regulating homeowners insurance in texas 2 7

Regulating homeowners insurance in Texas

October 18, 2010

This report reviews the recent history

of homeowners insurance regulation in Texas, as well as several proposals

for change that the 82nd Legislature may confront during its 2011 regular

session.

Number 81-14

2 Sunset Commission recommendations

7Using credit scoringto set rates

3 Definitions

Homeowners insurance policy forms

910

Expediting appeals in contested rate cases11Appointing or electing the commissioner

2 Methods of rateregulation

WiththecontinuinghighcostofTexashomeownersinsurancepoliciesandtheongoingSunsetreviewoftheTexasDepartmentofInsurance(TDI),theTexasLegislaturemayconsiderchangestohomeownersinsuranceregulationduringthe2011regularlegislativesession.TheamountTexanspayforhomeownersinsuranceisestimatedtobebetween52and76percentmorethanthenationalaverage,dependingonthetypeofpolicyformsbeingcompared.

Before2003,thelastyearinwhichtheLegislaturemadecomprehensivereformstohomeownersinsuranceregulation,premiumshadincreasednearly45percentinthreeyears.Thestatefacedacrisisofskyrocketingmoldclaims,and99percentofdirectwrittenpremiumsforhomeownersinsurancewereissuedbycompaniesexemptedfromrateregulation.The78thLegislaturereviewedtheseandotherissuesandenactedanewregulatorysystemintendedtolimittheincreaseinhomeownersratesbyeliminatingregulationexemptionsandestablishingaregulatorystructuretopromoteratecompetition.

ConsumeradvocatesarecallingformajorchangestoTexas’regulatorystructureforhomeownersinsurance,sayingthatreformsin2003havenotprovidedrelieftohomeownerspayingexcessiveratesforinsurance.Theycontendthecurrentenvironmentputsinsuranceindustryinterestsaheadofconsumerneedsinthenameofcompetition.Consumeradvocatessaythatbecausestandardinsurancepolicyformsnolongerare

requiredstatewide,insurersgenerallyareofferinglesscoveragebuthavenotdecreasedpremiumsaccordingly.Theysaymany

consumersarepayingmoreforlesscoveragethanbeforethe2003revisions.

InsurerssaythatbecauseTexashassomeofthemostextremeweatherinthenation,therates

Texanspayforhomeownersinsuranceareappropriatetoaddresstherisk.Thedirectlossesandexpensespaidby

insurersin2008,duemainlytohurricanesIkeandDolly,exceededdirectpremiumsearnedbymorethan$1.5billion.Theindustrysays

House Research Organization

profitsinyearswithrelativelylowclaimshelppayclaimswhenextremeweatherstrikes.

ThisreportreviewstherecenthistoryofhomeownersinsuranceregulationinTexas,aswellasseveralproposalsforchangethatthe82ndLegislaturemayconfrontduringits2011regularsession.

Sunset Commission recommendations

TheSunsetAdvisoryCommissionstaffhasconductedtworecentreviewsofTDI—acomprehensivereviewin2008andalimited,special-purposereviewin2010.SunsetstaffevaluatedTDI’simplementationoftherevisionstohomeownersinsuranceregulationenactedin2003bySB14byJackson.SB14madeallhomeownersinsurers,includingthosewhoseratespreviouslyhadbeenunregulated,subjecttoafile-and-userateregulationsystem.TheTexasfile-and-usesystemallowsinsurerstofilearatechange,thenputthenewrateineffectimmediatelyorwhenevertheychoose.TDImayrequirepriorapprovalofratesonlyifissuesareidentifiedwiththeinsurer’sfinancialconditionorratingpracticesorinastatewideinsuranceemergency.

SunsetstaffcompletedacomprehensivereviewofTDIbeforethe2009regularlegislativesession.Duringthisreview,staffsaidthatTDI’simplementationofthefile-and-usesystemlackedtransparencyandcouldcauseunpredictabilityinregulation.Thestaffrecommendations,whichwereadoptedbytheSunsetAdvisoryCommission,andtherevisionsproposedinSB1007byHegar,theTDISunsetbillin2009,focusedonclarifyingthefile-and-useprocessandthecircumstancesunderwhichaninsurermightbeplacedundertherequirementforpriorapproval.

SB1007passedtheSenatebutdiedintheHouseafteritwassetontheMajorStateCalendarbutnofurtheractionwastaken.The81stLegislature,initsfirstcalledsessionin2009,enactedSB2byHegar,whichextendedtheSunsetdateforTDItoSeptember1,2011,butdidnotincludeanyspecificregulatorychanges.SB2requiredtheSunsetAdvisoryCommissionstafftoperformalimitedspecial-purpose

reviewofTDIinpreparationfortheregularsessionofthe82ndLegislaturein2011,ratherthanrepeatthecomprehensivereviewof2008.FollowingthelimitedreviewofTDI,theSunsetAdvisoryCommissioninJuly2010madesubstantivelythesamerecommendationsforhomeownersinsuranceregulationthatweremadeinthe2008review.

Methods of rate regulation

Texascurrentlyregulateshomeownersinsuranceratesthroughafile-and-usesystem,inwhichinsurersmustfileratechangeswithTDIbutarenotrequired

towaitforTDIapprovaltoputnewratesineffect.File-and-useisoneofseveralrateregulationschemescommonamongthestates.Priorapprovalsystemsrequireinsurerstoreceiveapprovalfromregulatorsbeforetheymaychangerates.Flexibleratingsystemsallowinsurerstoimplementnewratesaslongas

theratesdonotexceedorfallbelowanacceptablerangesetbyregulators.ThemethodbywhichhomeownersinsuranceratesshouldberegulatedinTexashasremainedasourceofdebatesincetheregulatoryprocesswaschangedtoafile-and-usesystemin2003.

Background

In1991,tostabilizetheinsurancemarketandpromotecompetition,the72ndLegislatureestablishedamodifiedbenchmarksystemthatallowedforflexiblerate-settingforhomeownersinsurance.Underthissystem,TDIannuallyestablishedabenchmarkrateforhomeownersinsurance.Insurerscouldchargeanyratewithinarangeof30percentmoreto30percentlessthanthestatebenchmarkwithoutpriorapprovalfromTDI,buthadtoreceivepriorapprovalfromtheinsurancecommissionerforratessetoutsidethis“flexibilityband.”

TheLegislatureexemptedhomeownerspoliciesprovidedbycertainentitiesfromthebenchmarkflexibleratingsystem.TheseincludedLloyd’splaninsurersandreciprocalandinterinsuranceexchanges,whichhistoricallyhadwrittenpoliciesforonlyasmallportionofthemarketandgenerallycoveredspecialty

The Sunset Advisory Commission staff has conducted two recentreviews of TDI.


risksatrateslowerthanthestandardrates.Followingthisexemption,insurersbeganshiftingmoreoftheirbusinesstothesenon-rate-regulatedentities.TDIestimatedthatby2001,non-rate-regulatedentitieswroteabout95percentofTexashomeownersinsurancepolicies.

Homeownersinsurancepremiumsincreasedsignificantlybetween2000and2003,fueledbywidespread,costlyclaimsformolddamageandamarketthatlargelywasnotsubjecttorateregulation.ThispromptedGov.RickPerrytodeclaretheregulationofhomeownersinsuranceanemergencyissueforthe78thLegislaturein2003.Earlyinthe2003regularsession,the78thLegislatureenactedSB310byFraser,requiringcertainhomeownersinsurerstofilecurrentandprojectedratesandsupportingdatawiththecommissioner.TDIreportedtotheLegislatureitsfindingsabouttheratefilingsrequiredbySB310onMarch28,2003.Thereportindicatedthatinthepreviousthreeyears,rateshadincreasedstatewideanaverageof45percent.

Amongthetop12non-rate-regulatedinsurers,somerateswerejustifiedbutotherscouldbereducedasmuchas25percent,accordingtoTDI.

The78thLegislaturelaterinthe2003regularsessionenactedSB14byJackson,whichbroughtsweepingchangestohomeownersinsuranceregulation.Thebillmadeallhomeownersinsurers,includingthosewhoseratespreviouslywereunregulated,subjecttofile-and-userateregulation.

UndertheTexasfile-and-usesystem,insurersmustfilerateswithTDIandmayimplementtheratesimmediatelyorwhenevertheychoose.TDImaydisapproveadministrativelyaratedeemedexcessive,inadequate,orunfairlydiscriminatorybeforetheratehasbeenimplementedormaydisapprovearate-in-effectthroughacontestedcasehearingattheStateOfficeofAdministrativeHearings.TDImaysubjectcertaininsurerstoapriorapprovalprocessiftheinsurer’sfinancialconditionorratingpractices

File-and-use — aregulatorystructureunderwhichinsurersmustfilerateswithstateregulatorsbutdonothavetowaitforapprovalbeforetheratesmaybeused.Somestatesmayrequireinsurerstowaitaspecifiednumberofdaysbeforeafiledratemaybeused.Regulatorsmayretaintherighttodisapproveofaratelaterifitviolatesthelaw.

Prior approval — aregulatorystructureunderwhichinsurersmustfilerateswithstateregulatorsandthenawaitapprovaloftheratepriortoimplementingit.Somestatesmaydeemarateapprovediftherateisnotdeniedwithinaspecifiednumberofdays.

Flex-rating — aregulatorystructureunderwhichpriorapprovalofratesisnotrequiredunlessratechangesexceedacertainpercentageabove,orinsomecasesbelow,previouslyfiledrates.Forslightlymorethanadecadestartingin1991,Texasusedavariantofflex-ratinginwhichtheinsurancecommissionersetabenchmarkrateandallowedinsurerstouserateswithinacertainpercentageofthebenchmarkratewithoutpriorapproval.

Policy form — documentsthatestablishthetypesoflossesaninsurancepolicywillcover,theconditionsunderwhichtheselosseswillbecovered,andthedollaramountofthatcoverage.

Endorsement — modificationstoapolicyformthatmayclarify,broaden,orlimitthescopeofcoverage.

Deductible — portionofalossthattheinsuredmustpaybeforetheinsurancecompanypaysthebalance.Thismaybeaflatfeeorapercentageofthepolicyamount.

Definitions


requiresupervisionorifthereisastatewideinsuranceemergency.InsurerssubjecttopriorapprovalmustfilerateswithTDI,thenawaitapprovalbeforeusingtherates.Ifarateisnotapprovedordisapprovedwithin30days,theinsurermaydeemtherateapproved.

Toestablishamoreappropriatebaselineforratesinthenewsystem,SB14alsoauthorizedTDItorequireinitialratereductionsforinsurersfoundtobechargingexcessiverates.BySeptember2003,theinsurancecommissionerhadorderedmorethan30companiestoreduceratesbyasmuchas31percent,foranoverallreductionof12percent,amountingtoatotalof$510millioninratereductions.AlltheinsurersultimatelycompliedwiththemandatoryratereductionsexceptStateFarmLloyds,whichwasaskedtoreduceratesby12percentbutrefused.Thestand-offbetweenTDIandStateFarmhasplayedoutsincethattimeintheStateOfficeofAdministrativeHearingsandinthecourts.ThematterispendinginTravisCountydistrictcourt.BecauseofStateFarm’slargemarketshare,theratereductionsthatwereintendedtosaveTexasconsumers$510millionhavesavedthemonly$355million.

Recent issues

In2009,despiteimplementationofthefile-and-usesystem,only10percentofhomeownerinsurersfiledandbegantousenewratesonthesameday.ManyinsurershaveexpressedconcernsthattheTexassystemismorea“file-and-haggle”systemthanafile-and-usesystem.Theysaythatbecausetherate-filingprocessisunpredictable,insurersfaceariskthatiftheyfileandusearateimmediately,itlatercouldbecontested.Theysaythispreventsthemfromusingfiledratesrightaway,whichstiflesthepossiblecompetitivebenefitsofthesystem.

SB1007byHegar,theTDISunsetbillintroducedintheregularsessionin2009,includedprovisionsintendedtomaketheratefilingprocessmorepredictableandtoclarifywhatcouldsubjectaninsurertopriorapproval.SB1007wouldhaverequiredthecommissionertodisapproveratesthatdidnotcomplywithstatutoryrequirementsbeforearatetookeffectorwithin30daysofthedaytheratewasfiled,whicheveroccurredfirst.Ifthecommissionerhadnotdisapprovedaratebeforethesedeadlines,thecommissionercouldhavedisapprovedtherateonlyafterahearing.Thebillwouldhaverequiredthecommissionertoestablish

thefinancialconditionsandratingpracticesthatcouldsubjectaninsurertopriorapprovalandtoexplaintoinsurersunderpriorapprovalthestepsnecessarytotaketobeexcusedfromtheorder.

Thosewhosupportsomeformoffile-and-usesystemsayTexashasyettoseetheratereductionbenefitsthatenhancedcompetitionundersuchasystemcouldprovidebecausethecurrentregulatoryprocesscontainstoomuchuncertainty.TheysaythefearofTDIinterventionincreasescoststhroughouttheindustrybecauseinsurersmustanticipatetheriskofhavingaraterejectedandtheadministrativecostsofhagglingovertherate.Thisuncertaintyalsomeansthatinsurersrarelyfeelcomfortablefilingandimmediatelyimplementingratechanges.

Somefile-and-usesupporterssaytheSunsetrecommendationswouldaddthecertaintythatthecurrentregulatorysystemislacking,andotherssayTDI’sauthoritytodisapproveratesshouldbelimitedevenmore.SomewouldpreferthatTDIbepermittedonlytodisapproverates-in-effectandwouldlimitTDIregulationof“excessive”ratestocircumstancesinwhichthenumberofparticipatinginsurerswasinsufficienttomaintainacompetitivemarket.Theysaythatinacompetitivemarket,consumerswillnotpayexcessiveratesandthemarketwillregulateitselfnaturally.

Thosewhoopposethefile-and-usesystemsayithasbeenharmfultoconsumersandthattheSunsetreviewisanopportunitytochangetoapriorapprovalsystem—onethatrequiresTDItoapproveallratechangesbeforenewratesmaybeused.FifteenstateswererequiringpriorapprovalofallhomeownersinsuranceratechangesasofFebruary2010,accordingtoinformationcompiledbytheNationalAssociationofInsuranceCommissioners.

Debate about prior approval of rates

SupportersofimplementingapriorapprovalsystemofrateregulationsaythatTexashomeownersdeservetohavestateregulatorsensurethattheirinsuranceratesarenotexcessiveorunfairlydiscriminatorybeforetheyhavetopaythem.Theburdenshouldrestsquarelyoninsurerstojustifywhyarateincreaseisneededbeforeconsumersareaskedtopaymorefortheirinsurance.


Consumeradvocatessayafile-and-usesystembenefitsonlyinsurers,makingitmoredifficulttorollbackinappropriaterateincreasesoncetheyareineffectandthereforelesslikelythatTDIwillchallengearatechangethathasbeenimplemented.TDIcurrentlycannotdisapprovearateineffect,evenifthedepartmentdeemsitunfairorexcessive,withoutanadministrativehearingandpossibleappealtoadistrictcourt,whichcanbecostly.Meanwhile,homeownersmustpaythenew,higherratesuntiltheratechallengeisresolved.Apriorapprovalsystemwouldpreventconsumersfromhavingtopayhigherratesovermanyyearswhilearatedisputeplaysoutinthecourts.TheunresolveddisputebetweenStateFarmLloydsandTDIoveraTDIrequestforStateFarmLloydstoreduceitsrateshasbeeninthecourts

since2003,demonstratinginsurerresolvetodisputetheauthorityofTDItoregulaterates.

Thefile-and-usesystemwassupposedtodecreaseTexas’insuranceratesbyenhancingcompetition,yetTexasconsumerscontinuetopaysomeofthehighestratesinthenation.Asof2007,themostrecentyearforwhichdataareavailable,Texashomeownersinsurancewasthesecondmostcostlyinthenationandwas76percentmoreexpensivethanthenationalaverageforthemostcommonlypurchasedpolicy,accordingtotheNationalAssociationofInsuranceCommissioners.Thesehighpremiumshavebeenassessedevenasinsurershavemadehugeprofitsinseveralrecentyears.

Incurred loss ratio-annual losses incurred, including amounts already paid out plus the change in amounts set aside to coverfuture payments, as a proportion of the amount of premiums collected.

Expense ratio - annual business expenses incurred as a proportion of the amount of premiums collected.

Combined loss ratio - sum of incurred loss ratio and expense ratio.

Source for loss ratio data: Texas Department of Insurance

History of loss ratios for Texas homeowners insurance

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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

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HurricanesIke and Dolly

Hurricane Rita

MetroplexHail

TexasMold Crisis

MetroplexHail & Tornado

File-and-userate regulation

Incurred loss ratio

Expense ratioCommissioner approves

non-standard policy forms


Insurers’profitsaredemonstratedthroughtheirlossratios.Lossratiosareameasureofaninsurer’sannuallosses—amountspaidoutplusthechangeinamountssetasidetocoverfuturepayments—asaproportionofthepremiumsaninsurercollectedthatyear.Morespecifically,the“combinedlossratio”istheamountofclaimslossesandbusinessexpensesincurredduringayearasapercentageoftheamountofpremiumscollected.Before2008,whenhurricanesIkeandDollystruck,theaverage,combinedlossratioforinsurersusingratesunderthenewfile-and-usesystemwas72.9percent,meaninginsurersweremakingprofitsaveragingmorethan27percentfrom2004to2007(see chart).Thisfiguredoesnotevenincludetheadditionalprofitsinsurersweremakingfrominvestmentincome.WhiletheyearhurricanesIkeandDollystruckwasanextremelybadyearforinsurers,thisleveloflossisrare.HurricaneIkewasconsidereda35-to40-yearstorm,meaningthat,onaverage,astormofthissizeisexpectedtooccuronceevery35to40years.Insurerswillbepocketinghuge,unjustifiedprofitsonthebacksofconsumersiftheycontinuechargingtheircurrentrates,saypriorapprovaladvocates.

NotonlydoTexasconsumerspaymorefortheirinsurancethanmostofthecountry,buttheypaymoretodayforlesscoveragethantheyreceivedbeforetheshifttofile-and-use.TDI’sSB310reportpublishedinMarch2003estimatedthatafterTDIbeganapprovingnon-standardformsin2002,thecoverageTexashomeownerspoliciesprovidedwasreducedbybetween15and45percent,dependingontheform.Despitethereducedcoverage,asofMarch2010,homeownerswerepayingonaverageabout5percentmorefortheirhomeownerspoliciesthaninJune2003.Thisincreaseisespeciallytroublingsincethemoldcrisisandunregulatedmarketalreadyhadcausedhomeownersinsuranceratestospike45percentinthethreeyearsbeforethe2003reforms,supportersofpriorapprovalsay.

ApriorapprovalsystemwouldallowTDItoreviewandapprove,andrequireinsurerstojustify,allratesbeforetheywerepassedalongtopolicyholders.Thisisnecessarybecausetheinsurancemarketisnotastandardcompetitivemarketplace.Homeownersarerequiredbymortgagelenderstohaveinsuranceandneedittoprotecttheirmostvaluableasset,theirhome.Thisnecessitatesratereviewsothatinsurersdonottake

advantageofconsumervulnerability,priorapprovaladvocatessay. Supportersofmovingtoapriorapprovalsystemsaythatasurveyhasdemonstratedthatpriorapprovalisasystemthatpeoplewouldwant.TexasWatch,aconsumeradvocacyorganization,hadHillResearchConsultantsconductapollinlateAugust2010of600voters.ThosesurveyedwereaskediftheywouldapproveordisapproveofthefollowingproposalifitwerepresentedtotheTexasLegislature:““PRIORAPPROVAL,”whichwouldrequireinsurancecompaniessubmitandjustifyrateincreasesforreviewbytheTexasDepartmentofInsurancebeforetheycouldgointoeffect,notafter.”About74percentsaidtheywouldapprove,with51percentstronglyapproving.Onlyabout17percentsaidtheywoulddisapprove,with8percentofthosesayingtheywoulddisapprovestrongly.

Opponentsofimplementingapriorapprovalsystemofrateregulationsaythatpriorapprovalsystemsinhibitthebenefitsofacompetitivemarketplacethatcanbetappedthroughfile-and-usesystems.Ahealthy,competitiveinsurancemarketwithmanyparticipatinginsurersisthebestwaytoensurecompaniesstriveforefficienciestokeepcostsdownandtokeeprateslowenoughtoattractalargeconsumerbase.File-and-useallowsinsurerstoassessrisks,fileanactuariallyjustifiedrate,andimmediatelybeginusingthefiledrate.Bycontrast,priorapprovalallowsregulatorstointerferewithinsurers’determinationsofwhatratesarenecessarytokeeptheirbusinesssolventinthelongterm.

Theinsuranceindustryisbasedonassessmentofrisk,andinsurersmustassessavarietyofconsumer,environmental,andregulatoryfactors,aswellastheperformanceofthefinancialmarket,whensettingrates.Apriorapprovalsystemwouldintroduceyetanotherrisktoaninsurerbecausetheinsurerwouldnotknowwhetherinsuranceregulatorswouldapproveratechanges.Thiscouldleadtoworseoutcomesforconsumersbecauseinsurerswouldtrytosethigherratestoaccountforthishigherriskandalsocoulddecidetoleavethemarketorreducethenumberofpoliciestheywrotetoavoidlosses.

Whileeffortstoincreaseregulationthroughproposalssuchaspriorapprovalmaybewellintended,


theyleadtoworseconsumeroutcomes.Thebiggestrisktoconsumerswouldbetoregulateinsurerratesinawaythatledinsurerstobecomeinsolventandunabletopayconsumerclaimsfollowingacatastrophebecausestateregulatorshadpreventedtheinsurerfromestablishinganadequatereserve.Althoughinsurerprofitswererelativelyhighin2006and2007,theyallowedmanyinsurerstostayinbusinessdespitetheextremelossestheyfacedin2008forhurricanesIkeandDolly.

Thefactthatonly10percentofinsurersfeelconfidentenoughtofileandimmediatelyuseratesinthecurrentfile-and-usesystemmeansthatTexashasyettoseethefulladvantagesthatatrulycompetitivefile-and-usesystemcouldprovide.Insteadofracingtoscrapthefile-and-usesysteminfavorofpriorapproval,TexasshouldimplementtheSunsetrecommendationsproposedlastsessiontoclarifythecurrentfile-and-usesystemforinsurers.Thestateshouldconsiderstillmorereformstooptimizecompetitioninthemarketplace,suchasallowingTDItodisapproveofratesonlyiftheyarediscriminatoryorinadequateandnotiftheyareexcessive,saypriorapprovalopponents.

Priorapprovaladvocatescomplainthatratesaretoohigh,yetsince2003theindustryhasbeenhitbyclaimsresultingfromthreemajorhurricanes.Insurersneedtochargetheratestheyarecharginginordertostaysolventandcontinueservingconsumersinlightofhuge,weather-relatedlosses.Forexample,thecombinedlossratioin2008whenHurricanesIkeandDollyhitwas176percent.Thismeansthattheamountinsurersneededtopayclaimsandbusinessexpensesthatyearwasmorethanone-and-a-halftimestheamountofpremiumscollected.Surplusesinyearswithfewerclaimsareneededtopayforextremelossessuchasthese,criticsofpriorapprovalsay.

Homeowners insurance policy forms

Policyformsestablishthetypesoflossesapolicywillcoverandthedollaramountofcoverage.Endorsementsaremodificationstoapolicyformthatmayclarify,broaden,orlimitthescopeofcoverage.

Formanyyears,Texasrequiredallinsurerstousethesamepolicyformsandendorsements.Thestatehasshiftedawayfromrequiringstandardformsoverthelastdecade,butnotallpartieshaveseenthisaspositiveforconsumers.

Background

Inpreviousyears,Texashomeownerinsurerscouldofferonlythreestandard,state-promulgatedforms—theHO-A,HO-B,andHO-C.TDIalsoapprovedcertainendorsementstotheseforms.Morethan90percentofhomeownershadanHO-Bpolicy,whichcoveredall

lossestoadwellingexceptthosespecificallyexcludedandcoveredthecontentsofadwellingfromlossesduetospecificallynamedperils.

In1997,the75thLegislatureenactedSB1499bySibley,whichpermittedTDItoapprovepolicy

formsandendorsementsthatwereusedbylarge,nationalinsurersorthathadbeenadoptedbynationalinsuranceorganizations.ThismarkedthefirstoccasiononwhichTexasauthorizedtheuseofformsotherthanthestate’sstandardforms.Severalinsurersthenfiledalternateformsforapproval,andin2002TDIapprovedthefirstalternate,nationalpolicyforms.

Inresponsetoratespikesthatfollowedasuddenincreaseinmoldandwaterdamageclaims,TDIeliminatedcoverageformoldremediationinthestandardHO-Bform,effectiveJanuary1,2002.Atthesametime,TDIestablishedendorsementsthatgavepolicyholderstheoptiontobuybackmoldandwaterremediationatvariouslevelsofcoverage.Beforethismodification,someinsurershadstoppedwritingorrenewingTexashomeownersinsurancepoliciesbecausetheysaidthelackofflexibilityinformspreventedthemfromestablishingspecializedcoverageforhigh-risk,costlysituationslikemoldandwaterdamage.

In2003,the78thLegislatureenactedSB14byJackson,which,amongotherchanges,eliminatedtherequirementthatinsurersofferstandard,state-promulgatedhomeownersinsuranceforms.WhileTexasnolongerrequireshomeownersinsurerstoofferthestate’sstandardforms,TDImustapproveallalternate

The state has shifted away from requiring standard forms over the last decade.


policyformsbeforetheymaybeused.Manylargeinsurersnowuseplanstheyusenationallythatallowconsumerstochooseamongmanycoverageoptions.

Recent issues

Whilesupportersoftheformderegulationenactedin2003citedthemoldcrisisasanexampleofwhyformderegulationwasnecessary,othersbelieveformderegulationhasbeenharmfultoconsumersandhasmadeunderstandingtheimpactofthebroader2003reformsmorechallenging.Severalbillswerefiledduringthe2009legislativesessionthatwouldhaverequiredhomeownersinsurerstoofferstandardformswhileallowingthemtocontinueofferingtheircurrentforms.

SB1,thegeneralappropriationsactforfiscal2010-11,includesArt.8,DepartmentofInsurance,Rider20,whichdirectsTDItoconductareviewtodeterminewhat,ifany,changeshaveoccurredinthelevelofprotectionofferedbyhomeownersinsurancepoliciessincethedepartment’sadoptionofapprovednationalformsin2002.

Debate about using standard forms

Supportersofrequiringinsurerstofilestandardformssaythatwhenallinsurersarerequiredtoofferthesamepolicyforms,consumerscanmake“applestoapples”comparisonsofwhichcompaniesofferthemostaffordablehomeownersinsurancecoverage.Withoutsuchatool,itisdifficultifnotimpossibleforconsumerstointerpretandcomparecomplexpoliciestodetermineappropriate,cost-effectivecoverage.

Standardformswouldnothavetoberequiredexclusively.Insurerscouldbeallowedtocontinueofferingtheirexistingpolicyformsaswell.InsurersalsocouldmakestandardformscustomizablewithTDI-approvedendorsementstomeetahomeowner’sspecificneeds.

TheAugust2010TexasWatchpollshowsthatmostvotersliketheideaofstandardforms.ThepollaskedvoterswhattheywouldthinkofthefollowingproposalifpresentedtotheLegislature:“Uniformstandards,whichwouldrequireinsurancecompaniesofferafewstandardpolicieswritteninplainlanguagethatwould

beconsistentacrosstheindustry.”About85percentsaidtheywouldapprove,with58percentstronglyapproving.Onlyabout7percentsaidtheywoulddisapproveorstronglydisapprove.

Supportersofrequiringinsurerstoofferstandardpolicyformssaytheneedforstandardformsisgreaternowthaneverbecauseinsurershavebeenreducingcoveragethroughcrucialchangestopolicywording.Forexample,theHO-Bprovidescoverageforwaterdamageforboth“suddenandaccidental”causesandfor“continuousorrepeatedleakage.”Manypoliciesdonotprovidecoveragefor“continuousorrepeatedleakage,”whichahomeownermaydiscoveronlywhenaleakoccursandaclaimisdenied.Manyinsuranceagentsarenotfamiliarwiththesmallvariancesinwordingbetweenpolicies,soconsumersshouldnotbeassumedtorecognizethesedifferenceseither.

Whilewww.helpinsure.comisanexcellenttooltoperformbasicpolicycomparisons,itisinadequatetohelpconsumersunderstandthedetaileddifferencesinthecontentofvariouspolicyoptionsthatmaymakealargedifferencetotheirpocketbookswhenfilingaclaim.Standardformshavebeentestedsuccessfullyinthemarketplaceandinthecourts,providingtheconsistencythathelpstopreserveconsumerprotections.Evenwithplainlanguagerequirements,policyformsoftenarecomplicatedandcanbe50ormorepageslong.

Theindustryexaggeratesthecostsofbeingrequiredtoofferstandardformsbecausetheyfearthatifconsumerscouldcomparedirectlythepricesforthemorecomprehensive,standardformstheywouldrealizehowmuchinsurershavebeenchargingformuchlesscomprehensivecoverage.Anotherwaytheindustryhasusedpolicyformsinrecentyearstoboostprofitsistosignificantlyincreasedeductibles.Consumersformerlyhadmoreoptionstopurchasepolicieswithaflatdeductible,suchas$500.Increasingly,deductiblesareapercentageofthepolicyamount.Ifaconsumerwitha2percentdeductiblemadeaclaimonahomewith$100,000ofcoverage,thatconsumerwouldhavetopay$2,000insteadof$500beforecollectingonthepolicy.SomehomeownersontheTexascoasthave5percentwinddeductibles,whicharehigherthanthedeductiblechargedbytheTexasWindstormInsuranceAssociation,thestate’sinsureroflastresortforcoastalwindstormcoverage.


Most Texas insurers use consumer credit information as a factor in establishing rates for homeowners insurance.

Opponentsofrequiringinsurerstofilestandardformssaythatstandard,Texas-specificformswouldmakehomeownerscoveragemorecostlywithoutaddingsignificantbenefits.Inotherstates,nationalcompaniesmayusetheirnationalformsexclusively.HavingtomaintainandmarketTexas-specificformswouldleadtoextraadministrativeexpensesthatarepasseddirectlytoTexasconsumersintheformofhigherhomeownersinsurancerates.

Texasconsumersarenolesssavvythanconsumersinotherstateswhosimilarlymustshoparoundforthemostappropriatecoverage,opponentsofstandardformssay.Texasconsumersalreadyhaveatoolthatassiststheminestimatingthecostofhomeownerscoveragefromvariousinsurers.ThistoolismaintainedbyTDIatwww.helpinsure.com.Asinotherstates,ifconsumershavefurtherquestionsabouttheamountofcoverageaplanoffers,theycanuseaninsuranceagentwhosejobitistounderstandthedifferencesbetweenvariouspolicies.

Opponentsofstandardformssaythatevenifinsurerswereallowedtocontinueofferingtheirownformsinadditiontothestandardforms,theystillwouldbesubjectedtomajorriskssuchasoccurredduringthemoldcrisis.Foryearspriortothesurgeinmoldclaims,insurershadanticipatedpotentialproblemswiththestate’sstandardformsandhadbeenattemptingtohaveTDIadoptchangestoavoidtheseissues.TDIdidnotadoptanyofthesechangesuntil2002,aftertheindustryalreadyhadlostbillions.ThefactthatthisenvironmentputinsurersatthemercyofstateregulatorscausedseveralinsurerstostopwritingnewpoliciesinTexasuntiltheformswererevised.Thehighmoldclaimscostsdirectlyledtodramaticrateincreasesforhomeownersstatewide,whichcouldhavebeenavoidedhadstandardformsnotbeenrequired.

Using credit scoring to set rates

MostTexasinsurersuseconsumercreditinformationasafactorinestablishingratesforhomeownersinsurance.Theymayconsiderindividualcomponentsofcreditreports,suchasbankruptcies,

ormaycomputecreditscoresbasedonnumerouscomponentsofcreditreports.Insurerscalculatecreditscoresbyplacingvariousfactorsfromaconsumer’screditreportintomathematicalmodelsthatmayvaryfrominsurertoinsurer.Homeownersinsurersmayusecreditscoresasabasisforprovidingdiscountsorimposingsurchargesoncertainconsumersorforplacingconsumersinratingtiers.

Background

Inthe1990s,insurersincreasinglybeganusingcreditscoringasacomponentinsettingconsumers’homeownersinsurancerates.Thispracticeispermitted

federallybytheFederalFairCreditReportingAct(PublicLaw91-508),whichallowsinsurancecompaniestouseconsumercreditreportsforunderwritingpurposeswithoutnotificationorconsentoftheconsumer.

Becausemosthomeownersinsurancepolicieswereprovidedthroughnon-rate-regulatedcompaniesintheearly2000s,itwasnotclearhowmostinsurerswereusingcreditscoringtodetermineconsumerrates.TDIreportedthatcomplaintsaboutcredit-scoringpracticesincreasedfrom40in2000tomorethan600in2002.SB14byJackson,enactedin2003,requiredcompaniestofilewithTDItheircredit-scoringmodelalongwithotherinformationtoactuariallyjustifytheirratefilings.ThebillalsorequiredTDItoconductastudyofhowinsurerswereusingcreditinformationandhowtheircreditscoringpracticesaffectedconsumers.

Inaddition,underSB14,aninsurermaynotdeny,cancel,ornon-renewapolicysolelyonthebasisofcreditinformation.Insurersmustdisclosetoconsumersifcreditscoringwillbeusedinunderwriting.Theinsurancecommissionerisrequiredtoestablishruleslimitingtheallowabledifferenceinrateschargedbyinsurersduesolelytodifferencesincreditscores.

DuringTDIrulemaking,optionswereconsideredthatwouldhavelimitedtoafixedpercentageofvariancehowmuchratescouldvaryonthebasisofcreditscore.Ultimately,TDIruledthatanyratevarianceduesolelytocreditscoringwouldbeacceptableifactuariallyjustifiedbydatafiledwiththedepartment.


Recent issues

Credit-scoringforinsurancepurposeshasbeenanongoingsourceofcontroversyduetoconcernsthatitleadstodiscriminatoryratingpractices.Somestateshavebannedtheuseofcredit-scoringaltogether.Duringthe81stLegislature,severalbillswerefiledtobantheuseofcreditscoringinratesetting.AnunsuccessfulamendmentalsowasofferedduringSenateconsiderationofSB1007,theTDISunsetbill,tobancreditscoringpractices.

Debate about credit scoring in rate setting

Supportersofbanningtheuseofcreditscoringinpolicyratingsaycreditscoringisadiscriminatorypracticeusedasaproxyforsettingratesbasedonraceandisnotanappropriatewaytomeasurerisk.Creditscoringoftenleadstorateincreasesfortheconsumerswhocanleastaffordthem—eventhosewhohaveneverfiledaclaim.Manystudies,includingtheDecember2004TDIstudytitledUse of Credit Information by

Insurers in Texas anda2007FederalTradeCommissionreport,havefoundthatcredit-scoringscenariosdisproportionatelyhaveanegativeimpactonAfricanAmericans,Latinos,andpeoplewithlowerincomes.Supportersofbanningtheuseofcreditscoringsayitsuseinratesettingisnotjustified.Forexample,alowcreditscoredoesnotincreasetheriskthatahailstormwillstrikeaperson’shome,resultinginaclaim.

Opponentsofbanningtheuseofcredit-scoringinpolicyratingsaycredit-scoringhasprovedanaccuratewaytomeasureriskandisnotintentionallydiscriminatory.AsupplementalanalysistoTDI’sDecember2004reportfoundthatthe10percentofpolicyholderswiththeworstcreditscoreswere1.5to2timesmorelikelytofileaclaimthanthe10percentofpolicyholderswiththebestcreditscores.The2007FederalTradeCommissionstudycorroboratedthatlowercreditscorespredictahighernumberofinsuranceclaims.Whateverthefactorthatdrivestheriskassociationbetweencreditscoresandclaimsfrequency,insurersshouldbeabletomeasurethisactuarially

InTexas,thecommissionerofinsurancedirectsthepolicyandoperationsoftheDepartmentofInsurance.Thegovernor,withtheSenate’sconfirmation,appointsthecommissionerofinsuranceforatwo-yearterm.Elevenstateselecttheirinsurancecommissioners.Severalofthesestatesrestrictorbancontributionsfrominsurancecompaniestocommissionercandidates,citingconflict-of-interestconcernsaboutregulatorsacceptingdonationsfromtheindustrytheyregulate.Duringthe2009regularsessionofthe81stTexasLegislature,severalbillsandanamendmentofferedtotheTDISunsetbillintheSenatewouldhavemadethecommissionerofinsuranceanelectedpositioninTexas.Noneoftheseproposalswasenacted.

Supportersofmakingthecommissionerofinsuranceanelectedofficesaythatanelectedcommissionerwouldbemoreresponsivetoconsumersthananappointedcommissioner.Forhomeownersinsuranceregulation,theysay,anelectedcommissionerwouldenhanceconsumerprotectioninoversightofrate-settingandformregulation.Texanselecttheiragricultureandrailroadcommissioners,whohavelessimpactonthelivesofTexansthantheinsurancecommissioner,supportersofelectingtheinsurancecommissionersay.TheysaythecommissionerdirectspolicythatinfluencesallTexashomeownersandotherconsumersyetisaccountableonlytothegovernor.

Opponentsofmakingthecommissionerofinsuranceanelectedofficesaytheinsurancecommissionershouldbeanimpartialregulator,notanelectedofficial.Theysaythebestwayforaninsurancecommissionercandidatetoappealtocitizenswouldbetorunonthepremiseofloweringinsurancerates,yetthemarketdoesnotalwayssafelyallowthisgoal.Opponentsexpressconcernthataninsurancecommissionerelectedwiththemandatetolowerratescouldimplementpoliciesthatcouldjeopardizeinsurersolvency.

Should the commissioner of insurance be elected or appointed?


supportedindicatorofriskandchargeratesaccordingly.Ifcreditscoringweresuddenlybanned,theinsurancemarketwouldbedisruptedandmanyconsumerswithgoodcreditscoreswouldexperienceasuddenincreaseintheirpremiums.

Expediting appeals in contested rate cases

InsurersmayappealhomeownersinsuranceratefilingsthathavebeendisapprovedbyTDI.TheratedisputebetweenTDIandStateFarmLloydsthathaspersistedsince2003hashighlightedformanyobserverstheneedtorefinetheprocessforappealingratecasesforhomeownersinsurancesorateappealsmayberesolvedmorequickly.TheHouseCommitteeonInsuranceisrequiredbyaninterimchargetothe81stLegislatureto“studywhetheranewsystemorprocessshouldbeemployedtoexpediteappealsbyinsurersagainstTDIinhomeowner’sratecases.”

Background

Currently,theinsurancecommissionermaydisapproveadministrativelyafiledratebeforeitisimplementedormayrefer,withpropernotice,arate-in-effectforahearingbeforetheStateOfficeofAdministrativeHearings(SOAH).SOAHissuesaproposeddecisionincontestedratecases,andthecommissionerreviewsthisdecisiontomakeafinaldeterminationaboutwhethertodisapprovearate.ThelawdoesnotestablishcleartimeframesforhowquicklyaSOAHhearingmustbeconductednorhowlongthecommissionerhastoissueafinalorder.AninsurermayappealadisapprovedratetotheTravisCountydistrictcourt.FurtherappealsadvancetotheThirdCourtofAppealsinAustinandtheTexasSupremeCourt.

Recent issues

InSeptember2003,followingenactmentthatyearofmajorinsurancereformsduringtheregularlegislativesession,TDIreviewedhomeownersratesandorderedmorethan30insurerstoreduceratesfoundtobeexcessive.StateFarmLloydswasorderedtoreduceratesby12percentbutrefused.Thecompanyappealedthecommissioner’sordertotheTravisCountydistrictcourt.Sincethatappeal,TDIandStateFarmLloydshavefacedoffinSOAH,districtcourt,andtheThirdCourtofAppeals,withoutresolution.

InMay2008,theThirdCourtofAppealsorderedTDItorehearthecase.Basedonthatrehearing,thecommissionerfoundStateFarmLloyds’ratesfrom2003to2008tobeexcessiveandinNovember2009orderedthecompanytopaymorethan$310millioninrefundsandinteresttoconsumers.StateFarmLloydsappealedtheordertotheTravisCountydistrictcourt,wherethecaseremainspending.

Consumeradvocatesarefrustratedthatthe$310milliontheyfeelconsumersareowedstillcannotberefundedaftersevenyearsoflegalbattles.Theyfeelthebestsolutionwouldbetoavoidhavingconsumerfundstiedupduringlegalbattlesbyrequiringthecommissioner’spriorapprovalofallratechanges.Shortofthisproposal,manyfeeltherearewaystoimprovethecurrentsystemthatcouldspeedtherateappealsprocess.

Proposals for expediting appeals

Variousproposalstospeeduptheappealsprocesshaveemergedforpotentialconsiderationbythe82ndLegislature.Lawmakerscouldconsideramendingtheadministrativeandjudicialprocessesincontestedratecasestoexpediteappeals.TheLegislaturecouldestablishtimeframesinwhichSOAHhearingswouldhavetooccurandlimithowlongthecommissionerhadtoissueanorderbasedupontheSOAHdecision.ThescopeandtimelinefortheSOAHdiscoveryprocessalsocouldbelimited.Inthecourts,theTravisCountydistrictcourtcouldbebypassedandrateappealsinsteadcouldbesentdirectlytoappealscourts.AspecialcourtcouldbeestablishedwithintheAustinCourtofAppealstoperformexpeditedreviewsofrateappeals.Finally,thestatecouldimplementanarbitrationsystemforappeals.Floridahadanarbitrationprocessfrom1996until2007thatgaveathree-memberarbitrationpanel90daystoissueadecisionaboutarateappeal.

Whilepartiesonallsidesofratedisputesclaimtheycouldbenefitfromexpeditingtheappealsprocess,theysaythatproposalsforchangeshouldbescrutinizedtoensuretheydonotinfringeonanyparty’sdueprocessrights.TheysaythatanyproposaltoexpeditecontestedratecasesshouldmaintainthebasicrightsoutlinedforcontestedcasesintheTexasAdministrativeProcedureAct(GovernmentCode,ch.2001)—includingtherighttoahearingandtoconductdiscovery,presentwitnesstestimony,cross-examinewitnesses,andappeal.

— by Carisa Magee


HOUSE RESEARCH ORGANIZATION

Steering Committee:

Bill Callegari, Acting Chairman Drew Darby Harold Dutton David Farabee Dan Gattis Yvonne Gonzalez Toureilles Carl Isett Susan King Jim McReynolds Jose Menendez Geanie Morrison Elliott Naishtat Rob Orr Joe Pickett Todd Smith

John H. Reagan BuildingRoom 420P.O. Box 2910Austin, Texas 78768-2910

(512) 463-0752

www.hro.house.state.tx.us

Staff:Tom Whatley, Director; Laura Hendrickson, Editor; Rita Barr, Office Manager/Analyst; Catherine Dilger, Kellie Dworaczyk, Tom Howe, Andrei Lubomudrov, Carisa Magee, Blaire Parker, Research Analysts

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