Risk Management: 2003 More Of The Same

Risk managers probably think that they have seen the worst the hard insurance market has to offer, but they could well be wrong. With insurers and reinsurers unlikely to produce a significant turnaround in 2002 yearend financial results, the premium hikes and capacity crunch that categorized last year are expected to continue in the year ahead.

At the recent Membership Appreciation Day sponsored by the Ontario Chapter of the Risk and Insurance Management Society (ORIMS), risk managers heard that problems ranging from the resounding impact of 9/11 to lagging stock markets and lingering environmental concerns have hampered the “year of the comeback” and the hard market is here to stay for the time being.

ROUGH ALL OVER

The problems start with the reinsurance market, where Canadian companies produced a combined ratio of 108.5% in the first half of 2002. “People may think reinsurers are gouging, but we’re really trying to recover from a very difficult situation,” says Andre Fredette, senior vice president for CCR’s Canadian operations. Problems from asbestos, directors & officers (D&O) claims and the stock market meltdown have plagued reinsurers, who were already coming off a disastrous 2001.

For countries like Canada which act as “branch offices” for global reinsurers, these parent companies are asserting tighter control in light of such results. They are responding to concerns from capital providers, including shareholders, to return to profitability. “Many of the reinsurers are in panic mode, the gun is to their heads…there’s tremendous pressure to improve results,” Fredette observes.

The situation is just as bleak in the primary market, were Canadian insurers saw earnings fall an additional 22% in the first nine months of 2002, on the heels of the worst year on record in 2001. While industry premiums are $30 billion, earnings are less than $500 million, points out Stan Griffin, president and CEO of the Insurance Bureau of Canada (IBC). The combined ratio for the first nine months of 2002 is 105.4%, and, as Griffin notes, “this improvement is not enough to restore the industry’s profitability”. This is especially true given the anticipated worsening of results in the fourth quarter, a traditionally claims-heavy period. The commercial market is also feeling the impact of problems in the Ontario auto market, Griffin notes. With 53% of insurer revenue coming from auto, compared with, for example, 13% from commercial property, risk managers will not escape a “trickle down” effect.

Furthermore, the rate increases of 2002 did not solve the industry’s problems, notes Ken Arthurs, managing director of Marsh Canada Ltd. “We [the insurance industry] need to make money. People’s jobs are on the line.” Growth in net written premiums is estimated at 13.6% for 2002, but is expected to fall to 12.3% in 2003. Solvency is a real concern, he adds. “A 9/11 incident or a Hurricane Andrew incident can really buckle the knees of our industry.” Despite a drop in global non-life capacity of 25% in the last two years, and a decline in policyholder surplus of 18.7% since 1999, Arthurs still feels the market is open for business however.

LINE BY LINE

The result for commercial insurance buyers is increases across the board expected to continue through 2003. On property, the increase is expected to be 10%-20%, with 10%-40% jumps on casualty anticipated, Arthurs points out. Most troubling may be the D&O market, along with professional liability, where risk managers could see rates jump from 20%-100% this year.

Despite the introduction of about US$20 billion in new capital from the Bermuda market, US$60 billion has left the market, Fredette notes. Bermuda did help stabilize rates on property catastrophe, along with the London market, he observes. Reinsurers saw certain lines hardest hit this past year, including D&O, facultative markets and in particular builders’ risk. And along with rate increases, reinsurers introduced new exclusion wordings on such things as fungi/mold which are finding their way into the primary market. As such, Fredette expects capacity to remain scarce for the next two years, and the hard market to continue in response.

Of particular concern to some risk managers is the lack of terrorism insurance legislation in Canada, despite the U.S. government introducing such legislation late in 2002. Griffin says insurers were willing to push for a backstop, but there seemed to be little will in the marketplace for it. Risk manager Ed Martingano of Oxford Properties adds, “the real estate industry took a second look and we obviously have a very high stake…we couldn’t find anybody who had a problem with it”. As well, he confirms that RIMS surveyed its Canadian membership and found little force behind the idea. Arthurs explains that although terrorism insurance is expensive, the U.S. market is pricing the product attractively and this will likely drag prices down elsewhere.

MANAGING EXPECTATIONS

What can risk managers do to weather the market? Increasing importance is being place on their role, particularly in light of the corporate governance scandals ripping through the U.S. market. And Canada has not been immune from big company failures, notes Peter Winkley, vice president of finance for MDA Inc. Not only are CEOs and CFOs more focused on risk, but boards are becoming increasingly sophisticated, asking more questions, he adds.

In response, his department came up with a “risk document” to outline not only the company’s financial risks, but also operational, “reputational” and other threats. “It’s probably fair to say that they [the board] are skeptical that this document and the processes put in place to keep it a ‘living document’ is actually going to happen. They’re afraid it’s the flavor of the week,” he admits. However, Winkley says that risk managers have to find a way to step up and insinuate their role at the highest levels at a time when they are most needed.

In their relationships with insurers, Arthurs advises risk managers to do their homework on financial strength ratings as the “primary litmus test of solvency”. At the same time there is a flight to quality, many insurers are facing downgrades. For their part, risk managers need to provide timely, thorough submissions. But more importantly, they need to manage the expectations of boards and senior management of what can be expected from a very troubled insurance market. “Where we have seen large problems in renewals is where there is a disconnect in expectations.”