Throw Away Your Crystal Ball … The Stage is Already Set for 2004

With the clock ticking down on 2003, it’s only natural to begin forecasting the key trends that will impact the insurance industry in 2004. Like Thanksgiving turkey that can be served many ways but never seems to be finished, many of the things that keep insurers up at night will be leftovers from previous years.

Competitor behavior. Competitor behavior is always a concern but especially during transition periods in the underwriting cycle. Unlike the brave company that raises rates first (and consequently loses market share) when the market hardens, the carrier scorching the trail to a soft market is rewarded with market share gains. This has a lot to do with why soft markets last so much longer than hard markets. As we balance on the cusp of a transition, the exact timing of the softening is at the top of every insurance executive’s agenda. We will discuss pricing expectations by major segment later in this article but as a sneak preview we believe 2004 will be recorded as the tail-end of the current hard market rather than the beginning of the next soft market.

Investment returns. The second candidate for sleep deprivation is investment returns. While carriers create and destroy value relative to their peers with their underwriting prowess, they make their money largely on investment returns. This is a function of holding premium dollars in various forms (unearned premium reserve, claim reserve, IBNR reserve, etc.) over the life cycle of a policy until all claims are settled in full. The recent record low interest rates have devastated investment returns for carriers and don’t appear to be improving fast enough to help in 2004.

Asbestos. The final item, and the one with the strongest and oldest roots, is asbestos losses. This has made the list for more than a decade and reality has continued to prove more devastating than had been thought possible. While 2004 holds the opportunity for a brokered settlement that should provide a dramatic improvement in the administration and funding of asbestos claims, the day is always darkest before the dawn. The thought of letting a settlement slip away just when the industry can taste it is enough to induce nightmares among all stakeholders.

Writing on the wall
There is no need to look into a crystal ball for 2004—significant recent events have already laid the groundwork. The following are key issues born in 2003 that will blossom in 2004.

Scale in the commercial market. The St. Paul/Travelers combination makes this the question of the day. AIG’s size advantage has been rationalized away by most competitors as important for global service but not in mid and small market commercial. Should the combined entity provide superior value to the agent and broker community the race to consolidate will be on.

Head-to-head competition between national and regional carriers. Armed with lower expense ratios and a new wave of sophisticated underwriting models, the national carriers will seek to compete for the regional carriers’ most profitable business. The localized knowledge that has benefited the regional carriers is continually being encoded in databases and there are a growing number of content providers ready, willing and able to make this data available. Insurers taking advantage of this new content will be able to expand their underwriting appetite in a disciplined way.

More disciplined use of capital. Most lines of business should make money in 2004. But which lines are generating the most value? Is a 30 percent return on an excess property book better than a 15 percent return on a small commercial book? Hard to tell unless the capital supporting the book of business has been calibrated to reflect the underlying risk factors. The recent declines in industry capitalization and the related wave of rating agency downgrades have elevated this issue to the “A” list for most insurers.

Moving beyond the broad-reaching issues, many of the day-to-day challenges and opportunities in 2004 will be category specific.

Personal lines outlook. Auto pricing should remain stable in most markets, but perennial problem states will struggle with fraud and regulatory issues. Competition-wise all eyes will remain on Progressive and GEICO.

Homeowners pricing will stabilize in most areas. The restoration of this line of business should be considered complete in the eyes of carriers. Barring a resurgence of adverse mold verdicts, availability and competition should slowly improve. The recent California fires will continue to create upward pressures on prices in Western drought-prone communities.

Commercial lines outlook. On the commercial lines front, package pricing should moderate with pockets of competition for the best risks. Product features will retain a hard market feel as carriers remain vigilant in closing mass tort loopholes. Competition for small commercial risks will also remain moderate with, as mentioned earlier, most activity being between national and regional carriers. The most aggressive of the Bermuda capital will begin to migrate downward from the higher excess layers, which will cause certain hot spots for competition. This will be largely mitigated by future industry consolidation issues, which everyone wants to approach with a strong balance sheet and a reputation for underwriting discipline.

Overall, record low combined ratios should be posted in 2004, barring catastrophes. This will be driven by the fact that the hard market pricing will not be diverted (i.e., 9/11, asbestos, recent soft market impact) from the bottom line. But do not expect record returns from the carrier market due to the aforementioned investment income malaise.

Obviously, all of the above goes out the window if the wind blows, i.e., major catastrophes occur. Catastrophic losses, both natural and man-made (i.e., terrorism), have increased in frequency and severity over the last 15 years and today their occurrence or lack thereof plays a disproportionate role in the industry’s financial performance. While insurers have dramatically improved their internal risk management programs, the art of pricing for such events, and having those funds available when needed, remains elusive.

Of course, there will be some companies who make the “All-Star” list in 2004—the best managed carriers will create a noticeable separation from the pack. This superior performance will appear in efficiencies, customer service and creativity. Good pricing, purging of weak competition and a decade-long investment program in technology has set the stage for this uptick in performance.

Chris McShea is the national property/casualty director for Ernst & Young’s insurance and actuarial advisory services. With 19 years of insurance industry experience, he is a recognized expert on customer segmentation and selection, class plan design and pricing strategies, mergers and acquisitions, underwriting strategies and loss reserve valuations. He can be reached at chris.mcshea@ey.com.

Topics Carriers Underwriting Market