Cambridge Property & Casualty

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1. The first is the insurance company's ability to pay – Is it solvent and will it remain solvent in the future? ... the four corners of the insurance policy say? We call ...
CAMBRIDGE PROPERTY & CASUALTY

SPECIAL REPORT SHOULD THE PROPOSAL WITH LOWEST PREMIUM INSURE YOUR ASSETS? Five Major Areas to Look At In Reviewing Insurance Proposals

This Special Report was written by Kenneth R. Hale, J.D., CPCU, AAI, LIC. Mr. Hale is Chairman of Cambridge Property & Casualty and an attorney licensed to practice law in the State of Michigan. He can be contacted at 734-525-2412 or [email protected]. More Special Reports are available at www.cambridge-pc.com.

We as insurance advisors are often called upon to make recommendations regarding various insurance proposals, some of which are very attractive proposals from a pricing standpoint. Obviously, if saving premiums is the main objective, this would be the way to go. As insurance advisors, we strongly feel that there are numerous considerations in addition to price and many risks that factor into a decision as to how your assets should be properly protected from a property and casualty standpoint as well as which insurance carriers and insurance advisors are best to perform this task on your behalf. Business owners have invested time and money in developing substantial business assets. The process of owning and running a business creates many risks of loss, such as fires or other claims for damage to property as well as lawsuits arising out of people who get hurt, employees who claim they were not treated fairly, crime loss and more. Each of these items represents a possible risk of loss to the business owner, and it is important that the insurance company that you choose be in business to pay these losses and that your insurance coverage is properly structured to cover these and other losses going forward. There are five major areas that we look at as insurance buyers and advisors as we review insurance proposals. 1. The first is the insurance company’s ability to pay – Is it solvent and will it remain solvent in the future? Our discussion will help you understand how insurance works from an underwriting income, investment income and combined ratio standpoint as well as how fragile insurance carriers really are. 2. The second major area that we look at is the insurance company’s obligation to pay – What do the four corners of the insurance policy say? We call this terms and conditions. 3. The third major area is the willingness of an insurance company to pay promptly and without litigation. Mailing Address: P.O. Box 511077 Livonia, Michigan 48151-7077 Cambridge Plaza Building: 15415 Middlebelt Road, Livonia, Michigan 48154-3805 T: 734.525.0927 F: 734.525.0612 www.cambridge-pc.com

4. The fourth area that we will discuss is the role an insurance agent or insurance counselor plays in your insurance program and the difference between the two. 5. The fifth area we look at is the risks in changing insurance agents or carriers. Let’s look at all of this in greater detail. 1. Ability To Pay (Being legally obligated to pay and having the ability to pay are two different things.) We mentioned the risk of claims in future years because of activities that occur today. Your products or business activities can cause injury. You need an insurance company that is strong enough to be able to survive in order to pay these claims in future years. Had you been with Kemper Insurance Company, for example, and an injury occurred in 2003, you would have no insurance for that claim because Kemper became insolvent. The date of injury is the key date with products liability coverage, not the date of manufacture. The longer these products are in the field, the more likely it is that injury will occur. Therefore, you want to be certain that your insurance company will be strong enough in the future years to cover the products that you manufacture today. One example involves an injury today to a minor. That minor does not have to make a claim until he/she reaches the age of 18. You will want to be sure that the insurance carrier covering you today, the date of the injury, will be solvent when the child reaches the age of 18. We know this sounds surprising, but insurance companies frequently become insolvent or otherwise go out of business. Several of these were over 100 years old with fine reputations, yet they became insolvent and failed to pay hundreds of millions of dollars of claims. Let’s take a closer look at Kemper Insurance Company. Below you will see a comparison of the financial ratings from the nationally recognized insurance rating organization, A.M. Best and Company. You will see Chubb, one of the strongest insurance carriers in the world, at the top of the schedule and Kemper, a carrier that became insolvent in 2003, at the bottom. In the insurance world, we know that insurance carriers are fragile organizations and can become insolvent or severely weakened in the event of a major economic downturn reducing investment income and weather, or terrorist catastrophes can cause significant losses to insurance companies and weaker insurance carriers can easily become insolvent. Comparison of Financial Ratings from A.M. Best (All numbers are in thousands) Carrier Chubb

Best Rating

Year

A++ A++ A++ A++ A++

2005 2006 2007 2008 2009

Net Premiums Written $33,083,952 $36,130,077 $37,300,719 $36,586,805 $38,210,012

Underwriting Income

Investment Income

$722,619 $1,635,002 $1,821,066 $1,048,677 $1,433,540

$1,138,451 $1,124,871 $1,255,278 $1,255,461 $1,228,178

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Pretax Operating Income $1,897,657 $2,774,500 $3,098,059 $2,282,894 $2,658,554

Net Income

Combined Ratio

$1,672,881 $2,157,221 $2,654,044 $1,507,462 $1,986,000

81.8 72.4 68.8 76.5 72.0

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Carrier Kemper

Best Rating

Year

A A A A B+ D

1998 1999 2000 2001 2002 2003

Net Premiums Written $2,853,056 $2,430,695 $2,695,397 $2,510,184 $2,088,882 $208,477

Underwriting Income

Investment Income

-$208,762 -$263,185 $247,257 -$402,202 -$733,611 -$80,374

$356,091 $309,280 $320,733 $298,243 $231,002 $121,453

Pretax Operating Income $151,785 $69,372 $83,960 $114,360 -$305,804 -$308,465

Net Income

Combined Ratio

$207,026 $170,160 $115,132 $120,428 -$474,730 -$814,368

107.8 111.3 108.4 116.1 134.9 184.5

If you look at Kemper in 1998, they had an A.M. Best rating of “A” or excellent. That “A” rating was consistent until 2001. In the short period of time between 2001 and 2003, Kemper had their rating reduced to “D” and became insolvent. When an insurance company is rated “A,” they are two steps away from a “B+.” If, for example, there is a major downturn, their rating could go down to “A-” and then could go to “B+.” When it goes to “B+,” it typically results in insolvency to the insurance company because all of their insureds flee to other insurance carriers when they can, leaving only the higher risk accounts that are not desirable and cannot leave. It is just a matter of time before the insurance company becomes insolvent because all they end up paying high losses on the insureds that could not place their insurance with other carriers. Another item that we consider when we look at an insurance company is whether they are living off of investment income. This is called “cash flow underwriting.” This is particularly important after our most recent economic downturn and the low investment returns that we are seeing. Look at Kemper. In the underwriting income column, you will see that Kemper lost money from an underwriting standpoint (without investment income) every year before their insolvency. They made up for that investment income for most years until the year 2002 when they lost investment income and the spiral began. Companies that live off of investment income want to increase the premiums they write in order to invest the dollars. In order to write premiums, they have to be very competitive to take the account away from another insurance company. This makes the situation even worse because the underwriting income, which is the difference between the premiums and losses, will become worse and will not necessarily be offset by investment income as they under-price accounts in order to write more business. This downward spiral is reflected in the combined ratio. The overall measure of an insurance company is its combined ratio, which is the far right hand column on the above table. The combined ratio is the ratio of claims and expenses to premium dollars. For example, in 1998, Kemper paid almost $1.08 in claims payments and operating expenses as compared to every dollar received. This is not good and cannot be offset by investment income in this investment market. This creates instability. This instability is reflected in underwriting actions, such as cancellations or major premium increases, in order to increase their underwriting income and in order to create a higher net income and a lower combined ratio. Now look at Chubb. Chubb has the highest A.M. Best rating available, an A++. In 2009, Chubb wrote $38,210,012,000 in premiums. From an underwriting income standpoint, Chubb made

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$1,433,540,000 in underwriting profit and they added to that investment income. They had a combined ratio of .72. The Chubb premiums grew between 2008 and 2009, and their combined ratio improved at the same time. This is an example of a stable insurance carrier that protects its solvency and other strengths. Chubb is one of the great success stories in the insurance business. It is difficult to qualify to be an insured for Chubb; however, when you are a Chubb insured, you have the broadest of policy forms and the finest claim service that we have seen with any insurance carrier that we represent or know of. We do not see with Chubb the knee-jerk reactions or the up and down rate increases and decreases that you have with other carriers which are operating with combined ratios above 1. There are other fine insurance carriers as well, as the purpose of this report is not to tout Chubb but to show you both ends of the insurance carrier spectrum. Now let’s look at the second major area – the terms and conditions of the policy. 2. Terms and Conditions (It is folly to think that the carrier with the best premium should win the account. We wish it were that easy! It is really about terms and conditions.) It is not what the agent or broker says verbally or in writing that counts. In fact, in Michigan, the agent or broker is your agent and not the agent of the insurance carrier. If an agent lies to your insurance company or intentionally or otherwise misrepresents your account or does not disclose all of the information that the agent has, that failure will be imputed to you and the insurance company will deny a claim based upon what the agent the agent does on your behalf. This impacts the insurance company’s obligation to pay as well as the four corners of the insurance policy itself. The only thing that is important is the terms and conditions as stated within the four corners of the policy and the documents used to apply for the policy. This was set forth in Zaremba v Harco, a Michigan Court of Appeals decision on July 31, 2008. See our special report entitled “Read Your Policy Says The Court of Appeals” on this subject. An insurance proposal is not binding on the insurance carrier. It is critical to actually see the specimen insurance policies that would be issued so you or your insurance advisor can see the precise language of the four corners of the policies. All of these insurance policies are different. If they did not include those forms, you need to ask for them so you can see what the four corners of the policies themselves say. As we indicated above, the insurance broker is your agent; therefore, it is important to also take a look at the applications that were used in securing quotations. Any statements on the application would be binding on you and you need to see if those statements are correct. Applications are dangerous and can be used against you when you make a claim. You will typically see insurance proposals that have conditions, subjectivities or caveats. Here are some examples of conditions that are attached to proposals: a. Submit a business income worksheet.

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b. Proper insurance to value. Does this mean that the insurance company can come back after they write your insurance and challenge the values and require that you insure higher building values, for example? c. A signed statement of values. A signed statement of values can be used against you if the values do not have any rhyme or reason. d. Completed applications. Applications have many questions. Any one of those questions could be used to deny a loss if they are not complete and fully accurate. When looking at questions and applications, you will see that it is often not possible to give a complete answer, yet it can be used against you. e. A currently-valued five year loss history. f. Subject to inspection. This means that the insurance company has not seen the operations of its proposed insured. If they write your insurance and do not like what they see, they can cancel you with as little as 10 days notice. 3. Willingness To Pay (There is nothing more frustrating than trying to get fast money from an insurance company when you really need it after a major fire and being stonewalled.) The third issue that we consider when we look at an insurance carrier is whether the insurance carrier has the willingness to pay promptly and without litigation. In Michigan, the worst that could happen to an insurance company is that they have to pay the claim eventually, plus maybe some small interest penalty. It is important to have an insurance company that has a willingness to find a way to find coverage (rather than find a way to deny coverage) under an insurance contract so the loss (or at least loss payment advances) can be paid promptly and without litigation. If you sue an insurance company, you may win after hundreds of thousands of dollars of attorney’s fees (not recoverable) and a great deal of time. However, in some circumstances, you still may be out of business. If, for example, you lost your building and the insurance company found some reason to delay or deny the loss, and you had to litigate the claim, it could take years; and it is likely that your company would be so severely affected that it would be out of business. All the insurance company has to say is that the sprinkler system, for example, was not working properly and they are not going to pay the claim, or they are not going to advance money under business interruption to keep your business going until they have a full forensic accounting review of all of your documents. You may win in the long run, but you have still lost your business. This is an important consideration when you place insurance. Although a substantial savings may be attractive if it can be produced long-term, it may not be worth the insecurity of being with an insurance carrier that may not be that strong financially or may not have the reputation for paying claims promptly. The following is the philosophy of Chubb as stated by Hendon Chubb:

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“While an insurance policy is a legal contract that expresses our minimum responsibility, there are many occasions when equity demands that we recognize a moral obligation beyond the strictly legal terms – and this is always a consideration in our settlements.” “We want to build distinctive and valuable differences into the full range of products and services we offer our customers. We must remember that we cannot be all things to all people, that we can’t hope to successfully answer every insurance need that arises in the marketplace. So, it behooves us to find the customers we can serve really well, and then to bend our efforts toward doing it.” - Hendon Chubb (1874-1960)

This is the type of claims paying that you should be looking for with any insurance carrier that you are considering. 4. Agents or Counselors? (One is an “order taker,” and the other is an “advisor.”) The fourth consideration in this process is how your insurance agent fits into this whole process of buying property and casualty insurance and managing your risks. There is a big difference between an insurance agent and an insurance counselor. An insurance agent (absent a special relationship) under the Supreme Court decisions in Michigan is merely an order taker. See Nokielski v Cincinnati Insurance Company, a Michigan Court of Appeals decision from January 4, 2011 at the end of this report. They take orders from you, and they have no obligation to provide advice as to risk management, insurance buying terms and conditions and so forth. An insurance counselor, on the other hand, is an expert in insurance and does not expect you, the insurance buyer, to have all the knowledge necessary to understand insurance policies and have the ability to negotiate the terms and conditions of those policies. This creates what the courts call a special relationship. A counselor has far greater liability than the typical agent because of this. You also need to consider who actually will handle your account. It is not always necessarily the main person on the proposal or even the main person who presents the account. Often, the service responsibility is assigned to a commercial service representative who does not necessarily have the same experience that an insurance counselor might have. The person you deal with dayto-day should not only answer your questions, but in fact should be proactive in negotiating terms and conditions of insurance policies that are going to serve you best in the long run. One of the roles of the insurance counselor is to be your advocate in guiding you through the claims process and to be certain that you receive what the terms and conditions of the insurance policy obligates the insurance carrier to pay. This, of course, requires that the terms and conditions in the insurance policy be properly negotiated to begin with and where there is a dispute relative to a claim, that your agent or counselor uses its clout to reach a successful resolution. The fifth area that we always look at as insurance advisors and buyers is the risks of changing agents or insurance carriers, or both.

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5. Risks of Changing Agents or Insurance Carriers Changing agents needs to be done very carefully because of the many hidden risks. Let’s look at those risks of change generally. a. The new insurance agent misrepresents the account, using incorrect classifications or loss information. This can result in coverage denial, rescission of the policy, or retroactive premium adjustments. b. The new agent gets the account but then turns it over to either a less experienced customer service representative in the agency or sends it to an insurance company controlled service center, which assumes the service responsibilities, bypassing the agency and using everchanging customer service representatives who represent only one point of view - the insurance carrier that employs them. c. The new agent has financial problems and does not pay the insurance company. d. The new agent has little “clout” with the insurance carrier because of low premium volume or bad loss experience in the aggregate for accounts placed by the agent. e. The new agent is about to be terminated as an agent by your new insurance carrier which means a non-renewal of your account in most cases. f. The new agent quotes your account using computer based rating systems and assumes that the underwriter will honor the quote if the agent gets the business, but as it turns out the insurance company’s appetite has changed and the quote is not honored. g. The new agent is selling policies, not a coordinated program. h. The new agent lacks the capital or expertise to provide additional services. There are also risks in changing insurance carriers: a. There is the risk that the new insurance carrier will become insolvent and cancel mid-term. Most insurance carriers can cancel without any reason with only 10 to 30 days notice depending on the type of policy, and may fail to return pre-paid premiums or pay claims. b. There is the risk that after writing an account the new carrier will have a change of appetite or buyer’s remorse and will either cancel your account mid-term or non-renew at the next renewal date again. c. The new insurance carrier may terminate doing business with the agent with which you do business. d. The new insurance carrier will perform payroll or sales audits differently, resulting in major additional premiums retroactively applied. e. The new insurance carrier may cancel your account after one major claim. General Insurance: Should the Proposal With The Lowest Premium Insure Your Assets.doc (04-22-13)/hr.jt

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f. The new insurance carrier may inspect your locations after the business has been placed and then want to cancel the policies mid-term with 10 to 30 days notice because they do not like what they see or they insist on significant and expensive improvements. g. The new insurance carrier may find that the agent misrepresented the account and cancels midterm or denies a claim. h. The coverages are less than the previous carrier provided, but you do not determine this until you have a claim. i.

The new insurance carrier checks driving records and excludes drivers that were previously acceptable because of different underwriting standards.

Conclusion In this report, we discussed the five major considerations in considering a change of agents or insurance carriers: 1. The financial ability of an insurance carrier to pay. 2. The obligation of the insurance carrier to pay based on the negotiated terms and conditions of the policy. 3. The insurance company’s willingness to pay by way of its claims philosophy. 4. Why your insurance counselor is important in the process and the difference between an agent and a counselor. 5. You consider the risks of making a change of either your insurance agent or your insurance company, or both. Of course, what you pay by way of premiums is important, but this must be evaluated only after carefully considering these five major considerations.

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