Recent Meadowbrook Insurance Issues Recalls P/C Carrier Financial Turmoil of Past Years

09 Sep, 2013 John D'Alusio

                               

August 5, 2013 News Release: “Following a downgrade of its financial strength ratings (FSR) to “B++” from “A-” by A.M. Best Co., Meadowbrook Insurance Group announced that it will seek to make arrangements with an A-rated insurance company to issue some policies. In addition to seeking an arrangement relating to programs and lines of business for which a higher rating is required, Meadowbrook said its board of directors is undertaking a review of strategic alternatives and has engaged Willis Capital Markets & Advisory in connection with its evaluation.”

The financial rating hammer came down on Meadowbrook Insurance Company on Friday, August 2, 2013. That was A.M. Best released its official downgrade of the Meadowbrook's financial strength, prompted by weaker than expected second-quarter results. Meadowbrook reported a net operating loss of $4.4 million for the quarter, attributable in part of $21.4 million of prior year adverse loss reserve development and $8.2 million of pre-tax losses (on prior years) the result of adverse reinsurance arbitration.

This announcement brought back memories of such proud names as Reliance Insurance Company, The Home Insurance Company, Superior National Insurance Company, Mission Insurance, and a slew of others that are no longer in operation. The free market (when untouched by governmental safety nets) has a way of weeding out underperformers who have elected unsafe financial courses, which, in the long run, always have negative ramifications and repercussions on continued existence of the entity.

The Property/Casualty insurance industry is a rather simple business segment to understand. People try to make it difficult, but in reality it is quite straightforward. Insurance companies offer to underwrite coverage (whether statutory like WC, or contractual) for premiums. The premiums are collected and provide a pool from which to pay losses. The pool of funds earns interest, thus giving insurance carriers a “float” on the money.

There are three critical corollaries to a successful P/C carrier model: 1) Spread the risk, never concentrating all the exposure in one area (by business line or geography), 2) Charge a proper amount of premium for the coverage being provided, and 3) Reserve the claims promptly and accurately.

The P/C formula for success appears facile enough. The executive management teams in insurance companies always have some measure of intelligence, and should possess a sense of industry history when choosing a strategic course of action. Then why the problems that caused the demise of so many old line insurers in the last 30 years, while brining others to the precipice of extinction?

Obviously, there are those who did not listen to the footfalls of financial disaster coming up behind them. The first mistake is usually an idea that, ironically, has its genesis in seeking improved financial results. The strategy is to increase market share. If an insurance company has greater market share, perforce it will have more money flowing into its coffers from the growing number of policy holders. This will translate to greater revenue, and a higher stock price. Sounds like an excellent strategy.

The crux of the matter is always how best to go about executing on this increased market share strategic direction. After all, there are numerous insurance companies offering the same coverage, in the same geographic locations. The simple answer is “drop price!” Reduce the premiums you quote for the business you want to place on the books. Giving that all other things are equal (financial rating of the insurer, limits of coverage, availability of a solid distribution network, etc.), consumers will gravitate toward the company that charges less. That's simply the way a free market operates.

The not so subtle result of this strategy is that underwriters are now forced to “price” policies rather than truly underwrite them. It is true that underwriting leads to pricing, but in a market share mode, pricing becomes the primary concern rather than underwriting the exposure for the correct premium. “Cash flow underwriting” is, traditionally, the nascent step on the path to economic perdition. Once the corporate emphasis is moved from true underwriting to pricing, the spiral downward had begun.

Initially, as the coffers swell with additional premiums, the strategy looks to be an excellent choice. But what is really occurring is that the premium that is being booked is not adequate to cover projected loss development. The problem is that it will take several years for the folly of a “cash flow underwriting” philosophy to be fully felt on the financial ledger. But when it becomes evident, prepare for the worst, because it is going to come.

What inevitably transpires is that losses begin to catch up with the premium that has been collected, and then greatly exceed that amount. When this becomes manifest, there are usually several emergency steps that are undertaken. This includes holding down reserve development, while instructing your distribution/sales network to obtain still more premiums (more market expansion). But the latter will ineluctably be at reduced prices, because if “correct” premiums were quoted, no one would be interested because the company has become known as a discount insurer. So the spiral downward continues unabated.

At some point, the Actuarial Department warns that massive IBNR financial injections into loss reserves is necessary as projected loss costs exceed the money presently available to pay ultimate losses. This creates another fire drill as funds are transferred from one pocket to another. But the inexorable fact cannot be changed; the financial picture is declining rapidly into the danger zone, and there is no way to ameliorate the situation. This is when the regulators usually come knocking as they notice the premium-to-surplus ratio is seriously out of kilter.

This is the point to queue up Mozart's “Funeral Requiem,” because nothing of a salutary nature is going to develop. The insurance carrier will normally look for other companies who will have some interest in acquiring the organization (“seeking strategic alternatives” is the catchphrase), and if there are no takers, the plunge to financial and corporate extinction will commence. Of course, somehow, the CEOs who began this evolution downward, wind up with multi-million dollar exit packages, as if they were retained to drive the company out of business and were successfully rewarded for accomplishing that goal.

So what did the CEO of Meadowbrook announce when faced with A.M. Best's action? Meadowbrook group has been targeting—and achieving—overall rate increases that have been in excess of the loss ratio trends, which have improved its underwriting results for the most recent accident years. But he also indicated they are investigating “strategic alternatives.”

Insurers much larger than Meadowbrook have made similar mistakes, but somehow lived to tell about it. For instance the giant Zurich experienced near-collapse in 2002 following an ill-advised market expansion strategy, and AIG was infamously on the brink of disaster a few scant years ago (though due to insuring real estate based “credit default swaps” though its Financial Products division) before being treated to a government sponsored bailout. Whether Meadowbrook will survive as an independent entity has yet to be determined. But as veterans of many of the P/C companies that are now extinct will tell you, nothing is a sure bet once you start down the worm hole.    

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About the Author:

John D'AlusioJohn D'Alusio has over 30 years experience in P/C insurance with executive management positions in administration, field operations, and claim technical areas. Mr. D'Alusio has had many articles published in industry periodicals, and is also a contributing author to the LexisNexis published, “Complete Guide to Medicare Secondary Payer Compliance.”  He writes a monthly column for Risk & Insurance Magazine and is a quarterly columnist for AMComp Magazine.

His Risk & Insurance column is located at:
http://www.riskandinsurance.com/workerscomp.jsp


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