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By MARK D. LYONS, chairman & CEO Arch Worldwide Insurance Group

Insured Exposures

Offsetting this, however, is the potential for increased moral hazard losses: soft tissue injuries, fraud, employee dishonesty, cutting corners on fleet maintenance and perhaps a reduction in the internal control environment. Arch's approach is to be especially vigilant in our evaluation of individual insureds and various industry sectors as well.

Secondly, some insureds may go out of business, whereas others will be financially weakened or acquired. Insurers may be put in a difficult squeeze to decide between providing installment support for customers versus taking on unclear additional credit risk exposure. Our units have tightened their credit evaluation procedures and are additionally looking at an insured's financial condition as another piece of their overall risk selection decision.

The last thing any insurer wants is to increase their aggregate credit risk through underreported exposure bases and increased premium audit risk and to push off the need for more collateral into the future when our insureds may be the least able to obtain it.

Insurer Risk Management

Unprecedented upheavals have occurred in the insurance and reinsurance marketplaces. Carriers and reinsurers thought to be virtually invulnerable are either materially impaired and/or face an uncertain future of governmental and regulatory oversight. When insurers make risk management decisions of how much they choose to keep net, one standard mechanism is to use the reinsurance market as a risk-shifting device.

Once a carrier makes that decision, the risk immediately shifts from one of underwriting risk to credit risk. A flight to quality is clearly in the cards by both customers and insurers. Short-term views toward reinsurance recoverables could surely lead to long-term financial difficulties for a ceding insurer if proper care is not taken before ceding such exposures. Depending on how the reinsurance market stalwarts fare over the next six months, front-end capacity shortages could emerge as insurers become unable to find sufficient reinsurance capacity or sufficient quality reinsurance capacity.

Irrational Marketplace

As insureds and brokers settle on their opinions of marketplace credit risk, there is an opportunity for business to flood the market. New operations are being created almost weekly as executives leave impaired companies and branch out in new directions. These new entities will increase the competition for business and also will seek to get a piece of the finite quality reinsurance capacity that exists; likely more so because many of the new operations don't have the capital size of their predecessor organizations.

The thought of having an insurance/reinsurance marketplace that continues down a soft market path is an irrational one. Uncertainties caused by the global economic crisis, extremely low interest rates and unclear underlying insurance exposures increase risk rather than decrease it. We're in the risk business and should know that increased uncertainty should lead to firming prices. Reinsurers will hopefully be judicious in their deployment of capacity so as to not indirectly spawn increased competition at the wrong time in our economic climate.

Capital Markets

The flexibility of insurers and reinsurers to raise capital has been severely restricted. Debt markets are virtually nonexistent and the equity market has rendered stock to be a much less attractive currency. Reinsurance, however, continues to be an attractive form of alternative capital for the industry. Over the foreseeable future until financial markets stabilize, capital sources for the insurance industry may be more often "internal" via reinsurance transactions rather than "external" via the capital markets.

Changing Frameworks

Just as hurricanes Katrina, Rita and Wilma changed the industry's view of inherent natural catastrophe risk and caused material changes in the CAT models, views of capital needs may also likely change as recent seismic financial events are digested. As some stalwarts in the insurance and reinsurance industries are currently distressed, those organizations with the least leverage and minimal past liability issues will be most able to respond to changing circumstances. The ratings agencies continue to refine their capital adequacy models and they affect the landscape of competition.

April 15, 2009

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