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Competition, capital and catastrophes Insurer CEOs foresee both potential problems and opportunities in the year ahead By Phil Zinkewicz Will the property and casualty insurance industry be able to capitalize on its current profitable posture; or will new capitalization coming into the market, coupled with a possible moderate hurricane season, drive P-C insurers into a competitive bloodbath? Does the U.S. legal climate inhibit investment in insurance companies? What role will reinsurers play in the future of the property and casualty insurance industry? These are some of the provocative questions put to a panel of chief executive officers at Standard & Poor’s recent annual insurance conference. In addition to the panel discussion, some of the more than 600 executives who attended the conference partici-pated in a survey. It revealed that 36% believe that irresponsible competition is the single greatest risk impacting the insurance industry. Other risks cited included natural catastrophes (29%), regulatory risks (16%), terrorism (9%), rapidly rising interest rates (8%), and pandemics such as avian flu (2%). Decision-making by these executives is most influenced by shareholders (according to 47% of the respondents) with competition being the top influencer for 27%. Ratings agencies (17%) and regulators (9%) were also mentioned in the survey as influencers of decision-making. Moderated by Thomas Upton, S&P managing director, the panel discussion, titled “Rethinking Risk in the Property/Casualty Insurance Industry: The CEO’s Perspective,” included Constantine “Dinos” Iordanou, president and CEO of Arch Capital Group, Ltd.; Edmund F. “Ted” Kelly, chairman, president and CEO, Liberty Mutual Group, Inc.; and Martin J. Sullivan, president and CEO of American International Group, Inc. Upton set the stage for the discussion by reminding his audience of the traumas the property/casualty insurance industry has undergone in just the past several years. He referred to a period of necessary reserve strengthening as the result of long-tail liabilities, the horrific impact of September 11, the controversies over broker compensation, and the hurricane season of 2004, followed closely by the devastating Hurricane Katrina and the other storms that followed in 2005. He asked the panel how the industry has performed in the wake of these developments. Sullivan said that, despite these setbacks, the industry has performed “reasonably well” and that the profitable years of 2004 and 2005 have demonstrated that. “Prior to 2004, the property and casualty industry had gone through more than a quarter of a century of no underwriting profits at all,” Sullivan said. “Even with Katrina, 2005 was a good year for the industry. I think that this demonstrates that the industry needs to continue to concentrate on underwriting results and not rely on investment income for its overall health.” Kelly and Iordanou agreed that underwriting profits should be of primary concern to insurers, but Kelly added that a strong balance sheet is essential, and Iordanou said that many insurance companies also desire growth in addition to underwriting profits, and that sometimes underwriting profits are sacrificed to that growth. “If you look back to the early 1980s,” said Iordanou, “you see a classic example of cash flow underwriting, where companies were ignoring sound underwriting principles for the sake of growth. Of the 30 or so insurers at that time, only six have remained independent today. Others weakened their balance sheets so that they either went out of business or were taken over by other entities. Has such corporate behavior changed? I am not very hopeful.” Sullivan said he has been in the property and casualty insurance business for 36 years and that, during that time, he has come to the opinion that “we don’t seem to learn from our mistakes or from past cycles.” Kelly said that, right now, insurers are holding to sound pricing and strong terms and conditions, especially in the southeast areas of the country. “But I am very much afraid that, if we have a moderate hurricane season this year, there will be a bloodbath in the fall,” he said. One area that must be considered, according to all three panelists, is the new capital that is coming into the marketplace. Iordanou said that he is “surprised” at the ease with which some companies were able to capitalize after 2005. “These venture capitalists are making a bet that insurance prices will continue to rise.” Iordanou also referred to the changes that have taken place in the capital markets. “In 1992 and prior years, new capital came into the market to support existing capital,” he said. “After 1992, things began to change. For one thing, Bermuda attracted new entrants into the business with clean balance sheets. Today, it seems that capital markets are more willing to capitalize these new entrants than assist existing companies.” Sullivan said that capital markets are entering the market because insurers are now pricing their products properly and making underwriting profits as a result. “But what will happen a few months or a year down the line?” he asked. “Given the legal climate, what I’m writing today may be the subject of investigation five years from now.” Finally, Upton asked the panelists, if they were venture capitalists, what they would look for in terms of investing in the insurance industry. Kelly said: “Solid underwriting and a solid balance sheet.” Iordanou said that he would look for companies that were properly diversified. “I don’t care how good a meal is, don’t eat too much or you might get indigestion,” he quipped. “Look for diversified companies that know how to measure risk.” Also at the S&P annual, the Ratings Services division offered its midyear 2006 outlook on the personal lines insurance sector, which the division called “stable.” The outlook noted that the second half of 2005 may have been one of the most challenging on record for U.S. personal lines insurers, with more than $57 billion in catastrophic losses recorded. “An analysis of industry trends in 2005 is currently pointing toward low volatility over the next six months for this segment of the industry,” said S&P’s credit analyst, Polina Chernyak. “Combine that with strong first quarter revenues and earnings, and Standard & Poor’s is reiterating its stable outlook for personal lines companies, thus implying few if any rating changes for the rest of the year.” Looking at the reinsurance industry, S&P’s Rating Services division said that, despite the different dynamics and prospects of the U.S. and Bermuda reinsurance markets, they share many of the same challenges and opportunities. However, S&P says that, for the rest of 2006, differences between U.S. and Bermuda reinsurers should remain as clear as ever. “Whether U.S. reinsurers can turn around more than a decade of poor operating results, or whether Bermuda’s earnings potential will be threatened by increased catastrophes, remains to be seen,” says S&P. “At least for this year, both markets are poised for improved performance, especially if the winds blow mercifully in the coming hurricane season.” * |
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