The US insurance industry had a wonderful year in 1980. It also had a terrible year. It can thank inflation for both situations.
Like the wage earner who gets to relish his cost-of-living pay increase only until next month's bill-paying ceremony, the nation's insurers find they made record gains on their investments, but were hit with a near-record underwriting loss.
While it tallied $11.2 billion in investment income and $6 billion in capital gains, the industry had a $3.5 billion underwriting loss, its second worst ever.Although this may appear to be a positive development, "insurance companies are supposed to be doing a better job of insuring than investing," says Mervin Taylor, an analyst with A.M. Best Company, a firm that studies the insurance industry closely.
Inflation, a list of unusually large disasters, and a steady increase in fraudulent claims are just some of the reasons the industry saw its underwriting losses more than double from 1979's $1.3 billion level. In a recent report on the industry, A.M. Best looked at the investment gain-underwriting loss dichotomy and concluded that "a business that looks better while it is getting worse presents a fascinating challenge for analysis."
Faced with this situation, many of the nation's insurance companies are doing what they can to cut their losses from underwriting -- the factors and risks they assess when they write an insurance policy.
The insurance industry traditionally goes through five to seven year "cycles" when it is either making or losing money on underwriting. The cycle exists because underwriting is really a game of estimates. Sometimes the company finds it has overestimated how much money it needs to pay claims and will reduce premiums to stay competitive. Later, it may find premiums are not bringing in enough money, so it will raise rates.
But economic conditions have changed so much in recent years, analysts say, the rules behind this cycle may no longer apply. Two years of double-digit inflation, they note, have made it harder for underwriters to know how much it will cost to pay off claims, particularly now that so many policies have built-in inflation protection.
At the same time, insurance companies are having to write policies for risks where there are almost no precedents, a key to assessing risk. When a law requiring strict standards for the transportation and disposal of hazardous wastes -- such as from the nuclear and chemical industries -- became effective late last year, all the legitimate firms that were set up to handle this waste needed insurance.
"We have no past record to use as a basis to establish rates," said Paul R. Jurgens, vice-president for commercial casualty underwriting at the Hartford Insurance Group.
But even with a past record to go by, the industry has not been doing too well with its underwriting. Part of the problem is that inflation has been pushing up the costs of repairing or replacing insured goods faster than new rates can be drawn up, and faster than insurance companies can persuade state insurance commissions to let them charge higher premiums.
In automobile insurance, for instance, the Insurance Information Institute asserts that while the cost of car repairs rose 11 percent in the first 11 months of 1980 and medical charges went up 10.8 percent, the average premium increased only 7.7 percent.
There were also a fairly large number of losses from catastrophes, including a $100 million loss at the MGM Grand Hotel fire in Las VEgas; severe storms in the Midwest in July accounting for a $95 million loss; Hurricane Allen, which produced a $57.9 million loss in Texas, Puerto Rico, and the Virgin Islands in August; and May's eruption of Mt. St. Helens in Washington state, which acounted for some $14 million in insured losses.
To help cut underwriting losses, insurance companies are trying to select risks more carefully, turning more attention to less risky group pension plans, and doing what they can to limit claims. Aetna Life & Casualty, for instance, has hired a former New York City Fire Department official and put him in charge of its arson investigation program.
"We want to stop the arson-for-profit people," says S. Berton Guiney Jr., Aetna vice-president for claims.
While inflation has been making life hard for insurance companies, it has helped balloon their investments to record levels. Money market mutual funds, for instance, currently paying over 17 percent, have proven to be a lucrative place for insurers to park their cash. And many stocks, particularly on the American Stock Exchange and the over-the- counter market, have been steadily increasing in price. Of course, the bulk of insurance company money still goes into more conservative investments, such as government and corporate bonds and mortgages.
"Investment income has always been a vital part of the insurance industry," says Hartford's Mr. Jurgens in defending the investing-underwriting picture. "Underwriting profit is seldom more than 2, 3, or even 5 percent. Capital won't be attracted in that range."
Investors are not expected to see their rewards climb very much this year. Aetna, for example, which earned a record $6.90 per share in 1979, expects profits to be in the $6 to $6.40 range for 1980.