The weekend before April 15th typically means I’m working and this year is no different. I took a break from checking returns and surfed my blogroll and followed a link my friend Russell sent that he knew would capture my interest.
Before we get to Chip’s blog and the cyber stops it entails I’ll share some concepts that help pull together this post on insurance, statistical theory and economics. The best place to start is with Russell’s link to Bloomberg and a fantastic story they did on Nassim Taleb late last month. The piece is biographical in nature but does delve into Taleb’s thought processes and how some of his theories have shaken up the status quo in the statistical community which is where we find our intersection with insurance theory.
Taleb has made enemies, too. In August, The American Statistician, the quarterly journal of the American Statistical Association, came out with a special Black Swan issue that published a series of critical reviews alongside an article by Taleb.
“He characterizes statisticians as people who blindly assume things, and nothing could be further from the truth,” says Peter Westfall, the journal’s editor and a professor of information systems and quantitative sciences at Texas Tech University in Lubbock.
Even his one-time colleagues disagree with him. Robert Engle, a Nobel laureate in economics who teaches at New York University’s Stern School of Business in Manhattan, says Taleb’s book ignores a mass of literature on rare events called extreme value theory, which is often used to assess risks in insurance as well as finance.
I can already picture some of our reader’s eyes glazing over but I’ll note at this point that Taleb, along with Russell, myself and a few other bright and very lucky people saw the sub-prime debacle coming a full year plus before it unraveled. (See the Yahoo CFC board beginning April 2006.) The truth is traditional statistical modeling has it’s limits. I think the key is to understand that concepts like extreme value theory has limits and concepts like adverse selection have dual implications. For statistical/finance junkies I’ll also add two threads on Yahoo Allstate this week that I though very good that touch on some of these concepts. They can be found here and here.
These concepts are important to all of us however, because they can have dramatic impacts on the rates an insurer charges for coverage. Our posts on weather modeling including our observations on a related Boston Globe editorial have been among our least viewed but IMO are among our most important. This brings us to Sam Friedman’s latest blog entry on a very related topic, the insurance industry’s take on global warming. This is important because the 2004/2005 Hurricane seasons were trumpeted in the popular press as proof positive caused by global warming. Before I quote Mr Friedman I refer you back to the concept of Adverse Selection I linked above and the concept of Information Asymmetries contained therein. We posted on the related concept of Market Transparency here. Now we have setup Mr Friedman’s latest entry which I have excerpted:
In essence, as reported by our own Dan Hays, the National Association of Insurance Commissioners’ Climate Change Task Force is being asked to acknowledge the exposures to insurer books of business and investment portfolios from climate change–whatever the cause–and to demand greater disclosure from carriers on how they intend to deal with the risk……….
Indeed, an NAIC white paper on climate change revealed the regulator group assumes global warming is occurring because there is “ample evidence” to back up that proposition……….
As reported by Mr. Hays, the paper said “regulators need to know if insurers are adequately including climate in their risk assessment process, and should ask about data collection and computer model use.”
Oddly, the industry is very suspicious and resistant to such suggestions–odd for two reasons.
One is that insurers have actually been very progressive when it comes to acknowledging climate change and the impact on their business. (Read our March 10 cover story, “Insurers Brace For Global Warming,” if you have doubts. Click here and here for full coverage.)
Second, insurers make their living anticipating risk and quantifying it. Why should climate change exposures be any different?
Yet insurers were in anything but a cooperative mood when the data collection calls were debated at the recent NAIC meeting in Orlando.
Most said the data demands were unreasonable, or even punitive. Frank Nutter, president of the Reinsurance Association of America–and certainly no fear-monger–warned that in seeking such data, regulators should “be careful what you wish for,” because it could have a negative impact on insurance availability and affordability for coastal areas. I assume Mr. Nutter was alerting regulators to the risk that insurers, if forced, would err on the side of caution and perhaps overestimate their exposure, but it did sound like a threat of sorts.
I too wonder about the reluctance of reinsurers to share this data. But then our good friend from Louisiana Mr Comingsoonerlater chips in with a very timely post yesterday on Yahoo Allstate that may give a possible explanation, especially in light of record profits at offshore reinsurance concerns like RenaissanceRe Holdings.
The reinsurance recoverables that are listed on sop’s link to State Farm’s P&C subsidiary’s financials is interesting. R. Mowbray – T/P – wrote an article on 2/25/07 titled “Premium rates may be headed down, reinsurance prices seem to have peaked” which states that in hurricane prone south Louisiana, reinsurance might account for 30 percent of the premium that the customer is charged. (Of course, that’s if the insurer actually buys the reinsurance or merely overcharges the customer.)
Anyway, Ms. Mowbray article goes on to say that …
State Farm, a private company and the state’s largest residential insurer, declined to talk about any details of its reinsurance program.
Older post by insinvestwhore200 3-19-07 says that State Farm also doesn’t carry much reinsurance either. They retain a great deal of their risk net. All reinsurance retentions & limits are stratospherically high. Among other things, they don’t really like reinsurers and don’t really like reinsurance.AND REINSURANCE MIGHT ACCOUNT FOR 30 percent OF THE PREMIUM THAT THE CUSTOMER IS CHARGED!!!! BET THOSE CARRIERS REALLY, REALLY, REALLY LIKED THAT.
I’ll grant that at this point I’ve probably lost many “right brain” readers and the rest are wondering why I’ve wandered off into the world of Statistical Theory when the post title speaks of Chip Merlin’s blog. It is precisely at this point that Mr Merlin’s latest blog entry is completely illuminated, on the fallacy of the arguments used by Allstate in fighting against the release of the McKinsey documents to the point of being held in contempt of court and sanctioned to the tune of millions of dollars.
Within hours of the decision (Florida Court of Appeals upholding Allstate’s suspension in Florida), Allstate placed over 150,000 previously “secret” documents regarding its claims practices on the Web Friday night.
I was returning late Friday night to Tampa from Mississippi. I received a call from a journalist asking about my perceptions of the Appellate Court ruling and was informed of Allstate’s actions. I was in disbelief that after all these years of Court battles, appeals, flying all over the country for snippets of these documents, that Allstate finally was turning them over and placing them on the internet for all to see.
Mr Merlin continues:
How insurance companies handle insurance claims should neither be a mystery nor a secret. I cannot fathom a societal reason why we should allow them to be. Keeping them secret simply encourages cheating insurance company practices. If there is a “cheaper” and more efficient method to adjust claims, all of us should benefit by sharing that information since all of our claims in aggregate have an effect on rates.
Chip Merlin is right on target. Information Asymmetries are commonly cited by insurers as a disadvantage when they adjust claims or write policies. While we agree with that application of the concept is also true that consumers are at an extreme disadvantage due to a lack of information from insurers on the assumptions used to set our rates. Secrecy, whether in our government or an industry which enjoys an anti trust exemption is simply not good public policy. I close this post with the full text of Mr Merlin’s Editorial in the Tampa Tribune from February 4, 2008.
Even after we agreed to accept more risk in our policies, big insurance not only reneged on their promise to lower rates for Floridians, they continued to increase them.
And while the Office of Insurance Regulation should be applauded for its decision to hold hearings to find why we were lied to, they are also getting a real sample of what lengths insurance companies will endure to fatten their bottom lines at the expense of consumers.
Having battled these entities for over 20 years, I have seen firsthand how they will do anything to avoid exposing upper management tactics that would confirm our fears about an industry that has done everything possible to avoid accountability.
Furthermore, having chaired the American Association for Justice’s Bad Faith Group, I also have been witness to the much-sought-after Allstate-McKinsey documents along with similar unfair claims tactics used by carriers as far back as the early 1990s.
In Missouri, Allstate chose to pay a $25,000 a day fine rather than turn over key management documents regarding the tactics and goals of its claims practices.
In Michigan, State Farm was sanctioned for failure to produce over 2,000 McKinsey-related documents when ordered to do so. The landmark case of Campbell vs. State Farm, which began in Utah and made its way to the U.S. Supreme Court over a course of 23 years, uncovered documents detailing a systematic program to underpay legitimate claims.
Yet another regulatory action in South Dakota cost Farmers Insurance Company and its shareholders a $750,000 fine for having a program where cash incentives were used to encourage adjusters to underpay claims.
These tactics of secrecy represent an underlying business strategy to prevent public scrutiny of a highly regulated business that involves the public’s trust. They delay and deny with the hope that the other side will simply give up as we become numb to high rates and the broken promise of fast and full payment on legitimate claims. Policyholders, governments and even shareholders suffer as insurance industry’s management thumbs its nose at us.
While hearings and commissions will reveal more bad news, special-interest promises remain the biggest blockade to establishing true reform. Until the army insurance lobbyist roaming our capital is removed, along with their influence on the political system, it will remain broken.
It is time for us to enforce honesty and fair play upon an industry, which agreed to be regulated in order to do business in our state, with nothing less than an iron fist.