Insurance Crisis: Perceived Or Real?
By: Thomas M Kallman
The price of all forms of liability insurance rose dramatically in the mid to late 80’s, provoking a furor among members of the business community. This “insurance crisis” garnered the attention of lawmakers throughout the nation, spurring many proposals intended to address the perceived causes of the problem. This same crisis is reborn today.
Insurance rates, accordingly, reflect conditions in the financial marketplace as well as the assessment of risk. When interest rates are increasing, investment income from premiums produces a high return. Under such conditions, insurance companies reduce their prices and solicit and underwrite greater risks to attract capital for investment. When interest rates are low, however, and investment yields are correspondingly reduced, the industry increases premiums to maintain profit levels. This is known as the “insurance cycle.”
The insurance “crisis” of the mid-1980s seems to correspond exactly to the insurance cycle. Interest rates reached extraordinary levels in the United States in the early 1980s. Insurance companies responded aggressively, competing for premium revenue to invest by lowering prices, despite, in many instances, clear indications that the risk of a sizable loss warranted higher rates. When interest rates dropped, however, so did the insurance industry’s investment income. Moreover, many insurers found themselves paying costly claims on policies that had been under-priced relative to their risk in order to attract investment capital. To make matters worse, some of the insurers’ hasty investments in real estate and projects financed by savings and loans–had turned into major debacles. Finally, by 1984, faced with significant financial losses, the industry had only one choice in order to maintain profits: sharply increase premiums. During 1985 and 1986, the cost of liability coverage for businesses, municipal governments, non-profits, and motorists, rose rapidly. The industry also reduced the availability of coverage; the resulting shortages further boosted prices.
Insurance Company Officials Blame the System of Justice
However, when insurance policyholders and, later, elected officials demanded a justification for the rate increases, policy cancellations, and non-renewals, they received an entirely different explanation. The insurance industry insisted that an enormous increase in claims and “excessive” jury verdicts–a “litigation explosion” was forcing insurers to increase prices. The industry’s solution was “tort reform”. Insurance company lobbyists argued that such revisions in state tort laws would (1) enable actuaries to better quantify risks for underwriting purposes and (2) limit overall claims payments, thus enabling insurers to lower the price of insurance. Certainly, cutting back compensation paid to victims would reduce insurers’ costs; whether the insurance companies would pass those “savings” on to consumers was another matter. But the more likely purpose of the “tort reform” proposals was to provide a scapegoat for the premium hikes imposed by insurance companies.
Business groups supported “tort reform” because of (1) the promised premium reductions and (2) the financial benefits of limiting their own legal accountability for defective products, medical negligence, environmental pollution, and even drunk driving.
Between 1985 and 1987, forty-one states adopted one or more significant changes in their tort laws to limit the rights of injured Americans or, in the case of wrongful deaths, their next of kin. In the context of auto insurance premiums, the preferred tort “reform” was no-fault.
“Tort Reform”: Studies Show Premiums Did Not Drop
By 1986, many investigators and policymakers had begun to raise substantial doubts about the origin of the insurance crisis and the legitimacy of tort reform as the solution. States that had enacted tort reforms had not obtained the promised rate reductions. Perhaps most devastating to the insurance industry’s campaign to restrict legal rights were reports of massive increases in the insurance industry’s profits. The cycle seems to be continuing again this year.
Thomas Kallman is President of TMK Risk Management Inc dba Kallman Insurance Agency at PO Box 266736, Weston, Florida 33326. Phone 954-389-5897. Visit the website at www.tmkrisk.com. Your questions are always welcome.
