TIME: Almanac 1993/TIME Almanac 1993.iso/time/102290/1022207.000

Text File | 1992-08-28 | 12.3 KB | 261 lines

                                                                                BUSINESS, Page 48

Not a Sure Thing


S&Ls and banks aren't the only institutions in trouble. Failures
in the insurance industry could boost the cost of policies for
almost everyone.

By ANDREW TOBIAS


    Don't scream, but we may have yet another mess to worry
about: an insurance crisis. And while there's no reason at this
stage to think it will rival the savings and loan crisis, never
underestimate the worldwide insurance industry. It's tightly
interconnected, and nothing about it is small.

    Lah-de-dah, you say. Almost every state has an insurance
guaranty fund (though it's generally illegal to refer to it
when selling insurance), so it's not my problem.

    Oh, yeah?

    Consider the case of Jeannette Shulda, rendered a
quadriplegic in 1984. She was helping her long-haul trucker
husband when a pallet fell on her, crushing her spinal cord.
A company called Transit Casualty (remember that name) paid out
more than $300,000 in medical expenses and 24-hour care. Then
everything stopped. At the end of 1985 Transit Casualty went
broke. For technical reasons, the California state guaranty
fund wouldn't cover the claim. Eventually it probably will
(just hang in there, Mrs. Shulda), but nearly five years later,
the case is still in the courts.

    You and I will probably never have a major insurance claim,
let alone one that doesn't get paid by somebody. Yet it's still
our problem. If insurance companies start going broke in a big
way, state guaranty funds are going to need huge infusions of
cash to pay claims. That cash is not going to come from the
moon. It's going to come largely from us.

    Are you from California? Look at your auto insurance bill.
You'll see that 1% is earmarked for the insurance guaranty
fund. Right now, that's enough to cover the occasional
insolvency. But what if Transit Casualty proves to be an omen
rather than an isolated incident? Here was this little company
that never earned more than $60 million in net premiums in any
year -- peanuts, in the insurance industry -- and then went
broke. How much of a problem can that be, one wonders? How much
can a company like that lose?

    About $3 billion, by current estimates. To understand how
that's possible is to understand the ineffectiveness of
insurance regulation, the inefficiency of the insurance
industry, and the possibility that Transit Casualty is a
harbinger of big trouble ahead.

    For most of its life, Transit specialized in insuring
municipal bus lines, cab fleets and reasonably predictable
things like that. It made money. But in the late 1970s, the
same winds that were beginning to upend the boring old savings
industry -- high inflation and high interest rates -- were
blowing across the insurance fields as well. As interest rates
rose, insurers began competing ruinously for customer premiums
to invest at those high rates, especially in the lines of
insurance that had "long tails" -- decades, often, between
collecting premiums and paying claims.

    So Transit, among others, found itself squeezed in its
traditional business, but also saw a chance to profit. By 1981,
it had signed up 17 "managing general agents" to whom it "gave
its pen." That meant these agents could write Transit Casualty
insurance policies without even calling the home office for
approval. They got to use Transit's good name, its A rating
with insurance authority A.M. Best, and its licenses to operate
in 50 states. This is known in the business as "fronting." In
effect, Transit chartered 17 little insurance companies to go
out across the land and write policies. Transit's oversight was
so slight that when the court-appointed receivers came in to
clean up the mess (a job currently employing nearly 200 people
that should last till the end of the century), they found there
was not even any central register of policies. Transit didn't
know what promises its managing general agents had been making
on its behalf.

    Transit was willing -- eager -- to do this because as part
of the deal the agents were required to obtain reinsurance for
most of the risk. Aha! Transit didn't have to know the
specifics of each policy, let alone approve them in advance.
Transit got a nice "fronting" fee with little effort or risk
(unless some of the reinsurers couldn't  pay when the time came
-- but who ever heard of a reinsurer going broke? especially
since reinsurers themselves reinsure with other reinsurers).
Transit paid out about $15 million in dividends in 1982, 1983
and 1984.

    Then, in 1985, the accounting firm Touche Ross came in and
found it would be impossible to certify Transit's books,
because it was impossible to assess the liabilities Transit
faced. Soon after seeing a likely net worth of zero, the
Missouri Division of Insurance shut Transit down. Mrs. Shulda's
checks stopped.

    But is this more than an isolated horror story?
Unfortunately not. One of Transit's reinsurers was a British
firm called London United Investments, whose various
subsidiaries specialized in accepting risks most other
companies found too dangerous. Like liability insurance for law
firms and accounting firms (some of which may be faced with
liability from their work with failed S&Ls). London United faces
billions of dollars in promises it can't keep -- what may
eventually approach $300 million to Transit, $150 million or
more to Xerox subsidiary Crum & Forster.

    So these things are interconnected. Companies you never
heard of can affect companies you have. And in writing risky
"excess casualty" business, Transit Casualty did for only seven
years what London United did for nearly 30. "Excess casualty
business may not really develop losses for 20 to 40 years,"
says Paul Dassenko, Transit's court-appointed head of
operations, "and so is perfect for a scam. In addition to
paying yourselves dividends out of cash that should be invested
for future claims, you just siphon pennies from each dollar
into a variety of brokerages and servicing companies in which
you have an interest."

    Nor is London United the only reinsurer in trouble. "When
we send bills to reinsurers," Dassenko says, "some of the
smaller ones call us up and say, `If this bill is legitimate,
we're not solvent.'"

    Nor is it just reinsurers. Insurance companies are going
broke in Louisiana faster than you can say "corrupt
politician." Ralph Green, court-appointed liquidator of
several, says ruefully, "We have a severe problem nationwide."

    Congress is looking into all this. A House subcommittee
chaired by John Dingell of Michigan issued a report in February
that concluded, "The parallels [to] the early stages of the
savings and loan debacle are both obvious and deeply
disturbing. They encompass scandalous mismanagement and
rascality . . . along with an appalling lack of regulatory
controls."

    Insurance-industry spokesmen and state regulators say
everything is fine. Right now, Louisiana is the only state that
has had to raise its legislated cap on guaranty-fund
assessments (to 2%). But the numbers seem likely to grow.

    Three stories contribute to the potential insurance crisis:

    The first is simply the huge cost of legitimately
unanticipated claims. What company could have adequately
reserved for the thousands of asbestos claims that would
surface 30 years after the fact? What life insurer could have
anticipated a disease, AIDS, that would eventually kill
hundreds of thousands of policyholders in their 20s and 30s and
40s?

    Clearly, a major function of the insurance industry is to
set aside reserves today for massive losses many years from now
-- and to invest those reserves wisely, so they too grow
massive.

    Thus the second story is the inefficiency of the insurance
industry. Every dollar drained off in overhead is one fewer
available to invest to pay future claims. When Transit took in
$100,000 for a typical  policy, $7,500 would go to the
commercial insurance broker; $10,000 to the "excess and
surplus" broker, the specialist who brought the business to one
of Transit's managing general agents; $5,000 to that managing
general agent; $6,500 to Transit itself, for use of its name;
and then (here the trail gets murky) many thousands more to a
succession of reinsurance brokers and "retrocession brokers" and

to know.

    Bottom line: of the initial $100,000, less than half might
be left to build a reserve against claims that would come due
some day. And in this Transit was not atypical. (Meanwhile,
close to half of whatever claims eventually were paid would
likely wind up going to the claimant's own legal expenses.)
This is not an efficient system.

    The third story is of the difficulty of regulating the
industry. Where were the regulators? And how did Transit retain
its "excellent" rating with A.M. Best until mid-1983, and its
"good" rating until just a year before things began to unravel?

    Largely, as in anything else, all you can do is trust
people. Insurance companies submit annual reports to their
home-state insurance departments, but if incompetence or deceit
hides the true risks, the insurance department is unlikely to
know it. In 35 states, those annual statements need not even
be certified by an independent auditor! (And in Wyoming -- the
state of choice for crooks who have gone broke in Louisiana --
ex-insurance commissioner Gordon Taylor was charged in April
with six felonies for taking their bribes.)

    "The industry has resisted the creation of reasonable
regulation," Dassenko told a group of the reinsurers from whom
Transit is now trying to collect. "As a result, dishonest,
unethical and incompetent competitors play on the same field
with honest businessmen who exercise good judgment." In effect,
the bad guys charge too little for insurance, living high on
the hog and then just putting their companies into bankruptcy
when the claims come due. "The end result," says Dassenko, "is
that the good businessmen suffer twice: first by losing business
to the bad guys whose rates they can't match; and then again
by having to clean up the mess when the bad guys go broke."

    Status quo proponents argue that uneven and often mediocre
state regulation is no worse than consistently mediocre federal
regulation would be, and that the current furor in Congress has
snapped state regulators to attention. But where it's really
frightening, and where any crisis, if we get one, is likely to
erupt, is in reinsurance, an almost entirely unregulated field
of undisclosed relationships crisscrossing national boundaries.

    How solid is the global reinsurance system? No one really
knows, but less solid than it ought to be. The 1970s run-up in
interest rates attracted scores of companies that didn't
understand the business, that were easy marks for unscrupulous
operators and that had not established decades-long
relationships of trust. "It used to be, the handshake applied
to any kind of dispute, and you very rarely had disputes" --
as one reinsurance executive was recently quoted. "Things are
more complicated today."

    And these are just the problems on the property-and-casualty
side of the industry. Far better publicized of late have been
the woes of the life insurance side: losses on junk bonds and
bad real estate. Yet these should be manageable if the real
estate market doesn't collapse -- and that's not likely to be
allowed to happen (anything's possible), because if the real
estate market collapsed, everything would collapse.

    So what should you do about all this? Not much. If you're
a normal Jane or Joe with basic auto, homeowner's, life and
health insurance, you're probably fine, just as your money is
safe in S&Ls -- even failed S&Ls. Jeannette Shulda is very much
the exception to the rule. But as with the S&Ls, there are some
indirect costs we may have to pay. Routine insurance policies,
by and large, are not the cause of what may be looming
insurance problems. But their price could go up if the solvent
insurers have to pick up the losses of the insolvent ones.

    Oh. Did I mention that the year before Transit went broke
its chairman, George Bowie (whose criminal fraud trial begins
Jan. 4), was paid a $650,000 bonus? Way to go, George!