82 SQUIRES, DEWOLFE AND DEWOLFE the case in the early 1970's, companies must restrict their underwriting so that they are not, in effect, financially overextended (Alliance of American Insurers, 1977). Mergers and Moving Capital "Upstream" ...... Another limiting factor on the amount of insurance available is merger activity in which an insurance company's surplus is utilized to meet other financial obligations of a parent corporation. For example, when National General acquired the Great American Insurance Company in 1969, it paid a $174 million dividend from Great American's surplus. Similarly, soon after Insurance Company of North America formed its own holding company, INA Corporation used $175 million in surplus to acquire a bank, three manufacturers of fire prevention equipment, an interest in nursing home development, real estate and other assets. As Stevenson has shown, between 1969 and 1973 two and a quarter billion dollars moved upstream from insurance companies to their parent organizations. The overall condition of the stock market, the investment whims of a handful of major capital accumulators, and other highly complex factors having little or nothing to do with the insurability of risks or the demand for insurance all actually restrict the availability of essential property insurance (Stevenson, 1977a:166–174; 1977b:166). CONTRASTING PERSPECTIVES IN THE REDLINING CONTROVERSY The main focus of the redlining debate, however, and the one of most interest in our eventual analysis of recent Chicago data has been on the underwriting process itself and its effects on insurance availability, at least in certain markets. The underwriting process is the procedure through which an insurer decides if an applicant (or a class of applicants) is eligible for insurance, and if so, under what terms. The effects of such decisions are most evident in the marketing practices of insurers. Studies conducted by community organizations and state and federal officials have identified a variety of industry marketing practices which directly and indirectly restrict insurance availability within older neighborhoods in Chicago, Detroit, New York, New Haven, Cleveland, Philadelphia, Boston, Buffalo, Seattle, Milwaukee, St. Louis, Hartford and other cities. Such practices include: selectively placing agents' offices and "territories," and selectively refusing to insure property (or varying the availability of insurance) on the basis of age of a building, or the fact that the applicant has been rejected by another insurer, or had previously been insured through a FAIR Plan. [The FAIR-Fair Access to Insurance Requirements-Plan was established by Congress in 1968 as an "insurer of last resort" for those risks unable to obtain property insurance from a private insurance company (Federal Insurance Administration, 1974: 25; U.S. Commission on Civil Rights, 1979: Chapter III).] They also include: requiring inspections in certain communities but not in others, varying the price of insurance by area in such a way as to make coverage unaffordable, terminating agents and not renewing policies placed by those agents, and simply refusing to insure within designated geographic locations. Because it is the marketing activities of insurers that are the most visible and most directly touch consumers, it is not surprising that they are at the center of the public controversy over insurance unavailability and redlining. The industry and its critics alike acknowledge the legitimacy of charging some people more than others for insurance and agree that geographic location is a key factor in current underwriting activities. They differ considerably, however, in their understanding of how underwriting decisions are currently made and in their interpretations of the public policy implications of those decisions for urban communities. The Industry Viewpoint Industry representatives don't all agree about what redlining means, how extensive it is, and what the industry's responsibilities are; but they do have a consensus on certain key concepts. First, it is recognized that insurance is a mechanism for sharing risks (Jones, 1977:3; State Farm Urban Decline or Disinvestment 83 Companies, 1977:19); in essence, everybody pays a little so nobody is forced to pay much. However, not everybody pays the same. Individuals are expected to pay premiums commensurate with the level of risk each represents. While impossible to predict losses for an individual, it is possible to estimate general losses certain types of individuals will suffer. Risk classifications are developed to determine which types are insurable and which are not, and to determine the premium to be charged those who are insurable risks. Insurers assert that by developing risk classifications large enough to be credible yet small enough to be homogeneous, companies do discriminate among various types of risks but only so that individuals pay their fair share of anticipated losses (Casey et al., 1976; McGuffey et al., 1978; Rogers and Brunner, 1977). In emphasizing the difference between fair and unfair discrimination, industry people argue that fair discrimination (e.g., varying insurance premiums according to the objectively determined differentials in risk exposure represented by the various classes of risks) is a sound business practice. At present, to develop rating classifications on any basis other than objectively determined loss exposure constitutes unfair discrimination and violates basic insurance principles, and many state laws (Pugh, 1975:3, 4; Alliance of American Insurers, 1978:19). So, they argue, a decision, e.g., not to write insurance in a particular region of a city or a decision to charge a higher rate in that region, may be unfair from some social policy standpoint. But it would be fair in an insurance sense because "territorial rating is supported by a body of credible statistical data and is an equitable and sound principle for predicting future losses" (American Insurance Association, 1978:3). Industry representatives acknowledge that, in order to be credible, risk classifications must be based on objective data. They assert that it is evidence on actual loss experience and similar empirical data that is used for determining risk classifications. As two officers of the National Association of Independent Insurers recently stated: the insurance industry refrains from moral pronouncements about its customers. We measure risk as accurately as we can, applying experience and objective criteria refined for more than two centuries (Faulstich and Hall, 1978:7). Industry representatives do acknowledge that there is an insurance availability problem in older, urban communities and that racial minorities are more severely affected than the majority population (National Association of Insurance Commissioner 1978:4). But they stress that the industry is in business to make a profit and that decisions to write a policy or to charge a given price are based on sound actuarial principles and objectively determined loss experience. To make more insurance available to communities that critics see as underserved would require the industry to write relatively unprofitable policies and thus increase premiums generally-forcing "good risks" to subsidize "bad risks." Such subsidization would involve the industry in the development of social policy, an activity industry claims is not its responsibility. If "society" deems that actuarially unsound risks should be written, then -through its government-should subsidize those risks, rather than having private industry do so State Farm Insurance Companies, 1977:26; Casey et al., 1976:4). A crucial point of ideological consensus within the industry that insurance services can be most effectively provided to the public by private industry in a Competitive market. Publicly operated programs are deemed less efficient and governmental regulations in general are seen as encroachments on the market, which do little more than raise the price of the product for the consumer (American Mutual Insurance Alliance, 1976). Adequate rates, therefore, are the real key to making more insurance available. Unless insurance providers can earn adequate profits, insurance consumers will suffer. In general, the industry's representatives argue, "profit is the necessary cornerstone upon which social responsibility can be built (Advisory Committee to the NAIC Redlining Task Force, 1978:5); and they frequently emphasize that the industry did experi 83 888 84 SQUIRES, DEWOLFE AND DEWOLFE ence underwriting losses from 1974 through 1976 (Business Week, 1978:66-67). They also tend to assume that if consumers understood the nature of the insurance business better, particularly the underwriting function, then they would realize that what they misinterpret and criticize as redlining is simply sound business practice in their own interest. In other words, insurers maintain that the charge of redlining is basically a misperception on the part of uninformed citizens. The Industry's Critics Some observers have raised serious challenges to industry claims that its policies are based on objective evidence, statistical credibility and social neutrality. One criticism is that as companies compete by identifying the smaller subgroups of the population representing better risks (and shunning other risks), they actually create rating classifications too small to be statistically credible. Such practices, most common in automobile insurance, also obviously vitiate the concept of risk spreading (Federal Insurance Administration, 1974:54; Stone, 1978:2). So some critics label what the industry tries to represent as underwriting rules as "myths" or as "perceptions" based on "gut feelings” rather than objective, empirical data (Jones, 1977:10; Valukas, 1977:16, 22). An example is the following statement from the underwriting manual of one insurance company: There is also the type who has never lived anywhere but in a rural area. He commutes to an industrial plant, does odd jobs, lives on relief or lets his wife make the living. You can usually spot his place. Sometimes in the summer he can be seen sitting on his front porch without his shirt. He is not a good risk (Levin, 1978:8, 9). The practice of establishing general rates for particular geographic regions within cities has come under special attack. It is argued that an agent or company may draw vague conclusions about a particular neighborhood, community or other region, and then refuse to provide any service there regardless of the actual risk exposure represented by individual risks (Yaspan, 1970:219, 252). As a Michigan Insurance Commissioner stated, "no amount of home repair or improvement will make the resident of a redlined neighborhood eligible for homeowners insurance" (Jones, 1977:5-6). One investigator concluded that agents frequently acknowledge there is no statistical basis on which communities are labeled as good or bad, but still utilize territorial classifications in their sales activities (Valukas, 1977:16, 22). One clear negative consequence of using territorial classifications (and such criteria as an applicant's age, sex or occupation-utilized by the industry but ordinarily beyond the control of the individual) is that such a practice provides no incentives for customers to try to reduce losses. Instead of being an economical mechanism for encouraging responsible behavior, then, the critics maintain that such insurance becomes an expensive "cost-plus" way of "servicing" a continually increasing claims load-to the detriment primarily of inner city residents, who are either priced out of the market or can't find insurance for sale at any price (Stone, 1978:5). Further emphasizing what they see as subjective, arbitrary practices common in the insurance industry, critics argue that the industry is in fact deeply involved in matters of public policy and is involved in such a way as to discriminate unfairly, from both actuarial and social policy viewpoints, against residents of older urban communities. One result is the further deterioration of central cities (Stone, 1977:153, 154; Stone, 1978:5; Etgar, 1977:19, 20). In response to the industry's concern for adequate rates and the fact that underwriting activities recently lost money for three straight years, critics note that the industry still earned a profit -from its investment activities—and that rates should be based on total earnings, not just those from underwriting activities (Sharp, 1975). For example, in 1976 the property casualty insurance industry lost $780 million in its underwriting activities but earned $2.8 billion from investments, while paying out only 66 cents in losses for each premium dollar earned. The underwriting losses reported included approximately 20 cents in commissions and 15 cents in other administrative ex Urban Decline or Disinvestment 85 penses for each dollar earned (National Association of Insurance Commissioners, 1977). The critics conclude, then, that redlining by insurance companies is a real phenomenon, rather than a subjective misperception by misinformed consumers. In summary: the industry contends that its underwriting activities are based on objectively determined loss related characteristics of individual risks. In the process, insurers claim, they are forced to respond to uneven societal conditions which already exist, and what their critics perceive as unfair discrimination is simply a response to market conditions: as losses increase in certain areas insurance premiums must rise commensurately. Better communication with consumers, therefore, should defuse much of the redlining controversy. The critics contend, however, that those in the industry actually rely on very subjective perceptions of group (e.g., neighborhood) characteristics, and that their underwriting decisions make them shapers of—not just reactors to-societal conditions. Solutions to the controversy, therefore, will require changes in institutional practices, not better public relations. Several studies and public hearings have documented instances where individuals have in fact been subjected to arbitrary and unfair treatment by the insurance industry (Valukas, 1977; Levin, 1976). Others have demonstrated that there is a relationship between the age of housing and insurance underwriting practices as well as between the racial composition of a community and insurance underwriting practices (Federal Insurance Administration, 1978). As indicated above, the industry acknowledges such relationships but maintains they evidence higher losses in areas containing older homes and minority populations rather than redlining or unfair discrimination. No previous study has attempted to determine whether or not these relationships hold after the effects of loss experience have been removed from the correlations. That is our objective in the following section. THE MARKETING OF INSURANCE IN CHICAGO: UNDERWRITING OR REDLINING? There have been scores of demonstrations and protests by various community organizations in Chicago about insurance redlining,' and the State of Illinois has been quite active in passing relevant legislation. Also, Chicago is the only U.S. major city currently considering a redlining ordi 3. The following newspaper articles provide an indication of the kinds of activities that have taken place over the past two years: "Redlining Charges Confusing," Chicago Defender, May 17, 1978. "Charge Insurance Brokers in Redlined Area Snubbed," Chicago Sun Times, July 19, 1978. "Allstate to Drop 'Zone' Practice," Chicago Sun-Times, June 17, 1978. "Ald. Simpson Urges Job Ban on Biased Insurance Firms," Chicago Sun-Times, December 8, 1977. It is interesting to note that while minority communities in general suffer more than white neighborhoods as a result of insurance redlining, lower and middle income white neighborhoods in older areas of cities have also been victimized. In fact, it is the predominantly white community organizations which have been primarily responsible for making the insurance redlining issue one of public controversy. 4. In Illinois, insurers are prohibited from refusing to provide homeowners insurance solely on the basis of geographic location; from cancelling or refusing to write or renew automobile, homeowners or renters insurance because no agent or broker is located in geographic proximity to the risk; from cancelling, terminating or refusing to renew a policy because the company's contract with the agent who placed the policy was cancelled; and from cancelling or refusing to write or renew a policy because a person had previously been denied coverage by another insurer. When an application for a fire and extended coverage 86 SQUIRES, DEWOLFE AND DEWOLFE nance prohibiting the city itself from purchasing insurance from companies found to have violated state redlining laws. All parties to the extensive debates agree that insurance availability does vary from neighborhood to neighborhood in Chicago, but they disagree on why. Method In order to try to answer that question, the following data were obtained and correlated for each of the 47 predominantly residential postal Zip Code regions within Chicago: the number of homeowners policies and FAIR Plan policies written, renewed, cancelled, and nonrenewed for selected months in 1977 and 1978 (provided by the Illinois Department of Insurance, covering approximately 70 percent of all homeowners insurance activity in Chicago and all the FAIR Plan activity for this time period); the number of crimes (provided by the Chicago Police Department); and the number of fires (from the Chicago Fire Department). For the same Zip Code regions, we obtained data for: median income, total population, minority, composition of population, number of housing units and age of housing (from the U.S. Bureau of the Census). Data on actual loss experience in each Zip Code region by the many property casualty insurers in Chicago is unavailable to the public. But according to the Insurance Services Office (a principal statistical and rating service serving over 40 percent of the property casualty insurers writing in Chicago), approximately 74 percent of the dollars paid out by insurance companies to homeowners policyholders in that city are accounted for by losses due to fire and theft (Banfield, 1978a).' It would be reasonable to expect, therefore, that differences in underwriting activity from one Chicago community to the next would reflect the underlying disparities in fire and theft rates. If we were to find relationships between the minority composition of a Zip Code region, the age of its housing, or its median income level and insurance companies underwriting activities independent of their loss experience, this would indicate the presence of unfairly discriminatory insurance marketing practices. If we were also to find any such relationships independent of fire and theft rates, this too would imply that redlining is a reality. The two variables to be "explained" in our approach are voluntary market activity (indicated by the distribution of homeowners policies) and involuntary market activity (indicated by the distribution of FAIR Plan policies.) Because the FAIR Plan is basically an "insurer of last resort" the distribution of such policies is an indication of availability in the voluntary insurance market. In addition, given the fact that many individuals are unable to obtain voluntary market policies once they have been covered by the FAIR Plan, the distribution of FAIR Plan policies is also a rough indication of historical marketing practices on the part of the insurance industry. Several caveats must be kept in mind in interpreting the results we will present below. First, it policy is denied or a policy is cancelled or nonrenewed, the person can obtain the complete file the company has regarding the application or policy. In addition Illinois is the only state that requires insurers to disclose by Zip Code (within major metropolitan areas) the number of homeowners policies written, renewed, cancelled and nonrenewed. Such disclosure is required quarterly U S. Commission on Civil Rights, 1979; Chapters III and V). 5. The crime and fire data are for 1975. Since most companies develop their rates on data which are collected over a five-year time span and are generally two to seven years ord i Banfield, 1978b), the fact that the crime and fire data used in this study are three years older han he insurance data is a strength rather than a weakness. Ideally, data would have been obtained ·VCT five year span but such information was unavailable. The census data are taken from the 1970 cnsus of Housing and Population, Fifth Count, Selected Social and Economic Characteristics of Metropolitan Chicago Zip Code Areas. Only residential Zip Codes, defined for this study as those having a population of 0.00 or more, were included in this analysis. To avoid biases that might result from the different sizes of me Zip Codes the insurance and fire variables are operationalized as ratios of housing units while thefts Created as a ratio of total population. Minority composition is simply the percent minority. Age of housing refers to the percentage of housing units built prior to 1940. Income is the median family income. For a more detailed explanation of the data and methodology see U.S. Commission on Civil Rights, 1979, Chapter IV |