Public Policy Analysis & Opinion
When doing good is good business
Sometimes the industry's interests run parallel to the public's
By Kevin P. Hennosy
In 1893, Kansas City, Missouri, contracted with the National Water-Works Company to provide water services to the city. The National Water-Works Company was a poorly managed and under-capitalized affair. It appears that the senior management was more skilled at siphoning off proceeds from ratepayers than they were providing water to taps and hydrants.
The lack of water pressure at fire hydrants caught the attention of the Fetter Bureau, the second most powerful fire insurance rating agency in Missouri behind the St. Louis Board of Underwriters. William J. Fetter, an insurance broker, wielded legal cartel power over fire insurance rates in many parts of Missouri outside of the City of St. Louis, which had encouraged collusive creation of policies and rates dating back to the 1850s.
The fire insurance cartel system expanded rapidly after the Financial Panic of 1873 as a means of retarding competition between carriers and among agents. Competition led to inadequate prices and loose underwriting standards that were blamed for a rash of insolvencies after the Panic and the 1871 Chicago Fire.
William J. Fetter petitioned Kansas City municipal leaders and urged them to address the problems with the water system. After another financial panic in 1893, the performance of the National Water-Works Company deteriorated. City leaders turned deaf ears to the insurance broker.
Fetter began to raise the price of fire insurance on both commercial and residential property. Massive rate increases for fire insurance coverage caught the attention of the general public and the business community.
In particular, the Kansas City stockyards, meat packing plants and Board of Trade felt the sting of the rate increases. The Fetter Bureau notified the meat packing industry of future rate increases, and a possibility of refusing coverage at any price if Kansas City did not establish a public water system.
The pressure on the meat packing industry appears to have made the difference. The city ended its contract with the for-profit water company and launched a public system, which benefited the public interest at the same time it reduced the risk of catastrophic urban fires.
Recent news concerning the insurance sector's losses from catastrophic weather claims, brought to mind the example of the Fetter Bureau. This is not to say that I would advocate the revival of cartel power, but it is worth thinking about how the insurance sector reacts when the public interest and business interests clearly travel along parallel paths.
On June 10, 2011, Travelers Insurance, a component of the Dow Jones Industrial Average, issued a news release that helped trigger a bout of selling on the New York Stock Exchange. The release reported a smattering of elements of interest to investors, which portrayed the even keel nature of the company's year-over-year performance. In addition, the release offered good news with regard to the company's business and commercial insurance operations. Furthermore, the release contained some news about the company's more than $1 billion loss in catastrophic weather losses, which moved the market lower.
[The Travelers] estimates its range of catastrophe losses relating to the numerous and severe catastrophes in April and May to be approximately $1.00 billion to $1.05 billion, after-tax and net of reinsurance. These losses resulted from multiple tornadoes and hailstorms, primarily in the Midwest and Southeast regions of the United States, the largest of which occurred in the last week of April and impacted 13 states. These catastrophe losses were concentrated in the company's Business Insurance and Personal Insurance segments.
There is no reason to believe that Travelers' experience will prove more extreme than that of other insurance institutions. As a Dow component, Travelers attracts more attention, but the company is not alone.
For example, the day before Travelers disclosed its claims experience, Horace Mann released the following statement:
"While our underlying earnings are meeting our expectations, as a result of the significant level of catastrophe losses in April and May, we are lowering our estimate of full-year 2011 net income before realized investment gains and losses to between $1.10 and $1.30 per share from our previously estimated range of $1.75 to $1.95 per share," stated Peter H. Heckman, president and CEO. "This estimate assumes that catastrophe losses for the remaining seven months of the year will be relatively consistent with our expectations."
From a public policy standpoint, catastrophic claims initiate a series of concerns. The first concern centers on assuring that insurers pay claims in a timely and responsible manner. It is this phase where companies earn their reputations for better or worse. The immediate claims payment phase usually receives active oversight from regulatory agencies. It provides the financial resources for policyholders to resume their lives in the long-term, as well as short-term economic stimulus funds to jump-start local economies suffering from financial loss.
It is the later phases of post-catastrophe machinations that tend not to receive attention from the news media, and regulators tend to assume a more submissive position.
Quietly, underwriting rules and rating schedules might be tightened. Depending on state regulatory frameworks, this may or may not need insurance department approval or notification. The drafters of the McCarran-Ferguson Act assumed that such actions would require state approval, just as the pre-1944 cartels approved and disapproved underwriting practices prior to the act. Nevertheless, the intervening decades have seen the McCarran-Ferguson framework weakened beyond recognition by the legislators who wrote the law.
Insurance producers in the field are more likely to feel the pressure from any changes to underwriting and pricing. Producers will feel the recoil from customers who find it more difficult to place business or pay for premium increases. In addition, producers feel pressure from the carriers to meet sales goals at the same time the carriers make selling more difficult.
A third phase of post-catastrophe public policy activity happens far from the view of policyholders and producers. Carriers tend to bring proposals to insurance departments and the National Association of Insurance Commissioners (NAIC) aimed at weakening investment regulations in order to maximize investment returns. Those investment returns can be used to reduce the cost of insurance to the policyholder, and that argument tends to be repeated before regulators. In actuality, the investment returns have a greater importance to the carriers' value in the eyes of investment bankers and other financiers.
Of course, maximizing investment return usually means ginning up investment risk retained by the carriers. In a number of years, the weight of risk puts stress on these insurers' balance sheets and a few of them collapse, which tends to attract attention from Washington. The NAIC tends to become all agitated and lobbying firms start raking in the billable hours.
In idle moments, one might wonder what a world would be like where the insurance sector, and the carriers in particular, used their vaunted political influence to mitigate risk, rather than avoid or concentrate it.
What if the carriers and the trade associations worked to aggressively improve building standards and/or implement environmentally sound development? What if insurance trade associations lobbied jointly with the Sierra Club to implement sustainable land use and environmental policy, rather than working with the oil industry to fund sham "consumer" groups at the NAIC to urge deregulation?
What if the carriers' substantial financial investment power was used to develop new stronger and more sustainable construction techniques and products?
What if the insurers used the power of their investments to buy foreclosed properties, retrofit them for energy efficiency? Such a program could solidify housing markets, reduce the risk of loss to neighboring properties (that might be on the insurer's books), solidify housing markets and make resale at a profit possible. Furthermore, if in the long term the environmental retrofitting reduced the effects of climate changes that increase claims, so be it.
Contrary to the conventional wisdom, it is prudent for executives to think in creative and strategic ways, and expect to produce financial returns. Oddly enough, some of the people who argue the loudest against business addressing larger socioeconomic progress will also defend the financial alchemy of Collateralized Debt Obligations.
Murray D. Lincoln, founding president of Nationwide Insurance, was the type of highly successful American executive who did well by doing good. No, Lincoln's compensation was never measured in the millions, even if one corrects for inflation. Yet, he managed to grow an insurance company created from $10,000 in borrowed money into an industry leader. Lincoln's memoir, Vice President In Charge of Revolution, was a best seller in 1960, and remains a refreshingly interesting read today.
Murray Lincoln used the tenets of consumer cooperatives to serve human needs. As executive vice president of the Ohio Farm Bureau, he saw farmers who could not find or afford unadulterated chemical fertilizer and animal feed, and he created cooperative production facilities to pool purchasing power of raw materials and market both products on a fair basis. From this example, he started an auto insurance program for farm bureau members, who had not been offered coverage at fair rates and terms by the urban-dominated, stock insurance cartels. When a stock life insurance company named American Insurance Union failed due largely to the extravagance of building a new home office building, Mr. Lincoln bought the estate—which became Nationwide Life Insurance Co.
The revenues the company realized provided Lincoln with capital to serve other basic human needs, which sometimes confounded the company's board members. Lincoln wanted to launch a major initiative into building Ford-Ferguson Tractors, which did not share the tendency of most tractors to flip over and kill the operator. When the board stopped Lincoln from moving forward with the investment, the company walked away from decades of profits.
Perhaps the greatest story of missed opportunity contained in Lincoln's book relates to his interest in oil. In the late 1940s, Lincoln advocated creating a system of cooperative refineries in the Middle East, as a means to break the grip of oligarchical power that supported the brutal regimes that fostered violent political movements. In the interim, the oil reserves would be placed under United Nations control until the cooperative refineries could provide enough revenue to strengthen local private—not nationalized—producers. The plan earned the support of the then democratically elected premier of Iran, Mohammad Mossadegh.
The existing international oil sector, with its non-competitive agreements with brutal national regimes used their influence to kill the proposal. A decade later, rather than a cooperative framework to benefit workers and businesses, oil production became dominated by a cartel formed to enrich the antidemocratic regimes—the Organization of Petroleum Exporting Countries (OPEC). Concentration of wealth through nationalized oil production continued, while poverty and radical politics expanded in the Middle East.
They should have listened to "the insurance guy."
Over the past 30 years, attitudes in American business have echoed an earlier age in our history, an age before Murray Lincoln and before the United States assumed world leadership. Instead of thinking big thoughts that foster progress we are told to focus on technical matters that tend to make a quarterly statement look better, whether or not that reflects the organization's actual standing.
Lessons of the past go unheeded. For example, the city council of Kansas City, Missouri, is being lobbied to close the public water department and contract with a for-profit vendor. The actuaries might want to start re-figuring rates.
As the Supreme Court opined nearly a century ago, insurance is imbued with a public interest. The industry should use its vast economic and political resources to serve that interest—even if by doing so it aggravates Wall Street or other business sectors.
As Murray Lincoln said, "My own feeling has always been that a man who starts out to help people and succeeds in doing that makes money whether he means to or not." n
Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide Insurance Cos. and then served as public affairs manager for the National Association of Insurance Commissioners (NAIC). Since leaving the NAIC staff, he has written extensively on insurance regulation and testified before the NAIC as a consumer advocate.