Why Louisiana keeps turning to low-rated insurers to reduce Citizens' policy load

Members of the board that oversees the Louisiana Citizens Property Insurance Corp. were primed for a discussion that nobody wanted to have.

It took the public insurer more than a decade to trim the number of risky policies it was holding to less than 40,000, through a process called depopulation. But over the span of a few months, after the collapse of a dozen insurers, more than 80,000 policyholders had come rushing back into Citizens' arms.

The first board meeting of 2023 was an opportunity to consider something members might have overlooked.

In the previous depopulation effort, four of the insurers that helped reduce Citizens' rolls were allowed to participate even though they fell short on the required financial stability rating — and they ultimately collapsed. Seated in the quiet confines of a meeting room in Baton Rouge, the board had to decide if similarly situated companies should be allowed to do it again this year. The pattern of failures was hard to ignore.

"Do you all have any particular process that you go through to check on solvency, or is there any discussion with the Department of Insurance about that?" asked Jeff Albright, a board member who heads the Independent Agents and Brokers of Louisiana. "Any guidance that you can give us on the financial security of these companies?"

Albright pointedly noted that two insurers asking to write policies only had an A grade from the ratings agency Demotech — and not the B+ from A.M. Best that state law sets out. The four companies that took on the bulk of Citizens' policies and failed last time all relied on Demotech ratings.

Richard Newberry, Citizens' executive director since 2016, decided to punt on the question: "I'm agnostic as far as that goes," Newberry replied, adding that the insurers were all licensed to operate in the state.

In November, Insurance Commissioner Jim Donelon, a non-voting member of the board, had suggested the board would discuss the meaning of the ratings after a story in The Times-Picayune | The Advocate showed that insurers with an A rating from Demotech were nearly four times more likely to default than those with a B+ rating from A.M. Best.

But when the issue came up at the meeting, Donelon wasn't in the room. A spokesperson later said he stepped out to take a call from the governor. No other board member weighed in.

Behind the silence is a discomforting fact: More than 100 insurers operating in the state rely on Demotech ratings.

Louisiana has become heavily reliant on small insurers that often struggle to achieve higher financial stability ratings. If Citizens' board decided to apply a tougher standard, it's likely that fewer companies would qualify to take the high-risk policies.

That would likely slow Donelon's plan to steer customers off the public insurance plan, though it might benefit consumers in the long run.

The Citizens board approved the requests this month of two questionable insurers — Safepoint Insurance Co. and its affiliate Cajun Underwriters Reciprocal Exchange — to assume 6,360 policies starting April 1.

Donelon has promised that an actuarial consultant, Merlinos and Associates, will help the department closely track the finances of several companies. Its work will largely focus on smaller firms and not the major carriers like State Farm, Allstate and Progressive that are not at risk of failure.

"We're looking at their reinsurance buy for this year and how it compares to last year," said Donelon, who recently announced he won't seek re-election. "We're doing a couple things that we didn't do before to monitor all of the property and casualty insurance companies doing business in the state."

Repeating history?

Since its inception, Citizens has been focused on reducing its policy load by trying to steer its customers to private insurers.

The depopulation program is fairly simple. Lawmakers didn't want Citizens to become an attractive choice, so they required its policies to be priced 10% higher than private options. In addition to that markup, they instructed Citizens to offer their policies to any private insurer willing to take them.

To qualify, insurers need a B+ rating from A.M. Best, the primary grader for insurers, or its equivalent.

Determining what's equivalent isn't easy, and Louisiana regulators have been generous in interpreting the grades given out by Demotech. The performance gap between insurers rated by Demotech and those rated by A.M. Best became widely known last year when Demotech published the default rates for each letter grade it confers on insurers.

The disclosures to the U.S. Securities and Exchange Commission showed that, when measured over 10 years, Demotech's A rating had a default rate of 9.1%. A.M. Best's B+ rating had a default rate of 2.5%.

Over a little more than a decade, some 129,000 policies were moved off Citizens' rolls and placed with private companies. But after four major storms made landfall in the state in 2020 and 2021, the four firms that had taken over the largest number of Citizens policies all went under. All four had A ratings from Demotech.

Joe Petrelli, Demotech's founder, did not dispute the statistics.

But he said at least four of the company failures were related to incorrect modeling those insurers relied on to buy reinsurance, not his organization's ratings methodology. As evidence, he pointed to the Demotech-rated insurers that largely survived in the catastrophic year before Hurricane Ida.

"There was something about Ida or carrier data associated with Ida that was problematic," Petrelli said. "It was not our process, as carriers withstood the unprecedented six events in 54 weeks."

Other industry stakeholders say the quality of ratings frequently changes over time.

Questions over the ratings could have larger implications for the housing industry: Fannie Mae and Freddie Mac, both major buyers of home mortgages, accept Demotech's A rating as a minimum for insurers of homes they finance.

Fannie Mae officials, when asked about the default rates, said they regularly review insurance rating requirements to make sure they "align with our overall risk appetite."

"Ratings agency performance is not static," a spokesperson said in an email, "and can change based on market conditions, clientele, and catastrophic events that impact insurer losses."

Less qualified insurers

The ratings concerns come amid a revival of the state's incentive program. In a special session last month, Louisiana lawmakers agreed to offer $45 million in grants to insurers willing to sell more policies in the state.

Nine insurers have applied for the state's incentive program, seeking a total of $62 million. As a group, they appear less qualified than those that participated more than a decade ago.

For one, at least seven out of the nine insurers that have submitted applications possess A ratings from Demotech. One firm, Constitution Insurance Co., holds an A- rating from A.M. Best. On Friday, state officials approved grants totaling $42 million to eight of the nine companies.

During the last iteration of the incentive program, four out of the five participants held ratings from A.M. Best; the now-insolvent Southern Fidelity Insurance Co. was the only one rated by Demotech.

But in the eyes of the Department of Insurance, even a questionable rating is worth getting more companies in the market.

Department officials said the large national companies that generally have A.M. Best ratings don't appear to be interested in expanding in south Louisiana. Several of them already hold a large piece of the state's market.

Regulators said they will give preference to the highest-rated companies, but other factors will also be considered. And they note that the solvency monitoring performed by Merlinos should help the department keep watch on small insurers.

"We're mainly looking at those companies that have their risk concentrated in Louisiana, Florida and other Gulf South states, and that write a significant portion of the market," said Stewart Guerin, the department's deputy commissioner for financial solvency.

"So if a company is only writing $100,000 here, we're probably not going to look at it, but if they're writing millions in premium in Louisiana, then they're going to be on our radar."