THE SOCIAL CONTRACT IS BROKEN: WHEN INSURERS AVOID RISK AND REGULATORS SUPPRESS PREMIUMS

E91 THE SOCIAL CONTRACT IS BROKEN_ WHEN INSURERS AVOID RISK AND REGULATORS SUPPRESS PREMIUMS

Transcript

Dalton Anderson (00:01.388) Woke On A Venture Step podcast, we discussed entrepreneurship, into trends, and the occasional book review. There's a $200 billion gap between climate disasters and what is actually covered. That's not a crisis, that's a market failure. We're discussing an old system, how it's broken, and some radical new ideas that might create a solution. This is a spinoff from a conference I went to in September put on by the Insured Group.

during climate week in New York City. The insurer group was ran by Chris Lull and Charlie Segati. Appreciate the amazing panel that they put together. was many interesting folks and a great cohort of professionals that were very interested about climate and resiliency and building that into insurance. That being said, if Chris or Charlie, you hear this episode, please, please, please.

you're welcome to come on the show and discuss some stuff live. Before we dive in, I'm your host Dalton Anderson. It's episode 91. Last week was 90. And so we're getting a little bit closer to 100. We're almost there. Just keep listening in and eventually you'll get to 100 and you will be able to retire as the podcast listener. Put on

Dalton Anderson (01:34.094) I'm still dealing with this cough and that's unfortunate. So I have, I have taken cough syrup and I have taken quite a few lossages to soothe my cough demon so I can do this episode undisturbed. I'm sorry if that is disturbing to you. I also did some ginger tea to help me, help me get going, get my throat soothed. But anyways, what I was saying is this episode 91,

You're so close to being able to retire episode 90, but stay tuned. Set your feet up, throw the popcorn, take it out of the microwave and listen into this episode. And sooner or later, you'll be able to retire when you get to episode 100. If you don't want to retire and you want to keep going, that's fine. Just like and subscribe this episode or follow whatever your platform desires. They're nomenclature.

And this will get Spotify off my back. Spotify is all over me saying every time I upload an episode, it's like Spotify is like, hey, you're underperforming against your peers. I'm like, gosh, thanks. Thanks. Thanks, Spotify. I appreciate you. So that being said, let's talk about. First, the background on the market and how it's broken at the moment.

So think the first thing is to talk about three.

three authorities or three groups that.

Dalton Anderson (03:12.684) will dictate how insurance goes. So there's the insurance company, there's the DUI, and then there is the consumer.

And then there's this other thing called reinsurance that sits on top of a company typically for catastrophic risks, like carriers don't want to take all of that risk that happens when you have a hurricane and you can have this massive event, but it's a low likelihood that it happens. But even though it's low likelihood, insurance companies need to reserve what's called reserve.

that money on the books. so typically this stuff is outsourced to a reinsurance carrier, like a reinsurance group or a panel. And in a general sense is, and I think I said reinsurance carrier, ignore that. Just think about reinsurance panel or reinsurance group. They offer insurance to the insurance company.

and then the insurance company offers insurance to you. And then you offer insurance to your buddy. And before you know it, we're all making money and it's a triangle scheme. And no, that's not how it works, but that would be pretty funny. But in a general sense, they offer insurance to the insurance company and then the insurance company offers insurance to you. And basically the insurance company is basically covering

for similar things that you're covering for. Like, hey, if a hurricane hits my house, how can I pay for that? That's too much money. Similar thing that the reinsurance company is doing for the insurance company is, hey, what if my whole portfolio in the state of Florida gets hit with a hurricane? Like say like 80 % of it's damaged. How am I gonna pay for that? That's too much money.

Dalton Anderson (05:19.554) that ties up too much capital. Okay. So then you outsource it to the reinsurance group. So that's how that works. And then there is the insurance company that has to price what is called actually sound rates. And basically what that means is it takes a takes against in a general sense, it takes against expenses, losses, salary, future expenses, future losses, future salary. And then you price that all in.

and the price in also profit margin. The profit margin for a mid-lines, which is the more regulated part of insurance has a regulatory body that mandates the amount of profit that you're allowed. And so if you're trying to bake in too much, they'll be like, no, no, no, you can't do that. So

That is how that works. And it's similar to how an electric company works. You think about how regulated the price is towards your electricity provider is, because they have this pseudo-monopoly, or basically monopoly, on, or, Algo-poly, I think? Maybe I'm just saying that. It's life, whatever. But in a general sense, since there's a low amount of people, there's high barrier to entry,

and you need a lot of money to do it. There's not that many people offer it. So it's regulated. And it's also important to regulate it because you could invite fraudsters and all sorts of bad people and bad actors. And that's no good because insurance is really built on trust. so trust sometimes needs to be trust, but verify and you verify that with regulations, which is great. And there's the D.O.I., which are the people who regulate stuff.

So the DUI is the Department of Insurance who, let's say this.

Dalton Anderson (07:19.414) They specify the rules and regulations within their state. And so each state has a governing body of the DUI and the DUI approves rates and form changes, does all this stuff. Basically, if you want to do something and you're in the admitted lines, which is, as I said earlier, the more regulated part of insurance, which if you have a homeowner's policy or some kind of standard risk and you don't live in a catastrophic

prone area, like you don't live near the beach or you don't live near a place filled with wildfire risk or something like that, or with a lot of hail risk, you're probably insured by an admitted carrier. And so everything they do, how they underwrite, which is basically like, which risks do they want and which risks that they don't want, that's regulated, what forms that they have on your policy and the language on

to which that policy contains, that's regulated. Any of the rate changes that they wanna do, anything that they wanna add, all of that stuff's regulated and needs to get approved. And a lot of times that's slow moving, right? Like you're asking one group of people to approve all these changes, which sounds like a lot just for one company, but then you're asking them to do it for all of the insurance companies. So that's the general sense, like, DOI,

is to hammer, then the insurance company is the offer, offering of the insurance, the reinsurance company offers insurance to the insurance company. Okay, so we got that all settled. So then.

What happens is, as I talked about how we price insurance product, everything is historical. So what happens when things are not working in a historical sense, where current market conditions are not following historical trends? Well, that isn't necessarily bode well for insurance companies because insurance companies price with these historical trends. And so if

Dalton Anderson (09:35.873) they're substantially off trend, then they would be very underpriced, which is not good. And it's not good for the insurer. It's not good for the DOI and it's not good for the insurance company. So what do do when you're underpriced? Well, you've got to ask for rate changes. Okay. Well, if you're underpriced too much, then you have to file with the DOI. And then if it's a

a large rate increase, lot of states will ask for a hearing, like a public hearing. And it's like video recorded and it's quite like a legal thing.

Dalton Anderson (10:19.796) What can happen is if a lot of companies are substantially underpriced because there's a large change in the marketplace, like for example, California wildfires or Florida with the hurricane risk and the roof froth that was ongoing. Companies just either cease to exist. They go what's called insolvent or they

exit the marketplace. And the good example of that is State Farm exiting California.

Dalton Anderson (10:57.934) California DUI was very unreasonable with how they were going about mitigating the wildfire risk for the insurers. Like the things that you can and can't do. The ask of the California insurance companies to only price in, like you weren't able to price in your reinsurance costs and reinsurance costs in California are super expensive given all the wildfire risk.

Dalton Anderson (11:30.124) So you have this place that's really expensive to write business and then you can't raise rates because the DUI won't let you. And then you can't price in the costs of your re-insurance costs from the re-insurance company into your policy. So then what was happening was you were just losing money.

Then the DOI finally changed their verdict and said, Hey, you can price reinsurance costs, only, only with these market standardizations. But the problem is reinsurance costs are specified by like each individual, you know, it's, it's kind of like your genetics, like the portfolio of the company is like the genetics of the company. And so each portfolio is different. And so like, I can't say like, I can't pick somebody random off the street and just say, okay, like you,

me and you, we're going to be the same and it doesn't work that way. So that's a problem and that didn't work. And so long story short, the whole situation was mismanaged by the DUI and getting strong-holded by watch groups without fixing the issue. So then a lot of these large companies were like, Hey, we cannot continuously lose money. We're a business.

And so they left. And that's similar to how Florida was like Florida is recovering from just this market, market like failure, like a fundamental market failure in Florida because the DUI wouldn't act and the DUI wouldn't do the things that they needed to do to fix the issue. So insurance companies left. And when I say insurance companies, it's really

the admitted insurance companies. then so when admitted insurance companies left, then it creates a void because people need insurance no matter what. It's a fundamental part of life. Like if you need a loan or you need to do anything, there's any speculative risk, then you want insurance. And so...

Dalton Anderson (13:43.117) there is an opportunity for these companies to enter the marketplace, but they don't offer as much coverage. They don't offer the same form, form language. A lot of things are excluded. They pick and choose what they cover. They're not regulated. And so there's all these problems, but the big problem is,

Insurance companies and the DUI and the reinsurance groups, they all have different perspectives on how things should be treated. And at the end of the day, like the insurance or the insureds are at this tug of war between all these different perspectives and interests. And at the end of the day, they just want insurance at a reasonable price. Like if you could tell me what do I need to do to get insurance at a reasonable price?

I think a lot of people would be pretty reasonable on, what do I do? And then I'll do that. And there's a lot of initiatives to make that work.

Dalton Anderson (14:49.762) But the key problem here is

companies don't once they leave, they don't feel comfortable coming back until they figure out what's going on historically. But since there is not historical data, then they can't really come back and price things. And so what's happening is there's just a complete lack of supply, which drives up price, which you're seeing in the marketplace in Florida, California, specifically, and are these other catastrophic prone areas. It's just a super duper expensive to get insurance in

in those states, either from auto or from home to pretty much anything across the board. It's really expensive.

So then how do you, how do you combat that? Like, well, there is this thing called the insurer of the last resort or fair plans. So a lot of these States for the emitted carriers, your policy, and so your insurance policy has a fee that they pay a certain amount of the premium gets paid into the fair plan. And the fair plan is the reserve that goes to

the insurer of last resort and that would be like, it's a group called like citizens or whatever they call themselves. It's the insurance group of last resort and.

Dalton Anderson (16:28.044) These plans are not designed to take everything within the state. I could take all the high risk. They're designed to be a buffer for gaps in the marketplace where the market figures out what to do. But what is happening is that there's this complete.

absence of capacity to cover all this risk or appetite. And so a lot of these risks are being shoved into the fair plan. And the problem with the fair plan is that that's us. Like when you talk about the insurer of last resort, that is the citizens within that state, they're paying into the fund. And if something goes haywire and there's a massive claim,

Like if there was a massive hurricane for Florida.

Dalton Anderson (17:26.966) It's a big deal because it would bankrupt the state. There's not enough coverage to do this. They don't have enough money. they're taking on too much risk. And there's a whole bunch of issues. It's a big, big deal. And another issue with the Fair Plan is there's less coverage. They're underfunded typically. They're politically vulnerable. They're ill-equipped to handle this level of concentration of risk.

their temporary.

fixed to a problem, as I said earlier, as the market figures out what to do.

So.

There's just a systematic failure. There's not enough coverage. People are running away from covering areas that have catastrophic risk because one, there isn't enough collaboration between the DUI and insurance companies like, hey, what would make you feel comfortable coming into these areas and covering the risk? And what do I need to do to get out of your way, et cetera, et cetera? All those things. Really, everyone's protecting their own interests like,

Dalton Anderson (18:39.146) even if you wanted to cover risk in these areas, then you still would have to get the DUI to make sense of it all. Then you still would have to get the reinsurance companies to feel comfortable with it. And so you've got to appease all these perspectives and differ in opinions to move forward.

So the core of the problem is traditional insurance is relying on historical data and climate change has made the future fundamentally unpredictable. And so the only way that we could predict it is just say, Hey, it's going to get worse before it gets better and it's just going to get worse. And so the trends are, it's going to get worse, which is, which is not awesome, but it's not horrible. But the insurance,

industry is just trapped in a vicious cycle of

Dalton Anderson (19:37.817) just massive losses, then sharp premium hikes, then market exits. That's kind of how it's going in these catastrophic areas. And so there's no incentive, people are incentivized to make changes. So since that, in a general sense, is that because the insurance company needs lots of years of information, like historical trends, all that stuff, there is,

often not an incentive to try something outside or outside the box to mitigate risk.

And so insurers don't have, they're incentivized to avoid risk, fleeting the markets to protect their balance sheets, right? So not to manage and reduce risk. Regulators are often under political pressure to artificially suppress premiums to protect customers. Customers, their suppression feels like a false sense of security, hiding the true cost of the risk and incentivizing the development in high risk areas. The result,

the social contract of insurance is broken because the risk right now in this conversation is insurance companies are avoiding the risk to protect their balance sheets, regulators are artificially suppressing the risk, suppressing the premium, sorry. And then customers feel like the rates are just rising out of the ground, into the sky.

But really it was the regulators are like automatically or artificially suppressing the rates for you. And then it comes to the place where the market just absolutely plummets and then there's not enough supply. And then the DUI has no choice but to release the

Dalton Anderson (21:43.596) the chains and let it rip. And then when it rips open, it's under so much pressure that it just all explodes.

Dalton Anderson (21:55.447) So.

Dalton Anderson (22:00.658) There was a conversation of getting rid of the fair plan in the conference, which I thought was interesting, right? Like they talked about all these things and how the fair plan isn't good and that it's just a failure and people are, I wanna say people, companies are going into the fair plan and they're taking out the best risk and they're leaving the other stuff and the stuff that.

Doesn't get picked up, never gets picked up.

And so they talked about this thing called the Community Development Reinsurance Institution, CDRI.

and

Dalton Anderson (22:45.484) It was interesting. It's the first I've heard about it, but it's been around before. I don't think it's been utilized in a global scale. When I say global scale, like maybe a statewide or something like that. But I think there was some pilot programs back in the day.

Dalton Anderson (23:08.59) Sorry, my coughed even.

But in a general sense, it's to transform the product.

the relative insurance product to be reactive for planning losses into a proactive system, is like financially incentivizing resilience.

And there's some things where

Dalton Anderson (23:38.083) That works great. And I think the best example I can think of is I had utilized for my grandma, hey Nana, say grandma, I know, I know, I know, you're not my grandma, you're my Nana. But some people don't know what Nana is, okay? So it's just better I just say grandma for that one. But so my Nana, it lives in older home, the windows are older and.

the exterior windows and entry points like the garage and the doors were not impact ready. They weren't impact rated. And the state of Florida rolled out their hardening program that they wanted homes to be hardened for hurricanes. And, and so they put out a grant program, say, Hey, you spend 20, we'll give you 10. And so

Dalton Anderson (24:34.144) But you'd have to use like the specified vendors and it's a big list of any or it wasn't like, all right, I'm to put this grant program together and then the company that I'm partnered with is going to be the one gets selected. It wasn't like that. But so we use this program.

Dalton Anderson (24:52.758) Sorry, I didn't get water. We use this program to harden my Nana's home. So my Nana was able to get new doors and windows and a garage door. And that translated to her having less risk for her property where there was less and a new roof, by the way. So she had a lot less risk on her property because she had a new roof.

She's got new windows, new entry points, everything is hurricane. Hurricane rated.

ZipList here in a really good spot.

And that makes her property more insurable. And so that's kind of an example of this community development group, the reinsurance institution, it's more substantial than that, but that's like a groundwork example that I can think of is where it creates an ecosystem for this public

private partnerships to, you you're accepting like lower financial return in exchange for positive societal impact and creating a more resilient society in general. And when we're talking about more resilient, they're talking about risk, being more risk resilient. So that could be by offering these grant programs for hardened homes, this could be offering

Dalton Anderson (26:31.434) loans with better terms on risky disenfranchised folks. goes in all groups and all things of life about what it means to manage risk and like going to the places that the either insurance companies or financial institutions don't want to go because they don't trust that they have enough data or

they don't trust the situation or they don't like that risk. The only way to really push these big companies to do that is to show that it can be done. And so that's what they were talking about is like, all right, like we're gonna ensure these things that people typically won't do or we'll provide these bonds to these companies to

allow them to grow and have better terms. And once this gets caught on, like these larger companies will start taking our place. And that's awesome because it's, it's to provide coverage and or financial support where the traditional markets won't funding new climate tech or resilient projects that the private sector won't, won't cover.

And if it's purely just private sector, it's profit driven, but if it's private plus public partnerships, then it has less of a financial incentive than it would normally.

Dalton Anderson (28:17.762) but it's based on this community development model for financial institutions.

And one of the metrics that they cited in their paper, their white paper, was for every dollar in public funding awarded by a CDFI fund attracts $8 in private sector investment. And so the general sense is like, you fund these ideas, if you lay out the honey, the bees will come. I don't think maybe the bears, because bees

I don't think bees come to their own honey, but if you lay out the flowers, the bees will come. So they're laying out the flowers, the bees come and the bees make the honey. And that's like, all right, get your seeds, get your water. Those are your dollars. And then the bees come and they make the honey. That's where you get the eight bucks.

Dalton Anderson (29:22.114) But it's really an interesting topic. I would love to learn more on how it works in a functional fashion. I'm not necessarily too certain. It wasn't a detailed topic cover in the conference. But there are some things that were covered that I thought were interesting. And they're about individual companies and some kind of examples of how they've created innovative projects with the funds that

the group has provided. So this company is spelled Q-I-X-E-N-T and they provided a sunshine guarantee. And we don't have to get into the technicalities about like how this all works behind the scenes on the insurance product. But basically it's a parametric style warranty. And all that means is at point of sale,

of the solar panel, they are providing the sunshine guarantee offer. And so it's an add on kind of like, Hey, do you want the heated seat package or the sport package? It's more like, Hey, do want the sunshine guarantees package? And basically, it predicts saying basically a lot in this episode.

It predicts your sunshine that you potentially might get throughout the year, which then translates to your energy that you would get. And so it says, hey, here's if everything goes to plan, this is how much energy you should produce. If you don't produce that much energy, we'll cover you. And so.

what that does.

Dalton Anderson (31:14.926) Oh man, I coughed. Sorry, my cough even got me. I'm gonna take a swig of water.

Dalton Anderson (31:27.02) Okay, so what that does is it makes people feel more comfortable purchasing solar because the first question that people have is

Who's going to maintain it? And then what happens when I don't get enough sunshine? Who? What do I do? It's not really who is going to pay me. It's it's what do I do? And a lot of times it's like, well, I don't know. I mean, I know we'll come once a month and look at your look at your setup. But if you don't get enough sunshine, that's not on me. So it makes people feel less inclined to take the leap.

to jump.

So it removes the key anxiety for customers that are worried about the

Dalton Anderson (32:22.456) build or the amount of sunshine they'll get and it accelerates the adoption of this technology. There's another company called EV Star.

EV Star is a company that provides coverage on charging stations. And basically their whole thing was pretty cool, but I said basically, my gosh, it's killing me on this. It's my coffee. It's threw me off. But EV Star creates this product that monitors these charging stations and then comes out and replaces whatever the components are and

guarantees that it's back up and running within 24 hours. And what happened before EV Star was a thing was a lot of times charging stations would be down and there would be no one there to fix it. And that was because the big EV rush. We all remember that. There were so many companies that were worth billions of dollars, the unicorn of unicorns, and everyone was pushing to go public and some companies did go public and some companies were...

fraudulent and all sorts of nonsense going on with EVs.

Well, there's also the same thing going on with charging technology and charging stations. And so there was quite a few providers that were selling these charging stations and then they went bankrupt. And then so then there's no one to maintain them. And so whatever warranty these people bought, it's no longer in existence. And so they're holding the bag and they're typically not somebody who knows how to maintain a charging station because

Dalton Anderson (34:10.402) they might just be someone who owns gas stations and they wanted to get in the EV space or something like that. And so what happens is people feel more, less comfortable and they get range anxiety because, well, if you can't charge up, then you can't go anywhere. And so it was real problem because charging stations were down. And so that doesn't necessarily help with EV adoption. Adoption? Adoption.

adoption. And so that's where EVstar comes in and they provide a reliable charging network that DRIS

the issue of charging networks being dumb.

Dalton Anderson (35:01.516) Those are my two examples that I thought were pretty interesting that were pretty simple to think about, but I really enjoyed the conference. I don't think I did a justice talking about the CDRI, C D R I or what, what examples they provided and the details that they were able to provide in a short hand summary, but it was quite interesting and would love to learn more.

And the two companies that I talked about had cool products and were part of their resiliency program that I thought was really cool and well put together. And there's also a couple of things like scientists and different groups. And it was a amazing conference. I thought it was very thought provoking.

Let me know what you thought about this episode. I was kind of all over the place. I'm choking on my, my loss. It's just like stuck in my throat or something. It's pretty uncomfortable, but really appreciate you listening to the episode. And of course, wherever you are in this world, good evening, good afternoon, good morning. Thanks for listening and listening next week.