Florida’s Insurance Problem is Inadequate Surplus Growth During Good Years

The Florida legislature and Office of Insurance Regulation should learn from insurance history, recent warnings, and common sense when it comes to building a stable Florida insurance marketplace. Former Florida Insurance Consumer Advocate, and now lawyer in the Merlin Law Group, Sean Shaw highlighted a fundamental flaw in Florida’s insurance marketplace in a recent St. Petersburg Times Letter to the Editor. He noted:

In reality, the lion’s share of the blame for the industry’s solvency issues falls squarely on its own shoulders. During the current five-year storm-free stretch, the state’s insurers have neglected to build their capital reserves to levels that would enable them to withstand the next major disaster. Instead, insurers send as much as 86 cents on the premium dollar overseas to reinsurers who are not obligated to conform to the regulations that act to protect consumers. Florida’s undercapitalized and overleveraged insurance companies are essentially slaves to these offshore reinsurers, who often charge five times the actuarial risk of loss simply because they can.

There is another dirty secret that the state’s insurance companies don’t want you to know. Despite all the self-pity, many Florida companies actually make sizable profits. Nearly every private insurer in the state has divided itself into several separate subsidiary companies that swap money in a veritable shell game to escape regulation.

According reporting by Paige St. John, between 2006 and 2008 Florida property insurers gave out more than $149 million in executive bonuses, perks and dividends to their holding companies while increasing Floridians’ rates by an average of 35 percent over the same period.

Investigative reporter Paige St. John exposed these important issues, as I noted in Breaking News Story: Florida Insurers Hide Profits While Claiming Losses to Get Rates Raised and Insurance Rates Go Higher With No Hurricanes?

The concern and regulation of "management contracts" which provide accounting methods to take surplus from insurance companies and place it into the hands of the investors and operators of those insurers is not new. For example, in On Your Side (P. Franklin 1994), a book describing the history of Nationwide Insurance Company, George J. Mecherle, the founder of State Farm Automobile Insurance Company, was reported to have a management contract with Sate Farm. The nature of the contract concerned insurance regulators in Ohio. In essence, while George Mecherle ran a mutual insurance company for the benefit of the policyholders, he was also running it pursuant to an agreement with G.J. Mecherle, Inc. The Ohio Department of Insurance Superintendent would not approve of the State Farm license because of Mecherle’s contract.

Meherle’s management contract required a percentage payment of every policy written. It was quite lucrative and worth millions during the Great Depression. It was obvious to the Ohio Department of Insurance that the founder of State Farm Mutual was not simply interested in building a company for the benefit of the mutual policyholders. The side management contract allowed him additional profit to a company he controlled.

A more recent example of a side and silent management contract providing additional income to principals of an insurance company involves AIG and its former chairman, Maurice "Hank" Greenberg. Bloomberg Businessweek reported Greenberg’s third party management agreements in "AIG: What Went Wrong":

[AIG] has launched its own internal investigation, which has so far revealed several arrangements and deals that were not properly accounted for. The company says that its review is not yet complete. Moreover, AIG has pledged to change how it accounts for deferred compensation that’s now paid to senior executives through Starr International Co. (SICO) — one of several controversial private entities that also are under investigation.

AIG has a highly unusual arrangement with three private entities, governed and controlled by Greenberg and other AIG executives. Each serves a different purpose and raises unique concerns. SICO is a holding company that owns about 12% of AIG stock — making it the company’s largest shareholder — and pays out some of that stock to an elite group of AIG managers as deferred compensation. Greenberg and other AIG directors sit on the board, have large personal stakes, and decide who gets paid what. Regulators believe SICO hides executive pay and takes away powers that should rightly lie with the compensation committee of the board.

C.V. Starr & Co., on the other hand, is a group of agencies that develops business and issues specialized policies for AIG. It’s owned and operated by AIG executives — many of whom perform functions similar to what they do at AIG — and controls 1.8% of AIG shares. Critics worry that the opaque nature of its transactions, for example, could allow C.V. Starr to become a convenient tool for managing earnings at AIG, which has been a model of earnings consistency in a notoriously volatile industry. The arrangement also creates endless possibilities for conflicts of interest…

The problem is unregulated side management agreements line the pockets of insurance investors and speculators and rob surplus from company treasuries which would go to pay claims following catastrophic loss or increase capacity to sell more policies. As reported in the media, insurance company cries of meager profits and losses are misleading at best, as they are pocketing income through affiliated subsidiaries.

As a result of not having catastrophic hurricane losses since 2005, many of us believed that Florida’s insurance marketplace would be far better today. Florida insurance companies should have been building surplus and reserves for the catastrophes that are surely to come. Now we find that many of these companies’ investors quickly recouped investments and received significant profits through manipulation of expenses by affiliated companies.

The curious thing is that there has been almost nothing out of Tallahassee regarding this important issue. What are elected officials and regulators doing and thinking about this now that it has been raised? What does the current Florida Insurance Consumer Advocate think? With all this attention, one would think our elected officials in Florida Legislature, the Florida Office of Insurance Regulation and the Florida Insurance Consumer Advocate would be holding hearings and making pronouncements on this important social and business issue. Instead, we have silence.

I personally know and have supported Jeff Atwater while he was in the Florida Senate and in his run for Florida’s CFO position. He is a man of integrity and transparency. If there is ever a need for transparency in the expense accounting of insurance companies, this is it. He should encourage the Office of Insurance Regulation to vigilantly tackle this important topic and require insurers to transparently report expenses paid to companies affiliated to principals of insurers doing business in Florida.