The General Accounting Office inflated its new estimates of insurance industry profitability by adding in unrealized capital gains, an official of Insurance Services Office Inc. said.
Mavis Walters, senior vice president of the company, which compiles data for the property insurance industry, told a House subcommittee Tuesday that the congressional investigating agen cy's method increases its earnings figures improperly.The GAO Tuesday released to the committee its report on the insurance industry's condition, finding that the industry earned high profits on
investments despite billions of dollars of losses on policies.
Since 1975, GAO said insurers earned $81.1 billion in after-tax profits including $19 billion in 1986, when the liability insurance crisis was at its peak.
Ms. Walters argued that the accounting profession uses the same calculations that the insurance industry uses in which capital gains are not considered income unless the income is realized.
Policy holder dividends are also added into earnings figures by GAO, she told Rep. Dennis Eckart, D-Ohio, rather than subtracted as expenses.
The Insurance Services Office calculates that the property-casualty insurance industry had a net income of $12.6 billion in 1986, or a 13.1 percent return on net worth. Using generally accepted accounting principles, this level rises to $14.3 billion.
In contrast, Assistant Comptroller General William J. Anderson told the Energy and Commerce subcommittee that its calculations show $19 billion in net income.
J. Robert Hunter, president of the National Insurance Consumer Organization, supported the GAO calculations.
But Rep. Howard Nielson, R-Utah, criticized that support, saying that other industries do not add unrealized capital gains into their income calculations.
Ms. Walters told Rep. Eckart that she agrees with the GAO conclusions that return on net worth over the long term for the insurance industry is at the
average for other industries.
But she said if data from 1970 through 1986 is analyzed, the trend shows that property/casualty insurers have slightly under-earned.
In bad years insurers have very low returns, she said, while in good years return on investment is only slightly better. She cited the industry's 13.1 percent return in 1986, compared with 11.6 percent for the Fortune 500 companies.
The GAO calculations revealed to the subcommittee Tuesday indicate that when reserves set aside to pay future claims are discounted for the interest they will earn, both the medical malpractice and general liability sectors earned money even at the height of the insurance crisis.
Using figures for the 11 years between 1975 and 1985, Mr. Anderson and Nat Gandhi, GAO group director of tax policy, calculated $14.19 billion in net premiums earned for medical malpractice and estimated interest earnings of $4.35 billion.
If reserves are not discounted, there were losses of $653,000 with adequate reserves, $1.25 million if reserves were 10 percent inadequate and $1.84 million if reserves were 20 percent inadequate.
But when reserves are discounted, there were profits of $2.17 million with adequate reserves, $1.86 million with 10 percent inadequate and $1.55 million if reserves were 20 percent inadequate.
Those figures exclude the controversial unrealized capital gains, Mr. Gandhi said.
Subcommittee Chairman James Florio, D-N.J., indicated he sees no problem with discounting reserves being the rule since Congress ordered discounting for tax purposes last year.
Ms. Walters told Rep. Nielson only a few companies offer medical malpractice insurance. If that coverage was really profitable, she asked why would hundreds of insurers not move into the business to reap these great profits?
Mr. Hunter argued that the profits are there and insisted that the industry is able to create an insurance cycle in which price cutting leads to a need for sharp price increases because it is protected by the antitrust exemption enbodied in the McCarran-Ferguson Act.
He maintained that companies, when they could earn high interest, cut rates for insurance below costs because they could return to joint rates calculated by the Insurance Services Office and recoup when needed.
The price cuts are deeper and the duration of the price cutting longer than would be the case in the free market because the price cutters know that they can always return to the home base of the ISO rate, Mr. Hunter said.
That view contradicts recent findings of the Justice Department's Antitrust Division that found no evidence of collusive behavior.
Mr. Hunter argued that the cycle is swinging upward toward a return of insurance availability, even in the environmental area.
That conclusion was disputed before the House Small Business Committee Tuesday by Frank B. Swain, chief counsel for advocacy of the U.S. Small Business Administration.
He testified that in addition to the problems with specialty lines of insurance which have received much public attention - product liability, environmental impairment, malpractice and errors and omissions, obtaining general liability coverage continues to be a problem for many small businesses.
At the Small Business Committee hearing, Raymond Hayes, president of The National Association of Insurance Brokers Inc., also disputed the thesis advanced by Mr. Hunter.
I doubt that the marketplace would have reacted any differently in the last cycle whether or not McCarran-Ferguson was the law of the land, he told Rep. John LaFalce, D-N.Y.
It must be remembered that insurance is a commodity subject to the normal economic fluctuations. When capacity is plentiful, consumers benefit from low premiums and ample coverage. When capacity is down, costs for buyers escalate.