Insurers and Reinsurers Changing The Guard

Financial analysts and CEOs from the ranks of the reinsurance and primary insurance sectors expressed little concern over the global property and casualty insurance industry’s ability to absorb the cost impact of the September 11 terrorist attacks – which experts have yet to peg to a specific number beyond a range of “US$30 billion to US$60 billion”. Notably, the estimated cost tag projected by three of the leading analysts covering the North American insurance sector ranged widely, although all agreed that the availability of “interested” new capital in the investment markets greatly reduced the danger of companies not being able to refinance their balance-sheets.

This analysis formed part of a broader debate on the industry’s future financial growth prospects, which took place at the 2002 National Insurance Leadership Symposium co-hosted by the Council of Insurance Agents & Brokers, the American Insurance Association, the Reinsurance Association of America, and investment bankers Russell Miller.

Post-September 11

The chances now of a terrorism bill getting through the U.S. congress enabling the creation of a government-backed reinsurance facility for terrorism risks is next to zero, says Hugh Warns, vice president of J.P. Morgan Chase. “The argument that the ‘world would come to an end’ [without the creation of a government facility] has backfired, business has recovered. Also, congress is having too much fun at the moment skewering Enron [executives].”

Although the loss estimates relating to the terrorist attacks are “just so large” to quantify the long-term impact on the insurance industry, Warns says he has not seen any signs to suggest that major players within the industry could be facing financial difficulty. “Also, the investment markets have shown an appetite to refinance companies.”

Warns calculates that the total insured loss stemming from September 11 attacks will be between US$40-$60 billion. The biggest impact this is likely to have, he surmises, is that some non-U.S. players may look to exit the North American marketplace. The reduction in the “risk spread” with offshore carriers could create a situation where there will be a disproportionate concentration of the risk held by American operators.

Alice Schroeder, managing director at Morgan Stanley, expects the insured cost tally from September 11 to be about US$60 billion. So far, she notes, reinsurers have reported losses of about US$18 billion. The greater part of the insured cost of the attacks is likely to fall on the reinsurance side, and as such, she adds, “I’m hearing more and more of reinsurance and insurer disputes [over settlement]”.

Vincent “VJ” Dowling, co-founder of Dowling & Partners Securities, has a converse view to the extent and manner of settlement of the September 11 attacks. He believes that the final insured loss numbers will be more in the region of US$30-$40 billion, with the primary insurers eventually having to pick up about 60% of the tab. The concerns raised by regulators after the attacks over whether insurers would be financially capable to deal with their exposures, coupled with the issues that have surfaced concerning the financial management of Lloyd’s of London, will likely result in greater disclosure of companies’ financial affairs over the next five years.

Business basics

Schroeder concurs that, the influence of the September 11 events and the way regulators have viewed these developments, coupled with the poor financial performance of the industry in managing capital employed, will likely bring about pressure to change the way insurers handle their financial management. However, this “change process” also has to apply to the basics of the business. “The question is, will the industry be able to get back to underwriting?”

Although Warns is upbeat of the industry’s growth prospects for this year and 2003, he does not believe that the current firming in the price cycle will evolve into a long-term growth phase. Furthermore, he notes, “I don’t think we can look at a ‘cycle’ for the industry as a whole, companies are acting in ‘pockets’, some of them are reacting as though nothing has changed”. In this respect, he remains doubtful to whether the industry at a collective level will be able to maintain long-term underwriting discipline.

Based on current interest rate returns and premium rate levels, the U.S. insurance industry will have to write at a 92% combined ratio in order to achieve a return on equity (ROE) of 12%, observes Dowling. “A lot of people will say this is impossible, but it’s not optional. Investors won’t accept lower returns, so the industry will have to apply several years of double-digit rate increases.”

But, can the industry realistically maintain rate momentum? Dowling, like his counterparts on the analyst panel, is skeptical that the industry can pull off such a feat based on current market conditions. In addition, he notes, it is not only about rates, the terms of the business have to change as well. For instance, a greater number of catastrophic losses have been incurred by the industry over recent years, events which no one would have anticipated. “The industry has had [loss] event after event that ‘couldn’t have happened’, but they did happen.”

As such, Dowling believes the only workable long-term solution to the industry’s financial troubles is consolidation, particularly in the commercial field. “For over 30 years we’ve seen consolidation on the personal lines side, because this business we’re in is about scale, scale really does matter. So, I expect we’ll see further consolidation going forward, we really don’t need more than a dozen players.” Another factor which will have a profound effect on deciding the “winners from the losers” is capital management, he adds. Managing premium to surplus is an issue which is receiving greater attention, he reflects.

Moving forward, commercial brokers could also see commissions come under pressure as insurers are forced to reduce operating costs and increase efficiency, says Warns. As such, there could be a cut back on commission rates in the short-term, however, the pressure will remain on companies to attract new business. Overall, Warns does not expect to see companies cutting back on their expense ratios.

Reinsurance impact

“Reinsurance is riskier than insurance, and our pricing [as an industry] should reflect that volatility, at the moment this is not the case,” comments James Duffy, chairman of St. Paul Companies Reinsurance Group. In this respect, the next few years will have to be focused on “getting back to basics” with regard to pricing discipline, he adds.

Duffy says that the most disappointing development after the September 11 terrorist attacks was the far broader acceptance by the reinsurance community to continue underwriting this peril. “…there was broader acceptance for terrorism risk than had been earlier indicated by companies in the reinsurance business”. However, he does believe that reinsurance and insurance should have some role in providing assurance to businesses in the U.S.

But, Duffy cautions, reinsurers are already exposed to significant risks tied into the terrorism peril, exposures which as yet are not fully known. Another significant catastrophic event such as September 11 could easily destroy the reinsurance sector. “Another event would have a significant impact on the surplus position of the reinsurance industry, this is a global concern.”

Nicholas Spaeth, senior vice president of Employers Reinsurance Corp., adopts a slightly different perspective of the future risk of terrorism. He believes that primary insurers would face the greatest risk to such an event due to the regulatory demands placed on them. “On the reinsurance side, I think we could get by.”

“I think you’ll find a lot of consensus on this panel,” remarks Patrick Mailloux, CEO of Swiss Re America Corp. His comment refers to a firm stand reinsurers have publicly taken with regard to the fact that rates have to rise substantially. He notes that the 115% combined ratio that the North American reinsurance sector h ad been operating on prior to the September 11 attacks was simply not acceptable. “Everyone in this room [referring to the CEO audience] knows how to get into trouble, and how to get out of trouble. Now it’s time to do our homework and focus on underwriting. The question is, if everyone agrees that underwriting discipline is the solution, then why isn’t it happening. There’s a lot of moving parts [in the management process], so it’s really all about execution, setting your target is extremely important.”

Furthermore, Mailloux points out that the actions needed to be taken are not simply about getting back to where the industry should have been years before, but also taking into account the changing risk landscape. Notably, he adds, claims costs are increasing from auto to the volatility of jury awards. “We’re giving coverage for free, we’re like auto dealers throwing in free air conditioning as part of the deal, but unlike auto dealers, we don’t know what this is costing us.”

The underlying problems facing reinsurers and insurers stems from underwriting through to the broker, says Nick Prettejohn, CEO of Loyd’s of London. “Stable pricing is something that has to be addressed by all.” He observes that, post-September 11, reinsurance rate increases have risen substantially on a global level. “Albeit, this [rate increases] is coming off a very low base. This is important to remember, as the industry has been at the wrong starting base for the last five years.” Furthermore, Prettejohn notes that the extent of coverage, namely the terms of the business, has been almost “covertly” broadened over recent years. “Which has had as much an adverse economic impact as low rates.”

As a result, change to the fundamentals of the business process is paramount in order for the reinsurance sector to regain adequate profitability, Prettejohn stresses. “There was a lot going wrong before September 11 with the industry, as well as with Lloyd’s.” The recent restructuring process implemented by Lloyd’s is expected to address many of the weaknesses the market revealed in the aftermath of the terrorist attacks. Notably, he points out, Lloyd’s has bolstered its central contingency fund, and the restructuring actions announced earlier this year will allow the corporate board to intervene “more appropriately” with syndicate operations to ensure proper management as a commercial franchiser.

Commenting on concerns of new entrants having entered the reinsurance sector after the September 11 terrorist attacks, and the affect this may have in breaking down the resolve of companies in applying rate increases, Duffy says this new money has had little impact on the marketplace. “Right now, new capital hasn’t had an impact on rates, but it remains to be seen whether some of the new players will maintain underwriting discipline. I think 18 months from now we’ll be able to tell. This [reinsurance] is a risky business, and the new players need to learn that.”