On Tolstoy and Insurance Troubles in the Heartland

Property & casualty insurers are remarkably durable. Many of the country’s 2,422 insurers have been in business for over a century. Two – the Insurance Company of the State of Pennsylvania and the Philadelphia Contributionship–were formed in the 18th century, and are still going strong. There are many reasons for insurers’ longevity, including fortress balance sheets featuring low asset leverage (industry assets averaging three times net premium) and conservatively-managed investment portfolios. These factors, combined with strong risk management, underwriting and actuarial discipline, are also responsible for insurer failures being relatively rare events. In 2022 there were only two insurance company impairments – FedNat Insurance Co. and Americas Insurance Co.

This year, however, several insurers wobbled, and some are down for the ten count. A review of the stories behind the troubles, especially in the Midwest, holds lessons and reminders for all insurers.

The second and third quarters of this year brought much pain to Wisconsin Re, Germania Mutual, Cameron Mutual, MutualAid eXchange (MAX) and United Home Insurance Company. Wisconsin Re’s surplus took a nose dive from $43 million in 2021 to $8.4 million at the end of Q2 2023. In the second quarter Germania’s surplus was cut in half. Cameron Mutual entered rehabilitation, as did MutualAid eXchange and United Home.

The troubles at Wisconsin Re did not stop at the door of the Madison-based reinsurer of farm mutuals and county mutuals. Wisconsin Re’s losses were enormous – in 2022 it had $76 million in catastrophe losses, more than in the four prior years cumulatively. This triggered a few dozen of the 87 mutual insurers it reinsured to seek other forms of capital relief. The protective Wisconsin Re aggregate reinsurance cover for its small clients – premium averages $600,000 per insurer – was not obtainable elsewhere. Starting in 2022, numerous Wisconsin Re clients pursued merger transactions to build some scale, efficiency, and access reinsurance.

Whereas the main driver of Wisconsin Re’s troubles was exceptionally bad weather, such as a powerful June 2022 storm, there were other factors, or pre-existing conditions, that weakened Wisconsin Re and its clients. First, expenses were exceptionally high. An expense ratio (expenses divided by earned premium) of 54% was about 20 points higher than at other insurers. Second, lack of geographic diversification at the county mutuals left them perilously exposed to catastrophe events in their footprint, exemplified by the 2011 Joplin, MO tornado that ravaged Barton Mutual. Third, the risk profile has changed, necessitating a shift in reinsurance strategy. Whereas the aggregate cover provided by Wisconsin Re protected cedents from the rising number of severe convective storms, it was crippling for Wisconsin Re. And finally, an unhealthy dose of optimism bias and survivor bias may have contributed to some Wisconsin Re clients believing that because they had survived for over 100 years, which is the case, they did not take early action when losses began to build in 2020 and 2021.

Leo Tolstoy’s Anna Karenina opens with “Happy families are all alike; every unhappy family is unhappy in its own way.” This truism applies to insurance companies – there is a common formula for insurance company success, but there are as many ways to fail as there are failures.

The fall of Wisconsin Re is not expected to generate a ripple effect and fell other insurers. Its circumstances are special, almost unique – a Midwest reinsurer of farm mutuals was protecting the surplus of its clients, and in so doing, exposed its own surplus, leaving clients struggling to secure reinsurance. Perhaps Iowa is becoming “the Florida of the Midwest.” But lest any insurer maintain “it can’t happen here,” the saga of Wisconsin Re and other recent small mutual failures is a reminder that long-term success is not to be taken for granted. Company boards must recognize pain when it happens, and respond accordingly. The risk profile is changing, with extreme weather bouts high on the list of emerging risks. According to research by the American Academy of Actuaries, the second most common cause of insurer insolvency, after inadequate reserves (58%), is mismanagement (41%).

Good corporate governance and management behooves directors and executives to control expenses, keep a weather eye on risk accumulation, have deep knowledge of risk, and hew to a sound strategy. To the extent they do these things they’ll be Tolstoy’s happy family.