Some Notes From Kim

I'm getting my blog for tomorrow written, but thought I'd pause a bit to update you on a bunch of smaller things.

First, I hear that at the Federal Crop Insurance Corporation meeting on September 25, 2008, I was designated a crop insurance expert/actuarial reviewer, able to do reviews of USDA Risk Management Agency studies and reports. I'm looking forward to some interesting work here!

Next, I went with RiskLightHouse partners Robert Faber and Karen Pachyn to visit two midwestern insurance companies, West Bend Mutual and Jewelers Mutual.


Thank you to all three groups for the productive and enlightening meetings.

Karen then went off to the Midwestern Actuarial Forum meeting at Sentry. I couldn't go, but sure missed it that day, as I've been involved with the MAF for some time, most recently as president.

Lastly, the bailout plan and stock market drop are surely weighing heavily on all our minds. Bailout or no bailout, I see some very hard times ahead. Insurance has been on the edge of this financial downturn - perhaps it is due to 50 state regulators taking a good look at insurance companies that have kept the insurance companies out of the mess so far.

I'd appreciate any comments about whether insurance companies will be able to stay above the fray or not...Have the restrictions on insurance assets served to spare insurance companies? Will insurance companies be seen as a great investment? And what about state versus federal oversight of insurance companies?

Forward these questions onto other actuaries you know - It would be interesting to get a range of responses.

GAO on the Availability of Terrorism Insurance

On Monday, September 15, the Government Accountability Office (GAO) released a study called "Terrorism Insurance: Status of Efforts by Policyholders to Obtain Coverage". (GAO-08-1057) As a member of the American Academy of Actuaries Terrorism Risk Insurance Subcommittee, I was involved in meetings in Washington DC as the GAO was pulling together expert opinions and background on the issues involved.

Background

The terrorist attacks of 9/11 are estimated to have caused insured losses of about 32.5 billion (as of 2006). Just after the attacks, the availability of coverage was severely impaired, causing problems in the real estate sector and other negative economic consequences.

To help mitigate these consequences, Congress enacted the Terrorism Risk Insurance Act of 2002, more commonly known as TRIA. Under TRIA, insured must offer terrorism insurance to their commercial policyholders on the same terms they offer for other coverages on the policy. In the event of a terrorist attack, the insurance industry is responsible for a deductible of 20% of their direct earned premium and 15% of losses after that. The US government would cover 85% up to a maximum of $100 billion annually. (NOTE: This seems very small compared to the financial services bailout being considered!)

The act has been reauthorized in 2005 and 2007, with changing amounts of deductible for the industry and changes in the lines of business covered. The current act doesn't expire until 2014.

The study here was to determine if specific markets in the US are having any trouble getting the amounts of coverage they wish to obtain. Specifically:

1. Availability of terrorism insurance in certain geographical areas
   
2. Factors limiting insurers' willingness to offer coverage
   
3. Advantages and disadvantages of some options for changes to TRIA or the funding mechanism.
   

The study looked at take up rates, data on insurance companies, and interviews with more than 100 experts on various parts of the insurance process.

GAO Conclusions

The GAO Concludes:

• That some high-value properties in major cities may face initial challenges in obtaining enough coverage, but eventually manage to by using several insurance companies in more complex insurance structures, buying separate terrorism coverage, or self-insuring
  
• The current "soft" market has helped the availability of terrorism insurance overall
  
• Many insurance company CEOs worry about their overall exposure (aggregation limits) in some geographical areas and seek to control their concentration there.
  

• There is a lack of consensus on what future TRIA options would be the most useful for improving the availability of terrorism insurance coverage.
  

Other interesting facts from the GAO report:

• The "take-up rate", or the percentage of commercial insurance policyholders opting to buy terrorism coverage has been between 60% and 65% since 2004.
  
• The cost has generally amounted to about 4% of annual premium for these customers. Note that coverage is not usually priced on a percentage basis, but as a loss cost that varies by territory. I'm assuming that the 4% refers to high risk areas since those were targeted in the scope of the study.
  
• The policyholders that don't purchase coverage do so because they don't feel at risk or their lender doesn't require it.
  
• Reinsurers and Rating Agencies may influence the purchase of terrorism insurance.
  
• Options for modifying TRIA include:
  
  • Lowering TRIA industry deductible following large terrorist attacks
    
  • Permitting tax-deductible reserves for terrorism losses
    
  • Forming insurance pools for sharing assets and losses
    
  • Catastrophe bonds
    
  • Limiting state regulation and requirements
    

What does it mean for you

The fact that the GAO didn't find any serious availability issues means that TRIA will remain in place, unchanged for some time to come, unless a big terrorist attack occurs. In that case, availability will "harden" in the short term while losses are assessed.

From a risk management and actuarial point of view, controlling concentration (or your aggregation limits) is key to sleeping easy at night, even if it makes potential insurers (or their brokers) work harder to find coverage. That effort makes the system work better because spreading the loss is an important function of insurance.

The industry's lack of consensus when it comes to alternative options really hurts the industry's credibility and their ability to influence the options eventually selected. I think a industry-wide conference with interested stakeholders in the terrorism insurance arena (A "constitutional convention" so to speak) would be a valuable first step to a more permanent terrorism insurance solution. In my mind, the government HAS to have a stake in the final arrangement, since the government's actions have a great influence on terrorism activity in the US.

Sources:

GAO-08-1057 at gao.gov

I would love to field comments about the study or the options for modifying TRIA.

Pros and Cons of ZIP Codes for Rating Territories

Many lines of business include ZIP Code-based rating territories for ease of establishing where an insured location is without depending on the agent's input or to facilitate online quoting. But is this really a good idea? This blog entry provides some information about the pros and cons.

Instituted in 1967, ZIP Codes are now part of everyday life in the US. The approximately 45,000 ZIP Codes come in four types:

1. Unique (assigned to a single high-volume address)

2. PO Box-only (used only for P.O. boxes at a given facility)

3. Military (used to route mail for the U.S. military)

4. Standard (all other ZIP codes)

PROS:

1. ZIP Codes are readily available and can be easily verified, assuming that the record has the correct location ZIP Code on it. Some locations may have the billing ZIP Code on the policy record which may be a PO Box or a separate location than the building location.
2. Territories assigned based on the true location ZIP Code are accurate and are not subject to manipulation by the agent, insured, or insurer.
3. ZIP Codes are commonly used in ecommerce, facilitating online quoting and policy sales.
4. ZIP Code is a good way to tie information from several sources together. Building code information, wind or flood zones, catastrophe model results, home construction values, census statistics, etc., may all link up through ZIP Codes.

CONS:

1. ZIP Codes do not really specify a physical boundary, but are actually a collection of addresses. As such they are frequently changed. In my experience, over a third of the codes change within a 5 year time frame. Since the “boundaries” change without changing the ZIP Code value, it makes tracking rating territory changes more challenging. City and County limits change less often and do involve a physical boundary that can be accurately mapped.
2. While some ZIP Codes are small and relatively homogeneous, some rural ZIPs are very large and diverse. If the ZIP contains parts of several different fire district or topology, rating variables may not be appropriate for the entire ZIP.
3. The Postal Service assigns place names to the ZIP Codes that are, at times, confusing or misleading. These problematic ZIP Codes cause confusion among policyholders about where their location ZIP really is.
4. Making changes in ZIP Code territory rating may be difficult to explain to regulators due to some of the CONS listed here and may delay or prevent approval of your filing.
5. Some states do not allow ZIP Code rating for one or more lines of business.

ANSWER:

If you are grouping ZIP Codes into two or more larger territories each of which includes a number of ZIP Codes, the CONS are largely mitigated. Boundaries don’t matter as much, the diversity within a ZIP would be replace with diversity of the territory and making changes will be easier to explain and quantify to the insurance departments.

If you are using individual ZIP Code rates, I think the problems are too big to ignore. Even if you publish and maintain ZIP Code rating information, it is my opinion that the work should be done on the census tract level or using groups of geocodes, though each of these has its own pros and cons.

EPCOT’s StormStruck Attraction

Hurricanes are probably something that Disney World in Orlando, Florida, worries some about. I know a friend who was in one of the Disney Resorts for one of the hurricanes a couple of years ago and says that trees might be down and damage evident all through Orlando, but Disney had the resort cleaned up almost before anyone even got up the next morning! Customer satisfaction has always been a Disney hallmark.

Educational exhibits are also not new to Disney – EPCOT has many, if not commercialized, educational exhibits. And they've tackled controversial subjects in the past. I, myself, took my children to see a short animated presentation hosted by Martin Short about human reproduction (The Making of Me) at Disney several years ago. And it was very, very well done. Another educational, but controversial topic was one on "Universe of Energy" sponsored by Exxon, starring Ellen Degeneres and Bill Nye, that maintained that there is plenty of oil and gas for everyone, not to worry.

Disney's new attraction, StormStruck: A Tale of Two Homes, is sponsored by FLASH, Federal Alliance for Safe Homes, Inc., (there are other sponsors, see press release here) . It is a 4D presentation showing the destruction of hurricanes and, in an entertaining way, makes the case for building elements that reduce storm damage. StormStruck is aimed at raising awareness about safer, stronger, more weather-resistant homes.

The exhibit is probably very interesting to residents of the Gulf Coast and Atlantic states and probably surprising to residents from other areas. I appreciate the effort to educate the (Disney-going) public, even a little, with proposals for National Catastrophe Funds, among others, being presented.

One feature of National Cat Funds and reforms of the National Flood Insurance Program are the cross-subsidies that are bound to be a feature. You can't have a coastal resident pay less without someone else paying more. (That is not quite true if the variance is reduced, but close enough).

Yesterday, this article was printed by the National Underwriter, writing about leading reinsurers making the point that loss mitigation, like what they are teaching to 10 year olds at Disney, would be far better than setting up either intended or unintended subsidies. Along with land conservation, loss mitigation and stronger building codes significantly improve results after a hurricane and should be encouraged. Subsidies encourage behavior such as building on the beach without the proper building techniques.

A website about building techniques and how they help prevent storm damage is at this site about the ARA, Applied Research Associate's Intrarisk program, which provides certifications to Florida buildings regarding the building's loss mitigation features. The company helped the Florida Office of Insurance Regulation present a large schedule of credits for various loss mitigation credits that apply to the insured's Homeowners and Property Insurance. A search of the internet could not locate those reports, but I have pdf versions available (CONTACT ME). Other states may well follow with similar loss mitigation credits.

I believe that credits like these, along with a strong building code and land management/conservation efforts would provide the right incentives and avoid damaging cross-subsidies.

Hanna and her Siblings!

Well, the next few weeks will be interesting with three hurricanes all in a row. Hanna was briefly a hurricane over the Bahamas yesterday, but has weakened for now and seems a bit disorganized; Ike and Josephine are lined up in the Atlantic with projected paths similar to Hanna's. Ike is expected, though, to enter the Gulf of Mexico, while Josephine's ultimate destination is more unclear.

Everyone here is having fun with the fact that my middle child is named Hannah and she has kind of a stormy personality. Since Tropical Storm Hanna has caused death and destruction, I wouldn't want to carry the comparison out to too many decimals. My child is, of course, very sweet, but hurricanes really aren't.

Back to business... The absolute best place I have found to track storms is at this Florida site. I like how the Tracker shows the storm moving in time to scale, so that you can see where the storm stalls and where it moves quickly. And color coding the strength of the storm is a nice touch. I'm not sure where they get their storm projections. The tracker, though, does not show the size of the hurricane graphically. A good place to see the satellite view is here.

P.S. I'm glad Gustav wasn't the worst it could have been. It went over Cuba as a category 4, so I'm sure it caused a lot of damage and wrecked some lives. I'm relieved that New Orleans was spared the brunt though.

Pay-As-You-Drive Personal Auto Insurance

California private auto was changed forever in 1988 with the passage of Proposition 103.

Among other things the regulations provided that insurance companies must accept all good drivers (as defined by them) and rate auto on 3 primary factors: Driving Safety, Annual Mileage, and Years Driving (rather than age of driver).

(CONTACT ME FOR MORE CONTENT on the history of auto insurance in California)

Pay-as-you-drive insurance:

It is the limited number of categories for annual miles driven that catches the attention of regulators and others wanting a more refined rating plan. Number of miles driven seems like a reasonable way to measure exposure and is easily understood by policyholders. Presumably in combination with "where you drive" (territory, that is. Though this isn't "where you drive", it's "where you LIVE"), it would seem to cover a driver's exposure pretty well (see next section for what research shows).

The new proposed regulation is being touted as a "green" provision, encouraging drivers to drive less by having their insurance coverage apply by mile driven. California Insurance Commissioner Steve Poizner has proposed this optional rating mechanism, allowing insurers to offer a voluntary option for consumers who are interested in pay-as-you-drive coverage.

Consumer groups are opposed, saying that there is not enough protections in the law for protecting the privacy of insured's everyday activities. Some tracking mechanisms include "OnStar" satellite and GPS-based meters similar to those used in cell phones.

Quoting from the article:

The Environmental Defense Fund estimates that if 30% of Californians participate in this voluntary coverage, California could avoid 55 million tons of CO2 between 2009 and 2020, which is the equivalent of taking 10 million cars off the road. This would save 5.5 billion gallons of gasoline and save Californians $40 billion dollars in car-related expenses. Additionally, the California Air Resources Board has recommended the adoption of pay as you drive as one of the means to meet future climate change gas reduction targets.

Hard to ignore potential emissions reductions like these numbers.

But the research shows:

The research shows that pay-as-you-drive insurance may not get at the true exposure to auto insurance claims for each insured. The following table shows that annual mileage isn't one of the top three predictors of insurance claims. By the way, insurance score (or "credit" score) is not allowed in California.

Coverage	Factor 1	Factor 2	Factor 3
Bodily Injury Liability	Age/Gender	Insurance Score	Geography
Property Damage Liability	Age/Gender	Insurance Score	Geography
Medical Payments	Insurance Score	Limit	Age/Gender
Comprehensive	Model Year	Age/Gender	Insurance Score
Collision	Model Year	Age/Gender	Insurance Score

Source: The Relationship of Credit-Based Insurance Scores to Private Passenger Automobile Insurance Loss Propensity, Michael Miller, FCAS and Richard Smith, FCAS, Epic Actuaries, June 2003

Pros/Cons of Pay-As-You-Drive:

Pros:

• Exposure for insurance tied to miles driven – easy to understand by drivers
  
• The amount you pay for insurance would be directly controlled by the driver, rather than on factors such as sex, age, martial status, etc. that the driver has no control over.
  
• The current proposal is for an optional credit, giving low mileage drivers a choice.
  
• Reduced emissions
  

Cons:

• The amount a driver pays should be as closely tied to his/her exposure to loss as possible, to avoid cross-subsidies and comply with Actuarial Standards and Principles.
  
• Tracking mileage is difficult and some methods proposed inspire fear of lack of privacy in some consumers and consumer watchdog groups.
  

My opinion is that there are better, less complicated ways to refine the rating plan options when it come to annual mileage, and still emphasize lower emissions and "green" policies. One obvious one is to simply increase the number of mileage bands in the current plans and offer "green" discounts (and debits) based on the type of automobile covered. Discounts for Prius's, debits for Hummers.

My firm would be happy to work with you to weigh your personal auto rating plan options and refine your plan.

Current events link:
Insurance Journal Article

Background/Bibliography
Powerpoint by Harbage
Powerpoint by Kelleen Arquette
AAA Review of Pay-as-you-drive report (EPA, 2002)