Risky Business
Big insurers rig the game to avoid covering people likely to file claims
On a crisp, clear Saturday morning, two dozen people huddle in the drafty back room of a cramped community center in the Dorchester section of Boston. Mostly blue-collar African-Americans, they are learning how to become good, re liable homeowners. During a daylong class, they listen to an insurance agent and other experts. One goal: to make themselves more attractive to insurers.
In this ethnically mixed area, more than half of all homeowners strike out. A generation ago, the area was risky, its gritty streets troubled by crime and violence. But today, new shops are opening, traffic hums, and homes--including the area's signature "triple-deckers," with gilded trim--are selling briskly. Yet first-time home buyers like Diallo Ferguson, a 29-year-old Boston University financial administrator, find themselves tossed into a last-resort insurance plan set up by the state, which offers many of those it insures less coverage or higher premiums--and, sometimes, both. "I really don't understand why that's still happening," Ferguson says. "It's almost like you're obligated to go with that plan if you're in a certain area. That doesn't seem right."
Today, the risk business is increasingly too risky for insurers, and unsuspecting people like Ferguson are paying the price. What's happening in Boston has happened all over the country: Big companies have lobbied legislatures to create state-sponsored--but industry-run--plans to corral customers they don't want to handle. Then, with those risks isolated, the companies provide insurance to the customers they do want. Insurers "are the ultimate risk avoiders," says J. Robert Hunter, a former industry regulator now with the Consumer Federation of America. "If there's any hint of risk, they dump out of it."
In a four-month inquiry, U.S. News examined the increasing use of these special plans, which number in the hundreds and have become an industry in their own right. The findings:
Across the nation, thousands of individuals and businesses are being forced into special plans, as insurers are increasingly turning away those seeking auto, home, and workers' compensation insurance. Existing plans are growing, while new ones are being created. But in some cases, notably medical care, special plans are full, and people are being turned away--with no coverage.
The plans allow insurers to offload huge costs by putting policyholders or the general public on the hook for losses, or by using taxpayer money to pay plan costs. Meanwhile, tax exemptions granted to the plans mean that taxpayers effectively pay the price when insurers avoid risk and abandon unwanted customers. In Florida and California, for example, special plans created for hurricane and earthquake risk require the public to shoulder liability for billions in potential losses, and tax exemptions deprive the federal treasury of hundreds of millions of dollars a year. State tax breaks shore up insurers' bottom lines still more.
Although some companies are unwilling to take on risky consumers, they're perfectly happy to provide risk-free administrative services to the plans--for such things as issuing policies and processing claims--at often hefty rates. This business is so lucrative that some firms prefer it to actually writing insurance (box, Page 47).
After food and shelter, insurance is one of Americans' biggest expenses. So these special plans, also known as "involuntary markets," are just the latest burden for those who have no choice but to buy insurance if they want to own a home, drive a car, or run a business. Today, the simple act of filing a loss or damage claim with an insurer can result in higher rates or policy cancellation. In several states, including Florida, West Virginia, and New Jersey, doctors have gone on strike to protest the cost of malpractice policies. Homeowners are suffering double-digit premium hikes, and businesses face higher outlays for covering on-the-job injuries. Yet over the past decade, the insurance industry has ranked among the most profitable in America. And one way it boosts the bottom line is by forcing more high-risk insurees into special plans.
Although created by state and federal law to serve the public, special plans are often masked by secrecy. Many refused to provide even basic information to U.S. News, including names of board members or how they spend their money. The magazine's review showed, however, that many plans are dominated by insurance executives. Some refuse to provide audits to the public. Others engage in no competitive bidding.
There are, not surprisingly, two views of these special plans. "Under the table and out of the public eye, incredible amounts of money are being shifted around that have huge impact on people's lives," says Martha McCluskey, a law professor at the State University of New York-Buffalo. But David Snyder, vice president of the American Insurance Association, a trade group, says it's appropriate for the industry to run the plans, because its executives know the business and can regulate themselves.
Untouchables. "No one's going to touch those people," says Robert Black, a spokesman for the Texas Department of Insurance, acknowledging the thousands of homeowners whose claims for mold and water damage in the past several years have thrown the Texas homeowners insurance market into chaos. In response, Farmers Insurance Group--which last year reached a $100 million settlement with state regulators for alleged overcharges and deceptive practices--threatened to pull out of the state. So Texas launched a stop-gap special plan to cover homeowners, under which taxpayers could ultimately be responsible if losses are heavy. "We realized we had to spread some kind of safety net under the existing market," says Black.
The Texas case illustrates the way powerful insurance companies seek to position themselves to cover people who don't file claims, while forcing policyholders or the public to pick up the tab for the biggest losers. It works like this: People and companies must have coverage, either by law or other requirement. Insurers refuse to cover those they judge to be too unprofitable or too inconvenient to serve. Under pressure, lawmakers then create a special plan. Usually, this means companies band together to provide coverage for those denied it, and the special policies typically provide less coverage, a bigger premium, or both. "If you're in the involuntary market," says Tim Ryles, former Georgia insurance commissioner, "you're paying through the nose."
The plans are a windfall for insurers for several reasons: They can write policies offering less coverage at higher prices, spread losses among participating companies, and win tax subsidies from state legislatures. Insurance executives say the plans work well and provide a vital safety net for a small segment of high-risk policyholders who otherwise might have no coverage at all. It is factors beyond the industry's control, they say--such as higher costs for fraud, medical care, or legal damages, or oppressive regulation--that hold down profits and premiums, forcing companies to turn away high-risk customers. "It's not that we're dodging risk," says Larry Akey, communications director for the Health Insurance Association of America. "It's that we don't want to take on sure losers."
Although the special plans are billed as markets of last resort, they're actually commonplace. And with their growth, many more Americans are learning that their insurers consider them to be losers. There are no comprehensive statistics, but the number of customers in these plans varies, typically from several percent to perhaps 10 to 15 percent of the total market for a given kind of insurance. In specific locales, like Boston's Dorchester and Roxbury neighborhoods, the figure runs to half or more of all policyholders. The plans cover the commonplace, like home, health, and car. They're used in the disaster business, to provide coverage in case of flood, hurricane, or earthquake. But they can also be found in just about any niche--including crop loss, nursing home liability, black lung, underground storage tanks, harbor and shipworker injuries, building atop abandoned mines, or even bars when people drink too much.
In auto insurance, applications for special plan coverage reached 1.1 million for the year ended September 2002, up nearly 120 percent over two years. Among homeowners, applications for new special plan policies climbed by about 80 percent, to 104,000, in 2001. Another sign of expansion: Years ago, special plans for homeowners covered urban areas where insurance was tough to get following 1960s and 1970s rioting. Today some plans have expanded beyond "blighted areas" to encompass entire states. And special plans' exposure to potential hurricane losses along the East Coast soared to $112 billion in 1999 from $17 billion in 1992, as property insurers pulled up stakes to avoid losses.
Double trouble. On the job, special plan policies for workers' compensation can cost more than twice as much as regular coverage. Premiums paid by companies in such plans more than quadrupled from 1999 to 2002, to an estimated $2.4 billion. Why? Insurers are "making business decisions: Which risks do we want to keep? Which risks do we want to keep at higher prices?" says Peter Burton, of NCCI Holdings Inc., an industry-aligned private company influential in setting rates.
Even more people could find themselves forced to purchase coverage from special plans. New information technology allows insurers to weave together vast amounts of data--credit histories, criminal information, personal data, claims information, and more--to draw ever finer statistical portraits of policyholders and would-be customers, assessing the likelihood they'll file a claim or shop around for competitive coverage. "Insurance companies have radically changed the way they underwrite and segment the market," says Birny Birnbaum, executive director of the Center for Economic Justice in Austin. And with that, he warns, comes the ability to cull those seen as losers.
When insurers abandon the field--as they did in Florida after Hurricane Andrew stomped across the state in 1992, causing about $16 billion in insured losses--the public stands to lose. Florida created a special plan in 1992, which quickly became one of the state's biggest insurers, with about 937,000 policies. Alarmed that the plan had become too risky, officials decided they needed to move many policyholders back into the regular insurance market. Trouble was, insurers didn't want them. So, since 1995, the plan has paid private insurance companies about $130 million in bonuses to get them to provide coverage. Similar incentives are common in plans across the country. West Virginia went as far as providing taxpayer subsidies to doctors, to cushion higher malpractice premiums.
Florida also offered companies another sweetener. In 1993, the state created a "reinsurance" fund--essentially, insurance for insurance companies, to cover losses in case of a big payout to policyholders. But Florida offers its reinsurance coverage at about a half to a third the price it would cost insurers in the marketplace--a discount worth perhaps a billion dollars a year. "It's a tremendous bargain," says Jack Nicholson, chief operating officer of the reinsurance fund, called the Florida Hurricane Catastrophe Fund. Florida regulators claim that providing insurers with cheap reinsurance helps keep the lid on premiums. Consumer advocates scoff. "They never pass along any benefits to consumers," says Bill Newton, executive director of the Florida Consumer Action Network. "It goes right to the bottom line."
Both the Florida special plan for property insurance and the back-up reinsurance fund enjoy federal tax-exempt status. In effect, that means U.S. taxpayers subsidize insurers' decisions to walk away from the market, to the tune of about $215 million a year, an amount that will grow over time. Neither the plan nor the fund pays state tax, either.
Cocktail hour. Insurers cash in in other ways, too. In North Carolina, for instance, dozens of insurers that refused to write policies along the coast and in other underserved areas received at least $85 million in payments from surplus plan funds. Firms that did provide coverage--and, under plan rules, were therefore not eligible to divvy up the surplus--didn't cash in. "Weird, isn't it?" says Dascheil Propes, chief deputy commissioner of the North Carolina insurance department. "I don't know if that [money] went to cocktail parties, presidents' bonuses, or what." Today, there's about an additional $175 million surplus built up, and state officials are questioning insurers on the legal authority to pay the money to themselves. "When the wind doesn't blow," says Propes, "they make gobs of money." Donald Stauffacher, an executive of the plan, confirmed the general arrangement but declined a U.S. News request for details.
Backed by trillions in assets, insurers have long been a potent lobbying force, in state capitals around the country and in Washington, D.C. Last November, after a yearlong lobbying campaign, the insurers persuaded Congress to grant them $90 billion a year in taxpayer protection against new acts of terrorism. The industry also has a decades-old antitrust exemption that lets companies collude in what otherwise would be illegal price fixing when determining premiums. For many decades, insurers have fended off comprehensive federal oversight in favor of looser, less-sophisticated state regulation that's more vulnerable to lobbying and campaign cash.
That's why the industry brokers deals in statehouses. In California, it was disaster of another kind that triggered a classic industry squeeze play. In January 1994, the ground ruptured about 11 miles beneath Los Angeles's San Fernando Valley, loosening a 6.9 magnitude quake that caused more than $12.5 billion in losses. Afterward, the homeowners insurance market virtually dried up, as insurers refused to write coverage or charged prohibitively steep rates. Industry executives began to rail about a requirement that insurers offer quake coverage along with homeowners policies. Even some consumer advocates acknowledged the industry needed some relief if that requirement was to be kept.
But what happened next gave insurers more than a little relief. Under intense pressure from the industry--plus builders, bankers, and Realtors--legislators twice approved bills shearing insurers' liability by billions. Consumer advocates called it "corporate welfare" and the biggest bailout in the state's history.
The industry's quake-insurance blitz in California between 1994 and 1996 was well-coordinated and well-financed. Hundreds of thousands of dollars in campaign contributions came at key intervals; at one point, consumer advocates called on legislators to stop work on the issue until the latest batch of campaign contribution reports could be examined to see just where the industry was dispensing its cash.
Clout. As crucial details were being worked and reworked, upwards of 50 industry lobbyists joined the battle, which included closed-door meetings with top insurance officials. In 1995, insurers won Round 1, persuading lawmakers to allow them to offer stripped-down quake coverage that greatly reduced their potential losses. A year later came Round 2, as lawmakers approved creation of a special plan, the California Earthquake Authority, which cleaved off still more risk. When the deal was done, executives touted the authority as a national model.
Insurers say they had no choice but to shift the burden. "The magnitude of the earthquake liability and risk was so unquantifiable," says Jeffrey Fuller, executive vice president of the Association of California Insurance Companies, an industry group. Insurers' ability to erase tens of billions in possible exposure underscores a business axiom, says Harry Snyder, a consumer advocate who opposed the quake authority. "Companies make more money by going to Congress and state legislators than by designing better products and service," he says.
If insurers aren't bearing as much risk, then who is? In Florida, for example, property policyholders could be on the hook for billions of dollars in emergency assessments if another hurricane hits. "It's not going to be fun," says Jay Newman, executive director of the Citizens Property Insurance Corp., as the post-Andrew special plan is known. "Hopefully, it will be something people can afford." In California, only about half as many people are even bothering to take out policies. That gap could mean economic calamity if a big quake hits. If the quake authority runs short of money--which it well might--it isn't even obliged to make good on its policies. What's more, five years from now, the law permits insurers to walk away from another $2 billion in potential losses. "The industry did not want to be on the hook forever for that," says Tim Richison, the quake authority's chief financial officer.
Residents, however, can't just walk away. Depending on the scope of a disaster, they might have to pay up to a 20 percent surcharge on their premiums to cover some losses. To make sure they pay, the law allows for cancellation of coverage if they balk. "The industry rigged it up as a hostage-taking measure," says Brian Perkins, a senior staffer of the California State Senate Insurance Committee. Authority officials say the plan is improving, with better coverage at lower prices. But consumer advocates remain unconvinced. "You could be out thousands and thousands of dollars before you even see a penny," says Norma Garcia, an attorney for Consumers Union in San Francisco, "if you ever do."
Nearly three years ago, a moderate quake rumbled through northern California's Napa Valley wine country. Only 15 quake-authority policies paid off. "It's very telling about the insurance industry," says Amy Bach, executive director of United Policyholders, a consumer group. "They're running as fast as they can away from what they're supposed to do. They just want to make a profit without delivering the product. It's crazy."
Insurers bulk up
Insurers' assets have increased nearly 50 percent since 1994, despite 9/11 and the weak stock market.
[Chart data are not available.]
[labels]
0, 50, 100, 150, 200, 250, $300 billion
'94, '95, '96, '97, '98, '99, '00, '01, '02
Source: Insurance Services Office, National Association of Independent Insurers; USN&WR
Figures are for property and casualty insurers.
Big Bucks, little coverage
Homeowners forced into a special plan often don't reap many benefits from the policy. The California Earthquake Authority offers quake coverage, for example, that features a steep deductible and fails to cover key portions of a property.
[Drawing is not available.]
COST OF INSURANCE
For a median-priced 25-year-old home in the San Francisco Bay Area: $1,910 (including 15 percent deductible)
DOESN'T COVER features not part of the main structure, including:
Detached garages
Motor vehicles
Walkways
Awnings and patio coverings
Swimming pools, spas, and hot tubs
Decks and patios
Sources: California Earthquake Authority, Independent Insurance Agents & Brokers of America, Santa Clara County Assessor's Office, Marshall & Swift / Boeckh
Rob Cady--USN&WR
Playing politics with policyholders
Across the country, doctors are rallying and striking to protest soaring medical malpractice insurance costs, which the American Medical Association says top $200,000 annually for doctors in some specialties. Making insurance unavailable or too pricey is a standard tactic insurers use to dodge risk, as the protests that often follow pressure lawmakers. The gambit is working, as many states are moving to cap the pain-and-suffering damages juries can award to malpractice victims. President Bush is also calling for a $250,000 limit on noneconomic damages. Such legislation has passed the House and is pending in the Senate. Insurers claim that escalating jury awards force up premiums, but consumer advocates note that the size of awards is not up.
Insurance industry's campaign contributions to federal elections
[Chart data are not available.]
[labels]
0, 10, 20, 30, $40 million
'92, '94, '96, '98. '00, '02
2002 figures not yet complete
Source: Center for Responsive Politics
-Christopher H. Schmitt
With Edward Hof
This story appears in the June 2, 2003 print edition of U.S. News & World Report.