When Eliot Spitzer accused the world's largest insurance broker of fraud last fall, Joseph Belth, editor of trade publication Insurance Forum, described it as "the most important thing that has ever happened in the insurance industry in the history of the industry."
Many New Yorkers might be hard-pressed to name any other event at all in insurance history, aside from their own fender-benders and eye examinations.
But despite its low profile, the insurance industry is an important part of the economy, with insurers collecting trillions of dollars in premiums and providing millions of Americans with jobs. Insurance is also remarkably central to the lives of virtually every American.
Belth sees the New York State Attorney General's investigation as so significant because of the potential it has to change the way this vast industry works. Some see this potential for change as a way to combat a threat - widespread corruption that is forcing customers to pay significantly higher premiums. Others see Spitzer's investigation itself as the threat.
These are not the only threats the insurance industry feels. If insurance was devised as a way for both individuals and the community at large to reduce risk, insurance itself is at risk these days in a number of ways.
HOW INSURANCE WORKS
Broadly defined, insurance is a way to reduce risk. The insurance industry itself is split into two categories defined by the type of risk handled: The first category is life and health - providing those who are injured help with medical expenses, and the families of those who die with economic security; the second is property and casualty - reducing the financial risk of a variety of other activities.
Property and casualty covers a lot of ground. A partial list of types of insurance in the book The Invisible Bankers by Andrew Tobias, a book explaining the insurance industry, includes: protection for property damaged in floods, fires, or bridge collapses; losses stemming from riots, ransoms and political upheaval; and malpractice insurance for everyone from doctors to animal trainers to members of the clergy.
For a certain price, insurance can be bought to protect against almost anything. Certain types, though, are legally required, such as auto insurance for those who want to drive a car, or property insurance for those who want to take out a mortgage. Some insurance premiums are collected automatically and handled by the government, like social security - which protects against poverty in old age, or unemployment insurance - which protects against poverty for those in between jobs.
All of this is big business. American insurance companies collected over $1 trillion in premiums in 2003, employing 2.3 million people to sell and handle these lines. About two percent of American jobs are in the insurance industry.
JOB LOSS: A THREAT TO THE ECONOMY
New York City's insurance industry has lost almost 10,000 jobs since 1997, part of a nationwide trend for financial industries to move as much of their operation as possible out of high-cost areas. Insurance is among the three financial industries that the city has traditionally relied heavily upon. The others -- Wall Street and real estate -- are bigger and more high-profile in New York, but insurance is still big business in the city: The headquarters of four of the country's top 10 insurance companies (based on revenue in 2003) are located here. This "FIRE" sector of the economy (for Finance, Insurance, and Real Estate) provided the city with 434,000 jobs in 2003. While they are less of a driving force than in the past, these industries still figure significantly in the city's economy.
Many of the insurance industry jobs leaving New York go to other places in the United States. Since at least 1990 the national insurance industry has continued to expand overall while contracting in urban areas like New York.
Other jobs have gone overseas. Spitzer believes some are doing so to avoid regulations. "There is, I would suspect, a Pandora's Box that should be opened so we can understand what is going on in these offshore venues," he told Congress late last year. "It will not be a pretty picture."
But the main reason that such jobs are leaving New York is economic: real estate and labor costs are much higher in New York than they are elsewhere. Better communications technology has made it easier for companies to take advantage of these differences.
Since the gaps in expenses are unlikely to be reversed, some say that New York should accept the loss of back office operations, while focusing its energy on encouraging companies to keep their core activities in the city.
"Our strategy - because we do now have an economic strategy -- is to continue to attract the front office headquarter functions," said Kathryn Wylde, head of New York City Partnership, a business group based in the city.
TERRORISM: A THREAT TO BIG BUSINESS
Most New Yorkers can conceive the serious threat posed to the city by terrorism; fewer have considered how the insurance industry has been affected by this threat.
September 11 cost New York City $80 billion. Of that, about $40 billion was offset by payments from insurance companies. These insurance payouts amounted to the largest loss in the industry's history - double that from Hurricane Andrew in 1992, the second costliest event.
Insurance companies felt forced to reexamine the way they do business. Before 9/11, terrorism insurance was generally covered as part of commercial property insurance without extra charge. But the attack made insurance companies see terrorism as a new type of risk. Because terrorist attacks are very hard to predict, and because the losses can be so high, insuring against it is expensive.
"There has been a fundamental change in the nature of risk in our society," wrote the Insurance Information Institute.
The burden initially fell on those who have to buy insurance for commercial property: some had trouble finding any insurance at all. For those who could, the average increase in costs in the year after the attack was 73.3 percent, according to the city comptroller's office. The owners of the Empire State Building, for example, were suddenly faced with a $9 million annual premium - nine times what they paid beforehand. For that, they actually got less coverage.
In response, the federal government passed the Terrorism Risk Insurance Act in November 2002. This law required that commercial property owners be offered insurance that protected against losses due to terrorism. In return, the federal government agreed to back up the finances of insurance companies in case of attack. Insurance prices dropped; coverage became more widely available.
But the law is intended to be a temporary solution - it expires at the end of 2005. Those who buy and sell commercial insurance have been lobbying for an extension, but Washington does not seem prepared to pick up the issue immediately. Since insurance policies are generally written in one-year spans and since the expiration of the federal guarantee is less than a year away, many see some disruption in business activities looming.
If a company does not have terrorism insurance, then it will have to pay for all damages it suffers from a terrorist attack. This could cause companies to balk when it comes time to expand or move operations to the city, says New York City Partnership economist Jonathan Schwabish, author of a recent report on terrorism insurance in New York City (in pdf format). Banks are also much less willing to lend money to companies that have not covered their risks.
"This could have ramifications beyond just companies being on the hook for their buildings if an attack did occur, " warned Schwabish.
AUTO INSURANCE PREMIUMS: A THREAT TO CONSUMERSâ€¦IN BROOKLYN
Phony car accidents are common in New York. In order to collect money from insurance companies, people stage crashes, cause crashes and even file claims for crashes that never happened. Phony medical offices established solely to treat non-existent injuries are so commonplace that they now have their own business category - "Doc in the Box" clinics. (Read Auto Insurance Fraud: Driving Rates Up In Brooklynby Mark Peters.)
There were about 800 indictments statewide for auto insurance fraud in 2003. Cases were concentrated largely in New York City's outer boroughs: the Bronx, Queens, and, above all, Brooklyn. In one 2003 case in Brooklyn, 567 people were arrested for running an operation that allegedly collected $48 million in fraudulent claims over several years. One member had been in over 1,000 car accidents.
The New York State insurance industry pays about $1.4 billion to pay for fraudulent claims annually; $500 million in Brooklyn alone. Insurers, in turn, pass the costs on to policyholders. In the United States, the average driver pays $817 to fully insure a car for a year; the average New York State resident pays $1,161. In Brooklyn the same policy can cost over $4,000.
Auto insurance fraud is not solely a local problem, nor is it a particularly new phenomenon. But New York State's system of no-fault insurance, which ostensibly prevents frivolous lawsuits, has proven very susceptible to being ripped off. For claims under $50,000, no-fault insurance calls on companies to quickly pay out without establishing blame, leaving them little leeway to investigate fraud.
Increased enforcement over the last few years have begun to address the probem, say public officials and industry representatives.
"The situation has improved dramatically from what it was two or three years ago when New York was without doubt the auto fraud capital of the United States between 2000 and 2002," said Robert Hartwig, chief economist at the Insurance Information Institute. Hartwig said that New York's higher costs will always keep insurance rates relatively higher compared to other states, but that enforcement was bringing it more in line with the rest of the country.
A task force appointed by Brooklyn Borough President Marty Markowitz, however believes fraud is not the only problem that needs to be addressed.
"There must be a drastic revision of the entire auto insurance system if underserved and over-priced areas like Brooklyn are to have access to the affordable coverage that others around the state and country take for granted," a recent report by the task force read.
The insurance industry, the task force found, is practicing a subtle form of redlining, or restricting access to insurance based on location. Insurance companies base their rates on various criteria determining risk. Because insurers do not make these criteria public, some suspect that discrimination based on race, income, or the place where a person lives makes it harder for people with good driving records to get reasonably priced insurance.
"There's some concerns about racial and ethnic discrimination," said Jim Brennan, a State Assemblymember and the primary author of the report. "That people's real driving histories are not being taken into account."
ELIOT SPITZER: A THREAT OR A SOLUTION?
Parts of the insurance industry, said Eliot Spitzer, operate as "a secret cartel based on hidden payments and preferential treatment. As with any cartel, this results in higher prices for the public and a drag on the economy."
The obvious implication is that, by breaking up the ring, the insurance industry will become more efficient and, eventually, cheaper. But while Spitzer and his supporters see his work as a way to address a serious threat not only to a particular industry but to the nation's economy, some in the industry worry about what the end results of the investigation will be.
Secret Payments and Outright Fraud
Spitzer's investigation began with Marsh & McClennan, the world's largest insurance broker. Marsh's clients are corporations who need a lot of insurance. These companies hire Marsh & McClennan to consider offers from various insurers and find the best deal. While brokers ostensibly represent the buyer, Spitzer found that Marsh was also taking secret payments called contingency commissions from the insurance companies themselves. These payments are not illegal -industry groups defend them as necessary in many cases - but the investigation has questioned whether they raise conflicts of interest.
At Marsh, these payments were the determining factor in the broker's decision about which companies to send its clients to. To preserve the appearance of a competitive process, Marsh asked several insurers to enter bids that were higher than the one of the company to which it wanted to steer the business. This practice - called bid rigging - is a crime.
Spitzer has charged several others with similar collusive behavior, including insurance giants Met Life and AIG. His investigation has definitely shaken the entire industry, even if many say such practices are an exception, not the rule.
Is There Widespread Corruption in the Insurance Industry?
For those directly implicated, the consequences have already been rough. In the quarter after Spitzer made his findings public, Marsh & McClennan's net income dropped to $21 million, from $357 million the quarter before. It has subsequently laid off 3,000 workers - five percent of its total workforce. The company's CEO and five members of its board have also departed.
But insurance types are quick to claim that the practices taking place among several large companies are isolated incidents, and that industry-wide business do not need to change much.
"The people who are engaged in that activity should be prosecuted because it imputes the integrity of everybody else in the business," said Bernard Bourdeau, president of the New York Insurance Association, a trade group. "There are a few bad actors, and hopefully Spitzer got them."
But Spitzer has indicated that the public revelations he has made are not yet finished. Without saying so explicitly, he has hinted that those handling personal lines of insurance have been involved in many of the same shady practices.
Whether or not such charges turn out to be true, most people following the current investigations believe that there will be reform of certain practices within the industry. They disagree on how much is likely - or appropriate.
Will The Industry Reform?
Spitzer sees a major parallel the bad behavior he has uncovered in the insurance, financial securities and mutual fund industries.
"In each of these three story lines, there has been an abject failure of self-regulation," Spitzer testified at a congressional hearing. "Nobody came forward to say there is a problem."
New York, along with many other states and the federal government, is considering regulations that will better prevent such behavior. Many insurers resent this idea, describing Spitzer as more concerning with his own political image than with creating effective regulations.
"Filing lawsuits that significantly reduce the market value of individual corporations and entire industries - damaging millions of consumers and tarnishing the reputation of the vast majority of ethical business professionals in the process - is not my idea of consumer protection," said Ernst Csiszar, president and CEO of Property Casualty Insurers of America, who has also been the head insurance regulator of South Carolina.
But Robert Hunter of the National Insurance Consumer Organization believes that by drawing attention to the industry, Spitzer brings pressure on insurers to be more careful about their own practices; his investigation should also slow aggressive pushes for deregulation. Both of these things, believes Hunter, will ultimately lead to lower rates.
The question of whether reform is needed and whether reform will happen are not necessarily the same thing: the insurance industry is a historically powerful political force, effective in preventing being regulated in ways it doesn't like.
Some, including New York State's outgoing superintendent of insurance Greg Serio, hope that Spitzer's investigation gives enough push to overcome that barrier.
"The industry has earned a sweeping reform," he said.
Insurance Industry Information
Insurance Information Institute
Wikipedia Entry on Insurance
Terrorism and Insurance
September 11: One Hundred Minutes of Terror that Changed the Global Insurance Industry Forever (by the Insurance Information Institute)
9/11 Sparks Dramatic Increase In Commercial Insurance Premiums In New York City (by the New York City Comptroller's Office)
Terrorism Risk Insurance Act (by the US Treasury)
New York City and Terrorism Insurance in a Post-9/11 World(by the Partnership for New York City)
Auto Insurance Fraud: Driving Rates Up In Brooklyn(Gotham Gazette article by Mark Peters)
Driving Force: The role of lawsuits in pushing up the cost of car insurance in New York State (by the Public Policy Institute of New York State)
Putting the Brakes on Out of Control Rates: An Examination of Brooklyn’s Record High Automobile Insurance Rates and How They Can Be Reduced(by the Brooklyn Borough President's Task Force on Equity in State and Local Policy)
Eliot Spitzer's Investigation
Timeline of the Investigation (by the Insurance Information Institute)
What are Contingency Commissions (by the Insurance InB?Ă›Ăµation Institute)