Industry Forum Told to Expect Higher Tort Costs, Fewer Hard Market Opportunities

January 21, 2003

The length of the current hard market should not be overestimated and the creativity of the plaintiff’s bar to impose new costs on insurers should not be underestimated, a panel of outside experts told insurance executives recently attending the seventh annual Property/Casualty Joint Industry Forum.

“Companies think that over the course of the cycle they’re going to achieve a certain return on equity; the implication being that during the hard market they’ll get a 20 or 30 percent return, which will fund the inevitable downturn,” Alice Schroeder, a managing director at Morgan Stanley, commented. “I doubt whether companies would achieve the return they expected, partly because the current investment environment won’t permit it, but also because there’s greater transparency of information than in past cycles.”

Schroeder, who was one of three insurance experts on a panel discussing the industry’s profitability cycle, the impact of the plaintiffs’ trial bar and other industry issues, said opportunities are now more short-lived. “You can’t arbitrage your own industry the way you used to. People have learned from the last cycle and as a result you have to run your business differently,” she maintained.

Michael Pritula, a director with McKinsey & Company, agreed with Schroeder about the cycle. “There’s less at the top of the market to play with now,” he added.

With interest rates lower than they have been for 40 years, there is a greater need than ever to make an underwriting profit, but the figures companies are suggesting are not in line with the kind of returns investors want, according to Vincent Dowling, Jr., managing partner and senior stock analyst of Dowling & Partners Securities L.L.C. “You need to have a combined ratio in the low 90s,” he said. In other words, for every dollar collected in premiums, insurers should be paying 90 cents in claims, instead of the $1.05 they paid out in the first months of 2002.

Looking at medical malpractice, Pritula said that the current situation – soaring medical malpractice court awards and doctors protesting the resulting high cost of insurance coverage – was a testament to the creativity of the plaintiffs bar and one that the courts are going to have to address. “Without some change in either the state insurance rate setting mechanism or changes in the judicial and civil justice system, this problem is not going away,” he said. “The industry can’t earn a return on this line of business.”

Pritula said he expected states to experiment with new ways of funding compensation for medical malpractice, including taking it out of the tort system entirely and surcharging health insurers, as may happen in Pennsylvania. If this occurs, he said, health insurers will pass this charge through to their policyholders with the result that the state’s consumers will be paying for the excesses of the plaintiffs’ bar.

Turning to the industry’s regular business practices, Sean Mooney, chief economist and research director, Guy Carpenter & Company and moderator of the panel, said that there is currently a debate about whether the trial bar’s activities represented a form of regulation. “We have seen the use of competitive crash parts to repair cars and the computerized system known as Colossus used to quantify claims for bodily injury become victims of class action lawsuits.”

Panelists also discussed the recent announcement by the Travelers Property Casualty Corporation that it was setting aside an additional $2.45 billion to pay potential asbestos claims. They agreed that Travelers had set a completely new standard for disclosure and reserve adequacy.

“Other companies will have to scramble a bit to catch up,” Schroeder said. Pritula suggested that Travelers’ action was the result of a re-analysis of existing information rather than something new happening on the claims side and that other companies will have to reassess their reserves, too.

Commenting on events of the past year, Dowling said he had been surprised by “the implosion of balance sheets in Europe” where insurers are more exposed to fluctuations in equities than in the United States. “In the early 1970s, U.S. companies were levered to common stocks and there were companies that had to sell stocks at the bottom of the market to maintain their surplus. We never made that mistake again,” he said.

Pritula said he had been surprised by how little impact the new Bermuda companies had had on the market. “Twelve months ago, everyone was talking about the amount of money being raised. At that time they were confident they would earn a sure-fire
40 percent compounded return over the following two or three years, yet I haven’t heard a robust assessment of what they’ve done,” he remarked.

Dowling said he hadn’t expected a terrorism bill to be passed, noting, “It’s still up in the air as to how this is going to play out,” he said. “Primary companies have more terrorism coverage than a year ago, which, from a reinsurance viewpoint, is not a positive development. But we don’t know what the take up will be at the primary level.”

Schroeder noted that passage of the bill was an important achievement. “Over time the exclusions for terrorism damage would have been eroded,” she suggested.

Asked how insurers will go about pricing this risk, Schroeder said “pricing still seems to be in an embryonic state with some insurers literally giving the coverage away to low risk properties because it’s too much of a nuisance to try to adjust their IT system to charge for it separately. But for more serious risks, it’s very still expensive.”

She suggested that over time the market would become more efficient and prices might come down.

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