Risk Managers – Desperately Seeking Stability

Insurance market surveys seem to suggest the soft market is well on its way, if not already upon us. The second quarter Risk & Insurance Management Society (RIMS) Advisen “benchmark” survey shows commercial premiums having fallen year-on-year by an average 18%, with a host of lines showing rate relief, including property, general liability and even directors’ and officers’ (D&O) coverage. In every major commercial lines category, insurance buyers report price declines outpacing price gains.

Similarly, the second-quarter market index produced by the Council of Insurance Agents and Brokers (CIAB) has commercial lines intermediaries reporting price declines in all sizes of accounts. Specifically in medium and large commercial accounts, more than half of commercial insurance buyers saw rate decreases of up to 20%.

But, do these surveys reflect the reality of what Canadian commercial insurance buyers are experiencing? Risk managers say the market is certainly moderating from the intense price increases seen over the past three years, but are reluctant to say the soft market is in full swing yet. “What I’m hearing is that the rate of increase has moderated in some lines, but it’s still a pretty tough market in some lines, says Nowell Seaman, manager of risk management and insurance services for the University of Saskatchewan. These lines include D&O and other professional liability lines. Mainly, he says, the market is still characterized by a lack of consistency in terms of what is being offered. While some lines and accounts are flat to decreased, other are still seeing single or even double-digit increases on top of the steep price hikes already experienced in successive renewals, he notes. However, there does appear to be improved market capacity with new players willing to take on risks, he adds.

“People are having less difficult renewals this year compared to a year or two ago,” comments Joe Hardy, director of risk management and insurance for Hudson’s Bay Co. “There is more capacity and rates are becoming more competitive.”

Certainly “clean” property accounts should be expect to see rates falling off because this line experienced the steepest and earliest increases during the hard market, explains Stephen Mallory, managing director for Marsh Canada. Casualty, he adds, is following close behind. And more capacity is available in all lines – he admits surprise to see even a very troubled line like stand-alone auto for commercial fleets see a boost in available capacity.

HARSH CONDITIONS

Despite this softening on the price side, risk managers say terms and conditions remain tight. While insurers may be willing to bend on price, buyers say they do not expect to see exclusions and restrictions put in place over the last few years disappear anytime soon. “We may see more reluctance on the part of markets to give those up,” comments Ed Martingano, director of risk management for Oxford Properties. From the perspective of insurers, he says, “it’s going to be a lot easier to drop your price if you’re not offering the ‘Cadillac’ program you were a couple of years ago”. This may be especially true in the “executive protection” line given the floodgate of claims opened up in the post-Enron era.

The changing market is certainly about more than price, and has to be seen in the context of policy terms, notes Mark McKay, vice president for Willis Canada. As the market turns, it becomes about questions such as is the policy limit the same, are there new exclusions in place, is there a different reinsurance structure backing up the policy. “I don’t think things are necessarily ‘better’, but they have changed. There is the possibility of getting a better price, but not without creating some competitive action, and not without investment on the part of the broker,” he notes. “The entry into the market has to be very professional.” This means the importance is on risk classification, i.e. ensuring the underwriter fully understands the risk – the client’s industry, risk controls in place, etc. “If you can characterize a risk in a given class of business, they [underwriters] are more willing to underwrite it, and to underwrite it at the price you are looking for,” he adds.

Another element risk managers must keep an eye on, beyond price, is insurers’ attitudes to claims payment. “The premium side of the market is stabilizing to soft but you also have to look at the claims management,” comments Susan Meltzer, assistant vice president of risk management at Sun Life Financial. “The market is still very tough because insurers are taking very tough positions on claims.” While there can be legitimate reasons for denying payment of a claim, there must also be a fair response to legitimate claims, she observes. Furthermore, Meltzer points out that financial institutions are facing tight policy terms and conditions as insurers react to mutual funds issues.

TOO MUCH?

Insurer CEOs have been preaching the call of “underwriting discipline”, with many analysts previously predicting a hard market lasting well into 2005. Risk managers, however, are not surprised by signs of softening, and stress that despite market survey results, the marketplace continues to be challenging.

Seaman notes that the hard market of the mid-1980s similarly ended relatively quickly, with soft conditions setting in by the end of that decade. He adds that the continuing pressure on terms means the market today remains tight in many respects.

Martingano concurs that many accounts continue to face hard market conditions. “The market has softened, but I don’t think we can say it’s actually soft yet. A lot of it depends on the market and who you are [as a risk].” He adds that the lines which have softened, such as property, probably needed correction after the steep increases seen in the early 2000s. “At the end of the day, the market is moving the way we thought it would, it’s just sooner than we expected.”

“I don’t agree it [the hard market] has been short,” says Craig Rowe, risk manager for the City of St. John’s. “It’s not over yet. If your prices increased 100% and they’re still at that level, then you’re still suffering from the hard market.” He expects really aggressive price competition will not likely set in until 2006.

Mallory says the insurance industry, including brokers, have been taken aback by the speedy return to soft market conditions. “Overall, the insurance industry, like many other industries including brokers, miscalculated…the dip has occurred and caught most people off-guard, they’re not prepared for it.” He says the insurance industry did not budget for this kind of softening in 2004, and insurers are therefore reluctant to accept renewal rates below what they budgeted. This plays into the hands of new writers, not burdened by legacy issues, who are seeking out new business and can write it at lower rates with fewer restrictions. In fact, the whole market, including brokers, is seeking “new” business, “a panacea”, he says, because the rates are not what was expected on renewal business. For risk managers and brokers, this means “covering the marketplace to determine the appetite for the risk”.

UNDERWRITING STANCE

One thing that has pervaded into 2004 is the importance placed on underwriting by insurers, sources agree. Mallory says this is evidenced by the “less than clean” risks, which are not yet seeing the benefits of the onset of the soft market. “There are a few signs that the market hasn’t yet completely softened. At the bottom of the soft market, underwriting guidelines tend to go out the window and we’re still seeing some good underwriting guidelines and thought going into underwriting,” Mallory observes.

Insurers are focused squarely on return on equity, says McKay, and are specifically looking at the “tail” of the business they write – trying to ensure they are not writing something which could come back to bite them in five or 10 years. “While there is more capacity in the market, there remains pressure to get return on equity (ROE). ROE is the tune of the day,” he adds.

Hardy concurs that insurers have maintained a focus on profitability, a message which has been strongly heard in underwriting departments. “Underwriters are conservative people. They’ll start looking for marketshare, but do it cautiously because that’s the word from the top,” he comments.

The eminence of underwriting is “a plus” for risk managers, says Nancy Chambers, RIMS president and risk manager for Waterloo Region Municipalities Insurance Pool. “You can really market your account to underwriters. You can market that it is a good risk. It’s a chance to bring them in and say ‘come see what we do and how we manage risk’.” Meltzer agrees with this view, and says that she appreciates the good underwriting seen in the marketplace. What she does not like about the current insurance environment is insurers who practice “across the board” underwriting, or those who, in a bid to reduce exposure, do not want to offer coverage at all. Buyers, she says, are tired of having insurers “carve out bits and pieces” of their business through exclusions and endorsements.

Moving forward, brokers and risk managers are trying to remain optimistic that the attention to underwriting will lead to a more stable marketplace. “Because of all of this [underwriting] we’ll come out of this hard market better, the risks will be better risks,” says Rowe.

FAIR RULES

While risk managers say they welcome lower prices and increased capacity, they share the fear of CEOs who decry a return to “cashflow underwriting” and therefore stress the need for a return to stability. “There has been an element of ‘win-win’ for both [risk managers and insurers],” says Chambers. “It’s in our best interests to have risk properly underwritten, so that there’s money there to pay the claims. It’s tougher to manage programs when there are these swings.” As such, she says there is a need for reasonable and manageable pricing.

“We don’t mind paying rates that will provide a consistent underwriting return, but we expect to pay a fair price,” notes Martingano. He points out, as do other risk managers, the difficulty in trying to plan for the kind of peaks and valleys experienced over the last few years. Unfortunately, he adds, “the conditions that created the last soft market are starting to creep back in again”.

“It’s good that the market’s softening, but we’re going to go through the same roller-coaster [ride] again and again,” comments Rowe. “I think everything that comes with a soft market will come again. As companies reduce prices, competition will come back again with everything else [looser terms and conditions].”

One thing which may prevent insurers from falling back into intense competition and cashflow underwriting is the lack of recovery of financial markets, specifically in the U.S., Seaman notes. Another factor, adds Hardy, is that insurers have bolstered reserves and returns, and are reluctant to give up the ground made since the last soft market ended. “Personally, I believe the market will be stable because the pressure from insurers is ‘we have to stay profitable’.” This is especially true in the low interest rate environment, he says. “I think the insurance industry is learning.”

RISK EVALUATION

How will risk managers respond to the softening market? Most sources say they will not be quick to buy back deductibles which were raised during the hard market. They say higher deductibles give them a greater sense of control over their programs and loss ratios. Meltzer adds that risk managers should continue to question whether they need to cover risks via insurance. “It’s appropriate to look at every policy you have, whether you are getting a lower price or not, and ask yourself whether it’s worthwhile to buy it…it’s time to look at why you’re buying what you’re buying.”

McKay predicts risk managers will not return to the “ridiculously low deductibles” seen in the last soft market, but that some buyers may use the softer market to buy more limits.

Mallory, on the other hand, sees a likely return to traditional insurance coverage if the price is right and the cover appropriate. “As rates decrease, insurance is becoming the risk transfer vehicle of choice.” He cautions risk managers against keeping a high deductible – if insurance is the most economical means to handle the risk then it has to be assessed as an option, he adds.

The question remaining, however, is how much commercial business may have been lost to insurers as a result of the hard market – business that they may never be able to win back. Risk managers say those colleagues who took the time and resources to conduct a feasibility study on a captive, likely did so for reasons beyond price, and will therefore stay the course. “Anyone that is sophisticated enough to run a captive knows it is [about] control and consistency over time. You’re looking for more than just premium advantage,” Martingano notes. And, Chambers points to two government entities she is aware of – the Province of New Brunswick and Niagara Region – who are at the stage of implementing pool mechanisms.

BUSY TIMES

Risk managers report no let-up in their workloads, nor in the profile their profession continues to enjoy as a result of challenging times. “Over the last three to four years the profile of risk managers within most organizations has increased and in some cases quite dramatically,” says Seaman. “There are so many factors driving boards’ interest in risk management.” This includes terrorism, corporate governance, environmental compliance and risks, disaster planning and more.

Another aspect of the profession which is enjoying increased notoriety in 2004 is enterprise risk management (ERM). Meltzer, who serves as president of the International Federation of Risk and Insurance Management Associations (IFRIMA), was part of the team which devised IFRIMA’s guidance on ERM. Part of the document highlights the need to move the risk management function up corporate ladder so that risk can be understood and managed across the entity. In this respect, Meltzer notes that Canada and Europe are further ahead in ERM development, but many companies still find the concept overwhelming. “A lot of people didn’t know what it meant or were intimidated by it.” This included a belief that ERM meant investing in multi-million dollar programs. “People are making ERM a big deal. All it really is, is regular risk management, except you expand your definition of risk,” she adds.

Seaman says the ERM concept is getting the attention of corporate boards, to the benefit of risk managers. “The boards are asking ‘how do we do that?’ If there is a sound risk management function in place, those people are being asked to play a key role,” he notes.