More Consolidation in 2004: Tillinghast

December 11, 2003

The insurance industry is at a critical juncture, with issues surrounding consolidation, pricing, legislative reforms and capital concerns shaping the market for 2004, according to year-end industry predictions from Tillinghast-Towers Perrin.

“The poor economic environment, stock market volatility and credit losses of the past few years have taken their toll on the insurance industry, with some of the weaker players dropping out, said Patricia Guinn, managing director of Tillinghast and Reinsurance.

“Following a period of always being in reactive mode in an environment that no one expected, we may now be at a turning point where companies have learned how to better navigate in uncertain conditions. A tier of stronger players have emerged that are now ready to focus on growth strategies.”

Tillinghast foresees the following key issues for the insurance industry in 2004:

Further consolidation

Given operating and financial pressures, insurers are trying to do one or both of the following to improve their business: (1) gain market share through acquisition and/or expanded distribution and (2) raise capital or otherwise make more efficient use of capital to streamline their business to focus on core competencies.

“On average, we expect to see one significant insurance transaction per month over the next 24 months. Future deals will be about scale, distribution and restructuring,” says John Nigh, M&A practice leader. “Sizable deals like St. Paul-Travelers and Manulife-Hancock are going to force consolidation among other players. Companies that previously considered themselves big will now be mid-sized.”

Steve Lowe, global P/C insurance practice leader, predicts that the U.S. commercial P/C market will soon be dominated by a handful of major players, complemented by specialist firms operating in market niches.

“In both personal and commercial lines, a strong brand will become more critical to success,” he said. “Greater scale will be required to support the distribution of mass-market products. Going forward, size will be defined by companies like AIG and the new St. Paul-Travelers combination.”

Market challenges

There’s no relief in sight for tort costs. According to a recent Tillinghast study of the U.S. tort system, tort costs jumped almost 13 percent between 2001 and 2002, and we will continue to see double-digit increases for some time to come.

“Don’t expect a comprehensive federal solution while the pain is still localized,” Lowe said. “Tort relief will be piecemeal in 2004, focusing on key issues like class-action abuses and asbestos reform.”
Reserve “surprises” will persist. Destabilization in claim costs, manifesting themselves as an abrupt uptick in claim indicators or unanticipated claims from newly emerging risks, often lead to reserve and pricing problems — and there appears to be no shortage of these.

“We expect more companies to announce reserve adjustments in the coming year and there will be further withdrawals from certain areas — especially professional areas such as architecture, construction and engineering,” said Amy Bouska, North America P/C insurance practice leader.

A different kind of soft market?

Though many pundits are predicting a softening market, “don’t expect price cutting in 2004; there is just no appetite for it. Prices should begin to level out because they are perceived to be adequate, but they won’t fall because the mood of the underwriters hasn’t transitioned from fear to over-confidence,” Lowe said.

This softening insurance market may, however, prove to be different from its predecessors regarding the use of alternative financing.

“While the pace of insureds forming self-insured programs including captives will likely slow in a softening market, the reduction in the number of insurers due to consolidation and insolvency will lead to the continued formation of captives and other self-insured arrangements,” said Jim Swanke, North America risk financing practice leader. Captives will also play an increasing role as insureds deal with Sarbanes-Oxley’s imperatives to manage their total corporate risk profile.

“The act is forcing most companies to reevaluate enterprise risk management,” Swanke said. “We’ll see companies taking larger risk retentions across all lines in order to attract insurance industry participation for more catastrophic or difficult coverage lines.”

As insurers gain more confidence and work to better align business with capital, Tillinghast experts expect to see a “new religion” around underwriting. “We’re looking for a meaningful integration of underwriting discipline with company goals in 2004,” Bouska said. “Enterprise risk management and aggregation risk management, even in the casualty lines, are clearly the new order.”

After a year like 2003, rating agencies will look beyond traditional balance sheet issues toward a broader, business management focus, according to Bouska. “Rating agencies will become much more interventionist,” Bouska said. “P/C insurers will need to be perceived as strong, and underwriters will be expected to have more ‘skin in the game.'”

Wither TRIA?

While the threat of terrorist acts remains real, coverage for terrorism insurance seems to be falling off the radar screen.

“Right now, it’s probably among the top 10 issues on carriers’ minds,” Lowe said. “However, the issue should rapidly move up on the list to be front-and-center by the fourth quarter of 2004 when carriers begin to write contracts for Jan. 1 renewals, which will include coverage beyond the life of TRIA.”

As for an extension of TRIA beyond 2005, Lowe predicts it won’t happen. In the meantime, the workers’ compensation market remains a major concern. “A terrorist event in an urban work center could cost $50 billion in workers comp costs in a city like Boston or Chicago where there are more generous benefits. That’s a figure a pooling arrangement cannot handle,” he says.

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