”

Paul Kenner has been with Snapper Shuler Kenner (SSK) in Lynden since 1973. The company itself dates back to 1925. SSK is an independent agent that deals in all phases of insurance. There are 29 employees, most of whom specialize in a particular field. It’s one of the top three firms in Whatcom County.

“Historically, the insurance market cycle has swung every seven years,” Kenner said. “The soft market that started in the 90s ran 10 years and was fueled by investment income. Insurance companies were competing for your insurance premium so they could invest it. They were actually losing money based on premiums, but gaining in the stock market.”

The current hard market, Kenner points out, began well before 9/11.

“Beginning in 1999,” Kenner said, “the insurance companies’ investment income could no longer offset their losses and they were forced to increase premiums.”

The terrorist attacks of 9/11 constituted the perfect storm. It hit hard at the reinsurance industry. Those are the companies who insure the insurers. For example, if you have a $5 million policy on your business, your insurer may be underwriting only $1 million of that risk. A reinsurance company takes on the rest.

“It was like all disasters rolled into one,” Kenner said. “The reinsurers had to raise their rates, which meant the insurance companies had to pass it along to the consumer. I wouldn’t be surprised if some companies took advantage of the situation. Even companies that weren’t directly involved with the World Trade Center (WTC) were affected. Think of all the businesses that were in the WTC. Every one of them had insurance policies, most of them had multiple policies.”

That was how the ripple effect turned into a tsunami.

“The industry had enough surplus to absorb the losses,” Kenner said, “But they couldn’t take another hit. Hence we now have terrorism insurance.”

According to Kenner, some insurance companies were losing money well before 9/11 and were pulling back from some markets. The construction industry, in particular, has been hit hard.

“When there’s nobody left in the market but high risk insurers,” Kenner said, “rates are bound to go up. Some contractors have seen increases from 100 to 400 percent.”

A lot of the rate hikes stem from increasingly expensive litigation focused on problems involving mold and rot. Western Washington is among the nation’s leaders in those two categories.

“No insurance policy covers rot,” Kenner said. “That is the result of owner neglect, not contractor error. However, the policies do cover collapse, which can result if rot is ignored. This is not what the policy was intended to do and it causes insurers to walk away from contractors. The construction industry is not blameless, but state laws seem to encourage customers to sue rather than negotiate.”

Kenner cited statistics showing that construction defects are lower here than the average.

“Contractors who have had claims get slammed,” Kenner said, “but the guys who don’t get hit as well. It’s driven some of them out of business.”

Contractors who build multi-family dwellings have been hit the hardest.

“Granted, sometimes construction has not been as good as it could have been in order to save costs,” Kenner said. “But the laws in this state make it easy for owners’ associations to come after general contractors.”

Homeowners insurance has actually declined as a percentage of the purchase price of a home, but that’s somewhat deceptive given the skyrocketing prices of housing.

“People are using their homeowners as a maintenance policy,” said Kenner. “Got a problem with the roof? Don’t pay to fix it. Just wait until it causes some water damage and then file a claim on your homeowners policy.”

Mold and mildew have become huge issues, despite affecting a small number of homes. There’s even a wisecrack in some legal circles that Mold is Gold.

“The insurance industry is so scared of the mold issue,” said Kenner, “that they’re tracking homes by address. This means the owner of an older home could end up being penalized by an earlier owner’s claim. State Farm, the largest writer of homeowners insurance in the nation, will no longer accept applications from Washington, Oregon, California and several other states.”

Because of the litigious nature of our society, insurers are walking away from other potential problems, as well.

“Some companies won’t insure homes built of synthetic stucco,” Kenner said. “Some won’t insure owners of pit bulls. It boils down to the company losing money and sometimes they act unfairly.”

Kenner points out that while customers get penalized when insurance company investments go bad, they benefit from lower premiums when the stock market is up.

“Rates in the 90s were low compared to the risk,” Kenner said

He suggests the consumers put themselves in the place of the insurance companies.

“Would you insure your 17 year old son to drive?” Kenner asked. “Would you be willing to take on the risk the insurers are assuming? Apparently not, if you have insurance.”

Once the insurers get back to profitability, Kenner expects rate wars to start thereby driving down premiums. He feels that we’re on the tail end of the hard market.

“Unfortunately, we deliver bad news more than good,” Kenner said. “Rate increases hurt our clients. As professional shoppers, we are spending double or triple the amount of time on each client. We’ve added staff. We’re heavily into the construction industry and now have five people working on nothing but that. The stress level is huge.”

What can the average consumer do to cut insurance costs?

“Stop relying on insurance for maintenance issues or small losses,” Kenner said. “Put a high deductible on your homeowners and take care of your house. Fix the leaky window before it becomes dry rot. Take some responsibility.”

Bellingham’s Unity Group began in 1923 and grew to its present size through a series of mergers. With branch offices in Sedro-Woolley, Everett and Lynnwood, Unity employs 62 people. Barry Hanson agrees with Kenner that the insurance crisis would have happened with or without 9/11.

“The real issues here are jury awards,” Hanson said. “Asbestos claims, for instance, are out of control.”

Robb Dale points out that commercial insurance is subject to bigger swings than the private sector.

“Underwriters rely heavily in their ability to invest capital,” Dale said. “When those investments go down, more capital has to go into paying claims. The pressure to raise rates is strongly affected by investment income.”

Premiums as a percentage of the Gross Domestic Product (GDP) are actually lower than they were in 1987, according to Dale. That’s small comfort to businesses facing huge premium increases.

“These dramatic increases have come when businesses can least afford it,” Hanson said. “A lot of it goes back to the economic situation. The insurance companies want to produce an adequate return for their investors. They either have to reduce losses or increase premiums.”

Insurance companies think differently during a hard market.

“Right now, companies are looking to make money, not increase market share,” Dale said, “so the best clients are getting the best rates. Businesses got used to not having risk management practices and that has to change. Businesses that run a tight ship will benefit. Those who have had claims will have problems.”

Insurance companies are not only raising rates, they’re eliminating coverage.

“We’re starting to see a lot of exclusions for mold,” Hanson said. “There was a recent Texas case in which the plaintiff won a $32 million award for mold. That’s going to make it difficult to write policies without a mold exclusion. Some of these lawsuits name all of the subcontractors as well as the general. They can spend more defending themselves than the amount of the claim.”

An innovative approach that the Unity Group supports is the agreement by the purchaser to submit any disputes to binding arbitration. Under this system, the builder assumes the warranty for the first two years and the insurance company picks up the next 10.

“We have to create an environment that discourages litigation,” Dale said.

Unity is a member of what is called a Share Group consisting of hundreds of insurance agents. They can send out a request and tap into the wisdom of the whole group.

“We’ve found substantial savings for customers through national networking,” Hanson said.

A lot of commercial policies now exclude terrorism insurance. The problem that some have run into is that some lenders require it at the behest of their auditors.

“If everybody purchased terrorism insurance,” Dale said, “Rates might be kept reasonable. If only those who have a risk purchase it, the rates are going to be very high.”

Some of the regulations governing this area come from the Terrorism Act. Under that act, some of what used to be called vandalism can now be defined as terrorism.

“There are so many factors out of control,” Hanson said, “that the actuaries can’t handle it. It’s frustrating for all of us.”

Barkley Associates is a relative newcomer to the insurance business, but its eight employees are not. They are affiliated with a group called Trusted Choice, which is an attempt to give independent agents the same brand recognition as State Farm or any of the other major players.

“The Seattle area is a test market for this program,” said Barkley Associates president Rob Knode. “We have to agree to certain standards of ethics and performance in order to participate.”

For most small businesses, it’s vital to have professional help with insurance, according to Knode.

“Home and auto insurance rates are not keeping pace with claims,” Knode said. “The trend is for companies to move away from the old three tier system. That identified clients as standard, preferred or super preferred. Now there may be as many as 20 tiers. Some companies are backing out of homeowners because they just can’t make it.”

The agents at Barkley think of themselves as problem solvers. One of their missions is to work with nonprofits.

“We have been very successful helping nonprofits,” Knode said, “but it’s a lot of work. It’s a way for us to give back to the community.”

Knode agrees that litigation is a major force driving premiums skyward and that the woes of the stock market play a role, as well.

“The companies could underprice their services as long as investments were paying off,” Knode said. “Low rates were artificially subsidized by stocks and other investments. When the return on those investments dried up, the companies retreated into a box where the risks were lower.”

Barkley Associates can help clients understand how to use deductibles to decrease claims.

“If you have more than one claim on your homeowners,” said Knode, “you’re on a ‘watch’ list. If you have three claims, most companies won’t have anything to do with you. We should make it more inconvenient to make a claim by setting the deductible higher.”

Personal umbrella policies, which cover auto, home, life and any other needs at one price are becoming more popular, according to Knode.

“Those are usually a good deal,” said Knode. “We want to develop long term relationships with customers. People who walk in our door shouldn’t have to look anywhere else.”

InterPay, one of the nation’s largest payroll providers, has some suggestions to help employers keep health care costs down. They encourage cost sharing by employers and employees. Why? According to a study conducted by the Robert Wood Johnson Foundation, 43 percent of employees fear that their employer will eliminate health insurance during the coming year because of rising costs. Twenty one percent fear their own out of pocket costs will increase to levels they can’t afford. Cost sharing may be one way to avoid that eventuality. One of the strategies InterPay recommends is called the premium conversion plan, also known as premium only, or pre-tax plans.

If a company passes along any part of health care costs to employees, both parties can save by having those dollars taken out before taxes. This saves the employer on Social Security, Medicare and federal unemployment tax. The employee saves on federal and state income taxes, Social Security and Medicare.

Flexible spending accounts (FSAs), or flexplans, enable the employee to contribute funds through salary deferral to pay for qualified medical expenses not covered by insurance. The amount of salary earmarked for the FSA is not subject to income or employment taxes, enabling the employee to pay for deductibles and other out of pocket expenses with pre-tax dollars. The drawback is that amounts contributed to an FSA that are not used for qualifying medical expenses during the year are forfeited. It’s called the ‘use it or lose it’ rule.

The good news is that the hard market for insurance rates is going to end. The bad news is that by the time it does, a lot of businesses may suffer irreparable damage. That’s reason enough for small businesses not to rely on their own expertise, but to consult a professional.