The U.S. Marketplace Post September 11

Speakers at this year’s Joint Industry Forum — which recently took place in New York City — were bullish of the financial prospects of the North American property and casualty insurance industry in the post September 11 era. However, they, as well as the senior management audience in attendance, remained concerned with growing regulatory/political intervention in several critical lines of business, namely the ability to appropriately price the risk of terrorism exposures, or to exclude such risks. Most CEO respondents to a survey conducted by the Insurance Information Institute (III) of the attendees believe that the federal government will not step forward with legislation enabling the creation of a government-backed terrorism reinsurance facility.

Over two thirds of the 350 senior insurer executives who attended the sixth annual Joint Industry Forum and surveyed by the conference organizers are doubtful that the U.S. congress will pass legislation establishing a federal “backstop” reinsurance facility for terrorism risks. As Robert Hartwig, senior economist at the Insurance Information Institute (III), observes, “without a federal ‘backstop’, availability of insurance will continue to suffer. It will take longer for the industry to build the capital and confidence to underwrite this new risk, which will have an impact on the broader economy for at least the next year.” Hartwig notes that, since the beginning of this year, most terrorism risks have been excluded from commercial policies in the U.S.

Despite the “gloom” felt over the U.S. government’s failure to respond to the terrorism risk issue, over 90% of the CEOs surveyed by the III expect that the North American commercial marketplace will continue to show strengthened pricing through to the end of 2002, while 79% believe that this rate hardening will flow into the personal lines market. In this respect, over 60% were optimistic that auto business will improve in profitability this year, with 65% of the respondents expecting that returns on the homeowners line will improve on that of last year.

Overall, the vast majority of the Joint Industry Forum audience surveyed believe that 2002 will produce a marked financial improvement in both the commercial and personal lines of business. Roughly 80% also expect that the industry’s combined ratio will ease back this year from last year’s high of 108%. “Industry leaders are clearly anticipating signs of improvement in the year ahead. However, the environment remains very challenging. Rapidly rising jury awards, accelerating medical inflation and new types of claims will continue to put pressure on insurers,” says Hartwig.

Furthermore, he notes that the price hardening seen in both the commercial and personal lines markets had been in place prior to the terrorist attacks on September 11 of last year. As such, the current rate strengthening witnessed in the marketplace is not just a “knee jerk reaction” to an event, but rather a sustainable shift in the industry’s pricing cycle. “The current hard market was already well underway before September 11, with renewals in most major commercial lines in the 10% to 15% range. After September 11, the rate of increases for 2002 renewals in many of those same lines roughly doubled to 30% on average.”

The “future”

“I think this will be a better business in the next 10 years than it has been over the last 10 years,” says Raymond Barrette, CEO of OneBeacon Insurance Group. Barrette participated in a six-member CEO panel debate focussed on “the future landscape of the p&c insurance industry”.

Barrette went on to echo what many top executives in the industry having been voicing for several months: “It’s all about underwriting discipline”. However, where there once may have been room for rhetorical debate on the need to take action, he stresses the immediate need for effective pricing. “We have to,” he notes with open hands, as there is no room to maneuver with regard to investment gains, and the industry’s shareholders have become impatient with the lackluster returns of recent years. “The owners of the capital are now a lot closer to the business than they have ever been.”

On a positive note, Barrette believes that the cost impact of the September 11 terrorist attacks, combined with a more frugal attitude of corporate investors, has erased one of the industry’s biggest problems — excess capital. “I don’t think there’s now any excess capacity in the market, not after September 11.”

Saxon Riley, chairman of Lloyd’s of London, points out that underwriting is not at fault for the industry’s financial difficulties. He agrees that greater discipline needs to be applied by companies, but the onus here lies with top management. “Discipline is mostly a management issue, not underwriting.” As such, he believes the industry needs to write an underwriting profit for at least the next five years in order to stave off a mass of financial casualties. “Because as sure as eggs, we’re going to encounter a catastrophe during that period.”

Leaders in the insurance industry really do need to rethink some of the fundamentals of how they conduct their operations, says Ronald Pressman, CEO of GE Employers Reinsurance Corp. He also believes that greater attention will have to be placed by top management on underwriting and proactively managing their business portfolios.

Edmund Kelly, CEO of Liberty Mutual, is less than confident of the long-term ability of the current hard market. “There is no point in history to show that this industry has ever been able to apply discipline [in underwriting]. This worries me, I think there has to be a fundamental shift in thinking in order to bring about market discipline over the longer term.” In this respect, he expects that a soft market will eventually confront the industry. “That’s when we’ll see which companies applied underwriting discipline during the current hard price cycle.”

Flexibility needed

Despite a general sense of optimism for the future, Barrette is cautious of several factors which could undermine the long-term recovery of the North American insurance industry. Specifically, he believes that urgent change is needed in the manner in which the industry is regulated on a state-by-state basis. Political interference in the setting of rates and terms of business, as well as the licensing requirements placed on insurers operating onshore within the U.S. are hardly new developments, but they are issues which have to be addressed in a meaningful manner, he adds. “Unless there is [regulatory] change in the U.S. environment, then a lot more capital will go offshore, with Bermuda likely to be the most efficient market.”

Herman Arends, CEO of Auto-Owners Insurance Co., has a dour view of future regulation. “I think we’re going to face more regulation as we go forward after September 11.” As such, he feels that insurers need to get the message across to the public that free-enterprise is the best system for both insurance buyers and companies.

Consolidation

More than half of the CEOs surveyed by the III at the forum believed that consolidation within the industry as a result of acquisitions and mergers would slow down in response to the hardening price cycle. However, as Barrette observes, the hard market is not going to be the savior for all companies. Notably, the sharp upward shift in rate pricing will provide opportunity for outside players to enter the arena, specifically the commercial banks. In addition, more costly insurance will motivate some commercial buyers to look at self-insuring mechanisms, he predicts. In this respect, the industry may not consolidate in the number of players, but the premium pool could get a lot smaller. “The hard market is here, there’s no question about that, but it’s not going to save all of us…I think the banks will find there way into this business, where the risk is low. We’ll be left with the high risk.”

Arends agrees that a hard versus soft market environment is not necessarily indicative of the level of consolidation that is likely to take place. Notably, he says, not all companies
performed badly in the most recent soft market cycle. In this sense, he points out, “cycles weed out the weak companies, which I think is to the benefit of the consumer”.

People & technology

“As an industry, we haven’t been good at ‘institutionalizing’ our intellect. Our core function at the end of the day is risk management,” says Barrette. The two key factors determining the future success of the industry in this respect is people and technology, he adds. “Unless we harness the technology to collect data rather than process, then we’re going to have a problem.”

This argument was taken up by David Mathis, CEO of Kemper Insurance Companies. He believes that attracting new talent to the industry and finding a means of retaining that skill is going to be one of the biggest challenges facing the insurance industry in the near future. The new era of financial services is about information and service, and insurers need to stay abreast with these other competitive forces if they plan to stay in business. The really big challenge, he adds, is finding ways to achieve these objectives without adding to the cost of doing the business. “Our [the industry] expenses are already too high. Somehow we have to become more efficient without compromising service.”