Insurability Issues Detour Truckers

By Doug Voss

The trucking industry is faced with a crisis of insurability in the commercial automobile liability market. To a great degree, this crisis results from nuclear verdicts coupled with fewer insurance underwriters. Furthermore, while the trucking industry pursues various remedies to address nuclear verdicts, Congress is seriously considering an increase in truck liability insurance.

A provision in the Moving Forward Act, passed by the US House of Representatives on July 1, 2020, would raise the minimum coverage level for general freight from $750,000 per accident to $2,000,000 per accident.  This is occurring despite the need for more underwriters willing and able to insure trucking companies.

Many insurance rating agencies exist but AM Best is likely most utilized. However, AM Best tends to primarily rate larger underwriters rather than smaller, more regional providers.  Smaller trucking companies may particularly benefit from the ability to procure insurance from the smaller, regional providers typically reviewed and rated by Demotech.

To evaluate the efficacy of Demotech, I have completed my review of Cole et al (2011) as well as Barth and Klein (2018). Evidence presented in these works points to the similarity of AM Best and Demotech ratings. Further, comparable AM Best and Demotech rated insurers had nearly equivalent impairment rates. Based on findings contained in the aforementioned articles, I believe utilizing Demotech’s ratings as a supplement to the exclusive use of AM Best would provide a valuable and reliable service to the trucking industry.

Background

Many insurance sectors including the trucking industry are faced with a crisis of insurability.  This crisis is caused by several factors including nuclear legal verdicts and a reduction in the number of insurance underwriters willing to insure trucking companies. Greater risk combined with fewer insurance suppliers leads to higher insurance premiums, a factor cited in many recent trucking bankruptcy announcements.

Efforts are underway to improve both risk and insurance underwriter supply. The risk of nuclear verdicts can be reduced through improved safety management practices and tort reform. Increasing the supply of underwriters could be accomplished by accepting additional financially sound insurers to write trucking policies.

Trucking companies are required by shipping partners and regulatory agencies to maintain insurance coverage. Insurance rating agencies are tasked with determining the likelihood that underwriters have the ability to pay future claims. Insurance rating agencies include commonly recognized names such as S&P, Moody’s, and Fitch as well as less recognized but just as important firms such as AM Best and Demotech, Inc. AM Best is likely the most widely accepted insurance rating agency. Demotech was founded in 1985 and, since 1989, has focused on the review and analysis of smaller, more regional insurance underwriters.

To the extent that a) AM Best prefers to certify larger insurance underwriters with broader geographic reach and b) trucking companies are forced to purchase insurance from AM Best certified carriers then c) trucking companies are deprived of the opportunity to purchase insurance products from smaller underwriters such as those rated by Demotech.

If AM Best prefers to rate larger insurance underwriters at the expense of smaller companies, it likely does so because larger underwriters are perceived to be more secure, i.e., larger asset reserves would improve the underwriter’s stability and lessen the likelihood of underwriter impairment. Impaired underwriters are those that may not meet their future claim payment obligations.

However, if AM Best and Demotech use similar criteria to rate underwriters, then impairment likelihood should be roughly equivalent irrespective of underwriter size. Although smaller underwriters would likely cater to smaller trucking fleets, their participation in the marketplace would increase competition and drive down the price of insurance coverage.

As an academic member of the Arkansas trucking community, I was asked to provide my impressions of “A Comprehensive Examination of Insurer Financial Strength Ratings” (Cole et al 2011) and “Report on Calculation and Validation of Insurer Impairment Rates for Demotech, Inc.” (Barth and Klein 2018). These articles broadly compare criteria used by the major ratings agencies and document the similarity of AM Best and Demotech impairment rate outcomes.

Both articles are available either online or with Demotech’s permission. As such, I will not delve deeply into either and would refer interested readers to the articles themselves. My primary goal is to give an opinion on their work.

This work begins with a review of Cole et al (2011) then Barth and Klein (2018). An appendix is subsequently presented comparing longitudinal impairment rates for AM Best and Demotech rated underwriters.

A Review of: Cole, Cassandra R., Enya He, and Kathleen A. McCullough (2011), “A Comprehensive Examination of Insurer Financial Strength Ratings.”

Cole et al (2011) was published in The Journal of Financial Perspectives: Insurance. There is no journal description provided in the article’s online version. The journal appears to be published by Ernst & Young’s Global Financial Services Institute. I am unable to ascertain if the Journal employs a double blind peer-review process, which is the standard of trusted academic journals, but Ernst & Young is a well-regarded organization and I would tend to have faith in their editorial process. Further, based on their biographical information and curriculum vitae at the time of publication, the authors are qualified to conduct this research.

Cole et al (2011) is based on the premise that two general types of ratings exist: unsolicited and solicited. Unsolicited ratings appear to be based on publicly available underwriter information. Solicited ratings appear to be based on additional information gathered by the rating agency that is not publicly available.

Demotech provides a provisional (similar to unsolicited) rating to a large number of underwriters regardless of size or geographic coverage. Provisional ratings remain confidential unless the underwriter finalizes the rating. Demotech only publishes finalized ratings (similar to solicited).

The authors sought to accomplish several goals but examination of characteristics that most influence solicited ratings is the most germane to this report.

Ordinal probit modelling (i.e. regression with an ordered dependent variable) is used to determine the influence of eighteen (18) variables on underwriter ratings. The variables are generally classified as organizational characteristics (5 variables), business mix (4 variables), business risk (5 variables), and financial strength and flexibility (4 variables). Statistical significance is the first test of whether a variable is influences an agency’s ratings. However, the variable’s valence is also important: a variable may positively or negatively influence ratings.

Cole et al (2011) examine both provisional (unsolicited) and finalized (solicited) ratings. They find that Demotech’s ratings most closely resemble S&P and Fitch. However, they do not employ statistical inference to determine similarity.

The following table draws from Table 7 in Cole et al (2011) and compares Demotech’s finalized (solicited) criteria influence to that of the other ratings agencies. Note that the analysis below is my own and not contained in Cole et al (2011).

Doug  Voss, Ph.D is Professor of Logistics and Supply Chain Management. Scott E. Bennett, Arkansas Highway Commission Endowed Chair of Motor Carrier Management, University of Central Arkansas