Editor's note: The following is an edited transcript of a panel discussion titled "View From the Outside Looking in," held during the Insurance Information Institute's Joint Industry Forum on Jan. 10, 2005. Panelists included V.J. Dowling, managing partner, Dowling & Partners Securities; Frank Nutter, president of the Reinsurance Association of America; Brian Sullivan, editor, Risk Information Inc.; David Schiff, editor, Schiff's Insurance Observer; and Mark Puccia, chief quality officer for Insurance Ratings Criteria, Standard & Poor's.
Frank Nutter: Does the commercial lines business have the pricing power to sustain its modest (2005) success?
Mark Puccia: Assuming a normalized year, we don't see commercial lines being as profitable as personal lines. We have personal lines at a 96 percent or 97 percent combined ratio and commercial lines at 102 percent to 103 percent combined ratio. The fact is that casualty pricing is still deteriorating. If you take into account loss cost inflation, the price increases are not keeping up with loss cost inflation in the casualty lines. On the property lines, the fact is rates are going up significantly on a risk-adjusted basis. In top CAT-exposed areas, reinsurers are going to be raising rates. In fact, the pricing on reinsurance in top CAT-exposed areas is actually much higher than that.
In turn, the primary companies are not going to be able to do that all at once. It's going to take a few years for that rate increase to go through.
Brian Sullivan: There's still the opportunity for insurers to dilute themselves. That's one of the reasons you've seen the deterioration. People are still kidding themselves. So I think the cycle in commercial lines--that up-and-down underwriting cycle--is still more pronounced than it is in personal lines.
Puccia: We were disappointed in the pace of deterioration in the property lines business. The fact is, is that 2003-2004 were extraordinary years for pricing in commercial property, and there's just no question that rates were deteriorating in 2005, though now I would suggest they are moderating because of storm activity. But this industry has a hard time with success. An industry that has an ROE somewhere in the 7 percent to 9 percent (range) in the postwar period doesn't cut it. The fact is that top banks will be making an ROE in the 20 percent to 25 percent range.
Nutter: Any particular issues in 2006 in commercial lines, in particular reserve additions?
Puccia: The fact is, if you went back to 2001, a number of experts would have said the industry had about an $80 billion reserve deficiency. In 2004, the number was actually $14 billion. When you take a look at a lot of the personal lines business, that actually has about $5 billion in redundancies offsetting $19 billion of deficiencies in commercial lines.
Nutter: Do you think companies should take some comfort by the extension of the Terrorism Risk Insurance Act? Does TRIA offer the kind of comfort that it (the industry) needs?
Puccia: Were TRIA not to have passed, we would have been a lot more negative on the industry. The bill that was passed is not the greatest bill, but it does provide some comfort against outsized events. It's something that we do not believe that the industry can appropriately underwrite. We do think that the bill that passed provides protection in the outsized events, so it has some benefit to the industry.
Sullivan: I think a lower level of attachment from the federal government wouldn't have been good. I think this way the industry is on the hook for most everything. They can define it. They can afford it.
V.J. Dowling: We as an industry can't get anything done until the labor unions and those that are building office buildings decide that they are not going to be able to get coverage and they go to their legislators and put pressure that something has to be done.
So with all due respect to our lobbyists for the industry in Washington, they need help. You can spend all the time you want in your think tank, but unless you get those people who are going to be impacted who actually have some power in Washington, nothing is going to get done.
Nutter: Do you think that (there will be) further fallout from the investigations that we've seen over the past year, and (what are) the consequences of that in terms of the effect on business in the commercial lines market?
David Schiff: I don't know whether there is some bombshell waiting to drop, but people are looking at things closer than they have before.
Puccia: We do expect further fines. There's an awful lot of debate about whether what Spitzer's done to the industry has been beneficial or not. But the fact is, is that there is some abusive practices that have already been cleaned up. The fact is finite was getting abusive. But now you've got CFOs who can proudly say we don't do finite anymore. They are cleaning out the skeletons, and that's a good thing for the industry.
Nutter: One of the things that happened in December related to finite (risk transactions) is that the Financial Accounting Standards Board announced that it is going to undertake a review of rules related to insurance and reinsurance driven by the finite reinsurance problems. Anybody care to comment?
Sullivan: The industry has improved. But it took outsiders looking at the industry saying it's not right. It's going to improve the balance sheet. It's going to improve profitability. It's going to make the industry more transparent. Eliot Spitzer may drive a lot of people crazy, but that heightened awareness 12 months ago has led to a much better industry today. Scrutiny has lessened, but it's going to continue for awhile.
Schiff: It's a harsh environment when executives in any industry, not just insurance, undergo criminal charges.
Sadly, that's the only thing that changes behavior. If companies can take $5 million, $10 million in fines, for giant companies it's just not that big a deal. But going to jail for a week is a much greater punishment than a huge fine. That's what really puts boards and executives on pins and needles.
Nutter: The outlook for commercial lines: Premiums up 3.5 percent; combined ratio 104; underwriting gain of $1 billion; ROE of 12 percent to 13 percent. S&P has been negative on the reinsurance sector for some time. That continues to be, and do you see any change in that attitude going forward?
Puccia: We continue to have been surprised by the volatility that this sector has shown--more downgrades than upgrades. We're not expecting a substantial number of downgrades. But the industry's risk management capabilities continue to underwhelm us. You expect in the wake of some of these catastrophes to have companies with a difficult experience, but some of them really surprised us in the concentration, the way risk was aggregated, and that aggregation of risk wasn't recognized.
Nutter: Do you care to comment on whether you see a changing capacity or pricing environment for reinsurance?
Dowling: The market that tends to get a disproportionate attention by analysts, investors and the press is the property CAT, which is what I believe you're alluding to.
Yes, we do think that there will be pretty significant increases. Our view is that the peak in pricing is going to be a rolling issue. You may have some companies that bought cover on January 1 who, once they go through their model and talk to the ratings agencies, recognize they need more and then go back and try and buy more. So it's going to be an interesting year.
Schiff: Look how fast $15 billion came flooding into the industry. When all that money can come in so quickly, I would say you're closer to a top than to a bottom.
Dowling: I respectfully disagree. Of all the new capital that came in, much of it was filling holes. Florida has just shown that their potential loss has gone up dramatically; $6 billion is a drop in the bucket for what's needed.
Puccia: The new part is the sidecars. A sidecar is when a property CAT reinsurer says to the capital markets, "Trust us, hedge funds and other investors. Give us $1 billion. Give us half-a-billion dollars. We will put that money in a sidecar, and we will reinsure 40 percent, 50 percent, of our prop CAT business." That has always been the problem with the reinsurance business: ease of entry and difficulty of exit for capital. But this time the difference is ease of exit. That capital is there for one year, two years, and that's it.
Dowling: I agree with that. What is happening, though, is the companies that are not exiting are clearly exiting aggregates.
is managing editor of Risk & Insurance®.
February 1, 2006
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