SELECTING INSURANCE COMPANIES
Agents’ Responsibility for Company Insolvency
by Carol Hammes
Beware these warning signs of carrier financial instability.
Financial stability is one of the most important criteria for selecting and retaining an insurance company partner. The insolvency of a major carrier can prove disastrous, disrupting your agency, your reputation, and your insureds. And even if you survive the immediate crisis, the effects on productivity can linger for years, especially if you must defend E&O suits resulting from the carrier’s financial difficulties.
In the past 30 years approximately 650 P/C insurance companies have disappeared due to financial difficulties. More than half of these resulted from deficiencies in loss reserves, often accompanied by rapid growth. Both of these conditions often result from inadequate reserving. Nearly 20% of these insolvent carriers had less than $5 million in surplus and many were heavily involved in Auto insurance. According to A.M. Best, inadequate reinsurance protection and recent changes in ownership caused 15% of the financial problems. The ultimate cause of the insolvencies is generally the impact of poor management practices. Cash-flow underwriting and increases in short-term earnings intoxicated inexperienced management teams, who failed to recognize the dangers lurking in the quick fix.
In the past, courts generally didn’t regard insurance agents as professionals, thus absolving them of any errors & omissions exposures when a carrier became insolvent. With “professional” status came specific standards of conduct. Since 1975 the courts have required agents to have adequate knowledge of their companies and of coverages. If due diligence would have revealed financial difficulties before an agent placed the insurance, the court might hold an agent liable for placing a risk with an insolvent carrier.
Until 1987 the primary question in these cases was whether the agent had used reasonable diligence to determine the financial condition of the insurance company — a criterion which implicitly acknowledged that the agent was not a guarantor of the underwriting company. However, the Higginbotham v. Greer appellate court decision in that year expanded the legal duties of insurance agents. The court warned that agents might be held responsible for damages if “at that time or at a later time when the insurance could be protected, the agent knows, or by the exercise of reasonable diligence should know, of facts or circumstances” affecting the company’s financial stability and quality of insurance protection. In other words, monitoring the financial condition of carriers is an ongoing legal responsibility that doesn’t stop once you place the coverage.
Even if an agency has no legal responsibility for an insolvency, the experience of a major carrier going under can be expensive and emotionally draining. Some states require agents to keep paying accounts current to shaky and sometimes even insolvent companies and also to stand behind their insureds for the unearned premiums. This could add up to 25% or more of the agency’s total premiums with that company. Policyholders expect their agent to keep coverage in force as long as they pay the premiums on time. This means that if the company goes insolvent agent has to find alternate coverage. Agencies that went through the Iowa National or Mission failures in the 1980s still talk about the trauma. And those who must quickly replace business in questionable companies are spending valuable time that they could have directed toward new sales.
Considering the consequences of a carrier’s financial difficulties, you should make insolvency control a major responsibility of your management team. Make one individual responsible for tracking information regarding all of your current and potential admitted and non-admitted markets. Review all markets at least annually — preferably in conjunction with the annual review of contracts and relationships in general — and develop an Agency Watch List. Evaluate companies placed on this list monthly to make sure that their financial situation or service response isn’t deteriorating further. Start your financial review with the A.M. Best and/or S&P ratings. But be aware that these indicators don’t tell the whole story: Companies with an A+ rating have gone under in less than a year.
This list shows other indications that a company might have financial problems or suffer from a lack of direction. Because some very solid companies might demonstrate some of these characteristics, it’s important to weigh them carefully before reacting. In most cases, a combination of these factors should concern:
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Negative cash flow
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Inadequate reserves or partial transfer of loss reserve portfolio
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Combined ratio higher than the industry average and/or increasing rapidly
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Any state regulatory action
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Finance companies refusing to finance the company’s premiums
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Umbrella carriers refusing to accept underlying coverage from the company
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Major executive level management changes every couple of years
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Frequent changes in auditors
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Sale of some assets or business lines
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A declining stock price
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Premium to surplus ratio above 2:1 and rising
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Dramatic year-to-year changes in written premiums
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Consistently under-reserving on claims and/or a slowdown in claim payments
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Overall deterioration in service, especially when accompanied with a slowdown in processing return premium endorsements and audits
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Sudden increased attention paid to prompt collection of current accounts
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Frequent changes in reinsurance carriers
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Increase in accounting differences because the company is charging for policies that they haven’t yet issued
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Extensive changes in the agency force (a large number of either appointments or terminations).
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Sudden withdrawal from a territory or line of business or sudden entrance into lines or territories that other companies are avoiding.
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A company letter denying “rumors” about its financial condition.
The late Carol Hammes, principal of The Middleton Group, was one of the Independent Agency System’s most widely respected management consultants. She will be sorely missed.