Low ratings didn’t disqualify weak insurers from taking risky policies from Louisiana Citizens

State lawmakers created one rule that insurers had to follow if they wanted to take over risky policies carried by the state-run insurer of last resort, Louisiana Citizens Property Insurance Corp.

The private companies needed a letter grade of B+ or better from the leading rating firm A.M. Best — or its equivalent. But state regulators, desperate to move people off the public insurance plan, were lenient in how they interpreted that rule, a Times-Picayune review has found.

Twelve of the 18 firms that took Citizens' policies didn't meet the strict standard of the law. And six of the 12 have since failed, leaving thousands of insurance claims in limbo.

Southern Fidelity took on some 27,000 policies, the most of any insurer, over nine years. Access Home, Lighthouse Property, and Maison Property also jumped at the chance to quickly add thousands of new customers within a year of the companies forming.

Those four insurers took the largest number of policies from the state. Each also had an A rating from Demotech instead of the A.M. Best rating required. And all four companies failed in the last year.

Moving policyholders off the public insurance plan has been at the heart of the state's plan to keep Citizens from collapsing as it did after Hurricane Katrina.

Taking a cue from Florida, state lawmakers wanted to make sure Citizens didn't become the preferred insurer in Louisiana. They devised a plan that would allow Citizens to regularly send policyholders to any insurer that would take them.

They're hoping to do it again.

More than letter grades

The ratings are more than just obscure letter grades. They measure an insurer's likelihood of defaulting on their financial obligations.

"One A-minus doesn't equate to another A-minus, and it depends on the rating agency's methodology," said Jeffery Mango, a managing director of research for A.M. Best. "But what you can look at is default statistics."

Companies that have an A rating from Demotech have a 10-year default rate of around 9.1%. That means Demotech's A is closer to a C++ from A.M. Best, rather than a B+, according to data recently filed with the U.S. Securities and Exchange Commission.

The data show that insurance companies with an A rating from Demotech are four times more likely to fail than those that carry a B+ from A.M. Best – though Citizens treated the two grades as equivalent.

Insurance researchers have long said the financial stability scores rating firms generate have not been adequately studied. Although some have tried, three professors who study insurance told The Times-Picayune there's no consensus because the data is often kept as a trade secret.

The industry gained a new window into Demotech's ratings this year when the firm joined the Nationally Recognized Statistical Rating Organization. Membership is approved by the SEC; to be admitted, rating firms have to disclose the default rates of companies they've graded.

That data suggests that, in order to be comparable to A.M. Best's B+, Demotech-rated companies would need the highest rating Demotech offers: A".

The new statistics could reshape how the depopulation program is run.

"It absolutely triggers a need for a discussion at the next board meeting," said Insurance Commissioner Jim Donelon.

Donelon, who is a nonvoting member of the Louisiana Citizens board, said board members have discussed changing the rating requirement in the past. He stopped short of saying he supports raising the required minimum grade because doing so could limit the number of participating insurers.

In the past, Donelon said, the ratings didn't determine how many policies an insurer could take out of Citizens. So even a low-rated company could take as much as it wanted.

"We didn't give a higher-rated company more policies than a lower-rated company," Donelon said. "Someone could suggest that we ought to do that."

The rating game

Rating firms rely on different methods and often confidential information to determine whether an insurer is financially stable. Their rating of a company resembles a test score. And each letter grade represents an underlying percentage that measures the likelihood the company will fail.

"That's essentially what these rating agencies are doing, but they're not letting you peek at those percentages," said Tyler Leverty, an insurance professor at the University of Wisconsin-Madison. "That's the secret sauce."

Insurers can game the system. They can shop around for a rating that's most favorable. If they don't measure up to one firm's standards, insurers can choose not to publish the bad grade and go somewhere else.

Industry groups have tried to reduce rating shopping by encouraging insurers to get two or more ratings. But in distressed insurance markets like Louisiana, regulators are loath to erect any barrier to an insurer that wants to do business here, and companies can skate by with only one.

The federal government's standard offers one way to judge one rating against another. The Federal National Mortgage Association and Federal Home Loan Mortgage Corp., known as Fannie Mae and Freddie Mac, require minimum grades for insurance companies that want to sell policies to homeowners with federally backed loans.

For A.M. Best, it's a B; for Demotech it's an A.

A.M. Best is considered the gold standard for insurance company ratings. Started in 1899, the company grades insurers worldwide; its ratings often serve as a benchmark for federal programs.

Since the 1990s, newer insurers specializing in coastal homeowners coverage have turned to Demotech as an alternative. The Ohio-based firm now plays a major role in the property insurance markets in Florida and, by extension, Louisiana.

"Most insurers want to be rated by A.M. Best.," Leverty said. "There's less use of Demotech except by newer insurers that don't feel comfortable getting rated by A.M. Best. or they don't think they'll get the result they want."

Demotech's grading scale can be misleading. The vast majority of the insurers it rates all receive different versions of an A, leading consumers to believe that a company is highly rated.

Close to 100 property insurers doing business in Louisiana are rated by Demotech.

Trading one risk for another

Donelon has been under pressure to fortify Louisiana's insurance market and explain why his department failed to see a wave of insolvencies on the horizon. He told state auditors recently that an internal inquiry will focus on why the failed companies didn't buy enough reinsurance and whether they underpriced their services.

There has been less scrutiny of the depopulation program, and whether it helped lay the foundation for the collapse. Some lawmakers defend the program, emphasizing the benefits and downplaying the risks.

State Sen. Kirk Talbot, R-River Ridge, who chairs the committee and serves on the Citizens board, said consumers are grateful for the cheaper insurance coverage they get when they leave Citizens. If an insurer fails, he said, policyholders can rely on the state's bailout fund run by the Louisiana Insurance Guaranty Association.

"At the end of the day, your claim is going to get paid," Talbot said. "I would rather go 14 years saving thousands of dollars than stay in Citizens."

A bill was introduced in the Legislature earlier this year that would have raised the minimum A.M. Best requirement to an A – or its equivalent – but it never made it out of the Senate Insurance Committee.

Talbot said he did not support the bill because he was worried many insurance companies wouldn't qualify. He was unsure why the bill was pulled by the sponsor, Sen. Bret Allain, R-Franklin. Multiple attempts to reach Allain were unsuccessful.

Donelon, who was elected insurance commissioner in 2006, has also not committed to raising the rating requirement. As the architect of the state's response to past and current insurance crises, his decision will likely be the most consequential of them all.

His approach was shaped in the years after Katrina when Citizens issued bonds to raise nearly $1 billion to pay off unpaid claims. As a result, every property owner in the state is assessed an annual fee to help repay the debt. The bonds will not be paid off until 2026.

But his concerns haven't fully shifted to the new threat: weak insurance companies.

"We can always increase the financial strength ratings," Donelon said. "The more we do, the fewer companies we'll have taking policies out of Citizens. That will then put (them) at risk for assessment of everyone with property insurance — residential and commercial — statewide."