RAIN, RAIN, go away

2005 should have dawned with clear skies for risk managers, with all signs pointing to softening in the commercial insurance market following the price shock and lead grip on underwriting experienced since 2001. But gray clouds continue to hover, not the least of which have been brought on by the investigation into industry practices incited by New York Attorney General Eliot Spitzer. At the same time, risk managers recognize insurers, despite posting strong 2004 results, have all the reasons in the world to maintain underwriting discipline.

No one can question the uphill battle faced by risk managers over the past three years. Between rising commercial insurance rates coupled with severe tightening of terms and conditions, and the placing of corporate governance and risk practices under the microscope of regulators, legal authorities and shareholders, the profession has been put to the test.

At the same time, many risk managers have told CU this extreme environment has helped to vault the profession into the higher ranks of the corporate world and challenged risk managers to rise to the occasion. Nonetheless, with various industry surveys indicating commercial lines price softening beginning to take hold early in 2004, it appeared much of the turmoil of the past few years was behind risk managers.

Risk managers happily report a much more moderate and stable insurance market thus far in 2005, and while some say there is room for further price reduction, they quickly add that stability is what they most desire in their insurance relationships.

However, that stability remains elusive, not as a result of pricing now, but as a result of the scandal over business practices.

UNCERTAIN FUTURE

The commercial insurance market has been reeling since mid-October, when the Spitzer investigations resulted in civil charges filed against broker Marsh over broker compensation practices and allegations of misconduct. Marsh moved quickly to reach financial settlement and all three of the “big brokers” – Marsh, Aon and Willis – announced they would discontinue accepting contingent commissions. More recently, Aon has announced a financial settlement with authorities in New York, Illinois and Connecticut.

The commission scandal has been felt, albeit to a lesser degree, here in Canada, but risk managers say in many ways they have been left with as many questions as answers. Specifically, risk managers wonder, if contingent commissions are taken out of the equation, what does that mean for the cost of insurance?

“There seems to be a lot of speculation about what that means, does that mean a decline in service from brokers, or that risk managers might be required to pay more?” muses Nowell Seaman, manager of risk management and insurance services for the University of Saskatchewan. And, he adds, “if you eliminate that [contingent commissions], who does it benefit?”

While the big three brokers have abandoned contingent commissions, he notes, “there are many brokers that have not said anything”. He concludes, “at this point all I have are questions.”

Ed Martingano, director of risk management for Oxford Properties, expresses surprise that thus far there has not been an industry-wide response to the controversy, and says that while the Spitzer investigations continue, the story is far from over. Given the uncertainty, “no one’s going to come up with any plans” for the future with respect to broker compensation and its impact on costs, he says.

“It still a confusing message,” agrees Joseph Restoule, director of risk & insurance for NOVA Chemicals Corp. “They’re talking about new compensation systems [but] I can’t comment because it hasn’t been very transparent. I haven’t heard any talk of new products or services, just about paying more.”

“It’s not going to change the cost of insurance,” comments Susan Meltzer, assistant vice president, insurance & risk management, for Sun Life Financial. Overall, the cost allocation should simply shift from insurers to the client, and certainly no drop in overall costs to the client can be expected as brokers will have to find this revenue somewhere. However, she adds, “costs are going to increase [for brokers’ services] and they [risk managers] are going to have to decide if it’s worth it.”

Meltzer says the scandal brings to light the need for risk managers to manage their relationships with brokers “on a more strategic basis” if they have not already been doing so. “Risk managers should have been treating brokers as they do any other outsourcing contractor in their business.” She says risk managers should treat these relationships as they would their relationships with claims administrators or other such service providers, including performing audits of the level of service being provided. “How many risk managers have performed audits on what their broker has done?” she wonders. She also points to the lack of action taken follow discussions between the Risk & Insurance Management Society (RIMS, of which Meltzer was president at the time) and brokers in 1999 to devise standards on compensation disclosure. “Risk managers had the tools to manage, and regulators had the tools to manage, contingent commissions in 1999. The world knew, but no one did anything about it.”

Seaman believes Canadian risk managers have remained relatively “level-headed” about the situation thus far despite the Spitzer allegations, and adds “people still seem very confident in the brokers they deal with”.

The Canadian Council of Insurance Regulators (CCIR) is looking into the compensation issue, while the Insurance Brokers Association of Canada (IBAC) and Insurance Bureau of Canada (IBC) have jointly addressed consumers’ rights with respect to commission disclosure (while not advocating any sort of ban on contingent commissions). But thus far in Canada there have been no indications of the same kind of alleged misconduct in the form of bid-rigging or bid-steering which have been made in the U.S.

DISCIPLINE REMAINS

While the broker compensation issue remains an open question, risk managers seem to be on much surer ground when it comes to the insurance market. Surveys by RIMS and Advisen, and the U.S. Council of Insurance Agents & Brokers (CIAB) point to moderation in pricing on most lines of business, including formerly trouble lines such as directors’ and officers’ (D&O). The outstanding exception is U.S. workers’ compensation, where rates continue to climb.

The decreases seen have been moderate, even in the property line where rates rose first and thus declined early, and risk managers report price breaks are there only for “clean” accounts, rather than on a wholesale basis. There is also growth in capacity on many lines, both from new players and the re-emergence of existing carriers.

While some analysts were predicting a speedy return to the hyper-competitive market which drove down prices throughout the 1990s, risk managers welcome a continuation of strong underwriting on the part of insurers.

“I kind of like the market the way it is,” says Meltzer. “I like stability. I like having my account underwritten.” She adds, “I’m not looking forward to a soft market. Insurers need to build their strength and their reserves.”

“I don’t think people thought the market would bottom. As an industry we need to continue to support responsible underwriting,” comments incoming RIMS president Ellen Vinck, vice president of risk management and benefits for U.S. Marine Repair. “Underwriters did themselves a big disservice in the last soft market when it [pricing] wasn’t realistic. I’d like to see them really underwriting the account.”

“I’m encouraged to see that insurers are still underwriting and basing premium according to the quality of the account and how the risk is being managed,” agrees Seaman. “The danger is returning to the old ways.”

“I don’t see the average buyer being aggressive,” predicts Restoule. “What are you trying to achieve?” He point s to examples of underwriters more than willing to walk away from even major accounts if the price was not right. “I think if you’re more modest in your pricing expectations, you’ll have more success.”

Certainly there are many reasons to maintain pricing, notes David Bradford, editor-in-chief at Advisen, which publishes RIMS’ benchmark survey of risk managers. He notes the most recent surveys, while indicating overall softening, did show a “mixed bag” of pricing, indicating price decreases are not being made on a wholesale basis without concern for underwriting. “I don’t think we’re really at the slash and burn stage yet [on rates]. There is less of the back-stabbing, bloody competition than we saw in the last soft market cycle.” He notes that insurance industry surplus has shot up dramatically in the last two years, but not compared to gross domestic product (GDP) growth, and insurer returns still lag behind those of other listed companies. “The picture isn’t that rosy.”

The benchmark survey indicates total “cost of risk” (including premiums, risk administration cost and retained losses) declined slightly in Canada last year, but this is largely a result of a lower cost of risk administration and the fact that a large proportion of Canadian risk is in property. This compares with the U.S. where the cost of risk has is being maintained on the back of higher proportions of troubled lines like workers’ compensation and professional liability lines.

Bradford adds, “there is nothing in the immediate future that looks like it will cause the bottom to fall out on rates… beyond a return to the rabid bull market of the 1990s.”

Nonetheless, history has shown the tendency of insurers to forgo bottom-line returns for top-line premium growth. “I think there’s a sense from insurers when they’re quoted, they are expressing the “wish list” to maintain it [underwriting discipline] but they have a lot of competitive pressures out there,” Martingano notes. “Two or three years ago, we knew with certainty prices were going to go up. We knew the cycle was going to turn,” he adds. Now the question is how long can discipline last. He adds that there may be “room to come down” on price given some of the increases seen in the recent past.

Overall, though, Martingano points to stability characterizing the market. “The panic in the market of the last two to three years is gone. We’ve gotten used to the way things are. Certainly the pressure’s off.”

ENERGY CRISIS

Overall market stability does not mean certain commercial insurance lines are not feeling the pinch. Bradford notes, despite reports of softening in D&O, anecdotal evidence in early 2005 indicates this market may be firming up again, not unwelcome news for D&O writers who continue to face growing severity in terms of litigation costs.

Another sector in turmoil is energy, notes Restoule. Things had appeared stable until news came in recent weeks that a fire at the Alberta oil sands plant of energy giant Suncor has the potential to wipe out the worldwide property premium for the onshore energy sector in one loss. This is despite Suncor being part of the energy industry’s mutual insurer, OIL, because the loss will move well into the excess coverage layers, explains David Mew, director of national broking for Aon Reed Stenhouse. Restoule notes the news of the Suncor fire’s impact on the energy sector was shocking given that the company had a significant self-insured stake in the loss and also that these kinds of losses are exactly what companies purchase insurance for.

Restoule also notes the energy sector is struggling with construction coverage which may hamper the new exploration and expansion that would naturally follow the rise in oil prices.

Multi-media liability is another area which is seeing availability issues, notes Edouard Moreira, vice president and director of marketing, Willis Canada. “There are few underwriters on that line”, and the companies affected include giants such as BCE or Canwest, which have interests in publishing, online, television and more.

Another sector hard hit by rising rates has been that of volunteer and not-for-profit organizations, adds Jane Voll, chief economist for the IBC. The bureau has been working with this sector, as well as other businesses impacted by rising liability insurance rates to facilitate solutions with the insurance industry (see Insight of this issue).

In a recent IBC survey of the commercial market, Voll says, “there were signs the majority of commercial clients were seeing something [increases] at the rate of inflation or less on their renewals. But there remains some stubborn problems.” Specifically, volunteer groups were being plagued by court awards for vicarious liability and found themselves reclassified as “high risk” by insurers. In a sense, Voll says, this situation may represent a “canary in a coal mine”, a warning of a more litigious society emerging in Canada. Problems in the price and availability of commercial liability cover are “not just the ebb and flow of supply and demand. It is the expanding scope and extent of liability and questions this raises about us as a society.” she says.

BROKERS’ VIEW

Another area where risk managers have seen no relaxation on the part of insurers is in terms and conditions. Across the board commercial buyers report insurers are reluctant to give back the high retentions taken on during the hard market, nor to relax their demands for significant information to feed the underwriting process.

Brokers agree. While citing the transition of the market from hard to moderate, they say there remains a disciplined approach to the process.

Mew says the “best” accounts may have seen premium decreases on the order of 15-20%, but this has been reserved only for the best accounts, and has not been accompanied by an increase in retentions. “They [insurers] are saying the bottom-line result is more important than the amount of premium they write,” he says of the discipline which continues to characterize the market.

Where insurers are willing to negotiate on price, is on those good accounts which survived the paring down of books of business during the hard market, Mew notes. “A lot of them [insurers] spent the last two to three years working very hard to correct their books. Now they don’t want to lose those accounts [the ones they retained].” And, some competition has set in when it comes to new business opportunities, for which underwriters have been “fairly aggressive”, he adds.

The need to vet each submission which comes across the underwriter’s desk remains, notes Moreira. “Underwriters still have to beef up their files to say they have thoroughly identified the risk. You don’t see them going blindly into an account.” This stems from the need for insurers to sustain both internal and reinsurance audits, as reinsurers become increasingly aware of their aggregate exposures. However, he says, risk managers are prepared for these requests for underwriting information. “Risk managers and corporate clients are more used to that scrutiny than they were in the past. Their files are now in order,” Moreira says.

There is an increased awareness of the broad spectrum of risks, even amongst middle market, mid-cap companies, in the wake of corporate governance issues making headlines for larger corporations, notes Alan Garner, CEO of Marsh Canada. Marsh Canada recently completed a survey of a broad range of executives, including those not specifically involved in insurance and as high up the corporate ladder as the CEO, at these middle market companies. The survey is part of a five-year dialogue on the broker’s role in helping these companies manage the spectrum of risk beyond traditional insurable hazards. “It isn’t just about identifying insurance-treatable risks. It’s about identifying operational risks that are treatable in a variety of ways,” he says. “”The risk management community has started to get its head around broad risk management analysis. And more importantly , as we’ve seen from the 2004 Marsh Canada Corporate Risk Review, more small and mid-size organizations are taking risk management more seriously.” Part of this desire to take a more holistic view of risk, he adds, is an effort to attract board members.

Risk managers share the view that the current market is about much more than insurance and the turmoil of the last three years has done much to promote enterprise-wide risk management. As Seaman notes, “ERM is still grabbing the spotlight, it is becoming the standard.”