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charge)? This would be unfair to policyholders paying standard rates to nonassessable companies.

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D. In the second paragraph on page 95 of the transcript, Committee counsel makes an assumption that the average written premiums for the twenty insolvent companies, for which figures were not available in the replies to the June 6, 1968 questionnaire, were $5,000,000 each. We find nothing in the record to support this assumption. He then applies the aforementioned 21% figure to this total and arrives at an additional $21,000,000 of loss which, we presume, he would add to the $50,097,637 figure shown in the table, thus increasing the approved figure by 40%. Since 20 out of 109 companies is, numerically, only 18.3% of the companies studied, the assumption made is, in effect, that the 20 companies write about double the volume of premiums per company written by the remaining 89. If one were to indulge in assumptions at this point, it would be just as reasonable to assume that these companies would actually be smaller rather than larger. In any event, the assumption of additional loss appears to be completely unsupported, and such speculation should be accorded no weight in the Committee's deliberations.

II.

I was asked to comment on the chart which is shown on page 98 of the transcript. We had not seen this chart prior to the moment it was presented to me at the hearing by Mr. Sutcliffe and, accordingly, could not comment on it fully at the time. We would like, now, to add the following comments regarding the chart and the related testimony.

In summary, we must comment that the figures presented on the chart as comparable are, in each case, not comparable and are highly misleading.

A. The FDIC Examining Staff does not have the responsibility for examining all 14,000 banking institutions. This number includes all national banks, all state banks which are members of the Federal Reserve System and also the state banks which are not members of the FDIC. (Source: FDIC 1968 Annual Report, Table 101). Banks in the first two categories are examined by the Controller of the Currency, and banks in the latter category are examined by state banking officials only. The number of banks subject to examination by the FDIC is only 7,850 and these have about one-fifth as much in assets as the banks examined by the Controller of the Currency. (Source: FDIC 1968 Annual Report, Table 101 and 108). Accordingly, the inference that the entire banking industry of 14,000 banks is examined by 1,526 FDIC examiners at a cost of $28,771,737 is completely misleading and untrue.

B. The $12,000,000 shown as actual financial loss to the public resulting from insolvencies of banks (1934-1968) is not explained. Is this loss to depositors from uninsured banks? Is it loss to depositor from insured bank before the FDIC reimburses depositors? Is it loss to depositors in excess of the FDIC per account limit? In its 1968 Report the FDIC indicated accumulated loss and loss expenses of $55,000,000. How does the $12,000,000 figure square with this? As the government can only pay out money which it receives from the public. it is inisleading to exclude the $55,000,000 from any table comparing the financial burden on the public due to bank insolvencies with the financial burden resulting from insurance company insolvencies.

Of course, we believe that any mention of the financial burden on the public attributable to protecting against bank insolvency is incomplete without mention of the tremendous cost burden of operating the extensive examination operations. For the period of time in the table, this amounted to $362,000,000 for the FDIC alone. Probably even greater examination expenses were incurred by the Controller of the Currency since he examines about an equal number of banks, but they are banks whose assets aggregate about five times those of FDIC examined banks.

C. The chart includes the number of insurance institutions, administrative expenses, purported losses and examiners involved in state regulation of life insurance, which is not an appropriate subject for comparison here, since it is not proposed under S-2236 that life insurance be included in the FIGC. Further, we are not shown the source of the $600,000,000 insolvency figure attributed to the insurance industry and are not aware that such a figure has ever been substantiated by any well founded study presented to this Committee or to anyone else. The NAIC booklet (pp. 46 and 47) shows that during the 1930s life insurance policyholders suffered $180,000,000 in loss. However, this includes the depression years 1930-33, and during this period bank depositors' losses were 31⁄2 billion (Ibid, p. 46). Since then, life insurance company losses have been

miniscule. The studies of the fire and casualty industry go back to 1958 and show $50,000,000 in losses to claimants. There seems to be no credible basis for estimating fire and casualty losses prior to this date. The $600,000,000 figure, therefore, appears to be pure speculation.

D. The 1,200 state examiners, shown in the table, are not as high a percentage of the total number of persons employed by the state insurance departments as the 1,526 examiners employed by the FDIC are in proportion to its total personnel. State insurance departments have many employees who deal with such matters as rate regulation, policyholders' complaints, licensing of insurance agents, etc., whereas FDIC is engaged almost entirely in examination. The chart, however, us the entire cost of state regulation of $40,000,000— not just the cost of 1,200 examiners, thereby creating an inference that state costs per examiner are higher than federal costs. This, again, is an incorrect and misleading inference.

III.

In answer to question #1 of your December 9 letter, my first suggestion would be that the actuaries who prepared the NAIC study are the most logical persons to defend their compilation of the data furnished them by the liquidators as to insolvency losses. Nevertheless, upon reviewing the several estimates of annual insolvency loss which have been submitted to ... Committee, considering the adequacy of the data on which they were based, the experience of the personnel evaluating them and the plausibility of the assumptions and interpretations which have been stated in each instance, the NAIC study is the only one in which we are confident of the reliability of the underlying data and the manner in which it was used. A figure between ive and six million dollars per year is the best substantiated figure presented to the Committee. The NAIC figures were based on data furnished them by the liquidators and receivers, combined with the states' own records regarding premiums. What source could be better?

It is our belief that UM insolvency protection produced little or no effect on these figures, as UM collections would not be an offset against a claim filed with a receiver. Also, for the period for which the figures were compiled. there was little UM with insolvency protection in effect; the insolvency protection feature is a relatively reccnt development.

IV.

Our testimony that $1,000,000 of the $5,000,000 claimant insolvency loss would be picked up by UM insolvency protection was based upon a calculation that 80% of third party claims filed by individuals against insolvent insurers could potentially be covered by the insolvency protection under the UM endorsement. We had interpreted the words "loss to claimants" and "average annual claimant losses," which appear in conjunction with the NAIC loss estimates (e.g., page 21, line 28; p. 181, line 44) to refer to third party losses. However, we are now informed that the term "claimant" means a claimant against the receiver. Accordingly, in addition to third party liability claims by individuals a number of other types of claims would be included in the figures receivers furnished the NAIC, such as, (a) collision and comprehensive claims by policyholders, (b) subrogation claims by other insurance companies for collision losses they have paid their insured, (c) claims for return premiums from policyholders and (d) claims by reinsurers for premiums due under reinsurance contracts.

The foregoing information regarding the broader definition of “claimant loss”. requires a complete reevaluation, of course, not only of the manner in which UM insolvency protection affects the impact of insolvencies but, in addition, the entire question of on whom the impact falls. Accordingly, we respectfully request that the Committee add the material in this section IV to its records in correction of our previous testimony regarding insolvency protection under the Uninsured Motorist endorsement and in further examination of the subject. If the Committee should desire, we will be glad to return to testify on these matters. Without a field study of the files of a representative sample of claims in liquidation, there is no way to tell what proportion of the claims before liquidators are from third party claims, from first party coverage on policyholders. for subrogation claims by other insurance companies, for reinsurance premiums due other insurance companies, for return premium to policyholders of the insolvent companies. It would be very helpful if such a study could be undertaken either by this Committee or by the National Association of Insurance Commissioners.

Meanwhile, it is apparent that something less than the total of $5,000,000 to $6,000,000 per annum of insolvency loss is loss to third party claimants; prob. ably substantially less. We should then examine the nature of the other categories of claims, assess their impact on the public and assess the impact of S-2236 on such other claims.

First, regarding claims for return premiums, all solutions proposed to date to the insolvency problem make some acknowledgement of the fact that loss of return premium, although an unfortunate consequence of insolvency, is not of a catastrophic nature which demand a legislative solution. The loss of return premium is not, socially speaking, much different from the loss of any debt or account when a non-insurance firm goes bankrupt. In fact, the loss of return premium may have less impact on most people than would the average bankruptcy loss of an account or merchandise receivable. Thus, in some of the state insolvency plans deductibles are imposed, e.g., Wisconsin with a $200 deductible. In others, loss of premium is excluded from the plan, e.g., California and Michigan. Even under S-2236, only one-half of the premium lost is an allowable claim, so the sponsors obviously do not consider it a serious social problem either!

Second, the part of the "net loss to claimants" represented by subrogation claims of other insurers places no burden on individual policyholders or claimants. The inability of an insurance company to obtain a subrogation recovery · against an insolvent insurer constitutes no social problem justifying the creation of an insolvency guaranty fund. The same is true of inability of a reinsurance company to collect premiums due it from the insolvent carrier.

Collision and medical payments claims are more serious than the two previous items. However, even with respect to these claims, the individual may ultimately be reimbursed for his loss by a tort feasor.

The remaining claims are liability claims. We contend that UM with insolvency protection has the potential of reducing the impact of this problem on individuals by 80%. In saying this, we have considered the following points:

1. UM coverage with insolvency protection is now available in all states. 2. All but two of the 50 states now require by law that the UM endorsement be added to all auto policies. These two states have insolvency funds. Some states allow the policyholder to reject UM coverage and some do not. Even in those states where the policyholder may reject it, over 90% of the motorists carrying liability insurance carry the UM endorsement.1

3. Most BI liability losses are within the limits of UM coverage.' 4. Six states now require that UM coverage also apply to property damage liability claims, with deductibles from $100 to $300 being specified. However, since collision insurance may be carried as a voluntary coverage, and a substantial majority do carry collision, no policyholder need rely on either the solvency or liability of a third party and the third party's, insurer to avert major loss from vehicle collisions.

5. With regard to pedestrians who do not own (or whose families do not own) a car, we believe the number of such cases is relatively small, but we have proposed "gap-closer" legislation which would give such claimants priority over insurance companies' subrogation claims, thus reserving sufficlent funds to pay most pedestrians in spite of insolvency of the insurer. In summary, the proportion of uncompensated loss to automobile accident third-party claimants due to insurer insolvencies, which cannot be compensated for under UM coverage with insolvency protection, is very small. With respect to BI liability, it is something less than 7.8% of such loss (that portion of the loss in excess of the UM limits) and will further diminish as higher UM limits

1 We have calculated the percentage carrying UM coverage from NAII statistical data on 1967 Calendar Year Earned Car Years. In states where the UM law with right of rejection has been in effect a sufficient length of time so that all policies have been renewed at least once since the law's effective date, the figures indicated 91.26% of the cars insured carried the UM coverage. The states used in the calculation were Alabama, Arkansas, Florida, Georgia, Hawail. Louisiana, Michigan, Nebraska, North Carolina, Ohio, Pennsylvania, Rhode Island and Wisconsin.

Per NAII records, which include over half of the automobile insurance written in the United States, 92.2% of BI losses incurred are on the basic limits portion of the coverage. "Basic limits" is here defined as $10,000/$20,000. The statistics used are the NAII com pilation of 1966 Accident-Year, Countrywide Automobile BI Liability Experience, developed through March 31, 1968.

Uninsured Motorists limits on average somewhat exceed $10,000/$20,000. Minimum UM coverage is never lower than the Financial Responsibility limit, which is constantly being raised by the various states. State trends, including voluntary programs by some companies to offer higher UM limits, make it appear that UM limits will soon be written for amounts which average well in excess of Financial Responsibility Law limits.

become available. With regard to property damage liability, the insolvency of the third party's carrier can be ameliorated by carrying collision insurance. Most car owners do, in fact, carry collision insurance. This is especially true of newer, more valuable cars, as most of them are financed. Other gaps in protection are very small. Overall, we believe it a reasonable estimate that at least 80% of the third party claimant insolvency loss problem can be solved by UM coverage.

V.

In answer to your question #3, there is no coding of loss data reported by insurance companies to either governmental agencies or to the insurance industry's statistical agents which would segregate UM losses on account of insurers' insolvencies from other UM losses. Accordingly, there is no practical way to obtain this data on a segregated basis.

However. the administrative cost factors and the actual loss factors for the I'M endorsement as a whole, as requested in question #3 (3), are available. The NAII statistical service reports for 1966, the last available year with reasonably matured UM loss figures, that the loss ratio for uninsured motorist coverage was 70.8%. The remainder of the premium, 29.2%, would be what the public paid over and above losses to operate the protection system under the UM endorsement. Standard economic theory and inting practice would call for the application of the 29.2% cost of premis attributable to the insolvency protection as well as other parts of the undivided-premium UM endorsement package. In fact, there is no reason to assume any difference in normal insurance company expense items, such as commission, taxes, salaries and employee benefits, rent and building operating expenses, fees, accounting, loss experience compilation, equipment, policy issuance, underwriting reports and surveys. There might be some variation in the expense factors regarding claims handling, but which way the factor would vary is not clear. Chances are that if the matter were subjected to cost analysis, the variation of insolvency protection from the overall UM total cost factors would not be great. Accordingly. It seems reasonable to estimate the cost of providing insolvency protection under the UM coverage by applying the approximate figure developed on an overall basis. On this basis, the administrative cost of handling three million dollars in insolvency losses (if that should happen to be the BI component of the five million dollar figure developed by the NAIC, after deducting other types of claims against receivers-see our section IV.) would amount to only $1,250,000. This is, indeed, a modest figure in comparison with even the proponents' estimates of the costs of administering the FIGC.

Net direct earned premiums on UM coverage reported to the NAII statistical service for the aforementioned 1966 year were $64,728.200 and losses incurred were $49,238,598. Unfortunately, the compilation of "written premiums." which you requested, is not ready in time to include with this letter. We will send it to you in a few days.

Information supplied to us by Mr. Edward W. Dippold. Vice President. American Arbitration Association shows that payments to the AAA for UM arbitration were, for the year 1967, $997,027 paid by insurance companies plus $283,630 filing fees paid by claimants. During that year, 8.621 cases were filed for arbitration with the AAA. From the standpoint of the cost to society of operating the adjudicatory process, this appears to be much less costly per case than the alternative of putting UM claims through the courts. It is also a small figure compared to the total UM premiums shown in previous paragraphs. Again, please bear in mind that the foregoing cases involve very few matters under insolvency protection but, rather, they include all UM coverage arbitrations. Only a small percentage of UM cases are arbitrated and proportionately even fewer cases involving insolvency protection probably reach arbitration.

We hope you will find this letter a complete response to your questions at the hearing and your letter of December 9, and that you will place it in the Committee's records. However, if we can furnish further information, please let me know.

Respectfully submitted.

VESTAL LEMMON, President.

Senator HART. Our next witness is the president of the Insurance Co. of North America, Mr. Charles K. Cox.

Reprinted from FINANCIAL ANALYSTS JOURNAL, January-February 1970

Copyright 1970

Identifying Merger Targets in the Property and Liability Insurance Industry

T

HE rapid pace at which property and liability insurance companies were pursued and acquired by conglomerates during 1968 has temporarily abated as conglomerates have lost some of their investor appeal. During this lull, analysts have been assessing the reasons for the large number of mergers and the probability that the remaining companies can escape in the next round of merger activity.

The purpose of this article is to examine the 1968 merger movement with respect to property and liability insurance companies to determine characteristics which distinguish acquired from non-acquired companies. The objective of the research is to provide a means for evaluating the vulnerability of companies which are still independent.

Although there are many stock property and liability insurance companies, the large companies received most of the attention of the conglomerates during 1968. Of the top 20 companies, seven owning 21% of the entire industry's assets were acquired during that year by noninsurance companies. If companies which were actively pursued are included, then mergers affected 10 of the top 20 companies, owning 39% of the industry's assets. (Table 2 includes a list of the top 20 companies ranked according to asset size.) Little wonder that the merger activities of the conglomerates caused great consternation in the industry.

What were the factors which made the insurance companies almost irresistible targets for conglomerates?

1. Insurance companies can serve as a vast reservoir of credit.

RICHARD L. NORGAARD is Professor of Finance and Investments, University of Connecticut.

DAVID T. CRARY is Assistant Professor of Finance, University of Southern California.

by RICHARD L. NORGAARD and DAVID T. CRARY

2. The assets of insurance companies are primarily committed to cash and marketable securities which when coupled with a relatively large surplus provide a source of immediate cash to the conglomerate.

3. Many insurance companies supposedly suffer from inferior management. The introduction of modern management techniques can presumably improve the profit picture.

4. The acquisition of insurance companies can provide the basis for a profitable reciprocity. The conglomerate uses the insurance company's portfolio and cash flow to support its acquisition program and the insurance company uses the conglomerate's businesses and employees as a captive sales target.

The attraction of the insurance companies' portfolios to the cash-hungry conglomerates is obvious'. The vast security portfolios held by the insurance companies have not been used nearly so aggressively as mutual fund managers have used their funds. Investment management in insurance companies is generally considered secondary to underwriting which means that the portfolio in many cases is under-invested. In addition, in many firms there seems to have been an undue emphasis on liquidity at the sacrifice of investment income." Furthermore, the portfolio owned by the smallest of the 20 largest companies would be in excess of $400 milliona size which would allow tremendous possibilities for the active conglomerate manager.

Identification of Target Firms

In order to develop a technique for identifying those characteristics which seem to make an insurance com

1. Footnotes appear at end of article.

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