According to William Gray, the meteorological equivalent of Dr. Doom, the outlook for the 2007 Atlantic hurricane season is perilous–as many as 17 named storms, five hurricanes rated Category 3, 4 or 5 with wind speeds of 111 miles per hour or greater, and a 74% chance that one will hit the U.S. coast, when the normal odds have been closer to 50% over the past century. But not even predictions by Gray, the head of the Tropical Meteorological Project at Colorado State University, could elicit much more than a collective shrug out of the insurance industry that, only two years before, had to absorb $62 billion in losses from a record season that devastated large sections of the southeastern U.S. "Insurers should be able to weather it, no pun intended," says Don Bailey, CEO of broker Willis North America in New York.
Complacent? Arrogant? No, just flush. In one of the great industry turnarounds, the property/casualty insurance market that survived stunning losses from 9/11, corporate scandals like Enron Corp. and a series of record-breaking hurricanes is now swimming in capital. "There is so much capital in the industry right now, with more than $6 billion raised from sidecars, another $6 billion from insurance linked securities, nearly $9 billion coming from startup insurers and reinsurers, and another $12 billion coming from existing insurers, and that's just the last 15 months," estimates Robert Hartwig, president and chief economist of the New York-based Insurance Information Institute.
Many factors contributed to the turnaround. First, new property reinsurers sprang up like daffodils in the spring in sunny Bermuda, taking some heat off the primary carriers. Next, private equity funds, hedge funds and other investors willing to take a gamble on windstorms unveiled capital market instruments–known as sidecars since they run alongside primary coverage–which absorb a portion of property catastrophe risks. The reinsurers, who helped structure these mechanisms for investors, now had more capacity to offer primary insurers, with the potential losses backed by the capital markets. Thanks to a mild 2006 hurricane season, the investors made out like bandits–and risk managers had much better insurance options. "Carriers are upping the amount of windstorm capacity they have available, and this supply is putting downward pressure on the market, in some cases in a pretty aggressive way," says Bob Howe, global property practice leader for New York-based insurance broker Marsh. "We're also seeing higher limits of coverage being offered. Whereas, in 2006, the lid on windstorm might have been $200 million or $250 million (in financial limits), we're now seeing a lid in excess of $300 million. Overall supply is up a good 30% to 40% in the last couple years."
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Another surprise was the decision by Florida's legislature in January to expand the coffers of the Florida Hurricane Catastrophe Fund, providing insurers writing property policies in the state with low-cost additional reinsurance capacity of up to $12 billion above the fund's $16 billion limit. The fund is now the largest reinsurer of property catastrophe policies in Florida by far. The inexpensive government reinsurance spells a potentially huge shortfall in revenue for traditional reinsurers, but very good news for primary insurers writing property/casualty insurance, not to mention their commercial clients.
And finally, there is the remarkable health of primary insurers, who are awash in capital, raking in an estimated $59.8 billion in profits last year–a record. The money works out to a return on equity (ROE) of about 14.5%, which isn't a record but is the industry's best ROE since 1987. Some profit is due to Mother Nature's kindness in 2006 and the improved catastrophe underwriting models developed by modeling companies like RMS and AIR. Although the modelers missed the boat on Hurricane Katrina's potential damage, they regrouped and created more precise tools for insurers to underwrite and price hurricane risks.
One contributor to a robust casualty market is decreasing claims activity. "Frequency is dropping almost across every line," explains John Iten, a director at Standard & Poor's in New York. "We hear about it in personal auto, but it is equally true on the commercial side, such as workers' comp. The reduction in claims frequency is more than offsetting increases in claims severity brought about by inflationary medical care and car repair expenses." A factor in the decreased commercial claims activity is higher deductibles, Iten surmises. "Companies are taking on more risk, which reduces the number of claims filed," he explains.
With profitability at an all-time high, corporate risk managers are enjoying the most competitive pricing since the beginning of the millennium. Companies can purchase coverage with more liberal terms and fuller limits at less cost, and industry wags expect more of the same, given the industry's buoyant capital position and increased willingness to extend its capacity to absorb even the chanciest commercial risks. "Rates are coming down at a fairly steady clip on the casualty side, from the mid- to upper single digits in most standard lines," S&P's Iten says. "Larger lines like workers' compensation and general liability are declining an average of 8% a year, while specialty lines like D&O (directors and officers liability insurance) are falling a bit less than that. We expect continuing softening this year."
Dave Hennes will be glad to hear that. While the veteran director of risk management at The Toro Company wrapped up his casualty insurance and executive risk renewals in April with solid price decreases in virtually every single line, he still faces his property renewal in November. But he is confident. "There's nothing problematic," says Hennes from the Minneapolis headquarters of the $1.7 billion landscape products manufacturer. "It's a good time to be a risk manager."
The property/casualty insurance market is so competitive that Hennes is seriously considering shutting down Toro's two offshore captive insurance facilities that self-insure several layers of risk. "With rising compliance fees, Sarbanes-Oxley and the soft insurance market, the cost of running the captives is higher than the benefits," he concludes. Not all buyers are sharing in the fun, however. Companies with property exposures along the coastline in the southeastern United States are still paying more in insurance than their peers elsewhere–even with extra capacity from states like Florida. "Carriers are continuing to beat a slower drum in the geographic areas in which they're still smarting from claims from Katrina, Wilma and Rita," says Lance Ewing, vice president of risk management at Harrah's Entertainment Inc., the casino empire with significant holdings in the region. "Capacity is climbing out of its bunker–slowly." Other geographic areas giving property insurers pause include the central U.S. (because of the risks from the New Madrid Earthquake Fault) and the Pacific Northwest (because of the risk of tsunamis). The only threat to the current market seems to be the fate of the Terrorist Risk Insurance Act (TRIA). "If TRIA is not extended–and we fully expect this will not be the case–insurers will be required to insure a risk that defies underwriting," says III's Hartwig. S&P's Iten raises the specter of lower credit ratings for some insurers if TRIA's extension falls on deaf ears. (See sidebar.)
TRIA aside, the property/casualty insurance market is a risk manager's dream. It is becoming so soft that the usual phenomenon that occurs in the middle of a soft cycle–insurer offerings of multi-year policies with a locked-in rate–is already happening. "I'm working on a large program today with a client about a three-year arrangement with a guaranteed renewal, subject to certain exposure changes," says Bailey. "That's how competitive the market is getting."
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