NAMIC Conference 2003: Seeking Solutions

The power of accurate observation is commonly called cynicism by those who have not got it.” Like the playwright George Bernard Shaw, whose works draw tourists each year to Niagara-on-the-Lake, the insurance industry could be accused of a healthy dose of cynicism. Accurate observations of the industry’s status highlight spiraling claims costs, investment drought, capital and reserving problems, regulatory headaches, all of which have culminated in some company withdrawals in both the primary and reinsurance markets.

In this respect, a not so pretty picture was presented of the p&c insurance landscape at the recently held National Association of Mutual Insurance Companies (NAMIC) conference. Speakers drew attention to the industry’s woes, which are legion right now, they say. However, that “cynicism” was tempered by the hope that the industry might finally take this chance to learn from the past, and thereby gain control of underwriting while refocusing on core business. The objective: to tame the “insurance cycle” for good.

Big hits

The fourth quarter of 2002, and indeed the first half of 2003, has been characterized primarily by U.S. and international insurers/reinsurers taking large reserve hits to deal with liability claims from asbestos to directors’ and officers’ (D&O). But, the bleeding may not be over, says Nancy Carini, vice president of Conning Corp. “2001/2002 probably presented an increase in liability [loss costs] that I don’t think anyone was prepared for…we don’t think that [reserve taking] is over.”

In fact, a new Conning study shows a US$38 billion reserve deficiency for American p&c insurers, of which US$35 billion is in commercial lines such as workers’ compensation, commercial auto, medical malpractice and other liability lines. Forty-plus companies took charges in the fourth quarter of 2002. And of the about100 companies that went “belly-up” over the last two years or so, more than one-half were due to weak reserves/pricing, according to A.M. Best.

The financial malaise of the past few years, which saw insurers’ return on equity (ROE) drop well below 5%, will not likely see a quick turnaround. Conning is predicting a U.S. industry combined ratio of 104%-105% for 2003-2004, and 103% in personal lines (see chart 1), with a range of 105%-106% for commercial lines (see chart 2). Similarly, the industry’s ROE is expected to remain well below the 5% mark right through 2004.

Despite the lack of acceptable return levels, spring 2003 renewals have seen price increases drop off slightly, even in commercial lines. “We’re still seeing double-digit rate increases [on commercial lines], but there is a deceleration of price increases,” says Carini. Medical malpractice is up 41.6%, D&O up 30.8% and professional liability up 27.4%. But, overall, the market rose on average by 20.5%. Personal lines is up 12.9% overall, with most of this coming on homeowners’ business. In total, A.M. Best says the U.S. market’s surplus is down by 16% between 1999 and 2002.

In Canada, the issue has been “auto, auto, auto”, says Bert Hare of North Waterloo Farmers’ Mutual Insurance Co. “You can’t pick up a paper anywhere in Canada where there isn’t a story about auto insurance.” Companies are shedding auto business, “putting extreme pressure” on companies who remain in the market. “We need to find ways, and find them very quickly, to deal with auto insurance.”

Last year, Canada’s p&c insurers posted a dismal 1.6% ROE on a combined ratio of 105.8% – their worst performance on record. Industry net earnings fell to just over $300 million from the previous year’s $600 million, largely due to plummeting investment returns and the ongoing rise in claims costs. Large adverse reserve adjustments in the final quarter of 2002 also significantly undermined the industry’s earnings.

Mutual insurer CEOs say this is a time of challenge and opportunity. Mutual insurers are facing the same issues as other companies, but are buffered somewhat from the insurance cycle, notes Judy Jackson of Connecticut-based NLC Insurance Cos. “You can run a little counter-cyclical on pricing.”

That said, some companies have been forced to review their business and withdraw, while others are looking for avenues to raise capital to take advantage of the hard market. While mutual insurers do not have the stock market as a means of capital raising, given the low interest rate environment, there are other options, comments John Bykowski of SECURA Insurance in Wisconsin. Companies need to “get the premium while the getting is good…now is the time to use those [capital raising] options.”

Best practices

While premium growth may have already peaked, there is further need for reserve strengthening, with the gap between the top and bottom performers widening, says Carini. One broker, she has heard, says “insurers are scared, greedy and crabby”. This criticism may be valid.

Insurers must focus on their core business, something mutual insurers have a tradition of doing, and take a strict stance on underwriting. “Be sure to remain scared and be very conservative about the new business you put on your books.” Companies must manage the cycle. “It is inevitable the pricing cycle will swing, so you need to look at how you’re going to handle your business when it does.” Rating agencies, she says, will be watching for this.

In a study of “best practices” of U.S. p&c insurers, the top 11 personal lines performers created “sustainable value” through both investments and underwriting, rather than relying on the former, notes Bill Pieroni, general manager, IBM Global Insurance Industry. IBM’s study found these top companies made smart “marriages” with companies they knew well and were strict with acquisitions until they turned a profit. Although these operations had the highest loss adjustment expenses, they made up the difference through lower loss costs. Top companies paid for top claims staff and trained them. “These organizations all invested in these people.”

Furthermore, investment spread (between equities and bonds) was not a critical factor in separating the better performing operators, neither was company size. The top-ranked companies were not ahead of the game, and were perhaps even behind the curve on IT spending, he notes. But, the one thing the top performing companies did have in common was a “relentless focus” on conservative, traditional products.

Seeking cover

Topping NAMIC member concerns is reinsurance, says the association’s president Larry Forrester. Notably, U.S. mutual insurers are finding it difficult to be picky in choosing their reinsurance partners in the current environment. “There are just fewer players out there to talk to,” observes Jackson.

U.S. mutual insurers are particularly concerned about the issue of terrorism. There is widespread discontent with the government’s Terrorism Risk Insurance Act (TRIA) reinsurance program. “We were under the gun to get something done,” admits Forrester. “I don’t think today, if we had time, anyone would want the system we have now.” Bykowski says TRIA probably cost his company $250,000 just to implement and is unlikely to be renewed when it expires in three years time.

Regulatory example

One matter of interest to U.S. delegates is the Canadian system of regulation. Currently, state insurance departments are in a “fight for their lives”, facing budget cuts and the threat of growing federal presence in insurance, explains Jackson.

Canada has been moving to a more “risk-based” approach to regulation. In Ontario, this approach is being applied to both solvency and market conduct, says Bryan Davies, superintendent of the Financial Services Commission of Ontario (FSCO). Life companies already have a market conduct self-assessment audit in place to address best practices and controls.

In terms of solvency control, Ontario’s mutual insurers are leading the way. They have formed their own guarantee fund, which has been in place since 1975. The fund pays 100% of unearned premiums and has no cap on claims payments. An agreement also exists between FSCO and the OMIA where the association keeps solvency information on its member companies. “This is an innovative approach…the first of its kind in North America,” says Davies.