Texas Private Passenger Automobile Insurance Profitability 1990-1998 Continued

Excess Premiums and Profits in 1996, 1997 and 1998

Table 2 shows exactly how the benefits of "tort reform" have flowed to insurers as windfall profits. The table compares actual 1996 and 1997, and preliminary 1998, Texas private passenger automobile loss ratio experience to loss ratios determined by the Commissioner, in his 1997 benchmark rate order, to be reasonable. The technical notes accompanying this report provide details on data sources and methodology.

The premiums and rates for liability coverages were substantially excessive in 1996, 1997 and 1998. Liability premiums were excessive by 18.5%, 22.8% and 17.0% in 1996, 1997 and 1998, respectively. Stated in dollars, liability premiums were $928 million excessive in 1996, $1.187 billion excessive in 1997 and $869 million excessive in 1998 for a total of about $3.0 billion for the three years.

The dramatic excesses of the liability coverages led to excessive premiums for all private passenger automobile coverages combined. Total premiums were 9.3%, 14.5% and 10.5% excessive in 1996, 1997 and 1998 respectively. Stated in dollars, total premiums were excessive by $729 million excessive in 1996, $1.193 billion excessive in 1997 and $890 million in 1998 for total of about $2.8 billion for the three years.

Some insurers did return some excess premium to Texas consumers as policyholder dividends for 1996 and 1997. Table 3 shows total policyholder dividends of $49.0 million in 1996, $221.9 million in 1997 and $380.3 in 1998. Even after deducting policyholder dividends from the excess premium figures, Texas private passenger automobile insurers reaped windfall profits from 1996 to 1998 of about $2.5 billion for liability coverages alone and $2.2 billion for all private passenger coverages combined. Assuming ten million insured vehicles, Texas automobile insurance consumers were overcharged an average of $220 per vehicle for the period 1996 through 1998.

Padded Reserves in the Early 1990s Mask Auto Insurers’ Profitability

Some have argued that, when viewed over a longer period, Texas private passenger automobile insurers have not been overly profitable at all. Rather, they argue the better profitability of 1996 and 1997 simply averages out the inadequate profitability of the early 1990’s. Table 4, however, shows that Texas auto insurers masked their profitability in the early 1990’s by dramatically overstating the reserves included with incurred losses.

Table 4 shows pure loss ratios for Texas private passenger automobile insurance from 1990 through 1998. "Paid Loss to Written Premium" relates dollars paid out by insurers in a calendar year to premium on policies written in that calendar year. "Incurred Loss to Earned Premium" relates paid losses plus changes in loss reserves for anticipated payments to premium earned on policies written in that calendar year. Incurred losses are considered a better indicator of losses associated with policies in a particular year and are used in developing automobile insurance rates. These loss ratios are termed "pure" because they relate losses to premiums without any other adjustment and represent the percentage of the premium dollar returning to consumers in claim payments.

Several items are noteworthy in Table 4. First, the comparison of paid-to-written loss ratios with incurred-to-earned loss ratios shows that incurred-to-earned loss ratios greatly exceeded paid-to-written loss ratios in the early 1990s. Insurers set aside substantial reserves in the early 1990s – resulting in high incurred-to-earned loss ratios – for claims they allegedly expected to pay out in coming years. If these reserve estimates were accurate, we would expect that after a few years, the paid-to-written loss ratios would increase as the claims from, say 1990 and 1991, were paid in 1992, 1993 and 1994. The reversal of paid-to-written and incurred-to earned loss ratios never occurred. Rather, the liability and overall paid-to-written loss ratios remained remarkably and consistently low. Table 4 shows that insurers padded reserves in the early 1990s and thereby masked their profitability.

Further evidence of over-reserving for automobile insurance is provided by insurance industry analysts Dowling and Partners Securities. Dowling and Partners have analyzed countrywide private passenger automobile insurance reserves for several years for their small clientele of very large investors. The 1998 Dowling and Partners analysis shows $8 billion of "redundant" automobile liability reserves at the end of 1997 – representing about 12% of total automobile liability reserves. The Dowling and Partners study shows that the amount of redundant reserves did not change from the $8 billion total at the end of 1996. For example, aggregate incurred loss plus allocated loss adjustment expense ratios initially established by insurers at 83.8% in 1991 have been restated to 75.9% by 1997. The Dowling analysis shows reductions of 10.9% and 9.8% for 1992 and 1993 accident year experience loss and loss adjustment expense ratios since inception.

Paid-to-written loss ratios are not a good indicator of automobile insurance profitability over a shorter period – one or two years. However, the long-term, consistent pattern of overall paid-to-written loss ratios under 70% in Texas shows that Texas private passenger automobile insurers achieved reasonable or better-than-reasonable profitability from 1990 through 1995. After consideration of excess reserves, Texas auto insurers were profitable even before the windfall profits of 1996, 1997 and 1998.

Finally, it should be noted that the rate setting process starts with historical incurred losses. To the extent that historical incurred losses were exaggerated by excess reserves, rate indications during the 1990’s were overstated.