Subprime Crisis Could Lead to Higher Insurance Rates
WASHINGTON — In a bid to save the world's largest economy from recession, U.S. President George W. Bush and central bank chief Ben Bernanke yesterday endorsed a $100-billion stimulus package as the spreading housing mess continued to hammer banks, consumers and investors.
Despite the words and deeds of some of our elected officials, it looks like the country is truly heading into a recession. The subprime mortgage debacle truly damaged America’s financial stability. Lenders taking advantage of temporary post-9/11 consumer prosperity offered adjustable rate mortgages to people with shaky credit. When the markets shifted (as they inevitably do,) the rates of the mortgages went up, which meant that thousands of homeowners could no longer afford their monthly payments. And since real estate prices were at artificially high levels, it meant that people who couldn’t afford their monthly payments also couldn’t re-sell homes that were overpriced. The end result of this was that people were defaulting on their loans by the tens of thousands.
This lending practice sounds like the sort of thing that a shady strip-mall lender would engage in, but some of the largest and most reputable financial institutions in the country were knee-deep in subprime mortgages. Citigroup, which is the largest bank in the United States, recently posted a record loss of ten billion dollars. Countrywide Financial, which was one of the largest mortgage lenders in the United States, suffered staggering losses before being bought out by Bank of America for four billion dollars in stock.
What this means is that the stock market is taking a beating. Investors both small and large start to panic and start selling their shares to get what they can while they can, and this causes the market to drop. Since the majority of large corporations does their fair share of investing their profits, companies that don’t have anything to do with real estate will also be taking financial hits. And this includes insurance companies.
As an example, Nationwide invested $864 million in subprime backed securities, and Allstate had about $4.8 billion invested in the subprime backed bond market. Both of these companies saw the value of their stock drop significantly. Many of you may be wondering what their bad investment strategy has to do with your insurance premiums, and the quick answer is “everything.” As attorneys that are in litigation with insurance companies on a regular basis, we can tell you that we’ve seen this sort of thing before.
In the first half of the decade, medical malpractice insurers nationwide raised their premium rates to astronomical levels, so much so to the point that some doctors couldn’t afford to pay. The reason given by the insurance companies for the rise in rates was almost unanimous: “Frivolous Lawsuits.” Public Relations firms, lobbyists and advocacy groups nationwide told tales of greedy trial lawyers encouraging people to file ridiculously overblown lawsuits, and created what was called “The Medical Malpractice Crisis.” Their aim was to get friendly legislators to place “caps” on damages, and in many states they succeeded.
The problem was, there wasn’t a rise in medical malpractice lawsuits. There wasn’t a huge spike in the amount of money paid out in judgments or settlements. The only “crisis” faced by medical malpractice insurers was the fact that their investments performed poorly thanks to a decline in the bond market.
They find themselves in the same situation now. Insurers of every stripe have lost money due to market decline. And since insurance companies are not known for “tightening their belts” or making sacrifices, you can expect premium rates to rise over the next six months or so. There will probably also be a well publicized “crisis” of some sort to justify the rate hike.
A recent report by the industry-funded Coalition Against Insurance Fraud notes that with "untold thousands of homeowners struggling with ballooning subprime mortgage payments, fraud fighters are watching closely for a spike in arsons by desperate homeowners who can no longer afford their home payments." CNN, 1/10/2008
That should do for a start.