You're in Good Hands with Uncle Sam

Corporate Research E-Letter No. 18, November 2001

You're In Good Hands With Uncle Sam:
Federal Intervention In The Insurance Industry

by Philip Mattera

The terrorist attacks of September 11 will result in an estimated $50-70 billion in claims from property owners, making it the most expensive disaster in U.S. insurance history. The industry is patting itself on the back for its willingness to pay off these claims without protest. Yet, at the same time, insurers are putting a squeeze on their policyholders and on the federal government. 

Insurers are insisting that they cannot shoulder the cost of any future terrorist attacks on their own. Instead, they want the federal government to put up most of the money for such claims, at least for next year. Within a couple of weeks after the collapse of the World Trade Center, industry lobbyists had drawn up proposals for creating a federal backup for losses caused by terrorism. In other words, the U.S. treasury would take over part of the reinsurance business -- i.e. providing insurance for insurers to cover large unexpected claims. 

The concept was embraced by the Bush Administration, which bought the argument that ensuring the financial stability of the industry was essential to the well-being of the country. During Congressional hearings in October, Treasury Secretary Paul O'Neill sounded like an insurance lobbyist when he declared: "Leaving this problem unresolved threatens our economic stability." Consequently, the Administration proposed a three-year plan in which the federal government would provide up to $229 billion in coverage. 

The Administration's urgency was prompted by a crisis atmosphere created by the industry. Insurers began notifying customers that many policies would be cancelled unless the feds came to the industry's rescue. Carriers also ratcheted up the pressure by increasing premiums by 100 percent or more on many business liability policies. Last month, a newsletter associated with Lloyd's of London investors called the aftermath of September 11 an "historic opportunity" to increase profits.

As this is being written at the end of November, Congress is still working on its version of a rescue package. The Administration's proposed gift to the industry is being replaced with a plan that would require insurers to reimburse the federal government for at  least part of any payouts. On November 29 the House approved a bill under which the feds would pay 90 percent of all terrorism claims above $1 billion next year, up to a maximum of $90 billion. The insurance industry would repay the government up to $20 billion of that amount over time (the rest could get repaid by taxpayers or by surcharges added to the premiums of  commercial policyholders). The bill would also make it difficult for victims of future terrorist attacks to sue for damages. The Senate, meanwhile, is proceeding at a slower pace and is developing a bill that would require the industry to take responsibility for the first $10 billion in terrorism claims and that would not include the restrictions on damage awards.

Some of the companies that stand to gain the most from the federal rescue were previously at the center of attention in Washington for another reason: tax avoidance. It came to light last year that a number of U.S. property-casualty insurers, especially reinsurers, were moving their headquarters to Bermuda or being acquired by a Bermuda insurer as a way of sidestepping corporate income taxes. The news prompted calls on Capitol Hill to crack down on the practice. In the wake of the September 11 attacks, the migrations to Bermuda have accelerated, but Congress no longer appears to be concerned. 

Federal Assistance, But Not Regulation

It is more than a little ironic that insurance companies should be turning to the federal government for help. For decades the industry fought against federal regulation of its affairs, and in 1945 it accomplished the amazing feat of getting Congress to pass a law, the McCarran-Ferguson Act, that kept regulatory authority over a major sector of the economy in the hands of state officials. 

As the industry expected, most state regulators did not exercise very vigorous oversight. Thus, when a renewed push for federal regulation emerged in Congress in the early 1990s, insurers felt comfortable in suggesting that the National Association of Insurance Commissioners (NAIC) could meet the demand for more uniformity in regulatory practices from state to state. NAIC turned out to be a more forceful regulator than insurers had anticipated, but the industry clipped its wings by refusing to pay its full fees to the association. 

One of the regulatory issues that most haunts the property-casualty portion of the industry is redlining. For more than a decade there have been repeated allegations by activist groups such as ACORN and some of the more aggressive state insurance commissioners that the industry discriminates against low-income and minority homeowners by declining to write policies in certain neighborhoods or by charging excessive premiums in those areas. The industry has paid millions of dollars to settle redlining lawsuits. ACORN is currently proposing that one condition of any federal rescue plan be the creation of a disclosure system for insurers along the lines of the Home Mortgage Disclosure Act, which requires banks and thrifts to disclose detailed information about their residential lending. 

A series of articles in the Wall Street Journal and other reports have demonstrated that discriminatory practices have been practiced by life insurance companies as well as property-casualty ones. An April 27, 2000 front-page story in the Journal described how insurers systematically charged African-Americans excessive premiums for so-called industrial policies sold door-to-door, mainly to cover burial expenses. Although the industry was forced to abandon race-based premium structures in the 1960s, the article reported that many of the individual policies remained in effect, with blacks still paying premiums above the norm. Last year American General Life (now owned by American International Group) was fined $7.5 million and required to provide $206 million worth of relief to minority policyholders across the country as compensation for past racial discrimination. Similar suits are pending against more than a dozen other insurers. 

Another area in which the insurance industry could do with stricter regulation is in its marketing practices, both for insurance policies and for the investment products that many large insurers began offering in the 1980s. The leading case in point here is Prudential Insurance, which has had to pay more than $2 billion to settle charges that it engaged in deceptive tactics in the sale of limited partnerships. But it is not alone. For example, New England Mutual Life (now a subsidiary of MetLife Inc.) agreed last year to pay $120 million to settle a class-action suit charging that the company engaged in fraudulent practices in the sale of life insurance policies. 

Siren Song of Fat Returns on Investment

The dubious business practices of insurers in recent years are at least in part an outgrowth of the heightened competitive pressures. Insurance used to be the quintessential stodgy, tradition-bound business that made a good living without trying too hard. That comfortable existence began to disappear in the 1980s. Life insurers found their customers fleeing to mutual funds and other investments that promised much higher returns on their money. Some insurers were lured by the siren song of fat returns themselves, and they loaded their investment portfolios with junk bonds and speculative real estate deals. The result was the collapse of Executive Life and dozens of  other companies in the early 1990s.

Meanwhile, health insurance companies were taken in by the appeal of managed care. Aetna took the biggest plunge in this field, spending nearly $9 billion to buy HMO giant U.S. Healthcare in 1996. After adopting U.S. Healthcare's ruthless cost-control policies, Aetna alienated healthcare providers and found itself the number-one target of class-action lawsuits over denial of coverage. Aetna's subsequent purchase of health insurance businesses from New York Life and Prudential also brought it antitrust scrutiny. 

The problem in the property-casualty sector, according to industry analysts, is that there are too many carriers for the amount of business that exists. Overall, this sector of the insurance industry does not make a profit on its policies, but it ends up well into the black thanks to returns from investing premium payments. Last year the industry's profit was $27 billion. 

Property insurance companies have been trying to improve the profitability of their core business through a series of mergers that are increasing the already high degree of concentration in the field. Currently, the ten largest property-casualty carriers take in more than 40 percent of the premiums.  Some of the big players have taken advantage of the relaxation of federal rules to combine with banking operations, the most notable example being the 1998 merger of Travelers and Citicorp to form Citigroup. Other U.S. insurers have found themselves taken over by foreign financial-services companies such as Holland's ING Groep N.V., which has acquired a chunk of Aetna as well as a slew of life insurers. Other European insurance giants with a substantial presence in the U.S. include Germany's Allianz AG and France's AXA, which took over Equitable Life. 

Merger mania is prompting mutual insurance companies (those owned by policyholders) to convert to stock companies, so they can raise capital on Wall Street and use their shares in making acquisitions. Met Life and John Hancock have made the move, and Prudential is in the process. 

Demutualization is good news for expansion-minded insurance CEOs, but policyholders may get shortchanged. The conventional wisdom was that policyholders should receive shares when mutual insurers convert. Some mutuals have tried to get around that obligation by gradually transferring control of the company to a subsidiary set up as a stock company. A ruling by the Iowa Supreme Court earlier this year upholding the right of policyholders to sue in such circumstances shocked the industry. 

The battle over demutualization -- which mirrors the controversy over the similar conversion of Blue Cross-Blue Shield health insurers -- as well as just about all the other issues surrounding insurance all come down to a fundamental question: Does the industry still exist to serve the needs of policyholders, or has it become just another profit-maximizing business that will do whatever it takes to succeed? 

Top Ten Property-Casualty Insurance Groups
(ranked by 2000 net written premiums in $ millions)

1. State Farm


2. Allstate Insurance


3. Zurich American Insurance 


4. American International Group


5. Berkshire-Hathaway


6. Travelers Insurance


7. Nationwide Corp.


8. Liberty Mutual Insurance


9. CNA Insurance 


10. Hartford Fire & Casualty


Source: National Underwriter-Property & Casualty, July 23, 2001

Top Ten Life & Health Insurance Companies
(ranked by 2000 admitted assets in $ millions)

1. Prudential Insurance


2. Metropolitan Life


3. TIAA*


4. Northwestern Mutual Life


5. Equitable Life Assurance


6. Nationwide Life


7. Hartford Life


8. Lincoln National Life


9. Principal Life Insurance


10. New York Life


* Teachers Insurance & Annuity Association

Source: National Underwriter-Life & Health, July 30, 2001


Information Sources

Public interest and activist groups dealing with insurance issues:

Basic information and financial ratings of insurance companies:


For more detailed information on insurance companies, see A.M. Best's other products, including Best's Insurance Reports, which can be found in larger libraries.