Homeowners Insurance
in Alabama
November 7, 2011
Alabama Department of Insurance
Commissioner Jim L. Ridling
Alabama Department of Insurance
• Our mission is to serve the people of Alabama
by regulating the insurance industry, providing
consumer protection, promoting market
stability, and enforcing fire safety standards
and laws
Alabama Department of Insurance
• Licenses insurance producers (agents) and
agencies
• Licenses insurance companies and pre-need
providers
• Examines insurance companies for financial
solvency and market conduct
• Provides consumer protection and assistance
Alabama Department of Insurance
• Fiscal year budget: $16.6 million
– Tax generating agency
– Funded through fees collected (licensing fees,
primarily)
• 150 employees
– 100 in Montgomery
– 25 field examiners
– 25 deputy fire marshals
The DOI Perspective
• Despite the tragedy of April 27, the
homeowners insurance market remains
relatively vibrant in 65 of the state’s 67
counties
• Homeowners insurance remains readily
available despite the decision of a company to
non-renew a segment of its business
The DOI Perspective
• The problems in Alabama’s coastal counties
have endured for a variety of reasons
– Subsequent storms in coastal areas: Rita, Ike, etc.
– Expected increase in tropical activity
– Economic downturn
The DOI Perspective
• In the balance of the state, the DOI is not
receiving significant numbers complaints from
consumers regarding access to insurance
– Some complaints regarding the loss of coverage
from a single carrier, but not widespread
– The Department believes the issues will be
overcome as carriers contemplate Alabama as a
marketplace
Definition of Insurance
• Insurance is defined as the equitable transfer of
the risk of a loss, from one entity to another, in
exchange for payment.
• Insurance involves pooling funds from many
similar insured entities to pay for the losses that
some insureds may incur: Law of Large Numbers
says that the predicted losses for the pooled
insureds will be similar to the actual losses.
INDUSTRY HOMEOWNERS RESULTS
• We’ve defined the Homeowners problem from the coastal
consumer’s perspective. Now let’s look at it from the insurer’s
perspective.
• Over the 7 years 2003-2009:
– Insurance companies in Alabama have paid out
approximately $117 for Homeowners claims and operating
expenses for every $100 of premiums they have collected;
– Insurance companies Countrywide paid out approximately
$97 for every $100 they collected.
INSURERS REQUIRE CAPITAL
• Based on the law of large numbers, the premium
collected should be sufficient, on average over
many years, to cover the losses incurred.
• However, in any given year, there is roughly a 50%
chance that losses will exceed the portion of
premium collected to pay for those losses.
• Therefore, insurers must maintain capital over
and above the premium they collect in order to
be certain they can pay all claims.
INSURERS REQUIRE CAPITAL
• Typically, insurers maintain as much additional capital as
they collect in premiums in order to be assured they can
cover claims in the most adverse years. (Premium-tosurplus ratio = 1.0)
• Where do insurers obtain this additional capital? From
investors.
• What do investors require from insurers in return for
loaning them this additional capital? Investment income.
• What’s a reasonable rate of return for investors to make on
this capital loan? 11%?
INSURANCE INDUSTRY RESULTS
• Return on Net Worth for 1990-2009:
– Property/Casualty Industry = 7.3%
– Avg. of 227 other industries = 10.7%
– P/C Industry ranked 163 out of 228* industries
– P/C Industry ROE was lower than the 227- industry
average for 18 of the 20 years
* # of industries in S&P’s COMPUSTAT database for which 20 years of data was available.
INSURANCE INDUSTRY RESULTS
• Return on Net Worth for 2000-2009:
– Property/Casualty Industry = 6.3%
– Avg. of 301 other industries = 9.4%
– P/C Industry ranked 200 out of 302* industries
– P/C Industry ROE was lower than the 301- industry
average for all 10 years
* # of industries in S&P’s COMPUSTAT database for which 10 years of data was available.
INDUSTRY HOMEOWNERS RESULTS
Homeowners Return on Net Worth: 2000-2009
Louisiana
Mississippi
Missouri
Kentucky
Alabama
Arkansas
Georgia
Nebraska
Tennessee
Texas
Oklahoma
Florida
W. Virginia
Virginia
N. Carolina
S. Carolina
Countrywide
-32%
-29%
-12%
-9%
-8%
-7%
-7%
-7%
-5%
-2%
-2%
0%
+5%
+10%
+15%
+21%
+5%
INDUSTRY ROE BY LINE OF BUSINESS
2000-2009
P.P. Auto
W.C.
C. Auto
CMP
H.O.
F.O.
TOTAL
AL
9%
8%
3%
3%
-8%
-17%
3%
CW
7%
6%
8%
8%
5%
5%
7%
INDUSTRY HOMEOWNERS RESULTS
•
Alabama’s -8% average Homeowners ROE over the last 10 years means that if a company had
started with $1 billion in net worth 10 years ago, today the company would only have $434
million net worth remaining.
•
Companies must deploy their capital / net worth where they can achieve a reasonable return
for their investors. Clearly a -8% average ROE does not make Alabama an attractive
investment for companies.
•
On the Coast, approximately 70% - 80% of the Homeowners policy premium is required to
cover wind losses. Upstate it is only about 20% - 35%.
•
A company’s Homeowners ROE can be improved in several ways:
– Raise rates
– Reduce the company’s exposure to loss by raising deductibles or excluding wind
coverage
– Shift to writing more policies Upstate and fewer policies on the Coast
– Focus their coastal writings on homes that have been fortified; Improve building codes
to lower the damageability of houses; retrofit homes to higher building standards
INDUSTRY HOMEOWNERS RESULTS
• Companies must feel confident that over the long run they can
make a profit on Homeowners insurance in Alabama, or they will
choose not to offer insurance in our state and utilize their capital to
write more business in other states.
• The Dept. of Insurance permits companies to establish rates that
over the long run should generate a profit margin on premiums of
approximately 6% (which translates to less than 7% ROE, which is
approximately the industry’s 2009 countrywide average). Despite
that, insurers have not achieved those profit levels.
• If the Dept. of Insurance were to arbitrarily suppress rates that
companies could charge, companies would further reduce their
writings in Alabama, thus exacerbating the availability (and thus
affordability) of Homeowners insurance.
RATING AGENCIES
• Insurers are rated by A.M. Best for their
claims-paying ability, and by S&P, Fitch, and
others as to their debt security.
• Lower ratings by these agencies either drives
down the marketability of their products or
drives up the cost of their debt.
• Pressure by these rating agencies may drive
insurers to raise rates or reduce their exposure
to losses so as to maintain a better rating.
ALABAMA RATE STATUTES
• All Homeowners rate filings from admitted
insurance companies require prior approval by
the Department of Insurance.
• Non-admitted (Surplus Lines) companies are
not required to file their rates with the
Department and the Department has no
regulatory authority over their rates.
ALABAMA RATE STATUTES
• Alabama statute says that rates must not be:
* Excessive
* Inadequate
* Unfairly discriminatory
ALABAMA RATE STATUTES
• Not excessive: We require that rates are actuarially
justified, meaning the rates do not exceed those
rates statistically justified by the insurance
company’s claim history or models.
• Not inadequate: We do permit insurance companies
to utilize rates below their actuarially justified rates
in order to be competitive, as long as it does not
endanger the company’s financial solvency.
ALABAMA RATE STATUTES
• Not unfairly discriminatory: We review each
company’s rate structure to ensure that rates are not
excessive for any individual territory, policy type,
policy limit, deductible level, etc., separately for wind
versus non-wind coverage.
WHAT MAKES UP THE HOMEOWNERS
PREMIUM DOLLAR?
In general, the breakdown in Homeowners premium
might be as follows:
Coastal
Upstate
Claims Payments
=
23%
58%
Reinsurance
=
40%
5%
Claims Adjusting Expense =
10%
10%
Marketing Expense
=
19%
19%
Overhead Expense
=
5%
5%
Taxes, Licenses, Fees
=
3%
3%
Total
=
100%
100%
WHAT MAKES UP THE HOMEOWNERS
PREMIUM DOLLAR?
For 2009, the breakdown in Homeowners premium statewide for
Alabama was as follows:
Claims Payments
Claims Adjusting Expense
Marketing Expense
Overhead Expense
Taxes, Licenses, Fees
Total
= 96% of direct earned premium*
= 15%
= 19%
=
5%
=
3%
= 138%
Investment Gain
ROE
= 4%
= -24%
* Before reinsurance
HOMEOWNERS RATE COMPONENTS
• Most Companies publish a single combined
Homeowners rate to cover all perils insured
against. However, in providing justification for
those rates, their data is segregated into nonwind and wind components by territory, and
the Department of Insurance scrutinizes that
justification.
HOMEOWNERS RATE COMPONENTS
• The non-wind portion of a company’s Homeowners
rates must be justified by the company’s Alabama
non-wind claims experience statewide and by
territory over the past 5 years.
• For competitive reasons, for some or all territories,
companies may choose to file for lower non-wind
rates than those justified actuarially, and we
generally permit this.
HOMEOWNERS RATE COMPONENTS
• The wind portion of a company’s
Homeowners rates consists of three
components:
– The hurricane rate
– The non-hurricane wind rate
– The cost of reinsurance
HOMEOWNERS RATE COMPONENTS
• The hurricane rate is almost always developed from
independent vendors’ computer models that predict
the frequency and severity of hurricanes. The models
estimate the average annual claims that the
company will experience based on the policies they
currently write in the state. These claim estimates
are developed at the zip code level and then
aggregated for each rating territory used by the
company.
HURRICANE MODELS
•
Why are hurricane models used instead of actual hurricane experience?
The significant variation in the frequency of different magnitudes of hurricanes
diminishes the accuracy of historical hurricane loss experience for projecting
expected loss levels for the policies to which proposed rates will apply. Average
expected recurrence periods for the larger, more severe storms are so long that
many external variables will change in the time periods between occurrences.
For example, the area of southern Florida hit by Hurricane Andrew in 1992 was last
hit by a major hurricane, Hurricane Betsy, in 1965. The type, number, value,
vulnerability and geographical distribution of exposed properties in the area
impacted by Hurricane Andrew are very different than those of the exposed
properties in 1965. Actual loss statistics from a hurricane that occurred many
years ago are not easily adjusted for the type, number, value, and vulnerability of
present day structures.
HURRICANE MODELS
Since historical hurricane losses cannot be used to accurately estimate current
hurricane loss potential, insurers contract with an outside vendor, AIR or RMS,
which use an alternative methodology based on Monte Carlo simulation to arrive
at the insurer’s expected annual hurricane losses. This approach involves the
development of computer programs that describe in detail the frequency of
hurricanes, their meteorological characteristics, and their effects on exposed
properties. A high-speed computer then simulates a large set of hypothetical
hurricanes and estimates the resulting property losses based on the insurer’s
exposure.
In order to estimate the potential loss from hurricanes, 100,000 scenario years of
potential hurricanes are simulated. This large number of simulations attempts to
ensure that the resulting probability distribution of losses converges to a stable
representative distribution of potential annual hurricane loss (the Law of Large
Numbers at work again).
The pattern of simulated hurricanes is representative of what has occurred
historically because meteorological data on the actual events since 1900 were
used to estimate the parameters of the hurricane simulation model. The
meteorological sources used to develop the model are the most complete and
accurate databases available from various agencies of the National Weather
Service and the National Oceanic and Atmospheric Administration (NOAA),
including the National Hurricane Center.
HURRICANE MODELS
The primary characteristics of hurricanes used to simulate each storm and resulting wind
speeds are:
1. Hurricane Frequency
2. Landfall Location
3. Central Pressure
4. Radius of Maximum Winds
5. Forward Speed
6. Track Angle at Landfall
7. Storm Track
8. Gradient Wind Reduction Factor
9. Peak Weighting Factor
The probability distributions for several of these variables (2-6) are estimated for coastal
segments of equal length from Texas to Maine. Random samples are generated from the
probability distributions of these input variables to assign values to the variables for each
simulated hurricane.
HURRICANE MODELS
HURRICANE WIND SPEED ESTIMATION
Once the key parameters have been generated, the meteorological
relationships among them are used to develop a complete time
profile of wind speeds for each location affected by the storm.
This involves the following calculations for each simulated
hurricane:
1. Gradient-Level Wind Speed
2. Adjustment to surface (10-meter) level
3. Storm Asymmetry
4. Storm Decay (Filling)
5. Radial Decay (Storm Center-Relative Wind Speed)
6. Adjustment of Wind Speed for Surface Friction and
Averaging Time
HURRICANE MODELS
DAMAGE ESTIMATION AND DEMAND SURGE
Engineers have developed damage functions that describe the interaction between buildings,
(including both structural and nonstructural components) and their contents, and the local wind
speeds to which they are exposed. These functions relate the mean damage level as well as the
variability of damage to wind speed at each location. Because different structural types will
experience different degrees of damage, the damage functions vary according to construction
class, occupancy, and height. The model estimates a complete distribution around the mean level
of damage for each local wind speed and each structural type.
Losses are calculated by applying the appropriate damage function to the replacement value of the
insured property. The damage functions capture the effects of wind duration as well as the effect of
peak wind speed. The longer a property experiences severe wind speeds, the greater the damage.
The hurricane damageability relationships incorporate well-documented engineering studies
published by wind engineers and other experts . They also incorporate the results of post-hurricane
field surveys performed by engineers. These relationships are continually refined and validated
based on actual client companies’ loss data.
Any major hurricane event causes an increase in demand for materials and services to repair and
rebuild damaged property. This can put pressure on costs, resulting in higher than expected
costs. Therefore, models apply aggregate demand surge functions to loss estimates to take into
account the combined effects of events clustered in both time and geography.
HURRICANE MODELS
LOSS CALCULATION
The insurer supplies the modeler with a detailed exposure database containing insured
values by policy level and ZIP Code for each line of business, construction, and deductible
combination. Damage functions relating wind speed and wind duration to the percentage of
property damaged for varying types of coverage and construction are used to produce loss
estimates by zip code for each simulated hurricane.
MODELED LOSS ESTIMATES
Losses estimated from 100,000 years of simulated potential hurricanes are summed and
divided by 100,000 to produce the expected annual losses from all hurricanes for each ZIP
Code. ZIP Code loss estimates are then aggregated to produce expected annual loss by
county and state.
Hurricane factors are then calculated as the total loss estimate for a given ZIP Code, county,
or state divided by the total insured value in thousands of dollars (amount of insurance
years). This factor is applied to the expected average amount of insurance years in the
determination of the overall rate level indication.
HOMEOWNERS RATE COMPONENTS
• The hurricane computer models are reviewed by a
national industry expert panel every time they are
revised to ensure that their statistical methodologies
are valid.
• These models are being regularly updated to include
new analyses and data (such as climate change and
recent storms) that affect the frequency and severity
of hurricanes.
HURRICANE “MODEL MISS”
• Despite the progress made in developing hurricane
models, a study of the hurricanes of 2004, 2005 and
2008 show that the models typically under-estimated
the losses that those hurricanes would generate for
homes and small businesses.
• The actual storm losses ranged from 84% to 188% of
the losses predicted by the models. The average actualto-predicted ratio was 128%.
• The error in the model predictions was due to nonmodeled perils, poor data quality, and model error.
HURRICANE MODEL VIEWS
• As a result of climate change theories, hurricane modelers have
developed two approaches to estimating future hurricane losses.
Hurricane frequency changes cyclically, depending on whether we
are experiencing a cycle of warm sea surface temperatures (WSST)
or cooler sea surface temperatures. These cycles tend to run in 25year spans on average.
• The Long-Term View of the models utilizes data from all hurricanes
that have ever occurred, regardless of the cycle phase in which they
occurred.
• The Near-Term View only utilizes data from hurricanes that have
occurred in a cycle similar to the current cycle we are experiencing
(i.e. only warm water cycles or only cold water cycles).
HURRICANE MODEL VIEWS
• The U.S. is currently in a warm sea surface temperature
cycle. This cycle tends to produce more hurricanes than
the cold water cycle.
• Most insurers and reinsurers would prefer to use the
WSST view of the models, believing this is a better
prediction of what will occur next year while we are still
in a warm water cycle.
• The DOI does not permit insurers to use the WSST view,
but we cannot prevent the reinsurers from doing so.
HOMEOWNERS RATE COMPONENTS
• The non-hurricane wind rate is developed from either the
individual company’s 20- or 30-year historical claims data for
Alabama or from industry claims data for Alabama. The losses
for the 20 years are compared to the premiums for those 20
years to develop a non-hurricane wind load, which is then
added to the hurricane load developed from the models.
• In the case of the April, 2011 Alabama tornadoes, which may
be considered a 1-in-250 year event, the DOI has announced
that it will only permit 8% of these losses to be included in
future rate filings. (8% / 20 years = 0.4% = 1/250).
HOMEOWNERS RATE COMPONENTS
• The cost of reinsurance. Companies cannot risk having to pay
the entire loss from a large hurricane or tornado outbreak, so
they must purchase reinsurance.
• Reinsurers use the same hurricane models as the companies,
though they may utilize different assumptions, such as the
Near-Term version. The rates for reinsurance that are charged
to the companies are not regulated by the Dept. of Insurance,
and the companies pass this cost on to their insureds in the
premiums they charge.
COMPONENTS OF THE REINSURANCE
COST LOAD
If a reinsurer charges an insurer $1M for their
Homeowners coastal catastrophe reinsurance
coverage, the components of that premium
are approximately:
Expected Losses = $200,000
Risk Load & Profit = 600,000
Overhead Expense = 200,000
1,000,000
REINSURANCE COST
• Reinsurance is a global industry, so the cost of hurricane
reinsurance for most companies is unfortunately
impacted by large catastrophes experienced around the
world and by the current financial crisis.
• Over the past 5 years the cost of this wind reinsurance
had been rising, but recently it has stabilized and in some
cases declined. But with the high cat losses of 2011
(quakes in Japan, New Zealand, Turkey; tornadoes and
wildfires in the U.S.), it is not certain yet if reinsurance
rates will rise soon.
TERRITORIAL RATE DIFFERENCES
• So what causes rates to vary by territory?
– Actual Fire, Water, Theft, Liability claims
– Actual non-hurricane wind claims
– Hurricane model estimates
– Cost of reinsurance
– Competition in more desirable (i.e. predictable)
territories
HOMEOWNERS RATE FILINGS
• Companies almost never file wind rates below the actuarially
justified rates since there is a high risk that the actual
wind/hurricane losses could be greater than those predicted by the
models, and because of the cost of their reinsurance.
• Companies are typically justifying rate increases in the 10% - 20%
range due to higher losses, prior indicated increases that they did
not request, inflation, and increases in hurricane model estimates.
• The DOI has not been permitting any individual insured to receive
more than a 35% increase at renewal, assuming no change in
coverage.
HOMEOWNERS RATE FILING REVIEWS
• Though Alabama Homeowners rates are very
high on the coast, the DOI is scrutinizing every
admitted company’s rates to make certain that
they are statistically justified and that they will
not generate excessive profits for the
companies in the long run.
ALABAMA HOMEOWNERS RATES
• 2007 NAIC DATA – AVG. PREMIUM PER POLICY BY STATE
–
–
–
–
HO-3
COV. A = $175,000-199,000
DATA EXCLUDES WIND POOLS, CITIZENS OF FL AND LA
DATA INCLUDES PRIVATE MARKET POLICIES BOTH INCLUDING AND
EXCLUDING WIND
ALABAMA HOMEOWNERS RATES
STATE PREMIUM INDEX TO AL
STATE PREMIUM INDEX TO AL
CW
AL
AK
AZ
AR
CA
CO
CT
DE
DC
FL
GA
HI
ID
IL
IN
IA
KS
KY
LA
ME
MD
MA
MI
MN
MS
$718
946
730
573
832
656
693
653
466
768
1,365
661
534
76%
100%
77%
61%
88%
69%
73%
69%
49%
81%
144%
70%
56%
Gulf Coast – Averages 41% above AL
Tornado Alley – Averages 5% below AL
Eastern Seaboard – Averages 29% below AL
$397
597
650
640
957
590
1,468
562
586
737
695
732
1,133
42%
63%
69%
68%
101%
62%
155%
59%
62%
78%
73%
77%
120%
ALABAMA HOMEOWNERS RATES
STATE PREMIUM INDEX TO AL
STATE PREMIUM INDEX TO AL
MO
MT
NE
NV
NH
NJ
NM
NY
NC
ND
OH
OK
OR
PA
RI
SC
SD
TN
TX
UT
VT
VA
WA
WV
WI
WY
$716
686
826
586
612
576
641
624
635
854
529
1,162
440
Gulf Coast
Tornado Alley
Eastern Seaboard
76%
73%
87%
62%
65%
61%
68%
66%
67%
90%
56%
123%
47%
$607
737
779
691
726
1,369
467
600
603
421
678
470
629
64%
78%
82%
73%
77%
145%
49%
63%
64%
45%
72%
50%
66%
ALABAMA HOMEOWNERS RATES
Average premium relativity for 3 large companies for a $200,000 home compared
to Muscle Shoals, AL:
Rome, GA
Pittsburg, KS
Russellville, AR
Muscle Shoals, AL
Beatrice, NE
Farmersville, LA
Walls, MS
Joplin, MO
Brownsville, TN
Mt. Pleasant, TX
Miami, OK
Ft. Walton Beach, FL
= 78%
= 98%
= 99%
= 100%
= 105%
= 116%
= 127%
= 129%
= 135%
= 164%
= 171%
= 214%
ALABAMA HOMEOWNERS RATES
Average Premium Relativity (with Wind) by City for a $200,000 Home:
Birmingham (35242)
Huntsville (35801)
Montgomery (36117)
Tuscaloosa (35401)
Camden (36726)
Gadsden (35901)
Dothan (36301)
Saraland (36571)
Mobile (36608)
Bay Minette (36507)
Fairhope (36532)
Gulf Shores (36542)
=
=
=
=
=
=
=
=
=
=
=
=
100%
110%
111%
120%
135%
136%
139%
263%
294%
300%
311%
328%
REGULATION OF HOMEOWNERS
RATE FILINGS
Current rate filing environment:
• Prior Approval by the DOI – our current law
• All filings reviewed by an actuary for
justification
• We have for the most part pursued an open
market philosophy, not arbitrarily suppressing
rates, so as to not discourage insurers from
writing in Alabama
REGULATION OF HOMEOWNERS
RATE FILINGS
Steps Taken by DOI to Help Coastal Consumers With Their Homeowners
Costs:
• Capped profit margins built into the rates at 6%
• Disallowed an expense load for the cost of capital despite such load being
a reasonable financial concept
• Disallowed the use of near-term (warm water) hurricane models
• Required statistical justification by territory for all rate changes, then
limited carriers’ requested rate increases on the coast below those
increases that were justified
• Disallowed an expense load for cost of reinsurance with affiliates
• Disallowed premium surcharges for claims caused by Acts of God
• Disallowed carriers from raising rates more than once a year, despite
statistical justification to do so
• Capped individual consumer’s rate increase at 35% annually even though
larger increases were justified
REGULATION OF HOMEOWNERS
RATE FILINGS
Alternative rate filing environments:
• File and Use – File rate change and implement it after
30 days if the DOI doesn’t object first
• Use and File – Implement rate change, then file it with
the DOI 30 days later, at which time the DOI can object
• Informational Filings Only – DOI cannot object ever
• Prior Approval combined with a Flex Band – If the rate
increase is less than 10%, the DOI cannot object
REGULATION OF HOMEOWNERS
RATE FILINGS
Alternative rate filing environments:
• Generally the DOI only permits an insurer to make one
rate filing every 12 months. It has been suggested that
it would attract new insurers to our state if we would
permit multiple filings in a year under a Prior Approval
/ Flex Band environment.
• Additional filing restrictions would be required to
prevent an insured from receiving large increases at
renewal.
HOMEOWNERS DEDUCTIBLES
• Insurers are permitted to require minimum hurricane/named
storm/wind deductibles of 5% near the coast, 2% in the remainder
of Mobile & Baldwin Counties, and ½% in the remainder of state.
Some insurers also offer a 10% hurricane/wind deductible.
• Minimum deductibles for All Other Perils (AOP) tend to be $500 or
$1,000, with optional AOP deductibles up to $2,500 or $5,000.
Some insurers are now also offering AOP deductibles of ½% or 1%
with a $1,000 minimum.
• Insurers are permitted to exclude wind coverage completely in the
AIUA rating territories in Mobile & Baldwin Counties.
• The DOI requires insurers to justify the rates and credits that they
use for these deductibles and wind exclusions.
HOMEOWNERS DEDUCTIBLES
• Many consumers that are required to carry large % wind deductibles are
“functionally uninsured”, meaning they are not able financially to actually
pay for repairs within their deductible, so damage goes unrepaired.
• In Hurricane Ivan, approximately 90% of all hurricane claims were less
than a 20% deductible.
• One option that has been discussed is to permit insurers to sell larger
wind deductibles, even up to 15% and 20% deductibles, and have the
State offer low interest loans to consumers to repair the damage within
the deductible when a storm occurs.
• The consumer would receive a premium discount of approximately 30%
for a 20% deductible compared to the premium for a 5% deductible: a
savings of perhaps $1,000 per year.
• Also, reinsurers would likely lower their charges to the AIUA and other
insurers if more consumers carried a 20% wind deductible, thus helping
lower rates further.
AIUA
The purpose of the AIUA is to provide a market
wherein owners of eligible property located in
coastal areas of Baldwin and Mobile counties may
obtain essential insurance when they are unable
to obtain coverage in the private insurance
market.
AIUA is owned and managed by the propertywriting insurers of Alabama. Any losses in excess
of premiums collected are the responsibility of
the member insurers.
AIUA
• By design, AIUA policies provide basic, no frills, coverage at
actuarially sound rates. Typically, a property owner will seek
an AIUA policy as a "last resort" because they have been
unable to find better coverage at lower rates elsewhere.
• An insurer’s participation in the AIUA is determined, generally,
by the percentage of market share the company writes in
coastal areas of Baldwin and Mobile compared to the
percentage of market share that the company writes in the
entire State. A Company that voluntarily writes their share (or
more) in the coastal areas (as compared to their state-wide
market share) will generally have a smaller percentage or no
share of participation in the AIUA.
AIUA COVERAGE
The Alabama Insurance Underwriting Association provides two types
of policies:
– Fire and Extended Coverage policy (which includes Fire, Lightning,
Explosion, Smoke, Riot and Civil Commotion, Damage from Aircraft
and Vehicle Accidents, Windstorm, Hail, Vandalism and Malicious
Mischief).
– A Wind and Hail only policy (written with a package policy issued by
an insurance company that underwrites other coverages).
– Theft coverage may be added by endorsement.
– Policies may be written on an Actual Cash Value (ACV) or Replacement
Cost Value (RCV) basis.
• Only condominiums, homes, mobile homes and commercial businesses
located in Zones 1, 2, 3 and 4 of Baldwin and Mobile Counties are eligible
in the Plan.
AIUA COVERAGE
• The AIUA offers coverage on the building or structure up to
a maximum of $500,000, combined dwelling and contents,
for a one to four family residential location.
• A total limit of $1,000,000, combined building and contents
coverage, can be written for a commercial location.
• A builder’s risk policy will also be issued for the same limits
that qualifies for the Plan. Vacant property, motor vehicles,
and farm properties are ineligible for coverage.
AIUA Rates
• AIUA recently adopted RMS model 11.0, and
reduced wind rates approx. 15% in Zones 2, 3
and 4 but raised rates 11% in Zone 1.
• Average ratio of AIUA rates to private industry
rates, after adjusting for coverage differences:
* Zone 1 = +43%
* Zone 2 = -15%
* Zone 3 = +22%
* Zone 4 = -20%
AIUA WRITE-OUT CREDITS
• ZONE 1: Credit for voluntary writings shall be
calculated on the basis of 125% for Fire policies,
100% for Homeowners and Mobile Homeowners
policies, and 75% for Commercial Multi-Peril
policies.
• ZONE 2: Credit for voluntary writings shall be
calculated on the basis of 100% for Fire policies,
75% for Homeowners and Mobile Homeowners
policies, and 50% for Commercial Multi-Peril
policies
AIUA WRITE-OUT CREDITS
• ZONE 3: Credit for voluntary writings shall be calculated on
the basis of 75% for Fire policies, 50% for Homeowners and
Mobile Homeowners policies, and 37.5% for Commercial
Multi-Peril policies.
• ZONE 4: Credit for voluntary writings shall be calculated on
the basis of 50% for Fire policies, 37.5% for Homeowners
and Mobile Homeowners policies, and 25% for Commercial
Multi-Peril policies.
• Premiums for policies excluding wind and hail coverage are
not eligible for credit. Automobile premiums and Farm
premiums are not eligible for credit.
AIUA WRITE-OUT CREDITS
• Of 485 insurers licensed to write property in AL, 329 are
exempt from participation:
– 306 insurers write no P&C premium in AL
– 156 insurers are subject to assessments ranging from .0001% to
19.6%
– 69 insurers reported voluntary written premiums for credits
– Of those 69 insurers, 23 wrote enough voluntary premiums to
be exempt from AIUA assessments
AIUA PROFILES
Zone 1
Zone 2
Zone 3
Zone 4
Total
As of Sept. 2011:
PIF
WP
TIV
4,963 $16.6M $0.9B
5,708 13.2M 1.1B
4,330
6.2M
0.7B
7,973
8.9M
1.3B
22,974
44.9M
4.0B
Proj.
2012
27,000 54.0M
4.7B
2009
Mkt. Sh.
52%
11%
4%
3%
10%
COASTAL STATES WIND POOL PROFILES
TX
LA
MS
SC
NC
FL
AL
PIF
246,000
119,000
46,500
47,000
245,000
1,460,000
23,000
TIV
$68.5B
24.0B
7.3B
17.4B
72.5B
508.5B
4.0B
Mkt. Share
4.4%
8.1%
5.9%
4.9%
9.9%
16.9%
1.9%
AIUA REINSURANCE
Layer 5:
Layer 4:
Layer 3:
Layer 2:
Layer 1:
Retained Excess of $400M
$150M xs $250M = $400M
$100M xs $150M = $250M
$50M xs $100M = $150M
Retained $100M
:
:
:
:
140 Yrs
81 Yrs
49 Yrs
33 Yrs
Total annual reinsurance cost is approx. $18M
(without reinstatements) of the $45M
anticipated written premium.
COASTAL STATES WIND POOL
REINSURANCE
TX
LA
MS
SC
NC
AL
RETENTION
$
Yrs
1.6B
28
100M N/A
15M N/A
10M 5
1.3B 26
100M 33
LIMIT
$
Yrs
2.2B
40
500M N/A
779M 110
1.5B
200
3.6B
134
400M
140
COASTAL STATES
WIND POOL
RECOUPMENT CAPABILITY
AL: Levy assessment on all property writers.
Insurers can only recoup in rate filings.
LA: Policyholders of all property writers are
assessed; can take credit on state income tax.
MS: Policyholders of all property writers are
assessed.
FL: Policyholders and insurers are assessed.
TX: No Wind Pool direct assessment on
policyholders, only insurers. FAIR Plan
assessments can be passed on to policyholders.
AIUA EXCESS LOSSES
• If the AIUA experiences losses in excess of the
funds it has on hand, or in excess of its
reinsurance treaty, then it can either:
– assess all participating insurers for the needed
funds, or
– issue bonds to obtain the funds immediately, then
assess the insurers annually for the cost to service
those bonds.
CATASTROPHE FUND
• It has been suggested that a state or regional Catastrophe Fund be
created to provide reinsurance at a discounted rate to the AIUA and
other insurers (e.g. captives) so as to lower the premiums charged
to consumers.
• The FLA Cat Fund is an example of this.
• The Cat Fund could be a non-profit, and thus not require the
sizeable risk/profit loads that reinsurers charge.
• The Cat Fund could cover multiple states, either contiguous or more
remote, in order to obtain spread of risk, and thus hopefully earn a
lower rate from reinsurers than just a statewide fund.
CATASTROPHE FUND
• The Cat Fund would need some initial capital:
– State or County seed money
– LOC from some source
– Issue bonds
• The Cat Fund would charge insurers a
reinsurance premium, which would build the
capital base in non-storm years.
WHAT ARE CAPTIVES?
A captive is a single-state authorized insurer.
• Types of captives:
– Pure captive: A company that insures risks of its parent,
affiliates, or controlled non-affiliates.
– Association captive: Any company that insures risks of
association members & their affiliates.
– Sponsored captive: Any captive whose minimum capital/surplus
is provided by one or more sponsors to insure the risks of
separate participants.
– Protected cell: A separate asset account established by a
sponsored captive.
– A captive may be formed as a stock corporation, a mutual
corporation, or a reciprocal.
AN 831(b) CAPTIVE
• A captive or protected cell may elect to be an 831(b)
insurer for federal tax purposes:
– Federal income tax only levied on investment income, not
underwriting profit. This allows you to grow your capital
base quickly in non-storm years.
– Maximum annual written premium permitted in the cell is
$1.2M (at $3,000 premium per policy, max of about 400
insureds; perhaps one cell per town; fortified homes only)
– Each cell must have a substantially different ownership and
its own capital
– All of the cells could enter into a pooling reinsurance
agreement so as to get spread of risk
BENEFITS OF A CAPTIVE
• Purpose/advantages of a captive:
– To insure availability of a coverage at a price not
offered in the marketplace. Rates can exclude a
profit load, but must include interest payable to
provider of capital.
– To gain control over underwriting or claims
handling
– To offer flexibility in coverages and deductibles
– To share in any long-term earnings
– Premium tax only 0.4%
DISADVANTAGES OF A CAPTIVE
• Lack of spread of risk
• Lack of access to Guaranty Fund
• Possible lack of reinsurance availability due to risk
characteristics
• Possible capital calls or premium assessments required to
cover extreme losses, especially in the early years after
formation. Will captive members have the financial
wherewithal to respond?
• Mortgage companies may not accept a captive as your
insurer
CAPITAL REQUIREMENTS FOR A
SPONSORED COASTAL CAPTIVE
• Capital required for a sponsored captive is $500,000 in
cash, LOC, or high quality securities.
• Each cell must have capital sufficient to cover more than its
expected losses per actuarial feasibility study. Required
surplus > 10 times largest single net exposure insured.
• Surplus must be > 20% of loss reserves.
• Surplus must be > 33% of net written premium
• Cell insureds may be required to provide some capital.
OTHER ISSUES FOR A SPONSORED
COASTAL CAPTIVE
• Must hire a TPA to handle underwriting,
claims, administration, legal, accounting,
auditing, actuarial for each cell. This includes
an agreement for access to cat loss adjusters.
• Each cell must have its own Board, its own
reinsurance, its own capital/surplus.
MITIGATION OF HOMES
• The loss portion of Homeowners, the pure premium =
loss frequency times loss severity.
• On the coast, approx. 75% of premium is to cover wind
losses, and consumers cannot affect the frequency of
the wind.
• Therefore, to lower premiums for the long term, one
must lower loss severity. 2 ways to do that:
– Higher deductibles
– Reduce homes’ vulnerability to wind
MITIGATION OF HOMES
• To reduce your vulnerability to wind, retrofit your home to IBHS
Bronze, Silver or Gold standard.
• Cost to retrofit to Gold approx. $10,000?
– Annual premium savings from discounts is 35% of your wind
premium….perhaps $1,000?
– With a matching grant, that’s a 5-year payback period.
– Probably means you don’t have to find alternate housing while
repairs are made
– Could save your life!
– Should increase the market value of your house at resale; make it
more attractive to buyers
– As more consumers do it, improves resiliency of your town
BUILDING CODES
• Change municipal/county codes to build stronger
homes
• Toughen home inspections; hire more trained
inspectors
• Insurers will compete for fortified / mitigated homes
• Reinsurers will take note and should lower reinsurance
costs
Taxes on Insurance in Alabama
• For admitted carriers, the base tax rate is 3.6
percent – one of the nation’s highest (1.0 percent for
low value dwellings and residences in Fire Protection Classes 9
and 10)
– A credit of up to 1.0 percent is allowed for offices in
the state
– A credit of up to 1.0 percent is allowed for real
property investments
– 38 companies (not all homeowners’ companies) took
credits in 2010.
– 1 company took the full 2.0 percent credit in 2010.
Taxes on Insurance in Alabama
• Premium Taxes expected to generate $250255 million in 2011.
– This includes a one-time $10 million payment
– Premium tax collections have been flat or falling
since the economic downturn
– Approximately 90 percent of the insurance
premium tax goes to the General Fund. The
remainder goes to the Education TF and the
Mental Health Fund.
– The DOI keeps no tax proceeds
Taxes on Insurance in Alabama
• For the non-admitted market, the tax rate is
6.0 percent – again, one of the nation’s
highest
– The tax is shown on the declarations page, unlike
the admitted market where the tax is imbedded in
the rate
– The tax is collected from the broker (agent) rather
than the company
Taxes on Insurance in Alabama
• Surplus lines taxes collected in 2010: $187
million
• Taxes collected from brokers in
Mobile/Baldwin counties: $109 million
New Markets in Alabama
• In the past year, three new companies (two
surplus lines and one admitted) have entered
the coastal insurance market.
• In 2010 and 2011, the DOI has attended with
Florida Insurance Summit, where dozens of
property insurers meet to discuss current
trends.
• The DOI has met with approximately 20
companies to attempt to expand new markets
Consumer Issues
• The Department takes its consumer protection
role seriously, helping Alabamians every day
with insurance issues
• Available for town meetings, provide literature
and assistance to consumers
• While the coastal market is difficult, Alabama
is similarly situated to other coastal states,
particularly those on the Gulf Coast
Consumer issues
• There have been several bills introduced in
recent years to address consumer concerns.
• Many of these bills have been supported
conceptually or specifically by the Department
of Insurance
Role of Government in Rate Approval
• Alabama law requires insurers to file proposed
rates with DOI
– Law requires DOI to respond within 30 days or the
request is deemed approved
– Questions from DOI restarts the 30-day clock
– Many states have “flex rating” or “file and use” laws
– Alabama’s law is more restrictive than most
– Section 27-13-1 -- RATES
• Not excessive, not inadequate, and not unfairly
discriminatory
Bill of Rights
• Mississippi has done this more as a checklist
of the items in a policy
– Does not override what is in the policy
– Serves as an outline as to what’s in the policy
Declarations Page “Transparency”
• Bill previously introduced sought cost per
thousand for wind, catastrophic wind, fire, theft,
liability, flood, and others
• Issues:
– Flood is not in policy
– Smaller companies do not break out cost to that
depth
DOI Perspective: Supports actual cost of
wind, catastrophic wind and all other
perils on declarations page
“Clarity”
• The bill introduced last year sought to require
insurers to provide data going forward on
premiums and losses in several peril
categories by county and ZIP code
• The bill also would require premium and loss
data by county and ZIP code dating back to
1990.
DOI perspective: Room for a compromise
going forward
“Parity”
• Bills have been introduced in the past to force
rate parity:
– Equivalent rates in fire classes
– No more than 1.5 times rate within fire classes
– No more than 2 times rate within fire classes
DOI perspective: A highly questionable
strategy that would put the state’s
market in danger
Questions
APPENDIX: DETAILED HOMEOWNERS
RATE REVIEW OUTLINE
Insurance Departments Charge Regarding Rates
Alabama statute requires filed rates to not be excessive (that is, they must be actuarially justified), inadequate (to the point that insufficient premium
could lead to a company’s insolvency), or unfairly discriminatory (ensuring that rates are not excessive for any individual territory, policy type,
coverage, etc.). The Department therefore reviews all Homeowners rate filings to ensure compliance.
General Outline of Procedure
When an insurance company makes a filing to revise their Homeowners rates, they are required to provide 5 years of premium and loss data on a
statewide basis to develop their statewide rate change indication. The premiums and losses from those 5 years need to be adjusted so as to be
representative of the premiums and losses that would be generated in the upcoming 12 months after the rate change effective date. The company’s
projected overhead expenses for the coming year are added to the projected losses, the sum of which is compared to the projected premiums to see
if the projected premiums are sufficient or deficient to allow the insurance company to make a 6% profit.
Premium Adjustments
The premiums collected by the company over the past 5 years need to be adjusted so as to be a good proxy for the expected premiums for the
upcoming year. There are two adjustments required.
Adjust premiums to current rate level. The company has most likely taken some rate increases or decreases over the past 5 years, and these changes
must be taken into consideration. To test the current rate structure, all of the policies written in the last 5 years must have their premiums
recomputed using the rates the company is currently charging. Some companies have sophisticated computer systems that can rerate all policies
from the last 5 years at today’s rates so as to accomplish this adjustment, and this is the most accurate way to accomplish this. Most companies,
however, do not have this capability, so a standard, approved mathematical formula is used to make this adjustment. These calculations must be
provided to the Department for verification.
Adjust premiums for premium trend. Over the years a company’s policy profile will undergo coverage changes such as change in the average amount
of insurance, deductible mix, territorial mix, construction mix, protection class mix, and other endorsement changes. Past years’ premiums must be
adjusted to reflect this change from the past and into next year. These calculations must be provided to the Department for verification.
Applying these two adjustments to the actual collected premium yields trended earned premiums at current rates that can be used to calculate a loss
ratio (which is the projected losses divided by projected premiums) for each year.
DETAILED HOMEOWNERS
RATE REVIEW OUTLINE
Loss Adjustments
Losses will typically be separated into three categories: non-wind losses (such as fire, theft, water, liability), non-catastrophe wind losses (wind losses not attributed to a hurricane or
tornado), and catastrophe losses.
Catastrophe losses: Most companies now have access to hurricane/tornado computer models and must provide the model’s “average annual loss (AAL)” for their company by territory
in Alabama. Many companies will run two different models (from two different model vendors) and take an average of the two models’ results, or just use the output from one model.
Models provide both a long-term result and a near-term result (the latter is currently always higher, as it reflects anticipated greater frequency and severity of storms due to the warmer
Atlantic water temperatures). The Department does not currently permit the use of the near-term versions of the models for ratemaking purposes. The Department always asks the
company what model they used, verifies which version they used, and verifies what adjustments were made to the model. The Department generally only permits two adjustments to the
models: (1) demand surge (reflecting the anticipated increased cost of building materials and labor after a hurricane due to supply shortage), and (2) loss adjustment expense (covers the
cost of the claims adjusters handling the claims).
On the rare occasion that a company doesn’t have access to a model, they usually refer to an Insurance Services Office (ISO) filing and use ISO’s hurricane load for Alabama by territory.
Non-catastrophe wind losses: Companies will typically calculate the ratio of their non-catastrophe wind losses to non-wind losses for each of the last 20 years and determine an average
ratio over the 20-year period, then apply this ratio to their trended ultimate non-wind losses in order to incorporate a non-catastrophe wind load. Some companies may have this ratio
generated by a model. The calculation of this load must be provided to the Department in the company’s rate filing for verification.
Non-wind losses: These losses must be provided for each of the 5 data years being used in the filing. Two adjustments must be made to these losses: (1) trend (i.e. the impact of
inflation), and (2) loss development factors to project reported losses to their ultimate, settled level.
Trend: The trend factor is intended to bring a past year’s losses up to the inflationary level the company will experience in the coming year. The calculation of the annual trend factor
begins with the average pure premium for a company, which is the total incurred losses (paid losses plus reserves) from all claims for a data year divided by the earned policy counts in
that data year. The pure premium may also be calculated as the average claim frequency for the year (claim counts divided by earned policy counts) times the average claim severity for
the year (total incurred losses divided by the claims count). Companies will either develop an annual trend factor for the average pure premium per policy, or they will calculate the trend
separately for frequency and severity and then multiply those two trends together. Either method is appropriate.
To calculate these trends, the company will display their company’s frequency, severity, or pure premium for Alabama by quarterly periods for approximately 20 quarters, then fit a
statistical curve to the data to calculate the average annual percentage change in the frequency, severity, or pure premium. If the company does not write much business in Alabama
(suggesting that their data is not statistically credible), they will need to supplement their own Alabama data with industry Alabama data to develop the annual trend factor. This data and
the calculation of the annual trend factor must be provided to the Department for verification.
The annual trend factor for Homeowners is usually in the 5% range, not much higher than the annual change in CPI. This annual trend factor is now applied to each of the 5 data years’
losses. For the oldest year, the losses are increased by the annual trend factor 6 times in order to account for the inflation for the six years from that data year to the year after these new
rates go into effect. The second oldest year’s losses are increased by the annual trend factor 5 times, and so on for the remaining three years of losses.
Loss development factors to generate ultimate losses: Reported incurred losses for each of the 5 data years are immature, in that some claims are still not settled and their reserves that
are included in incurred losses are often understated. Loss development factors are calculated to project these immature incurred losses to an ultimate settled level, and the calculation
of these development factors must be provided to the Department for verification.
DETAILED HOMEOWNERS
RATE REVIEW OUTLINE
.
Data Year Loss Ratio
For each data year, the company takes the incurred losses that have been multiplied by that year’s loss trend factor and loss development factor, and divides it by the earned premium
that have been multiplied by the rate level factor and the premium trend factor, which yields the trended ultimate loss ratio for each data year. The company then takes a weighted
average of these 5 loss ratios using weights of 10%, 15%, 20%, 25%, and 30%, giving the more recent years the greater weight since they should be more representative of what the
company can expect to happen next year. This yields the trended ultimate weighted average non-wind loss ratio.
If the company computed a non-catastrophe wind factor (discussed above), then this ultimate non-wind loss ratio needs to be multiplied by that factor to arrive at the non-catastrophe
ultimate loss ratio. If the company computed a non-catastrophe wind loss ratio, then that loss ratio needs to be added to the non-wind loss ratio. The Department verifies all of these
calculations.
Credibility: The company now needs to determine how credible this non-catastrophe ultimate loss ratio is. Different companies use different standards based on statistical assumptions,
but the more common standard is 40,000 policy counts. They add up the number of policies they wrote over the 5 year experience period, divide that total by 40,000 house years, then
take the square root of that result to arrive at the credibility ratio. The Department verifies this calculation. To the degree that the non-catastrophe ultimate loss ratio has a credibility
factor less than 100%, then that loss ratio needs to be averaged with the trended permissible loss ratio.
Trended Permissible Loss Ratio: To develop the Permissible Loss Ratio, the company first develops its expense ratio, which is the sum of their Commission ratio, General Expense ratio,
Other Acquisition ratio, Taxes/Licenses/Fees ratio, and their Profit margin. The company provides an exhibit displaying their actual ratio for each of these component ratios for the last 3
years, and computes the 3-year average of each component ratio. (Commissions can range from 0% to 25% depending on whether they sell through agents or directly on the internet,
General Expenses (Overhead) are usually 8-15%, Other Acquisition (Marketing) Expenses are usually 8-15%, Taxes are usually 4-5%, and Profit cannot exceed 6%.) They will then select a
ratio for each component and add these to get their Permissible Loss Ratio. Multiplying this Permissible by the annual loss trend factor (discussed above) and dividing it by the annual
premium trend factor (discussed above) yields the trended permissible loss ratio. The Department reviews and verifies these calculations.
Credibility-Weighted Non-Catastrophe Loss Ratio: This ratio is derived by multiplying the non-catastrophe ultimate loss ratio by the company’s credibility factor, then adding to it the
product of the trended permissible loss ratio and the complement of credibility (100% minus the credibility factor). The Department verifies this calculation.
Loss Adjustment Expense: At this point, assuming loss adjustment expenses were not already included with the original incurred losses, the credibility-weighted non-catastrophe loss
ratio needs to be multiplied by the loss adjustment expense factor. The company provides an exhibit showing the calculation of this factor by comparing loss adjustment expenses to
losses for the last 3 years or more, and computing an average factor.
To this result is now added the company’s catastrophe loss ratio (discussed above).
Reinsurance Load: Companies must add in a reinsurance load to reflect their net cost of reinsurance. The reinsurance load is computed by subtracting from the company’s reinsurance
cost (as a percent of premium) what the catastrophe model says the company can expect to recover from their reinsurers if a catastrophe occurs. The company must provide this
calculation to the Department for verification. Generally the Department only allows a company to include their reinsurance cost for reinsurance purchased from a non-affiliated
reinsurer.
This now yields the final adjusted loss ratio.
Indicated Rate Change: The indicated rate change is determined by dividing this final adjusted loss ratio by the Permissible Loss Ratio (discussed above), multiplying that result by 100,
then subtracting 100%.
DETAILED HOMEOWNERS
RATE REVIEW OUTLINE
Territorial Changes
Most companies are not going to change the rates in all territories by the statewide rate indication, but will want to vary the change by territory. To
justify the territorial rate changes they must follow these steps:
•
Provide 5 years of earned premiums at current rate level for each territory separately, and for statewide.
•
Provide 5 years of incurred losses (separately for non-wind, non-catastrophe wind, and the model losses for catastrophe) by territory and statewide.
•
Calculate each territory’s 5-year loss ratio by dividing the total losses in (2) by the premiums in (1). Also calculate the statewide loss ratio in the same
manner.
•
Calculate each territory’s loss ratio relativity by dividing each territory’s loss ratio in (3) by the statewide loss ratio calculated in (3).
•
Multiply each territory’s relativity in (4) by the statewide rate level indication derived above to yield the indicated territory rate change. The
Department does not permit companies to raise any territory’s rates by more than the territory’s indication. In order to be more competitive,
however, a company may choose not to raise the rates in a territory by the full indication.
•
In this way, each territory’s rates are developed based on the relative difference in their losses and premiums compared to all the other territories
across the state. The Departments verifies all of the data calculations in the 5 steps above.