Crystal Ball 2006

Foes of fortune-telling beware: while the insurance industry is indeed capricious, the reality is that many professional predictions will come to fruition. the challenge, according to industry “psychic” philip cook, ceo of omega insurance holdings, is turning an eye inside and working towards the select predictions that seem likely to affect a company’s strategic plan.

When considering strategy, many companies look outwards and simply react to events, Cook told the attendees at a breakfast symposium hosted this January by the CIP Society. If companies worked internally instead and customized corporate responses to a select few potential predictions, they would be able to capitalize on their planned and fruitful response to industry events.

“Sometimes we forget to look inside at our own organizations in order to tailor our company’s response to what will happen in the marketplace,” Cook said. “It is not that these predictions will necessarily happen, but we should look at the indicators and work toward reacting to those that seem certain to happen.”

Cook warned attendees of last years CIP-sponsored breakfast seminar that the property and casualty insurance market would react to countless catastrophes in 2005, challenge consumer confidence and better broker relationship.

Some of the more sagacious organizations armed their “forces” for proper response in lieu of these “prophecies.” Many others were less able to address the resultant needs and expectations of the consumers, regulators and investors.

However, a mistake made is often a lesson gained, Cook noted. By reviewing the trends arising out of insurance predictions, organizations can glean insight into the insurance industry of 2006.

PROPHETIC PROGRESS

Having already forecast the recent black clouds that gathered over the insurance market, Cook is now expressing concern about the potential increase of natural catastrophes. Cook’s prediction, made late in 2004, that “there will be continued growth in the number of natural disasters around the world” was watertight: only about three weeks later, on Dec. 26, 2004, a tsunami washed over Southeast Asia, killing 223,000 people and leaving almost 2 million people homeless.

“There is empirical evidence that this (increased Hurricane seasons) will continue,” Cook predicted for 2005. “Maybe not as severe but just two or three will dramatically affect the market.”

He also foresaw a 2005 catastrophe market that would increasingly “expand from its base in Bermuda as additional capital finds its way to that market and looks for effective deployment.” As predicted, capital moved into Bermuda; luckily, this amount surpassed the amount of losses incurred due to catastrophes. The “Benfield Bermuda Quarterly Report” indicates Bermuda reinsurance startup ventures raised $9.3 billion of new capital by mid-December. Cook believes additional capital will continue to pour into the Bermuda catastrophe market in 2006, as investors search for financial opportunities in the wake of last years record cat losses.

Once again true to his word, Cook properly predicted that D&O coverage exposures in 2005 would “begin to crystallize largely as a result of the insurers recognizing a changing legal environment.” Last year, insurers charged more for D&O coverage and, as prices dramatically increased, insureds paid more. Cook also proposed that specialty liability – professional indemnity, etc. – rates would “vary greatly depending on underwriters perception of the direction of court decisions in Canada.” As noted, rate increases in D&O changed substantially after 2005 judicial decisions increased the scope of culpability of directors and officers.

Continuing his ‘perfect prophecies,’ in late 2004 Cook predicted that commercial insurance buyers would become “more skeptical and probably less loyal” in 2005. Looking for alternatives in 2005, commercial insurance buyers began to shop around for coverage of their significant accounts, leading to the deterioration of the “old insurer-to-broker relationship.” Cook also pointed out that he accurately predicted large insurers would “become less ‘broker sensitive’ as they pursue their own objectives.” He forewarned that the broker’s role will continues to change in 2006.

TRENDS 2006:

CONVERGENCE

Convergence of coverage – a savings-type insurance product that, in a single policy, offers multiple-risk coverages for personal injury, disease, fire, property, liability and auto – is heating up in the U.S. and Canada, Cook noted. He predicted this trend towards a more holistic approach for corporate risk coverage is likely to sizzle in 2006, when corporate risk managers demand more from their insurers. This, he said, may be due to the fact that single insurers are prepared to offer a greater range of covers, or a closer liaison between insurers and corporate clients that are demanding “single source” solutions. Cook warns, however, that insurers must take an internal enterprise risk management approach towards reducing risks. He said currently most insurers are not matching the expected “degree” required of internal risk management.

Insurers offering convergence insurance must “be the sole supplier of risk management coverage to their policyholders.” In order for this to happen, Cook said there must be some blurring of the insurance industry – and therefore some consolidation is required. In order to fulfill this holistic insurance approach, insurers will “have to be there through the broker link,” Cook said.

BROKER DISTRIBUTION

Unlike the all-embracing ideal behind convergence insurance, distribution may be an ill-fated issue in the insurance industry, Cook suggested. In fact, distribution could render the holistic insurance practice null, by potentially creating a great divide between insurer and broker relations. Cook predicted distribution would continue to be a major issue demanding attention in 2006. He told his audience to beware of a trend towards a troubled broker distribution network. Many are aware that the possible deterioration of the broker role is on the horizon, he said.

This October, the Bank Act will be revised. The Canadian Bankers Association (CBA) wants new provisions allowing the banks to retail insurance through branches. Cook warns that because the CBA is making the “small request” of retailing out of their branches, the government is likely to give the green light. This is disconcerting, he said, because banks will be able – based on their clout, their customer information lists and their strong relationships – to attract consumers if and when increasing rates lead customers to seek alternatives.

In response to a force of personal insurance-peddling bankers, Cook predicts the insurance industry will aggressively grow its direct writers. By and large, however, this is a battle that brokers alone are forced to fight. “The threat is not to insurers,” Cook said. “They’ll just have an alternative group referring business to them.”

Catastrophic repercussions for future broker and insurer relationships will invariably occur if insurers fail to support the broker’s role in insurance, Cook said.

BERMUDA CAT

Catastrophe in broker lines is not the only cat area to light up the 2006 radar screen. The Bermuda cat problem is sure to demand attention this year, according to Cook. “A huge amount of additional capital was put into market in mid 2005,” Cook said, adding that the ability for the industry to raise so much capital on the heels of such a devastating hurricane season is “amazing.” However, he said the funds are really merely replacing the reserves of the cat events that have already happened; as such, the value of investment is “the same as the day before.”

In the instance of the capital invested into Bermuda for 2006, there is less concern for financial risk as long as the rates return in 2007, he said. Investors will be at a great financial loss, however,
if the 2006 storm season is as severe as the one in 2005. If so, this would mean 2007 rates would likely not meet initial investments, he said.

Cook predicted the 2006 storm season would include “16 storms, eight hurricanes, and, of those eight [hurricanes], two or three will move into the Gulf, which means that some will make landfall.” This prediction represents a significant exposure that will put pressure on the entire insurance industry, but the most pressure will be on investors, he said. Currently there is US$58 million in the reserve level. All the same, Cook noted “signs of huge residual exposures” that may arise due to pollution liability exposures are being uncovered as the water dissipates. “The issue of pollution is huge and that will become a major source of litigation over the next few years,” Cook said. “Those figures are not being accounted for at the reserve level.”

AVIATION

Cook said aviation is another area that is not being accounted for in terms of risk severity. He said aviation might have been gliding by more or less unnoticed because, by and large, only reinsurers and direct writers are involved. But Cook warns it will not stay under the radar for much longer. “This year (2005) has been the worst year for aviation disasters,” Cook said. “There were eight major crashes that involved western planes.”

These crashes, which involved planes belonging to major airlines, resulted in 718 deaths and a total loss of almost US$1.5 billion. This represents a significant catastrophic loss, which is absorbed by only a few of the top reinsurers. According to Cook, this represents a great cause for concern: reinsurers are usually in the practice of making money, which ultimately allows them to improve on safety measures. Cook warns that if these kind of catastrophic losses continue, reinsurers will have one less safety net on which to rely; this will cause great disturbances in the global insurance market at all levels.