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Claims Don’t Drive Insurance Rates!

Blaming the Victims

Miami Herald
December 30, 2002
by Edward Wasserman

Why are liability insurance rates soaring again?
It’s the courts, stupid. Runaway juries award lottery-sized winnings for groundless claims filed by money-mad lawyers. Facing grievous losses, battered insurers have no choice but to raise premiums.

This, we all know.

At least, that’s what we’re told — by the insurers that pocket the soaring rates and by the companies and professionals who pay them and repeat what the insurance companies tell them.

The problem is that it’s not really true. Here’s why:

  • The amounts paid out in claims haven’t really been rising, even though a few outlandish cases make it seem otherwise.
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  • What drives insurance rates has little to do with claims — and has everything to do with the profitability of the real business that insurers are in: investing in stocks, bonds and real estate.
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Those are the conclusions of studies directed by J. Robert Hunter of the Consumer Federation of America. Hunter is an actuary who was insurance commissioner for the state of Texas and federal insurance administrator under President Gerald Ford.

The story of insurance rates that emerges from the studies is a stunning departure from the tale that we’ve long been told.

Investment Pools

Here’s how it really goes: Insurance companies are essentially huge investment pools. The whole reason insurers sell coverage is to raise money to invest.

Now, when interest rates are high and the bond and stock markets are returning nice profits, insurance companies are hungry for as much money as they can get their hands on. So they cut their premiums to sell more insurance, offer marginal lines of coverage and relax underwriting standards, even if that means taking on risks that turn out to be imprudent.

Naturally, insurers don’t like to pay out on claims; they’d rather keep that money invested. But the risk of claims losses is acceptable when the investment markets are hot and they can make profits from the premiums.

Then the markets cool off, and things are different. When interest rates fall — as they have now — and the profitability of investments plunge, insurers pull back from insuring. They jack up their rates to unaffordable levels, abandon lines of insurance with unappealing claims histories and narrow down the risks they accept. Clients start howling.

To cover their own tracks — and save themselves money later on — insurers clamor for restrictions on lawsuits that, they declare, are the real reasons they’ve had to raise their rates.

Lawmakers obligingly push through so-called tort reforms. They limit how much injured people can sue for, how much lawyers can make by taking on long-shot litigation, how much courts can make wrongdoers pay for grossly irresponsible actions, and how long manufacturers remain responsible for dangerous products they make.

These limits save insurers money. So, does the industry cut premiums?

In the 1999 study ”Premium Deceit,” Hunter and his associates looked at the impact of 15 years of tort reforms. They divided the 50 states into three categories depending on how aggressively legislatures had slashed the rights of plaintiffs.

Their conclusion: ‘States with little or no tort law restrictions have experienced the same level of insurance rates as those states that enacted severe restrictions on victims’ rights.”

For instance, Massachusetts — which had passed no tort reforms — had annual rate increases of 1.8 percent, the 10th lowest in the country. New Jersey, which had enacted tough lawsuit limits, had increases of 4.7 percent per year, or 2.6 times those of Massachusetts.

Stable Pools

In another study released in October, Hunter and his colleagues looked at medical malpractice insurance over the past 30 years. While doctors were periodically hammered by huge premium increases, the study found that the purported explosion of malpractice payouts that might account for the rate hikes had never occurred. Payments “have been extremely stable and virtually flat since the mid-1980s.”

Actual payouts on malpractice claims averaged under $30,000 — when the many claims on which nothing was paid are considered — and had risen not in any explosive way, but at the same rate as the overall inflation of medical costs.

Malpractice premiums “rise and fall in concert with the state of the economy,” the study concluded. Rates reflect the gains or losses of the insurance industry’s investments, and the industry’s calculation of how much can be made on the investment ”float” — the time that elapses between the inflow of premiums and the outflow, if any, on claims.

Affordable premiums during the 1990s encouraged more people to pay in money to insurers so the industry could profit from red-hot investment markets.

With the market cool, there’s little money to be made, so rates are heading into the stratosphere. The industry’s legislative allies are preparing for a new round of assaults on the courts in an effort to explain the sudden unaffordability of insurance. The specific lawsuit limits take various forms, but their objective is to deter plaintiffs by making suits harder to bring, harder to win and less likely to yield enough money to make them worthwhile.

Having a profitable insurance industry is in the public interest. Insurers historically have put vital pressure on businesses to stop practices that harm employees and customers. But they act only when they feel the hot breath of the courts on their necks. And it’s no less in the public interest to have a court system that lets ordinary people be compensated in a way that juries think fitting.

We don’t see the social cost of a family that can’t get its day in court because reforms have capped its potential gains to where they won’t cover the expense of litigating. But justice denied has a cost. It’s just not a cost the insurance industry wants you to care about.

Edward Wasserman is a writer and consultant in Miami.