A Billion Dollar Insurance Diaster in Louisiana

Unnatural disaster

A BILLION-DOLLAR DISASTER: Citizens Insurance had both the reinsurance and the cash on hand to handle Hurricane Rita (above is the aftermath in Cameron Parish), which was six times larger than the previous record event in the state. The insurance of last resort, however, was left with a billion-dollar debt.

By Seth Fox (Contact)

Tuesday, July 31, 2007

John Wortman has spent the past two months finding out exactly what he’s dealing with as the new head of Louisiana Citizens Property Insurance Corporation. Those who have been following the progress of the state’s insurer of last resort might tell Wortman he has been given the honor of captaining the Titanic—after someone else ran it into the iceberg.

“Citizens could be the worst financial disaster in the last 100 years in Louisiana,” former Insurance Commissioner Jim Brown says. “It was a disaster from the very day it was created.”

Wortman remains cautiously optimistic. After spending decades in the insurance business, he saw this as an opportunity to help out. “I think it’s going OK,” Wortman says. “There’s a lot to do, but we’re making some progress.”

It has been a trying time for Citizens to say the least, particularly since the 2005 hurricane season. The company took over the state’s residual property insurance market at the beginning of 2004, replacing the FAIR and Coastal plans.

Sen. James David Cain, a Republican from Dry Creek, was one of two senators to vote against the legislation to create Citizens. He now pairs the bill with the Stelly Plan as the two worst pieces of legislation passed in the state. “It was the fox watching the henhouse,” Cain says. “There was a lot of money made off this deal.”

When Citizens was created, it involved two changes from the FAIR and Coastal plans that detractors point to as opportunities for money grabs. The first benefits the private insurance market.

Under FAIR and Coastal, the private market was on the hook for any shortfall the plans encountered in claims payments. Insurance companies would be billed in proportion to their market share to cover the residual market’s deficit. But Citizens implemented an assessment system that allowed the private market to pass along to policyholders any money paid to cover a shortfall.

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The FAIR and Coastal system encouraged private insurers to closely monitor the well-being of the residual market and to write more business in the state. Since they were going to be stuck with the tab for the residual market anyway, private insurers trusted their underwriting abilities to handle the borderline properties themselves and left the highest-risk properties to FAIR and Coastal.

Brown and others say the introduction of Citizens to the state effectively ended any reason for the private insurers to police the residual market. Once the companies were given the ability to pass assessments along to policyholders, they no longer had a financial interest in the health of the secondary market. Instead of getting rid of the high-risk policies and underwriting the rest, companies now have an avenue to get rid of everything but the most profitable, low-risk policies.

Cain says it has proven to be difficult to find support from those willing to challenge the private market to act more responsibly with writing policies. “Insurance companies are strong in this state,” Cain says. “Especially the ones who put their fingers in this pie.”

The other change involved going to multiple service providers. The FAIR and Coastal plans used Audubon/AIG as service provider for more than 30 years. When Citizens was formed, it opted for multiple service providers.

Detractors say this was an opportunity to create more contracts for the Department of Insurance to bid out, thus more potential suitors when it came time for campaign fundraising for Commissioner Robert Wooley, who left office mid-term to take a governmental relations position with Baton Rouge law firm Adams and Reese. He did not respond to multiple interview requests.

The Citizens stance on the move to multiple service providers is substantially more vanilla. AIG had been downsizing the operations of Audubon and the long-term availability of the service was in question. When the Legislature formed Citizens with multiple providers, lawmakers were simply following through with a decision previously made by the management of the FAIR and Coastal plans.

Shaky beginnings

There are three necessities when it comes starting a successful insurance company, Brown says: sufficient capital, quality management and enough reinsurance. In his opinion, Citizens failed at all three.

Hurricanes Katrina and Rita left Citizens with a billion-dollar debt to be covered with a bond issue and recouped through an assessment of private market insurers. The state initiated a tax credit to cover the expense of policyholders hit by the assessment.

Matters worsened this year when Citizens leadership revealed that the company had been unable to provide auditable financial statements for two years or balance its books because of data-recovery problems. “Management failed this company,” says state Treasurer John Kennedy, who serves on the Citizens board of directors. “It’s inexcusable when a management team can’t balance a checkbook.”

While it is technically correct that Citizens did lack the capital and the reinsurance to handle the 2005 hurricane season, Commissioner of Insurance Jim Donelon disputes that the company was grossly ill-prepared on those fronts. Citizens had both the reinsurance and the cash on hand to handle Hurricane Rita, which was six times larger than the previous record event in the state.

The management aspect, however, is a little more difficult to defend. Kennedy believes there is a fundamental flaw in the company’s makeup. The Legislature created a board of directors, but gave the Department of Insurance, not the board, the responsibility of selecting management. “The board needs to be able to hire its own management,” Kennedy says. “If you’re going to do it, structure the thing properly.”

Recently, the original CEO, CFO and board chairman of Citizens have been replaced. Wortman took over for Terry Lisotta, who was serving a dual role as CEO of Property Insurance Association of Louisiana. William Newton, a finalist for the CEO position, was hired by the Department of Insurance as chief deputy commissioner and replaced Chief of Staff Chad Brown as board chairman. The company hired Mark Brockelman as CFO to replace Caryl Mathes, who was temporarily serving in that capacity. It seems to be a matter of semantics as to whether the original management team was fired or resigned.

“If they were still around, I would be screaming for them to make the change,” Kennedy says. “All I know is we have new management, and that’s all I care about.”

Wortman has spent his time working on the operation and process problems of Citizens, and he has declined to offer an opinion on how much of a role management played in past problems. “My job isn’t to assign fault, but to assess what’s there and fix what’s there.”

The data loss ultimately proved to be the undoing of the original management. Donelon points out, however, that the company’s problem is that it cannot compile auditable financial statements and that it has never had a problem accessing the information necessary for the daily operations. Policy creation, renewal, cancellation and the payment and collection of claims and premiums have not been affected. “No one needs to be worried about their policy or their bond,” Donelon says.

Adds Kennedy: “We have no reason to believe the company is not solvent.”

The lack of auditable financial statements did prove to be a problem in January when Citizens went before the state rating commission to request a rate increase. The company could only provide its finances up to the third quarter of 2005, so that was the basis of its 7% statewide rate increase. The company will have to reappear before the commission once its finances are current to also bring its rates up-to-date.

Any hope?

Wortman not only believes that Citizens can be turned around, he expects it. “We sell four products in one state,” he says, “we ought to be able to get it right.”

The recent legislative session was an opportunity for changes to Citizens. Act 403 changed the governor’s appointees to the Citizens board of directors to include more diverse professional backgrounds, including representatives nominated by the Louisiana Bankers Association, Louisiana Home Builders Association, Society of Louisiana Certified Public Accountants and Louisiana District Attorneys Association.

Gov. Kathleen Blanco recently vetoed Senate Bill 195, a bill by Cain that would have privatized Citizens. Blanco had previously supported a method for shrinking Citizens book of business by selling off policies in bundles. While Cain considered the veto a loss by the people of Louisiana, Wortman isn’t positive selling the entire Citizens book is as easy as it sounds. “I’m trying to give it away and can’t find anybody to take it,” he says.

Prior to the session, Donelon indicated that the only bad bill would be one that would make Citizens larger. Florida recently enacted legislation that will keep its program as the third-largest insurer in the country. Donelon, Kennedy and Wortman all stated that Louisiana Citizens should continue to try to depopulate.

The company is currently handling about 5,000 new policies and renewals monthly, a slower growth than was expected. Estimations had Citizens reaching 190,000 policies, $350 million in annual premiums and a $28 billion total insured value by Sept 1. It appears that those numbers will be closer to 150,000 policies, $300 million in premiums and $22 billion TIV.

Citizens and the Property Insurance Association of Louisiana are mutually examining the possibility of “divorcing” the two companies. “With 20/20 hindsight, it should have been done from the beginning,” Donelon says. PIAL provides the administrative services and manpower for Citizens, and was the only company in place to do so at the time Citizens was created, Donelon says.

Kennedy agrees with Donelon that a move should be made, while Wortman is noncommittal. “I’ve looked at the options,” Wortman says. “I’m trying to do a list of pluses and minuses of the various options. Then we’ll do an impact statement and make a decision.” That decision is expected this week.

Brown, meanwhile, believes the best thing that could happen to Citizens is an overhaul of its operations and structure. Kennedy doesn’t necessarily disagree. “I’m not convinced at all the Legislature did the right thing in creating Citizens,” he says. “The jury’s still out on that. I’m not convinced the old system wasn’t better.”

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