March 1, 2004 by Vikki Spencer
At the end of 2003, two commercial insurance surveys came out suggesting the market turn risk managers had been praying for was on its way. First, the Risk and Insurance Management Society (RIMS) benchmark survey (inclusive of U.S. and Canadian commercial insurance buyers) indicated signs of softening rates in the property line, with some accounts even seeing slight reductions. Then, the U.S. Council of Insurance Agents and Brokers’ (CIAB) third-quarter market pricing survey came out with the same good news – property rates were flattening and even dropping in some cases.
The results of these surveys may have been shocking to some, with many industry experts having predicted it would be well into 2004 and even 2005 before the soft market would return. Certainly given the depletion of industry capital following the 9/11 terrorist attacks, followed by sharp price increases and intense underwriting scrutiny, some question if insurers are sufficiently financially stable to justify a return to a “kinder and gentler” marketplace.
Risk managers, however, say even with price softening, they can expect a “new reality” in their relationships with insurers. With insurers facing shareholder expectations for solid returns, brokers and their clients expect to face a tough market for some time to come. And, some even question how long this next soft market will last.
SIGNS OF HOPE
Risk managers and brokers speaking to CU all agree that signs of softening in the property line became evident towards the end of 2003. Specifically, large accounts are seeing better treatment. The reason, sources say, is that following 9/11 the property line hardened fast and intensely, thus it is the first to show indications of softening.
However, other lines are also seeing reduced pricing. “It’s fair to say most lines and most terms are being relaxed,” notes Stephen Mallory, managing director for Marsh Canada. And, he adds, “as the risk grows in size and premium dollars, insurers are being more flexible”. Overall, Mallory expects insurers to begin looking for new business. “The doors are open for new business,” he says, as insurers foresee price softening on the horizon and look to compensate by writing more business.
“Particularly on property and primary casualty, those very large accounts are seeing some softening and even some rate credits,” agrees David Mew, director of national broking for Aon Canada. “That has started to move down the food chain [to smaller accounts], especially on property.” But, Mew speculates that tougher property risks may face further increases, although these will not match the increases seen over the last two years, probably hitting 20%-30% at the high end.
Most of the better property line terms are still reserved for the clean risks, and any price reductions are not likely going to be huge, observes Ed Martingano, director of risk and insurance for Oxford Properties. But, he adds, “any reduction is a reduction”. While there is evidence of some insurers increasing their capacity, he notes that it is not likely that it will be enough to replace the large amounts of capacity taken out of the industry after 9/11.
“My feeling is that some stability has returned in terms of pricing and availability of capacity, more so with respect to property, and just starting with liability,” says Karen McWilliam, a risk management consultant. This year, she says, will be a transitional period for liability lines, with risk managers still waiting to see which lines will remain troubled, and which may experience better terms.
“We are lagging the U.S. a little bit,” confirms Greg Belton of the price flattening seen in Canada. Belton, chairman of international company Assurex and Toronto-based brokerage Hunter Keilty Muntz and Beatty, says he is even seeing some signs of returning price competition in the marketplace. “There are a couple of companies being more aggressive [with price] out there.” But, he agrees with Martingano that overall the market is still experiencing a significant reduction in capacity.
Specific lines are feeling the brunt of the capacity shortage, and both brokers and risk managers agree the worst of the troubled lines is directors’ and officers’ (D&O). The Enron scandal has been succeeded by an almost daily dose of headline-making corporate governance scandals, leading to new regulations being introduced in the U.S., and now similar proposals being put forward in Canada. “I think people feel it’s just the tip of the iceberg,” says Belton. “There’s just going to be more and more of these scandals.”
“You have to ask why some [insurance] companies are in the business,” comments Martingano on the losses being face by D&O writers. “The markets that are writing it are going to be asking for more money and tighter underwriting. The days of the ‘sweetheart deals’ are probably gone.”
D&O raises the issue of insurers taking greater scrutiny of which lines of business they want to put their precious and scarce capital towards. “I don’t think insurers did that with D&O four or five years ago,” Martingano notes, looking at the exposures they now face from this high profile line. “Lo and behold, now they’re behind the eight ball.” Not only are there few writers of D&O, those still writing it are not located in Canada. The lack of a domestic market for D&O means buyers are sharing their risk with companies doing business in the U.S., companies facing U.S.-style litigation.
This same problem continues to burden Canadian companies with any cross-border exposure, who are also not feeling any benefits of a softening market. Specifically, the inability of U.S. legislators to pass successful tort reform last year, dampens the picture for Canadian companies with a U.S. products liability exposure, says Mark McKay, executive vice president with Willis Canada.
McKay also points to problems with the errors and omissions (E&O) coverage, which along with D&O is making the professional liability segment a “minefield” for insurance buyers. In particular, anyone giving financial advice, including insurance brokers, are facing ever increasing E&O rates with no signs of abatement.
Last year’s troubled line, construction risks, continues to face pressure. “The insurance is out there, but it’s pretty expensive,” Mew says of construction defect coverage. McKay cites a “lowering of the guard on construction standards” during the recent construction boom as part of the cause, leading specifically to the issue of water leakage and mold. Roofers and now groups such as window and door installers are becoming part of the ever-widening “net” being cast for mold lawsuit defendants, McKay says.
In addition, Mew notes that there are large-scale construction projects slated for 2004 which could signal a growing market for this coverage. But, with so few carriers willing to write it, these insurers do not have to be flexible.
This said, sources say the litigation environment in Canada does not appear to be approaching the U.S. crisis. “It [Canada’s legal environment] is changing, but I don’t know if it’s reasonable to say it’s a structural change,” says Martingano. For example, “class actions have not taken off the way people thought they would”, despite most provinces now allowing for them. “I don’t think there’s a sea change in the culture of the Canadian court system,” agrees McKay. “It still operates for the common good rather than the good of the individual as in the U.S.” The main difference is the prevalent use of juries in U.S. lawsuits, versus judges in Canadian cases. Also, with Canadian workers’ compensation and medical liability being publicly provided rather than involving private insurers, carriers here do not face these exposures which have reached crisis proportions south of the border.
Nonetheless, the seeds of litigation growth are there with the increasing acceptance of contingency fees in Canada, as well as class action growth. And, McWilliam notes, even without a change in the frequency of liability claims, there is heightened awareness of the potential for large judgments
. She uses the example of restaurants facing potential suits over Mad Cow disease – while those lawsuits may not have materialized, the threat of them has put these establishments in a vulnerable position with their underwriters. “It is a poor marriage between the risks they face and the coverage they are able to obtain.”
One thing brokers and risk managers agree on is the change in the attitude of underwriters, who have become increasingly strict, requiring more and more information and demanding immediate action on loss control recommendations. “Even though we’re seeing softening on rates, there is no softening on the stance with respect to the level of information they want, the level of due diligence,” says Mew. But, he adds, insurers are being held to higher standards by their investors and therefore have little choice but to highly scrutinize risks.
“Underwriters continue to be exhaustive in their search for underwriting information,” says McWilliam. But the real challenge for insurance buyers is to reach decision-makers. “Decision-making authority is being held at the very top levels of organizations, not at the branches where it ought to be. It’s hard to find who the decision maker is and deal with them in a timely manner.” Currently, risk managers are dealing with high demands for information, and receiving “just in time” quotes. “That’s creating a lot of havoc for buyers… that will continue for some length of time.”
She says not all of the expectations by underwriters are understandable. “I hope to see underwriters become more adjusted to what information is truly necessary. A lot of what is being asked for is not truly necessary.”
However, Belton says the new scrutiny can be seen in a positive light. “There was strong underwriting discipline brought to bear during the hard market. A lot of it was discipline that was required.” Martingano says he has seen no softening of terms despite the softening of rates, but he has witnessed the continuation of insurer head offices keeping a firm hold of underwriting discipline. “Insurer business practices are being controlled by an iron fist by head offices.”
But, Mallory says that with the softening of rates and increased competition will likely come the corresponding loosening of requirements for information. The one area this does not apply is in respect to corporate governance and the need to meet new standards. “Companies that show signs of weakness [in corporate governance] are being scrutinized.” Mallory also thinks if insurers are not able to turn their financial results around to the level expected by shareholders, the coming soft market may not last. This means risk managers need to maintain their own discipline when it comes to information quality in expectation of the next hard market turn.
Martingano says the new corporate reality is one where risk managers are increasingly being called on to account for how their companies are meeting new standards – this includes corporate governance as well as the health and safety standards, which are bringing more severe financial penalties for non-compliance. “Boards are more cognizant of these risks and I don’t think they’re going to let them slide because the penalties are just too dear.”
Between pricing and terms, the relationship between insurers and their commercial clients is strained heading into 2004, sources say. “I would characterize my risk management colleagues as hostile,” says McWilliam. “There needs to be a lot of discussion and healing because these people [insurers and risk managers] are still a long way apart.”
McWilliam points out that some insurers do not seem to be working as hard as brokers and risk managers to find solutions to the current market challenges, and in this respect have lost their focus on customer service in their drive for underwriting profit. While sympathetic to insurers’ financial woes, she says the dialogue needs to turn to the issue of helping customers solve problems.
“Today, the relationship between buyers and insurers is fractured,” admits McKay. “It’s the result of not understanding each other’s expectations.” He says insurers are under increasing pressure from shareholders to produce returns, and not the 5% returns traditionally achieved but returns of 12-15% as seen in other industries. McKay says there needs to be a reevaluation of the way the insurance business is being conducted, and part of this onus falls to brokers, some of whom have turned to highly centralized systems which have created a “choke point” given the current high levels of churn. Also, he says the industry should be moving away from binders, and the “I’ll get to the policy later” practice of signing binders and worrying about the policy details later.
The threat, if insurers cannot heal the breach with risk managers, is that money that has left the insurance market may not return when rates are better. Some of this “premium dollar” could go to alternative risk transfer (ART) products, with captives and risk pools receiving the most attention. McWilliam says insureds who have “massaged their deductibles” and seen little rate relief in return are starting to move into action on ART projects in 2004.
Belton says he has seen growing interest in ART. “We’ve seen people with serious [rate] increases who have said, ‘I’ve had it. I feel like I’m being held hostage.'” The question is whether the new, softer market may tempt them away from ART, with projects such as captives demanding significant initial investment in exchange for long-term stability. “It will be interesting if they have the discipline to stay with it.”
“We saw the market change so dramatically [and] so quickly, chances are we are going to see a reversal of that fairly quickly,” Martingano observes. However, despite much lip-service being paid to ART, he has witnessed few risk managers actually willing to take that final leap. “We’re starting to see a return back to insurance as a risk vehicle, versus self-insured retention,” says Mallory. “If it’s affordable, insurance as a risk transfer tool will become a much more favorable alternative.”
Higher deductibles and self insurance were the two most popular responses to the hard market. McKay says insurers may find themselves facing a new reality, predicting Fortune-500 companies will not go back to the days of taking on lower deductibles. “Those days are over.”
After the turmoil of the last three annual renewals seasons for commercial insurance buyers, indications of a softening market have been met with sighs of relief. Beginning in the property line – the first and worst to reflect price and term strengthening and now the first to show signs of weakening – risk managers are looking forward to market stabilization in other coverages. But, will risk managers get the right price? And, if they do, how long will this “new period of stabilization” last?