Bad news sneaks in near end of the year

What a week for the industry! Just as December arrived, and the end of the year was in sight, along came two developments to spoil an otherwise terrific year for many insurers.

First, a federal judge in Louisiana ruled against most insurers in coverage litigation over the New Orleans flood exclusions in Katrina policies, and then Eliot Spitzer reminded everyone he hasn't forgotten the industry by ordering four insurers to cease certain types of payments to agents and brokers.

Until last week, the U.S. property/casualty industry could be forgiven for thinking it would finally have a quiet and profitable year, especially after the tumult of 2005, a year in which the twin perils of regulatory intervention and record hurricane activity provided a relentless barrage of bad news.

As the Atlantic hurricane season ended last month, the insurance industry escaped without a single hurricane-force storm striking the United States in 2006, compared with 27 tropical storms, 15 hurricanes and $61.2 billion in catastrophe losses the year earlier. Combined with hefty rate increases in the wake of 2005, the light cat record spelled profitable coastal property underwriting for the first time in years.

Indeed, as pricing for other lines of business softened in 2006, favorable loss experience in property cat lines created pressure from buyers and regulators alike for more competitive pricing in that line, as well.

Now, however, with the risk that Katrina flood exclusions could be reinterpreted in policyholders' favor, the industry faces billions of dollars in additional claims—if the ruling is upheld on appeal. In the meantime, any momentum for lower rates for cat-exposed property is likely to vanish.

Although flood coverage has long been avoided by the private insurance industry, as evidenced by the federal flood insurance program, it's amazing that the industry has left its policies ambiguous on this front and put itself in this vulnerable position. The fact that two insurers, State Farm and The Hartford, were exempted from the ruling for policy wording that left no room for doubt suggests the rest of the industry should have done the same.

Meanwhile, if that ruling were not enough to give the industry a bad case of post-Thanksgiving indigestion, Mr. Spitzer did his part to increase sales of antacids and analgesics.

In another example of the dangers of complacency, a feeling that might have pervaded the industry after his widespread inquiry seemed to run its course in favor of a successful run for governor of New York, he served notice last week that he has not forgotten insurers.

Mr. Spitzer was joined by Connecticut and Illinois in notifying four insurers that they could no longer pay contingent commissions on homeowners, personal automobile, boiler and machinery, and financial guarantee insurance under the terms of settlement agreements the states reached with those insurers this year. Under the deal they struck, they must halt the payments if more than 65% of coverage in a line is provided by insurers that do not pay the commissions.

If anything is surprising about Mr. Spitzer's announcement, it should be that after the long and painful debate and costly settlements over the practice that they were continuing at all. I wonder how many policyholders of the four insurers—ACE, AIG, St. Paul Travelers and Zurich American—were aware these payments continued on the affected lines? What about on other lines that have not yet reached the 65% limit? Are buyers even asking these questions?

As these developments show, the year is not over yet, and the industry has a long way yet to go before it can truly put the ravages of Katrina and Spitzer behind itself.