California Commissioner Questions Homeowners’ Insurance Rates

California Insurance Commissioner John Garamendi has announced he will approve an 18 percent decrease in homeowner and renter premium rates by The Hartford Insurance Co. The Hartford’s filing for a decrease contrasts dramatically with four other major insurers who were ordered to justify apparent excessive rates; they must explain why roughly 25 to 40 percent of premium dollars go to pay claims, leaving 60 to 75 percent in corporate coffers, the CDI said in a statement.

The Hartford, which filed for rate review earlier this year, has worked with the Department to achieve a rate reduction that appropriately reflects its current claims payment experience, CDI said. The action is in stark contrast to four other major insurers who on Wednesday were ordered by the Commissioner to justify apparent excessive rates.

Applauding The Hartford’s action as “in the best interest of its policyholders,” the Commissioner said the rate decrease should take effect within 30 to 60 days. The Hartford is the 26th largest homeowners and renters insurer in California, with more than 50,000 policyholders.

“Yesterday, I described the current insurance market in which an incredibly low percentage of premiums collected are used to settle claims,” said Commissioner Garamendi. “Today, I will approve The Hartford’s commendable request for a rate reduction and continue my effort to ensure that other insurers do not charge excessively high rates.”

On Wednesday, in light of the extraordinarily low percentage of premium dollars used to settle policyholder claims, Commissioner Garamendi ordered four major insurers – State Farm, Allstate, Farmers, and Safeco – to prove that their current rates were not excessive. If they fail to provide the necessary proof, rate reductions will be ordered, benefiting more than 4.1 million policyholders served by those companies, CDI said.

“I will determine why up to 70 percent of the hard-earned dollars that consumers pay end up in corporate bank accounts, instead of being used for policyholder claims,” said Commissioner Garamendi. “If the rates are determined to be excessive, immediate reductions will be ordered.”

That action follows a Department of Insurance study of the loss ratios of the top twenty insurers in California. A loss ratio is a measure of the relationship between the dollars paid out in claims and other expenses, compared to premium dollars collected from policyholders. The study found that the four companies, representing 51 percent of the California homeowners insurance market, pay far less than 50 cents of each premium dollar to settle policyholder claims, CDI said.

According to CDI, in 2005 State Farm paid 37.6 percent of each premium dollar for claims; Allstate paid 41 percent; Farmers paid 37.7 percent; and Safeco paid 26.31 percent. Some insurers have claimed that such a large percentage of premium remaining with the company is needed to build financial reserves and surplus. However, the companies’ own filings with the Department disprove this contention.

“These companies have very strong financial reserves,” said Commissioner Garamendi. “Therefore, they do not need to build surplus by maintaining such extraordinarily low loss ratios. I will not allow the insurance industry to charge excessive rates at the expense of consumers.”

Under the California Insurance Code the Commissioner has the power to lower premium rates if they are “excessive.” In May, the Commissioner published a Department study of Homeowners and Auto insurance rates, called “Lower Claims, Higher Profits: Where Do Your Premium Dollars Go?” that he said disclosed the historically low loss ratios that insurers had experienced during the past two years.

The study was undertaken in response to an emerging trend in which insurance carriers experienced dramatic reductions in the percentage of premium dollars used to pay claims. In 2003, for example, State Farm paid out 104.9 percent of its collected premiums to settle claims, yet still managed to make a profit due to investment and other income. The following year it paid only 32 poercent of collected premiums to settle claims. In 2005 it paid only 37.6 percent. Other companies mirrored this trend, the department said.

“We all know where the rest of those premium dollars go,” said Commissioner Garamendi. “It is clear that these numbers are a compelling reason for this Department to conduct a thorough investigation and to determine whether these rates need to be reduced.”

However, “The true picture of whether rates match insurer losses and expenses can only be determined over a period of time, certainly more than one or two years,” said Sam Sorich, president of the Association of California Insurance Companies in a separate statement. “Data from the National Association of Insurance Commissioners does not show evidence of excessive rates. From 1995 to 2004 homeowners insurers in California recorded an operating profit of 5.9 percent. The operating profit is the sum of the underwriting profit plus investment gains.

“Looking at loss ratios over one or two years is a snapshot that doesn’t show the whole picture,” Sorich continued. “Therefore, loss ratios have to be put in context in order to be properly understood.”

According to Sorich, unlike other industries and businesses, the insurance industry must price its product well in advance of knowing its costs, so uses actuarial analysis to estimate future losses and develop its rates. “These estimates are part of the rate filings that are submitted to the Department of Insurance,” he said.

Although the Commissioner claims some insurers’ rates are excessinve, in California, all homeowner rates are approved by the Department of Insurance before they can be used by insurers, Sorich indicated. “The proposed rates reflect anticipated losses that are estimates based on past claims and events, such as the wildfires that swept Southern California in 2003,” he said.

“All the rates in effect today have been approved by the department,” Sorich said. “Adjustments can be made later to the rates to reflect loss trends, but only after a significant period of time. If rates are reduced based on insufficient loss experience, it could jeopardize a company’s ability to pay claims in the aftermath of a catastrophe.”