"History indicates that hard markets are generally short-lived. There are more indications that rate increases are beginning to moderate."
--Jack Gohsler, Senior Vice President, Conning Research & Consulting
In 2002, legislators in about two dozen states discussed whether and how to regulate insurers' use of information in a person's credit history.
By virtually all measures of performance, 2002 was a most difficult year for the insurance industry, as the effects of the September 11, 2001, terrorist attacks continued to be felt. Conning Research predicts there will be a modest improvement in 2003, continuing into 2004. For consumers, legislators and regulators, credit insurance scores will be a front burner issue, according to the Insurance Information Institute (I.I.I.). Analyses by the two organizations provide some reasons
Conning Research and Consulting, Inc., has taken a look at property and casualty insurers for the year 2003 and finds that while the industry outlook is improving, it will not be dramatic. The growth of premiums is likely to be significant, but income and return on equity are projected to show only a modest improvement--for 2003 and 2004 as well. That's the industry assessment from its study: "Property-Casualty Forecasts & Analysis by Line of Insurance." The study provides industry results for 2002, forecast updates for 2002 and 2003, and an initial forecast for 2004.
In reviewing the study, Jack Gohsler, senior vice president at Conning, notes the following: "Our study expects strong premium growth in 2002 with continued but lesser growth in 2003 and 2004, which we expect will result in combined ratio improvement. While underwriting improvement is expected, investment returns are likely to remain depressed. Overall, we expect the industry to be slightly more profitable, but overall financial performance leaves much room for improvement."
The study notes that the industry's net written premiums increased by 10.0% in 2001, For the second consecutive year, premium growth rates were more than double the prior year's increase. Conning projects even stronger premium growth in 2002, at 13.3%, with growth declining to 9.2% in 2003 and 6.5% in 2004.
Driven largely by catastrophic losses, including those of September 11, 2001, the industry's 2001 combined ratio increased to 115.6. Assuming a more normal level of catastrophes, Conning anticipates the combined ratio to improve to 109 in 2002, 105.2 in 2003 and 104.5 in 2004.
Despite these underwriting improvements, GAAP after-tax income and return on equity (ROE) are projected to improve only modestly. The industry suffered its first-ever, after-tax loss in 2001, at $8.3 billion, and ROE was a negative 2.4%. While improvement is expected in 2002, 2003 and 2004, Conning projects after-tax income to reach only $11.5 billion in 2003, with an ROE of 3.6%. GAAP capital and surplus is expected to continue to decline in 2002, as well as 2003 and 2004.
"Several factors cloud our future outlook of the industry," says Gohsler. "First the industry will continue to address significant reserve deficiencies. With premium growth continuing, more reserve strengthening is likely. While reserve additions strengthen balance sheets, they constrain earnings growth. Second, history indicates that hard markets are generally short-lived. There are more indications that rate increases are beginning to moderate.
"The industry faces numerous and diverse challenges. More regulatory constraints on insurers' pricing and underwriting actions are likely after several rounds of significant rate increases. Economic recovery has been slow and appears fragile. Litigation continues to threaten the industry on many fronts. Insurers face highly uncertain risks from natural disasters as well as terrorism.
"Finally the industry continues to face difficult capital markets with low interest rates, declining equity prices and rising credit defaults. While we consider these factors in our forecasts, they defy accurate projection."
By Dr. Robert Hartwig, Ph.D., CPCU
Vice President and Chief Economist, Insurance Information Institute
The use of credit information is a fact of life in many areas. Landlords, employers, mortgage companies and utilities use that information regularly and, more recently, insurers have been using it for underwriting. For many years, insurers used only such rating factors as a person's driving record, years of driving experience, and the age and construction of a home in making those decisions.
In today's market environment, some insurance companies supplement these factors with another factor found to be a highly accurate predictor of risk in the underwriting and ratemaking processes: insurance scores based on credit information. This score is based on various elements of a consumer's credit history, such as how that person has repaid debts in the past. This financial management assessment closely correlates with insurance risk--which is the risk of filing a claim and the cost of that claim. The carriers using insurance scores have found that the lower the score, the greater the potential cost of claims. They have also learned that insurance scores are highly accurate predictors of future loss in auto and homeowners insurance; that insurance scores provide an accurate, objective and consistent tool that can be used with other applicant information to better anticipate claims, and that credit information is used as a measure of determining an individual's responsibility and performance under the terms of the insurance policy. Insurers have been using credit information for personal insurance since the early 1990s and in commercial insurance for decades.
Using credit information in underwriting
There are four primary factors as to why insurers use credit information in their insurance underwriting:
* There is a strong correlation between credit standing and loss ratios in both auto and homeowners insurance.
* There is a distinct and consistent decline in relative loss ratios (which are a function of both claim frequency and cost) as credit standing improves.
* The relationship between credit standing and relative loss ratios is statistically irrefutable.
* The odds that such a relationship does not exist in a given random sample of policyholders are usually between 500, 1,000 or even 10,000 to one.
Yet despite the strong correlation, the link between credit criteria and insurance loss experience is not well understood, a factor that is reflected in the current state legislative and regulatory environment. In 2002, legislatures in about two dozen states discussed whether and how to regulate insurers' use of information in a person's credit history.
Many states already require insurers to notify their policyholders if credit histories are used or play a role in adverse decisions such as raising rates or placing a policyholder in a higher tier. Many also already bar insurers from using insurance scores as the sole determinant in underwriting. Also, some states have gone further in restricting the use of credit history in their insurance decisions.
It is likely that such legislative activity in the year 2003 will continue. In addition, some state insurance departments are conducting educational campaigns to alert the public about the importance of maintaining a good credit record and help them correct inaccurate credit information.
Among the states that have passed laws regarding the use of credit histories in the past year are Washington, Maryland, Idaho, Minnesota, Utah, and Kansas (which created a task force made up of legislators, insurance regulators, agents and representatives of insurance companies to study the matter); and state insurance departments in Colorado and South Carolina have taken regulatory action.
Insurers support good public policy in the use of credit information, including:
* requiring insurers to notify customers that credit is used to help assess risk;
* requiring insurers to provide applicants with an explanation of why coverage is not offered if due to credit and providing existing customers with a written statement of reason, upon request, why they received a premium increase or cancellation notice if due to credit;
* prohibiting insurers from using credit as the sole factor in denying, canceling or not renewing a home or auto insurance policy;
* protecting those who have little or no credit history by limiting how insurers use a lack of credit history as a determining factor in denying coverage;
* prohibiting insurers from using certain credit information--such as medical collection and disputed information under investigation by a credit bureau--to assess risk;
* requiring insurers to reevaluate policyholders, at their request, if they discover errors in their credit report;
* and requiring insurers that use credit on renewal to reassess consumers' credit information periodically and, when necessary, adjusting their premium accordingly.
It's a fact of life
Despite the current concern of consumer groups, increased use of credit information is a fact of life in the 21st century. This includes when applying for loans, leases, rentals, and utilities. It is also a factor in employee screening and background checks and will likely come into play in preferred airport screening for frequent fliers. Insurance scores do not make use of a wide variety of personal information, including ethnicity, nationality, religion, age, gender and marital status, familial status, income, address and any handicaps. None of these factors determines whether a person has a good or bad credit history. People with low incomes may have insurance scores as good as or better than people in higher income groups.
In addition, if a consumer is denied insurance because of information in his or her credit report, the insurance company is obliged to notify him or her. Consumers have the right to dispute any information in their credit report. By law, the credit rating agency must provide them with a free copy of their credit report and must correct inaccurate or incomplete information at no charge to them.
Debate will continue
The debate about the use of credit scoring will continue in 2003 and beyond. The National Association of Insurance Commissioners (NAIC) has created a committee to determine whether it should adopt a model act of regulation addressing the use of credit-based insurance scores and has indicated that state legislatures may adopt the model act on a voluntary basis. The NAIC is also considering whether to undertake an actuarial study on the predictive aspects of insurance scores. Studies from Tillinghast-Towers Perrin and the Virginia Bureau of Insurance have shown a strong correlation between insurance scores and the filing of insurance claims; but according to a number of NAIC committee members, these studies focused on underwriting only. If conducted, the proposed NAIC study would also address the impact of credit history on rating. *
The outlook by Conning and the thoughts of Hartwig were compiled and adapted by Samuel Schiff, a
New York-based freelance writer.