U.S. Primary Market Outlook: Big Stakes Game

A survey conducted by the Insurance Information Institute (III) of the 250 insurance management attendees of its annually held Joint Industry Forum (JIF), which this year’s event recently took place in New York, suggests that four out of five U.S. industry executives believe that profitability within the insurance community will be stronger this year than the mild recovery seen in company financial results for 2003. This more “sunny outlook” was motivated by an expectation that rate adjustments implemented during the most recent “hard market” have finally begun to produce meaningful gains in premiums over claims costs – which has seen insurers’ average combined ratio drop during 2003 (the III estimates that the combined ratio for the full 12 months of last year will be about 101%) with a further decline in the ratio expected for 2004.

However, the JIF survey results paint a less defined picture with regard to continuation of price firming on an “across-the-lines basis” within the U.S. marketplace. Approximately 54% of the survey respondents expect pricing in the commercial market will continue to firm in 2004, while 59% of insurers see premiums leveling off in personal lines during this year. These “outlooks” from the frontline are not surprising, observes the III’s chief economist Robert Hartwig. “The current hard market is likely to stabilize in 2004,” he predicts. But, he cautions, “rates of return in the [U.S.] property and casualty insurance industry, while improving, are still only in the 9%-10% range, well below the 13%-15% typical of Fortune-500 companies.”

Although price firming on the underwriting side may be leveling out, the JIF survey respondents were confident of an improved investment environment this year. Over 80% of the respondents expect interest rates will rise during 2004, with 98% believing that this year will also produce further recovery in equity markets. Hartwig notes that the poor investment yields seen in companies’ results over recent years – which led to the industry’s sudden profit slump – mainly resulted from the corresponding drop in interest rates to historically low levels. Higher interest rates this year would therefore provide significant relief to insurers’ financial bottom-lines.

That said, the CEO speakers that partook in a panel discussion at JIF, as well as the insurance management attendees responding to the III’s market survey, were overall cautious in predicting an end to the industry’s troubles. Notably, about 60% of the survey respondents expect that rating agency “financial downgrades” of insurers will continue to outpace “upgrades” during this year. According to the CEO speakers, much of the uncertainty remaining in the marketplace concerns the ever-rising cost of liability exposures and a sense that regulative reform will not be achieved during 2004.

One of the bigger “price tags” facing insurers is asbestos liability losses – which has been a prime factor in the negative outlook adopted by many of the rating agencies of the p&c insurance industry – and in this respect companies are not optimistic that the federal government will be successful this year in signing through legislation to quell the litigation volume. About 65% of the JIF survey respondents do not believe the U.S. Congress will during 2004 pass legislation to contain the “asbestos crisis”. Similarly, over 60% of insurers in the survey do not think that congress will approve tort reform legislation this year enabling President George Bush to move ahead with “meaningful” regulative reform.

Hartwig points out that tort costs within the U.S. have reached an estimated US$200 billion a year, equal to about 2% of gross domestic product (GDP). “The [present] tort system is extremely inefficient. Only 22% of the tort dollar compensates victims for economical losses,” he observes. While many industries other than insurance are pressing the government for tort reform, the concerning issue is that insurers seem to share little optimism for regulative relief, Hartwig notes. “Yet, only 38% of [the JIF] survey respondents think congress will pass and President Bush will sign meaningful tort reform legislation in 2004.”

FINANCIAL FORTUNES

“It’s amazing what a year does,” observes Edward Rust, CEO of State Farm Mutual Automobile Insurance Co. Rust, who moderated the eight-member CEO panel, refers to the last industry financial quarterly report issued by Hartwig (being the third quarter of 2003), in which he headlined the immediate outlook for the industry’s future as being the “Goldilocks” period. “We [the industry] have moved from the ‘Perfect Storm’ to ‘Goldilocks’,” Rust notes.

Jay Fishman, CEO of The St. Paul Cos., holds an upbeat view regarding the improved financial position of U.S. insurers. “The industry is in a better financial position now.” The industry also appears to have improved its financial expertise as a result of the most recent “soft” to “hard” market swing, he says, which will hopefully result in more moderate pricing actions taken by companies in response to future market movements. “The extreme actions of the past might be more moderated [moving ahead],” he adds.

Although the industry is now “in a better zone” regarding financial health, property and casualty insurers are still a long way off from achieving the investment returns of diversified financial services companies, observes Ronald Pressman, CEO of GE Employers Reinsurance Corp. As such, the p&c insurance industry will have to overcome this hurdle in order to attract new capital, he warns.

Caution is required by companies as they move forward, says Edward Liddy, CEO of Allstate Insurance Co. Liddy notes that, whilst the industry’s improved financial position may have brought it to within reach of its “cost of capital”, this cannot be the final goal. Insurers have to maintain pricing discipline to achieve the satisfactory returns expected by shareholders, he adds. “We’ve [the industry] got a long way to go.”

Perhaps one of the more positive results to have emerged from the most recent financially challenging years is that insurers are no longer relying on investment returns in their underwriting decisions, says Michael McGavick, CEO of Safeco. “One of my reasons for optimism [regarding the industry’s financial future outlook] is the low interest rate environment which has reinforced the fact that underwriting discipline is not a short-term extreme action.” McGavick adds, “if the low investment environment persists, it will make the change in underwriters’ behavior permanent”. Liddy supports this theory, suggesting that the industry’s inability to rely on investment income to prop up financial results could result in companies emerging with more efficiently run operations.

Another reason insurers should not be overly elated by the industry’s dramatic change in fortune is that there are many “operating expenses” which had been neglected during the difficult years, notes Catherine Rein, CEO of MetLife Auto and Home Co. The most obvious item would be “technology investment”, which p&c insurers have not kept abreast with new advances. “We [the industry] have ‘infrastructure deficits’ which we’re going to have to pay for.”

TORT CANCER

The biggest cost challenge facing not only insurers, but the economy of the U.S., is tort reform, the CEO panelists affirm. In this respect, Lloyd’s of London’s chairman Lord Peter Levene describes the runaway and frivolous cost of litigation in the U.S. as a “cancer” infecting the insurance industry. Levene points out that insurers have to get the message out to the public that the cost of tort is hitting them in their own pockets. “We have to make sure that the public understands that the impact of the current [litigation] system on the business community is like a 5% payroll tax. The pressure for tort reform cannot be let up on.”

Rein notes that raising public attention to the abuses taking place under the current tort system is highly difficult due to the fact that the business community is the target in most actions. “It’s difficult to get the public to see th at abuses in the system, like class actions, cost them. We as an industry have to be more proactive in getting that message out.”

Despite the industry’s very mixed viewpoint to whether tort reforms will be enacted by the federal government this year, Rust says he is optimistic that positive change will be brought about. “Abuses in class actions are catching the general media’s attention, and this is providing ‘public connectivity’ to the abuse.” As such, he notes that the passage of reform legislation on the tort front is “closer than ever before”. He adds, “the good news is that the bad news is getting so bad that it’s getting people’s attention.”

Liddy also maintains an optimistic view regarding the passage of tort reform. However, he says insurers can ill afford to let up pressure in keeping the problem a central focus for the government. And, he cautions, “we [the industry] can’t afford for the problem of class actions to be seen as an insurance industry problem instead of being a public problem.”

REGULATIVE TUSSLE

With the industry on surer financial footing, cost efficiency issues will see increased attention, the CEO panelists predict. One such area is “regulation”, which in the U.S. largely rests with the state authorities. This situation, many of the panelists point out, has resulted in an overly costly and time delaying regulative process.

While not all of the CEO panelists support a shift to an “optional state or federal regulative regime”, many believe that the current state system has restricted industry product development because of the cost and time delays involved with getting each state’s regulatory approval. And, some of the panelists observe, the current state regulatory approach entices “politically motivated” decisions.

William Jurgensen, CEO of Nationwide Mutual Insurance Co., is particularly critical of the manner which the state regulators treat p&c insurers from a “consumer protection” standpoint. Referring to his past management experience in the banking industry, he adds “regulation in this industry [p&c insurance] appears to be opposite to the approach [by regulators] to banking which is ‘soundness’ based on ‘profitability’. They [banking regulators] are interested in how profitable the bank is. They count on competition, not regulation, to protect the consumer.”

Liddy believes that an optional federal charter of regulation would make sense for national p&c insurers. However, he concedes that “selling this argument” will be difficult in the face of the political opposition from state regulators. “It’s kind of like trying to roll a snowball uphill. Having 51 regulatory bodies is slow and expensive.”

With more than 80% of the senior insurance management attendees at this year’s Joint Industry Forum (JIF) holding an upbeat perspective regarding improved profitability of U.S. property and casualty insurers for 2004, it would seem that the hardships endured by companies through the most recent “hard market” business cycle have finally produced positive results. However, the forum’s CEO speakers remain wary of increasingly large underwriting costs stemming from liability exposures, with the call for “tort reform” and the enactment of specific legislation to curtail asbestos losses now being prime industry concerns. Unfortunately, the JIF survey of attendees’ perspectives on the market suggests that most insurers are far from upbeat that appropriate legislative reform to combat tort costs will be introduced by the federal government during this year.