North American Insurance Conference: Dawn of a New Day

The financial numbers for insurers and reinsurers across North America are not good – but they may only tell part of the story of the property and casualty insurance industry’s woes. It has become a familiar refrain, the need to return to core underwriting discipline. But are companies listening?

“We need profound and committed change in our industry,” comments Scor Canada CEO Henry Klecan. Based on the current operating platform, “we can be seen as cheap capital providers or as providing underwriting capacity with little or no idea what we’re writing”. In Canada, claims are growing at a faster pace than premium increases, while south of the border, 2002 year end estimates point to a combined ratio of 107%, says Sean Mooney, chief economist for Guy Carpenter & Co.

In 2001, Canadian reinsurers posted a 119% combined ratio while the primary market produced a 110.7% ratio, reflects Klecan, “and all in the context of no significant cat losses since the ice storm of 1998”. Troubles are throughout lines, in Canada beginning with auto but moving into mid-market commercial, he points out. And, in the U.S., both personal and commercial lines are under pressure from investment market declines, claims (including litigation), reserving issues and despite price increases, continuing rate inadequacy.

DISCIPLINE, DISCIPLINE

Pricing has plagued the industry, and it is a problem speakers did not see being resolved quickly. U.S. personal lines, where there are a few giant players to control price discipline is one exception to the fragmentation seen in other markets, notes Mooney. In commercial lines and reinsurance, where major players are pulling back and there are few barriers to entry for new players, this market control is elusive. “Looking into the future, we’re not going to see a lot of price discipline in reinsurance and commercial lines.”

Mooney observes a “disconnect” between the insurance and reinsurance markets, with the primary market turning earlier and reinsurers still not attaining historical “rate highs”.

In Canada, despite a 41% increase in 2002 premiums, rates have not returned to 1993 levels. “We make money once every ten years, and we don’t get the returns to sustain those ten years,” says Klecan. He notes that pricing problems are not simply about rate adequacy but about risk selection and accumulation. The myriad of lines affected by 9/11 losses was proof of the industry’s short-sightedness regarding accumulations. Still other companies have been hard hit by heavy losses in specific lines of business. “Don’t write what you don’t know,” cautions Klecan. “If you’re going to dip your toe in, you’re going to get burned big time.”

Still another gambit that has not produced results is financial services convergence, he adds, which proved “an expensive trial” for those companies which have tried to be all things to all people. And, perhaps the biggest industry headache in recent months has been reserve deficiencies. In light of future concerns about asbestos and other exposures, several companies have had to take massive charges for reserves, among them Chubb and St. Paul.

Morgan Stanley pegs U.S. reserve inadequacy at US$50-$120 billion, notes Mooney, but this figure could be even higher, as much as US$500 million if trends such as litigation growth are taken into account. In the U.S., insurers have been working towards tort reform to limit ever-increasing awards, but former New York insurance superintendent Jim Corcoran, now principal of Insurance Investment Associates warns, “tort reform is not a panacea”. He sees plaintiffs’ lawyers finding an end-run around any caps that might be put in place. Litigation promises to make pricing and setting reserves just as much a gamble moving forward. Litigation is a “hairy monster”, says Klecan. “You might as well be aiming at a dartboard to guess what the next award will be and what [premium] should be charged.”

BERMUDA SHADOW

New entrants into the marketplace since 9/11 may not face the same balance-sheet concerns, giving them some leeway for pricing, notes Mooney. “The problems of reserves and the problems of investments tend to be legacy problems.”

This new capital, mainly based in Bermuda, is softening the market to some extent, although nowhere near the degree seen after Hurricane Andrew in 1991, he adds. “These new entrants are not predatory. They are in there to make a buck and get out fast.”

Klecan does not see the Bermuda market having as big an impact in Canada as in the U.S., partly due to the declining Canadian dollar and because these new players expect a high rate of return. New capital is not idealistic, he says, and shows signs of discipline. While big cat cover has been affected to some degree, he does not see new capital moving into the working layers of reinsurance cover.

Based on these new entrants, Mooney expects the reinsurance market to soften before the primary market, although he admits this is not a popular view. “Every reinsurer says we’re bonkers, but that’s the way we see the market, and that’s because of the Bermuda shadow.” Nonetheless, he adds, there were signs of softening in July 2002 renewals, and further indications of weakness are expected in January 2003 renewals.

In the primary market, Mooney sees pressure on both personal lines and commercial moving through 2003. Klecan predicts the hard market will be in force until 2004 at least, noting that 2002 will “not be a banner year” for reinsurers, and investment markets show no sign of significant rebound. Interest rates, which have remained low, will also play a role, says conference host Bill Star, CEO of Kingsway Financial Services. This is a different scenario than the mid-1980s, when interest rates were in the double-digits, and the soft market was short-lived. “There just isn’t the capacity, there just isn’t the appetite to write business,” he says.

HAUNTED PAST

Shareholders have taken notice of the lack of a real rebound for the industry, but speakers remain optimistic that this trend will change moving forward. “You look at the stock market and there’s some great companies out there that are really undervalued…you’re going to see our markets improve and that’s going to be helpful for capitalization,” says Star.

He adds that for Canadian insurers, the new Ontario auto legislation introduced in Bill-198 should ease some of the burden imposed by fraudulent accident benefits claims. Unlike premium increases which show no impact on balance-sheets for 12 to 18 months, dealing with fraud should show a speedy impact. “I’m optimistic we’re going to have a good 2003,” Star says.

Insurer stocks should pick up momentum in the next 12 to 24 months, predicts Greg Peters, senior vice president, equity research at Raymond James & Associates. Money managers see insurance as one of the few industries with real pricing power. That said, the industry has been “marred by a period of overconfidence as it relates to reserves and balance-sheet concerns”. The industry has been “chronically under-reserved” and has had “a notoriously bad track record of setting reserves and pricing the product”. Investors see the industry’s inability to generate strong returns even in good years. Klecan says insurers are going to have to look for real change to win back shareholder confidence.

“Shareholders have heard our story so many times. ‘Next year I’ll be better. I’ve got all my ducks lined up.'”

Indeed, the industry’s woes have also caught the attention of regulators, with the International Association of Insurance Supervisors (IAIS) looking into reinsurance supervision. While Mooney sees this interest as relatively benign for the time being, he says that should one major reinsurer in one territory collapse, this could draw the focus of regulators. This is especially true in an era of lost public confidence in big business.

“People on the street have lost faith not only in government, but in corporations,” says Chris Mathers, vice president of KPMG Forensics Inc., who notes that insurers should be getting their houses in order to deal with coming le
gislation on corporate governance, including provisions for whistle-blowing.

Corcoran adds that this “total breakdown in trust of institutions” is taxing regulators with already strapped budgets. He sees a particular need for controls on insurer solvency to deal with unhealthy companies before they collapse, leaving guaranty or compensation funds to clean up the mess. Insurers will also have to look seriously at their exposure on financial guarantees to companies, to avoid the kind of losses sustained by some insurers after the Enron collapse, for example.