North American Insurance Conference: Shelter From the Storms

As Floridians cleaned out and patched up their homes in the wake of one of the worst hurricane seasons on record, insurers and reinsurers descended on St. Pete’s Beach for the 5th Annual North American Insurance Conference, hosted by Kingsway Financial Services. The property & casualty industry was itself reeling, both from the storms and from the mid-October filing of civil charges against Marsh & McLennan (MMC) by New York Attorney General Eliot Spitzer amidst allegations of widespread industry corruption in the form of bid-rigging and fraudulent commission practices.

SWIFT RESPONSE

Speakers at the conference took a more moderate approach to the controversy – agreeing that bid-rigging, if proven, should certainly be punished, but urging authorities to keep this issue separate from that of the long-standing industry practice of contingent commissions.

“No rule-making will ever do away with the passions of mankind,” says Ernie Csiszar, president of the Property Casualty Insurers Association of America (PCI) and a former insurance commissioner. “We must accept that there are going to be some bad apples out there, we will never eliminate that.”

While he says no mercy should be shown any individuals guilty of bid-rigging, he stresses that “a contingent commission is a neutral device”. Contingent commissions, which insurers pay to brokers on top of traditional commissions based on factors such as volume or profitability of a book of business, are much like incentives given in other industries for excellent performance, Csiszar says. Such incentives “are as old as America itself”.

He adds that when it comes to commercial clients, insurers and brokers are dealing with sophisticated buyers who should understand the nature of the transaction they are involved in. “What is Eliot Spitzer doing defending the General Motors of the world?” he asks.

Csiszar and the PCI have publicly stated their intention to fight for the legitimacy of contingent commissions. “If we take this lying down, it’s going to be with us for the next 10 years.” He says he is disappointed to see the world’s largest brokers – Marsh, Willis, Aon among them – so quickly abandoning contingent commissions.

Regulators speaking at the conference also seemed less convinced than Spitzer that contingent commissions represent a conflict of interest – Spizer contends brokers routinely steer business to insurers with which they have the best commission terms rather than based on who is offering the best price and coverage for the client. Louisiana insurance commissioner James Robert Wooley says he will not be looking into the issue of contingent commissions based on what he perceives as a largely politically-motivated campaign by Spitzer. Florida insurance commissioner Kevin McCarty says, “I’m not sure it [contingent commissions] is either criminal or bad policy or bad economics.”

Nonetheless, the perception of wrongdoing has taken a significant toll on insurers and brokers under the shadow of Spitzer’s investigation, as have investigations into other aspects of insurance, including finite risk reinsurance. Shares of MMC had, at the time of the conference in early November, dropped by US$22 from their 52-week high, notes Fred Ketchen, managing director of equity trading for Scotia McLeod. And AIG was down US$16 per share from its 52-week high, prompting him to note, “at worst, MMC and AIG have shed more than US$30 billion in market value”. “Perhaps what investors are looking for is a quick remedy, an immediate response to these charges,” Ketchen comments. While he notes that the kinds of abuse being alleged in the U.S. have yet to be seen in Canada, overall there is a need for a new culture of transparency amongst corporations. “It takes long, hard work to build a reputation and it takes a day to destroy it.”

REPEATED BLOWS

The impact of “Hurricane Spitzer” has been so profound, it has almost overshadowed the more tangible financial impact insurers face as a result of the record four major hurricanes which made landfall in the southeast U.S. this fall. The storms are expected to produce more than US$20 billion in insured damage, according to early estimates, but this figure could well rise to US$30 billion, speculates Sean Mooney, chief economist for Guy Carpenter & Co. Given demand surge for reconstruction goods and services, fraud and inflation factors, early storm estimates tend to rise, he explains.

While “insurance companies have risen to the occasion”, in terms of handling the claims following Hurricanes Charley, Frances, Ivan and Jeanne, there are repercussions from this unprecedented Atlantic storm season, says Leslie Waters, Florida state legislature representative. “Who would have ever thought three hurricanes would crisscross in the middle of Florida?”

Several issues have been raised by the quartet, including the need to revisit the Florida Hurricane Catastrophe Fund (FHCF) – a government-run reinsurance program – to determine its suitability for addressing three, four or more events in one season, and the adequacy of FHCF retentions, Waters notes. McCarty explains the program will likely pay out US$2 billion, with US$6 billion in total capacity, adding that the program was successful as a buffer against the kind of insurer insolvency seen after Hurricane Andrew in 1992, when 11 carriers went belly-up. While one insurer has been placed into rehabilitation following the storms, McCarty stresses the company, American Superior, was already facing financial trouble.

Also, the issue of consumers being subject to multiple deductibles for property damaged by the storms has arisen, something the Florida legislature has already vowed to deal with in its late fall sitting. In the meantime, McCarty says, “we are encouraging our [insurance] companies to look at policies and liberally construe them.”

That said, McCarty says it is important to have homeowners’ deductibles substantial enough to encourage policyholders to practice good hurricane risk mitigation. “You can’t expect the insurance industry to bear that exposure time and again.”

MARKET IN TRANSITION

The full financial impact of the four hurricanes on insurers is unclear, but Mooney expects U.S. carriers should end 2004 with a combined ratio of 103%, and a return on surplus of 13%. The impact will most likely be felt in terms of residential property pricing, where he notes it is unlikely the market will soften readily.

However, the storms are not likely to halt the overall trend to price softening being witnessed throughout 2004 in both primary and reinsurance sectors, speakers note.

“The list of reasons why it [pricing] shouldn’t slow down is as long as your arm. The list of reasons why it should is non-existent,” comments Dave Delaney, president of Lancer Insurance Co. “It’s discouraging to see that’s happening as quickly as it is.” He expresses amazement to see softening in areas such as directors’ & officers’ (D&O) and errors & omissions (E&O), lines which continue to show claims growth.

Delaney, whose company specializes in niche markets such as bus line coverage, says he sees generalist insurers creeping back into specialist lines with competition increasing. However, he has not seen the “chaos” of the late 1990s “when all hell broke loose and we sat back and watched retail brokers being handed underwriting authority” and “insurance companies gave away their pen”.

Nonetheless, he fears large insurers will fall prey to the “muscle memory” of price competition, an eventuality which makes little sense given that despite successive years of hard market pricing, the U.S. industry has yet to achieve 10% return on equity (ROE).

The weak returns seen on the stock market this year, and pervasive low investment income should act as a catalyst for insurers to maintain price discipline, says Mooney. “If companies get into trouble, especially legacy companies, they’re not going to get much help from equity markets.” However, he predicts “destructive” pricing could hit in commercial lines given the lack of concentration, which should produce a wide disparity in terms of t he results produced by the winners and losers in the market.

“Why would we expect the market to be changing after one or two years of decent results? I don’t know,” speculates Britt Newhouse, president of Americas for Guy Carpenter & Co. He says there are a variety of forces which should keep reinsurers specifically on the straight and narrow in terms of pricing, including: pressure from rating agencies who will be slow to issue upgrades and unlikely to lift ratings back up to double or triple-A levels; diminished parental support for under-performing operations; and continued reserving issues for the 1997-2001 loss years. There is a “line in the sand” which reinsurers will not cross in terms of pricing, Newhouse comments. However, of January 1 renewals, he says: “It looks like the market is not going to flatten or tick up a bit, it looks like it’s going to be a little bit softer.”