Execs Talk Future of Industry at 9th Annual ITC Forum

“Amateur hour is over.”

Those were the words of the Sullivan Group president Gerald J. Sullivan, addressing a roomful of industry executives recently at the 9th Annual Insuring the Children Forum. Sullivan’s words were marked with caution as he warned the room that they are not out of the water yet, in terms of the industry backing off in hopes that the market will soon stabilize.

“This industry is not well yet. It’s gradually getting better, but we still have a long way to go…. We’re not ready to start backing off yet…. We’re going to see more insolvencies. We’re going to see more difficulties.

“I’m afraid if we do this quickly… we could really truly bring this industry to its knees,” Sullivan warned.

Sullivan, along with fellow panelists Jeffrey Post, president and CEO of Fireman’s Fund Insurance Company; Renee Koren, vice president of State Compensation Insurance Fund; and moderator Mayra Guffin, regional vice president of American International Group, discussed the current trends in the marketplace encompassing all areas: tort, workers’ compensation, medical malpractice, D&O, etc.

While Sullivan agreed that the industry is gradually getting better, he cautioned that there is still a long way to go out of this hard market. He noted that the capital base of the industry began its decline in 1999, and has continued since. Declining to term it as just another “tight market,” Sullivan described the current state of the industry as “significant… deep-seated, and…. going to have a long-term impact.”

Trouble brewing
Quoting AIG chairman Hank Greenberg, Sullivan described several factors troubling the marketplace right now, and what remedies are being considered. “The key reason that our industry is in the condition that it is in today is because we have spent about 17 years exercising an enormous lack of discipline,” Sullivan said. “It has been extensive, it has been rampant, it has been major, and it is finally coming home to roost big time.”

According to Greenberg, Sullivan said, a major issue that must be addressed is reserve adequacy. Sullivan cautioned that insurers’ balance sheets must be prepared and reviewed with caution. Rating agencies such as A.M. Best estimate the inadequacy of insurers’ reserves “at somewhere in the vicinity of $100 billion. That’s on an industry whose entire surplus today is about $260 to $270 billion. The return on investment in our industry -if we are lucky-Conning estimates that may get as high as four percent next year. You could do better burying your money in the backyard,” Sullivan said.

“The process trying to figure out those what those reserves should be is a very difficult one,” he added. “But if you always want to air on the optimistic side, you’re going to fail. And we’ve had a lot of companies fail by estimating on the optimistic side year after year.”

Sullivan stressed that leadership is critical in the industry-and the turnover at the top levels of many companies must come to an end. “The change is disruptive,” he said. “If we’re constantly changing, that does cause great problems.”

Along with leadership, Sullivan wants to see changes in corporate governance, and again, stressed the importance of discipline in the industry. “Discipline is critical,” he said.

The global political climate, current economic conditions, and the threat of terrorism add to the long list of factors stirring up the industry.

Catastrophe losses, Sullivan warned, will be unavoidable in the future, citing the most recent losses in the Southeast due to deadly tornados. “Every year we face more catastrophe exposure because we build more in areas that are subject to catastrophe exposure, and they’re getting more expensive all the time. Is this industry really prepared to deal with that?”

Sullivan also discussed tort deterioration -“This is an area that we really have to pay a great amount of attention to. The tort liability system is really causing our industry and the entire nation enormous problems.”

Recent studies from industry analysts revealed a dismal future. Morgan Stanley’s April 29 estimate of inadequacy of reserves in the U.S. P/C industry is somewhere between $90 and $110 billion. According to Sullivan, “They [Morgan Stanley] actually don’t believe that we’re going to be smart enough to keep prices up. Their essential comment is, with very few exceptions, the insurance industry is a lousy place to invest money because the balance sheets are so weak.”

Standard & Poor’s recently downgraded several major European reinsurers-“About half the world’s reinsurance comes from Europe,” Sullivan said. “Reinsurance is terribly tight right now.” He attributed the troubles of European reinsurers to the struggling European economy.

A recent study by Tillinghast Towers Perrin revealed that tort liability in the United States cost $205 billion-almost as much as the entire surplus in the P/C industry, and the equivalent of a five percent tax on wages. “It’s growing at the rate of somewhere between
$15 and $20 billion dollars a year. [It’s] an enormous drag on this country. Everyone needs to know how costly this system is,” Sullivan said.

He noted the case of State Farm vs. Campbell in particular, in which a Utah Supreme Court awarded plaintiff Curtis B. Campbell $145 million in punitive damages when he alleged State Farm handled his claim wrongly. Campbell was allegedly at fault in an automobile accident in which one victim died, and another was left permanently disabled. Campbell was uninjured in the accident. The U.S. Supreme Court overturned the ruling in April 2003.

“The U.S. Supreme Court, for the first time, has begun to deal with the issue of punitive damages,” Sullivan said. Quoting Lloyds’ chairman Lord Levene, Sullivan said, “Of all the challenges we face, the culture of litigation is one that we can tackle and we can solve. It is a culture which, if left unchecked, threatens to sap the American will.”

Workers’ comp
Before speaking of the current status of State Fund and it’s ongoing concerns regarding it’s financial stability, Renee Koren thanked brokers, saying, “We opened up to brokers in 1993. Without the brokers in this room, and the brokers in the state of California, we could not have gotten through all of the challenges in the state of California after open rating, and we would not have been able to provide an available market for employers without broker participation.

“We appreciate you, we need you, and we want to continue our partnership with you for years to come.”

She then addressed the concerns of the industry regarding the solvency of State Fund. “It’s simply not true that State Fund is on the verge of collapse,” Koren said. She said that State Funds nationwide have been under attack for many different reasons, including by private carriers.

“Our role that we are designed to play in the insurance industry is the stabilizing influence,” she said. “We are there to provide an available market in times of hard markets.”

Because State Fund is non-profit, Koren explained, the company operates in a different context than a private carrier would. The Governor appoints a Board of Directors, who in turn, governs the company. The Board of Directors also appoints the president.

“Growth has caused surplus challenges for State Fund,” Koren said, “not a solvency crisis. We are solvent, we are able to pay all liabilities, and we are providing an availability market.

“Our surplus level is not where it should be,” Koren continued. “Our surplus level could not be where it should be given the market conditions of the last three years. Our exposure growth… peaked in the first quarter of 2001. Since the first quarter of 2001, we’ve seen a steady decline in actual exposures. We’ve seen a steady increase in premium. That’s what’s putting the pressure on our surplus. The premium continues to grow because of loss development, higher rates, and benefit increases.”

While Koren acknowledged that the system is broken, she added that no amount of regulation of insurance companies or administrative remedies would solve the problem. To fix the workers’ comp system, according to Koren, the problems must be legislatively addressed, or “there is going to be a complete collapse in the system which will be a disaster for injured workers as well as employers.

“Our role in the marketplace is under continuous attack throughout our history,” Koren said. State Fund’s rates have always been above those of private carriers, even after the advent of deregulation, she added.

Koren explained that since the year 2000, there has been 24 workers’ comp carrier insolvencies. “There is a direct correlation between those insolvencies and State Fund’s growth,” she said. “Insurance insolvency is not something that is going to attract capital to any insurance market.” Koren said total market share of the top carriers in 1996 was 31 percent. Those carriers, she said, no longer exist. “You cannot take this kind of capacity out of a market and have a healthy market.”

Koren noted the recent victory for State Fund in the A&J Liquor vs. State Fund case, for “a conspiracy to over-reserve claims just prior to open rating in order to develop a war chest to garner the market share and to take over the world,” Koren said.

“The decision is a complete validation of State Fund management and our role in the market,” she added. “The judge declared that there was no predatory pricing on State Fund’s part, that our market share was a direct result of the insolvencies in the workers’ comp market which were a direct result of greed and improper management of those companies during the early years of open rating.”

State Fund has taken several steps to work towards financial stability, including working cooperatively with the CDI, a safe conservative portfolio investment strategy, a business plan that includes decreasing exposure, and a comprehensive reinsurance program.

“Bottom line here is that reform is critical,” Koren said. “You will not get additional competition in this market any other way than dealing with the cost drivers.”

Decades of hard markets
“This is an industry that really has caused itself a lot of pain over the past eight or nine years,” Jeff Post said. “It’s an industry that is in fundamental change today.

“We are, as an industry, in the midst of a hard market. Some lines are even harder than others. However, the big question always, is will it continue?”

Post discussed the hard markets of the past three decades-and their causes. The stock market decline in the 1970s led to heavy rate increases. Environmental and asbestos (E&A) “first reared its ugly head” in the ’80s, Post said. A liability crisis and legal inflation in crisis proportions led to a capacity crisis, defining the hard market of the Ô80s. In the ’90s, Post continued, Hurricane Andrew led to a short-lived hard market “that particularly influenced catastrophe-prone properties and reinsurance.

“What I would propose to you today is that we have the perfect storm,” Post said. “We clearly have a stock market decline…. We obviously have a liability crisis. Ninety to 95 percent of all people being reimbursed for asbestos injuries have never been injured and probably never will be injured; yet they are taking the value out of asbestos lawsuits.”

Adding to the perfect storm, Post acknowledged the large property losses that have incurred over the past couple of years, most notably, the $50 billion loss of Sept. 11, which, Post added, only about $30 billion of has been accounted for presently.

“How can we have the highest rates in the last 10-12 years, and yet insurance companies are still failing?” Post asked. “That seems like quite a paradox.”

Post discussed how the nation’s economy is taking a toll on the industry. “Just the change in interest rates causes hardening for rate increases to be almost 10 percent higher,” he explained. “The equity market is equally a mess. Where the insurance company doesn’t make money on underwriting, it makes money on interest income…. [which] is down from six to one-and-a-half.

“One of the things that will give you a sense of the economy turning around is when you actually see investors start to have more confidence in the predictability of earnings.”

Post estimated that between $20 and $25 billion dollars of unrealized losses are sitting on the industry’s balance sheets.

In discussing the impact of terrorism on the industry, he mentioned the recently passed Terrorism Risk Insurance Act [TRIA]. “TRIA is not perfect legislation, but it does remove the open-ended risk of terrorism on the insurance company balance sheets. The problem is, it has such a large deductible, and it sunsets in three years, that while I would say it’s a step forward, it’s not a march forward. And it’s unclear what’s going to happen long term.”

Post said that Sept. 11 was “an act of war,” and therefore, should have been recognized by the government as such. “This industry was never equipped to deal with losses like [Sept. 11].” He explained that TRIA has additional complexities, such as the exclusion of from the act, regulators will not allow for adequate premiums to be available, and California, Florida, New York, Texas and Georgia are holding out from TRIA.

Post noted tough times for the reinsurance marketplace too; facing similar economic challenges as insurers. “Reinsurance is going to be a lot less available,” he said. Concerns of reinsurers’ solvency are paramount right now, with reinsurance receivables garnering a lot of attention.

Post concluded, “We as an industry need to continue to be disciplined,” he added. “We need to find a way to operate more efficiently between the carriers and the agents and brokers. The issue is about changing people’s perceptions about what is right and what is wrong.”

Topics California Trends Catastrophe USA Carriers Profit Loss Agencies Workers' Compensation Excess Surplus Europe Reinsurance Market