Not A Sure Thing

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 "facultative intermediaries" and -- believe me, you don't want 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!