The fundamental purpose of insurance is to provide the purchaser with a greater sense of financial security, protecting assets and income from accidental loss and misfortune. So insurance is a financial market. Considering the current state of the economy, you might want to know just how secure your coverage is.
While insurance investments—the places where premiums and policyholders’ surplus are parked while waiting to pay out claims, expenses and dividends—have taken a beating over the past year, they’re in much better shape than most retirement accounts. By their own nature and as imposed by state regulation, insurance-company investments are generally very conservative. Typically, two-thirds of an insurer’s investments are in high-rated bonds. Less than 20 percent may be tied up in common and preferred stocks, and typically less than 2 percent in mortgage loans or real estate, the sectors of the financial market most affected by the recent downturn.
The bond markets did not turn in a profitable performance over the past year, with bonds of even high ratings posting high single- or double-digit losses. Still, these losses seem a blessing compared to the slide in equity markets, with the Dow Jones Industrial Average down more than 35 percent over the last 12 months and the S&P 500 down more than 40 percent.
Some of you are thinking, “Wait, I’m a taxpayer, and I now own a portion of the federal government’s substantial equity stake in an insurance company called American International Group. AIG is obviously in serious trouble.” Let’s be clear: The problems of AIG are due to the failure of a financial unit regulated by federal agencies, not its more traditional insurance products, which are regulated by state insurance departments. Financial problems from such risky investments as credit default swaps are not shared by companies who focus and restrict operations to traditional insurance products.
While I just painted a picture of the insurance industry designed to reduce your stress level, I would be remiss in leading you to believe all is rosy. The combined ratio—incurred losses plus expenses divided by net earned premiums—was 105.6 percent for the first six months of 2008. In other words, insurance companies paid out about 5.5 cents for every dollar they took in.
Catastrophe losses accounted for higher than average annual losses for the property and casualty industry in 2008, with hurricanes Ike and Gustav contributing to $14.3 billion in losses. Ike was the fourth most expensive storm on record. While year-end results for 2008 were not published at the time this article was written, the projected loss to the property and casualty insurance industry surplus for the year is about $80 billion, or about 20 percent of policyholders’ surplus.
Policyholders’ surplus is a financial cushion that protects a company’s policyholders in the event of unexpected or catastrophic losses. A certain margin of that cushion is required for every policy based on line of business and state regulatory requirements. What this means for companies that have seen a decline in their policyholders’ surplus is they must write less insurance or raise more capital during the next year. Raising new capital is not a simple task in today’s market.
Know Your Carrier
What does all this mean for you, the business owner and insurance consumer? First, look at the company or companies with which you are insured. How are they weathering the storm? One of the primary and perhaps most reliable sources for checking the condition of your insurance provider is A.M. Best Co. Founded in 1899, A.M. Best is a full-service credit-rating organization dedicated to serving the financial-service industries, including the banking and insurance sectors.
You can review the financial ratings of your insurance carrier at www.ambest.com. For a secondary source, many analysts and interested parties also check the Standard & Poor’s financial ratings for insurance companies. Alternatively, you can request this information directly from your insurance agent or provider. If your carrier’s rating is slipping below an A or is on a watch list, you should have healthy concern about its condition.
Examine Your Program
Now that you’ve increased your knowledge of your insurance carrier, let’s look at your overall program. When finances get tight, people become more litigious, so consider raising your limits for coverage in areas such as premises liability, customer-goods legal liability and sale-and-disposal legal liability.
Since increasing your liability coverage will boost your premium, you might reduce in other areas. For example, consider accepting higher deductibles for your property coverage, which will lower your premium. Customers may be more inclined to place the blame for property damage or theft on you during hard times. This makes tenant insurance or property-liability retention programs even more valuable.
The increased potential for loss does not reside solely with your customers. While the potential for employee theft always exists, the probability increases during a poor economy. Employee-dishonesty coverage is available as an option with many insurance package policies and should be considered where employees are entrusted with cash transactions. Improved audit precautions are strongly encouraged at this time.
If you’re an employer who provides employee benefits such as health insurance, annuity or retirement-income accounts, give extra attention to purchasing errors and omissions coverage for your role as an agent or representative in these accounts. These are uncertain times; accounts will lose value, and you may be brought into an action that requires you to defend yourself―at significant cost―against the actions of a financial market that has lost its way.
We are living in interesting times. Make sure your insurance is really working for your business.
Scott Lancaster is the regulatory compliance officer for Deans & Homer, which has provided insurance products designed to respond to the unique risks of the self-storage industry since 1974. Lancaster started his insurance career in 1976 as a licensed insurance agent and broker in California. For more information, call 800.847.9999; visit www.self-storage-insurance.com.