Editor's note: In April, Steve Pozzi, senior vice president and chief underwriting officer, Chubb Commercial Insurance; Donald J. Pickens, executive vice president and chief underwriting officer national markets, Liberty Mutual Group; and John R. Glancy, chief underwriting officer, XL Insurance, sat with
Risk & Insurance® Editor in Chief Jack Roberts to discuss the state of underwriting today. An edited version of those comments is reprinted here.
Editor: Clearly, there's more capital markets participation in what was the insurance business, In light of the recent issues with the subprime market. What are the underwriting issues for you when you are looking at options for your companies in the capital markets, whether it be the CDO, or any other kind of risk underwriting.
Steve Pozzi: Just like you diversify your own investment portfolio, you diversify your underwriting portfolio. You get too deep into any one area and you fall in love with it, it can come back and bite you. So I think maybe on a general macro basis, we learned or relearned that if you fall in love with something and it seems to be taking off and it seems too good to be true, it probably is too good to be true.
John Glancy: It was interesting to me, and I have been doing a lot of studying of subprime. Its cause was underwriting. It's really bad underwriting. If you look at pre-2006, the underwriting of loans was pretty good. While that's being tainted, mark to market that will come back from an investment standpoint. But the stuff that was really toxic, no-documentation mortgages, no income verification. What type of underwriting is that?
Steve Pozzi: What were they getting paid for? I bet the people that got paid the biggest bonuses in those companies were the people who were writing those subprime loans in 2005 and 2006 and where the four of us might have said, "Why don't we just loan money to people who could actually pay it back?" And they would have said, "Luddite!" They would have said "no, no, here's where the money is." And for two or three years, they take off. My guess is that if we went back in 2004 and 2005 to see who was getting paid the big bonuses, who was being pointed out in the monthly/quarterly marketing meetings as the guys who were innovative, who were sexy, who were running this thing, it would have been those folks.
Don Pickens: It has cycles just like our business. If you look back to the mid-1980s and the S&L crisis - when the housing market crashed - there was easy money to be found. But I think the big differentiator is the leveraging issue and how some of these financial instruments created a much more complex network in the movement of money and really leveraged it beyond what anybody thought was happening.
John Glancy: One of the things again, though, is--and very germane to our business--that people felt they ignored the risk or they continued to pass off the risk, whether you're retroceding. If I know I'm just going to get a fee income out of something and I'm not taking risk on a deal, I'll do those all day long.
Don Pickens: Yes, skim the margin and push it through.
John Glancy: And if you thought I'm going to securitize this, and put it out onto you, the risk isn't with me, it was a game of musical chairs because what happened is they all ended up with it on their books because they couldn't sell enough of it. They thought there was no risk, and the risk was there all along.
Don Pickens: No different than what we've seen in our industry.
Editor: One of the things that went on there and what they'll say is that these securities were all rated investment grade, and we were covered because the ratings agencies said it was good. The question really is how well can the ratings agencies assess risk?
John Glancy: I think it's a constant challenge to them as it is for us. The capital models, the ratings models, they change monthly it seems. How much capital you need or how much aggregate you can take on any zone or anything like that, the ratings agencies are constantly changing and they are under pressure as well. What they through was triple-A wasn't triple-A. Their models told them it was triple-A. So they have modeling issues as well.
Steve Pozzi: My guess is the four of us would have no problem with the ratings being a little tougher and demanding a lot more screening. That's going to help us. There are a lot of folks out there who are fine with the ratings agencies being not quite as strict as some of us might like to be, so they are playing to a very broad-based group of people as well.
One of the potential positives is that even as recently as the late 1990s, the ratings agencies were about the top-line growth: What are your new products? What are you doing next? When the market turned hard, we were all trying to fix our book and get things right. We educated them on things like retention, new loss ratios, and a lot of that stuff. If you went back and listened to questions they asked us in the late 1990s vs. questions they asked us in 2007 and 2008, they are very different questions.
Now the good news there is that they hold to those. But my guess is that you're not going to have any companies who are going to be able to say they cut their rates six, eight, 10 quarters in a row and have their agencies just kind of blow by it. I think we're going to get asked about that. What are you measuring? I think we're already seeing that. For any company I think that's got to be a help. I think it will be difficult for some others, but I think that's good for us, but it will be interesting to see. I think that that relationship has changed even since the late 1990s.
Don Pickens: Certainly helping and educating ratings agencies in a much more detailed and sophisticated way ultimately is a good thing. There are problems going through that phase because sometimes the ability to be self-critical in front of somebody is harder then when you're not in front of them. But I think that over a period of time, they've gotten better and hopefully they will continue to get better, perhaps even get out in front of the industry to tell us what might be coming.
JACK ROBERTS is editor in chief of Risk & Insurance®.
July 1, 2008
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