Searching for Market Direction
By: Banham
Which way is the insurance market headed? That will be the question on everyone’s mind as the 2009 renewal process begins.
After several years of insurance customers enjoying a softer market, it now appears that insurers will increase prices and tighten up coverage terms and conditions in 2009. The culprit: the global economic crisis that is eating away at carriers’ investment income and whittling away the industry’s aggregate policyholder surplus. Then again, in the topsy-turvy world of the cyclical property-casualty insurance market, no one, including ratings agencies and brokers, is willing to put their name behind market predictions. “It’s hard to say what the impact on the p-c market will be, although certainly the capacity in the industry is shrinking,” says Robert Hartwig, president and chief economist of the New York-based Insurance Information Institute. “Whether that will affect pricing in the market is still a bit premature to call.”
AIG Stumbles
The drastic climate changes have everyone hedging their bets. A year ago, if people knew about the enormous upheaval that would surround major independent agency carrier American International Group, Inc., heads would shake with disbelief. The international insurance giant is daily media fodder with its double, multi-billion dollar bailout by the U.S. Federal Reserve in headlines across the country. Although AIG’s woes did not emanate from its insurance subsidiaries—the company’s insurance of mortgage-backed securities were to blame—trepidation arose that failure to make good on its promises would threaten the American financial system. Hence, the U.S. Federal Reserve decided to loan the insurer another $37 billion on top of the $85 billion it had handed over just a few weeks earlier. As of mid-October, the U.S. government held warrants that could be converted at some point into an 80%ownership of AIG.
Adding insult to injury is the parade of embattled AIG executives called on to face livid congressional leaders who have excoriated them for allegedly hiding from the company’s auditors its risky practices as losses piled up. But, the New York-based insurer wasn’t the only carrier making headlines. Following a steep decline in its stock value, Hartford Financial Services received $2.5 billion from German insurer Allianz in the nick of time, derailing the possibility of a ratings downgrade. Principal Financial Group, Allstate and MetLife also recorded share declines in the double digits at various points.
A Changing Landscape
As for the industry as a whole, investment income this year continues to spiral downwards. Since insurers typically make up the bulk of their income through investments, the portfolio declines in the midst of the worst financial crisis since the Great Depression warrant concern. Standard & Poor’s most recent gauge of the industry’s net investment income in the first six months of the year indicated a downward trend, prompting the ratings agency to give the entire commercial lines insurance sector a negative outlook.
John Iten, an S&P director, was cautiously optimistic in his August sector outlook, stating that “for the most part” p-c insurers maintain investment portfolios with less volatility than those of many other types of financial institutions.” In a follow-up interview, Iten says the investment picture is a bit darker. “We anticipate bigger investment income declines, although I cannot speculate at this point which carriers might be affected the most,” he says.“On the bright side, I still believe the industry’s conservative stance with respect to investments will help. In the last market downturn, we saw several insurers that had 100% of their surplus invested inequities get burned. This time around most carriers are starting with much lower equity positions, and it is pretty uncommon to see anyone with more than half their investments in equities these days.”
Warren Mula, chairman of the U.S. retail business of large broker Aon Risk Services, says the fact that ratings agencies like S&P and A.M. Best Co. have been sparing in doling out downgrades bodes well for the industry. “XL Insurance, MetLife and Hartford were all under much-publicized stock pressures, yet they retained their ratings, and that is good news,” Mula affirms. “While ratings alone don’t necessarily give us a 100% degree of confidence, they certainly provide a strong degree of validation.”
The P-C Ripple Effect
Investment income, while the key factor at the moment in determining the impact of the financial crisis on the industry, is not the only thing causing pause. “The financial crisis is multi-dimensional, and therefore its impact on property-casualty insurers is also multi-dimensional,” Hartwig explains. “For example, because economies around the world are weakening, everything from fewer businesses being formed to fewer cars on the road and fewer homes and public projects being built translates into less need for insurance. Day-to-day growth prospects consequently are impinged.”
Some carriers like AIG and others, he says, have exposure in their non-insurance subsidiaries to Fannie Mae and Freddie Mac, in addition to shaky asset-based securities, as do the reinsurers to whom primary carriers cede risk. Last year, Swiss Reinsurance Corp., for instance, wrote down $1 billion because of subprime mortgage losses in the U.S. Borrowing costs for insurers also are up, which means that insurers interested in tapping the market for short-term debt and even long-term debt will have less recourse to do so. Hartwig speculates that the dearth of available or affordable credit could affect some insurers’ growth plans, organically or through acquisitions.
Hard Market on the Horizon?
Buyers, of course, are eager to learn what their insurance costs will be when renewal time comes around. Right now, uncertainty is the answer. “It’s frustrating for clients,” Mula says. “Everyone wants a forward-looking statement, but it is hard to do. Clearly, the recent cost of catastrophes, from fires on the West Coast to floods in the Midwest and two decent sized hurricanes—that adds up. Obviously, when you toss in the financial crisis, no one’s anticipating third quarter results will be anything to brag about.”
Nevertheless, corporate risk managers are bracing for the industry’s notorious cycle to kick into gear. “I’m hearing from my brokers that that the market will tighten and we will see a few upward ticks in specialty lines like D&O, with an awful lot of lawsuits that will be flying as a result of the downturn,” says Wayne Selen, director of risk management at Labor Finders International, Inc., a West Palm Beach, Fla.-based temporary staffing company, with roughly $300 million in annual revenues. “Beyond that, in terms of the general commercial lines market, I’m not so sure. There is this feeling that AIG, to maintain market share, will be eager to keep pricing competitive. The reality is they have to fight back the market pressures. Fortunately, there is no question that their property-casualty operations are stable and they remain well capitalized.”
Selen says the key to the puzzle may be the financial condition of overseas reinsurers.“Their transparency is not as clear as reinsurers domiciled here, insofar as their investments,” he explains. “They have capital that is critical to our industry. So far we’re relying on what has been disclosed, and it has been okay.” Selen renews much of his insurance program in January and he comments that, “At this juncture, I’m not hearing it will be a rollicking ride.”
What do the insurance companies have to say about market projections? They’re customarily mum on the subject, for regulatory and competitive reasons. Nevertheless, Bryan Rogers, vice president of finance in the Internet and mail distribution segment of mid-size, Chicago-based personal lines carrier Unitrin, with $3billion in 2007 revenues, says, “I think the market will tighten to some degree. I don’t know if we’ll see anything major on the personal lines side, but we will probably see restrictive growth or a slowdown in general.”
A telltale sign of softening, he muses, is the cutback in marketing dollars by some direct carriers. Without naming names, Rogers says, “certain insurers are not blowing the marketing dollars they’ve spent in the last several years. When direct insurers pull back on advertising, it tends to mean they’re raising rates, which creates opportunities for independent agents.”
As for the industry as a whole, Hartwig says capacity is down about 2.5% through June 30 and has shrunk more since then. “The third quarter will likely be the fourth quarter in a row in which policyholder surplus has shrunk,” he says. “Underwriting loss experience is deteriorating because of the very aggressive pricing environment as well as such things as higher catastrophe losses. What this means is that insurer margins are shrinking fairly rapidly, and in fact with the data available this year, profits are down a good 45% to 50 % from where we were at this point last year.”
What do the numbers reveal about the market? Mula says not to expect a material spike in premiums in the short-term. “I think there is enough competition and capital out there that pricing is not going to shoot up,” he adds. “I just don’t anticipate trouble like a double digit increase at late-year renewals. Next year, on the other hand, especially if we see changes in reinsurance prices, is another matter altogether.”
Banham (Russ@RussBanham.com) is an IA senior contributing writer.
The M&A Impact
While the financial crisis has made many insurers’ stock values a buyer’s delight, the credit squeeze has actually made buying them a difficult proposition. This should forestall industry consolidation, which seemed in the cards earlier this year when Liberty Mutual announced its acquisition of Safeco—only to incur a downgrade to “A-minus” by S&P. “The volatility in the economy and the higher credit costs will likely crimp merger and acquisition activity,” Hartwig says.
Nevertheless, several observers, noting that AIG has a hefty loan to repay taxpayers, say it is possible its insurance subsidiaries may be put on the block. Others say AIG’s non-insurance assets (it owns an annuity business and an aircraft leasing operation) are more likely to be auctioned off first. If “for sale” signs attach to the insurance subsidiaries, they would not have trouble finding interested buyers, given their financial soundness. “Although AIG at the holding company level experienced a liquidity crisis, it has been working hard to get out the message that its insurance subsidiaries are solvent, paying claims, open for new business and underwriting and developing new products,” Hartwig maintains. “The subsidiaries were not and are not bankrupt.”
—R.B.
D&O Distress
Hartwig also predicts the financial crisis may prove distressing for directors & officers liability carriers, due to an expected increase in claims from disgruntled shareholders, not to mention the Securities and Exchange Commission. Marty McNerney, head of the insurance coverage practice at international law firm King & Spaulding in Washington, also foresees a possible uptick in D&O shareholder and securities claims. “There will be more government investigations for sure,” he says. “Policyholders will be looking to insurance companies to pay for the fallout from the financial crisis. I’ve got a number of clients who have had their stock price drop who have received inquiries from government agencies, which will be looking to D&O insurance for coverage and defense costs.”
Regarding the market as a whole, McNerney says, “I would not be surprised if the substantial uncertainties related to insurers’ investment income, in addition to the liabilities lurking out there, will cause a movement away from the soft market.”
—R.B.
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