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2008 can be described as a year like no other in the property/casualty insurance world. This year we saw the near death of the world’s largest and most successful insurance company, AIG. The soft market continued to hamper revenues in virtually all lines of insurance, while catastrophes and the economy soured profitability for many P/C insurers. Below is a list of some of the top stories of the year, complied and selected by Insurance Journal’s editors Andrew Simpson, Charles Boyle, Stephanie Jones, Kenneth St. Onge, Susan McKenna and Andrea Wells.
1. AIG in Crisis
Insurance news doesn’t get bigger than this. American International Group (AIG), the world’s biggest insurer, a company with a trillion dollar balance sheet and 74 million customers, had to be rescued from bankruptcy. The U.S. government decided that AIG was too big to let fail, especially at a time when the entire financial system was under strain. But AIG’s survival is not guaranteed.
AIG’s troubles can be traced to its financial products unit, AIGFP, which sold credit default swaps tied to subprime mortgages. AIG got caught holding a big portfolio of these contracts at a bad time — mortgage foreclosures were multiplying and credit markets were deteriorating — and had to take big write-downs on them.
For the fourth quarter 2007, AIG reported a record $5.3 billion loss, due largely to the write-downs. CEO Martin Sullivan suggested the firm was in “uncharted waters” but vowed the crisis would not be long-term.
In February, the company acknowledged it had not been accurately assessing the credit default swaps.
For the first quarter, AIG posted another record loss of $7.81 billion, again largely tied to bad mortgages. In its second quarter, it suffered a $5.36 billion loss, bringing to $18 billion the total in write-downs for the last three quarters. Given the weak housing and credit markets, the future did not look much brighter.
Sullivan and state regulators stressed that while AIGFP was a concern, AIG’s core insurance units were strong.
Wall Street and credit agencies were reacting. By June, AIG’s share price had dropped more than half from one year ago. AIG’s biggest shareholder, ex-CEO Maurice Greenberg, said the insurer was in “crisis.”
In June, AIG replaced CEO Sullivan with former Citigroup banker Robert Willumstad, who was AIG chairman. He promised a turnaround plan by Sept. 25 but events would not wait.
By September, AIG was no longer the industry leader in market value. Compared to a year earlier, its shares had fallen more than 70 percent and its valuation had dropped from $175 billion to about $47 billion, according to Reuters.
Through the summer, mortgage and credit markets worsened and AIG needed more cash to keep up. It went shopping for money but Wall Street was in no mood. Goldman Sachs, Merrill Lynch and Lehman Brothers were reeling from their own losses tied to mortgages.
State insurance regulators agreed to allow AIG to borrow $20 billion from its property/casualty units but now that wasn’t enough.
As AIG’s liquidity concerns deepened, credit rating agencies threatened downgrades that would make it more costly for AIG to access capital — $14 billion more right away. By this time, the company also needed another $10 billion to cover AIGFP debt.
AIG had to act quickly to avoid bankruptcy. On Sept. 14, Willumstad, representing a desperate AIG board, took an unprecedented step. He approached the Federal Reserve for $40 billion in financing.
At first, it was not clear what the Federal Reserve would do. It had aided Bear Stearns but refused to save Lehman Brothers. Greenberg, who ran AIG for 35 years, said it was in the “national interest that AIG survive.” The Federal Reserve came to agree. AIG had dealings with many thousands of companies, so bankruptcy would have huge global repercussions.
By Sept 16, a federal rescue was ready. The price tag was up to $85 billion — plus the U.S. would take an 80 percent stake in the insurer. Within weeks, AIG would get another $40 million.
Former Allstate CEO Edward Liddy, who was installed as CEO replacing Willumstad, said the “mess was solvable.”
Under political scrutiny, AIG agreed to restrict executives’ pay and cancel pricey conferences. Liddy agreed to work for $1.
AIG was to pay back the loan by selling off assets but deals were difficult in a tight credit market and global recession.
Some AIG rivals stood to benefit from AIG’s woes. AIG insisted it was not slashing prices to keep business as some competitors charged.
In November, AIG’s loans were revamped using the $700 billion bailout package Congress had approved for Wall Street. The interest rates were cut and credit default swaps were taken off AIG’s books. The resulting $150 billion U.S. loan is the largest ever to a single company.
Subprime mortgages continue to haunt AIG and the entire economy. AIG is also contending with more familiar insurance losses. For its third quarter, AIG posted its largest-ever quarterly loss — $24.47 billion — as the damage from the man-made catastrophe of write-downs was exacerbated by damage from natural catastrophes.
2. Soft Market Continues
By the end of the third quarter 2008, the property/casualty industry had experienced five consecutive quarters of written premium declines; a sure sign that the industry was knee deep in a soft market. Two major hurricanes and a global credit crunch were not enough to derail the relentless soft insurance market, but commercial buyers and insurance brokers did report some signs that the market was beginning to stabilize at year end. During the third quarter, 69 percent of the commercial agents and brokers responding to the Council of Insurance Agents and Brokers’ survey reported premiums for their small account renewals were down only slightly — 10 percent or less — compared with similar renewals during the second quarter. Fifty-three percent said their medium account premiums were down 10 percent or less. Premiums for large accounts, which escalated the most and the fastest during the hard market cycle, were still dropping, the survey showed. “Nearly five years of deteriorating rate levels are taking a toll on underwriting profits,” says Dave Bradford, executive vice president at Advisen. “A.M. Best forecasts a 2008 combined ratio of 104.0 for the commercial property and casualty industry. Together with lower investment returns as a result of the global credit crunch, conditions may be ripe for a reversal in the market cycle in 2009.”
3. Earth, Water, Wind, Fire – Essential and Catastrophic
The ancient Greeks and other early civilizations identified earth, wind, fire and water as essential elements in the creation of the cosmos. But in 2008 that quartet once again flipped the creation/destruction coin and proved just how catastrophic those essential forces can be.
By the end of the third quarter 2008 the Insurance Services Offices Property Claim Services (PCS) unit estimated that 36 weather-related catastrophes in 22 states had caused an estimated $22.1 billion of insured property damage and resulted in approximately 3.7 million claims. An estimated 2.5 million personal lines claims accounted for $14.5 billion of property damage, while 356,000 commercial lines claims cost an estimated $5.4 billion, and 840,000 vehicle claims cost insurers $2.2 billion, according to the PCS. The most costly, and deadly, was Hurricane Ike — which the Insurance Information Service has deemed the fourth costliest hurricane to hit the U.S. coastline. Ike made landfall in Galveston, Texas, on Sept. 13. as strong category 2 storm and wiped out whole coastal communities before heading north to surprise the Midwest with hurricane force winds and heavy flooding. But wildfires in the West and Southeast, spring flooding and tornadoes in the Midwest and on the East coast also took their toll. As claims costs continue to be assessed, the year-end total for the 2008 combined natural catastrophes is sure to go higher. After the relatively mild catastrophe years of 2006 and 2007, for proponents of a federally backed catastrophe insurance fund, 2008’s mounting losses serve to underscore the need for such a program. Many coastal insurance regulators, such as Louisiana Insurance Commissioner Jim Donelon, say they would welcome some kind of federal assistance to insurers that provide coverage in catastrophe-prone areas, as long it is not used “as an excuse to deregulate and remove jurisdiction from the states.” Regulators from states that don’t regularly suffer from severe catastrophic occurrences on the other hand are not so sure. Mary Jo Hudson, director of the Ohio Department of Insurance, says the structure of a catastrophe plan would have an influence on whether or not she would support it. Ohio taxpayers, she says, shouldn’t “have to share the burden with folks that live in much riskier areas and choose to live there. There are some intriguing proposals out there … that we will continue to watch.”
4. Failing Economy
They’re tearing down the old bar — Boo! They’re going to build a new bar — Yeah! Sound familiar? Something equivalent has been going on in global finance ever since the U.S. subprime mortgage crisis landed on the world’s doorstep in the summer of 2007. To continue the anthem: Anybody can get a mortgage — Yeah! They’re being securitized — Yeah! They’re rated ‘AAA’ — Yeah! Many people can’t make the payments — boo! Homes are being foreclosed — boo! All the banks and hedge funds are in trouble — boo! They’re going to bail them out for $700 billion — yeah! But not Lehman Brothers — boo! Only American International Group (AIG), Yeah! And so it’s gone for over a year: World stock markets are in steep decline; pensions are at risk; the automakers are going to the wall, banks aren’t lending and consumers aren’t buying. Can it get any worse? See Bernard Madoff. If there’s one bright spot in all this mess, it’s the insurance industry (AIG, mortgage insurers and some life companies excepted). The longstanding regulations, the companies’ own need to keep reserves to pay claims and to make only prudent investments — “stodgy,” in the words of Richard Ward, Lloyd’s CEO — has stood them in good stead. When Swiss Re’s economists urged the industry to “preserve capital,” most of the companies had already gotten the message.
5. Financial Fallout
What began as a subprime meltdown and credit crisis has morphed into a broader economic downturn, which had a negative impact on the insurance industry’s financial performance in 2008 and will continue in 2009, according to financial analysts and insurance industry experts. Insurance executives see credit and pricing risks as posing the most significant challenges over the next three to five years, according to a survey conducted by KPMG LLP, the audit, tax and advisory firm. And the soft market coinciding with a bad economy is a real challenge for independent property/casualty agents, especially for the smaller firms, said Leonard Brevik, president and CEO of National Association of Professional Insurance Agents. While independent agents and their employees probably have more job stability during a down economy than other parts of the service economy, directors’ and officers’ risks rise during a recession, according to John Lumelleau, president and CEO of Kansas City, Mo.-based Lockton Cos. The current subprime mortgage/credit crisis, a weakened global economy and substantial declines in the stock market are expected to drive D&O frequency and severity, said analysts with A.M. Best. The broad reach of the subprime/credit crisis and the financial market meltdown may drive a surge of D&O claims beyond the financial services sector, which has been the hardest hit so far they said. “The next few years will be very challenging for many insurers in terms of turning the page on credit issues and in strengthening balance sheets,” said Scott Marcello, partner, Insurance Industry Leader at KPMG. “While executives have been keenly aware of the subprime and other credit risks, overall many members of the insurance and broader financial services industries do not seem to have clearly and fully understood their exposure.” Lawsuits associated with the economic crisis have already emerged, and more are likely well beyond the end of 2009, said Kevin LaCroix, an attorney and partner in OakBridge Insurance Services’ Beachwood, Ohio, office. Indeed, in its most recent estimate, Advisen predicted insurance losses — aggregate D&O and E&O losses — arising from the credit crisis of $9.6 billion.
6. Housing and Construction Woes
Insurers and agents have felt the backlash from a weakening residential construction market. The industry has experienced a significant drop in residential premium growth due to declining new construction and banks’ unwillingness to continue lending at prior levels. The Insurance Information Institute estimated that the housing market crash has already cost home insurers $1 billion per year in lost premium growth, based on a 50 percent or more decline in new home construction (about one million few homes per year). This trend is expected to result in declining underwriting revenue growth and, thus, negatively impact the valuation of insurance companies. Despite the downward trend in home prices across the nation, homeowners insurance premiums have not declined on an individual basis due to the rising cost of labor and construction material prices. However, this factor is expected to only partially offset the negative effects of slowing premium growth. In December, the Mortgage Bankers Association reported the percentage of U.S. mortgage holders who were behind in their payments soared to a record 6.99 percent of loans outstanding in the third quarter, and foreclosures were also at new highs. Just under 3 percent of U.S. mortgages were somewhere in the foreclosure process, and mounting job losses were sure to send that figure higher in coming months. Problem loans in California and Florida accounted for much of the increase, and more than 19.5 percent of all subprime loans were seriously delinquent in the quarter.
7. Insurance Goes Green
From wildfires to hurricanes and all in between, climate change has long remained a major concern for the insurance industry. But going “green” — that is, finding ways to lessen or counteract impacts on the environment — is a relatively new trend in insurance. And in 2008, a flurry of green products were launched or expanded nationwide for both personal and commercial lines of insurance from most major and regional carriers, including Firemen’s Fund, Lexington Insurance Co., Chubb and American International Group, to name a few. The products range the gamut from discounts for energy-saving buildings, agreements to rebuild property with environmentally friendly materials or reduced auto insurance rates for those who drive less. Some companies are even experimenting with unusual coverage — such indemnifications against negative publicity caused by a green building. The trend could end up being a big boost to companies’ bottom lines, too. A study released in November by a major consulting firm polled 1,500 U.S. insurance executives and found 67 percent believe green products to be a durable and profitable market segment. Why? In addition to the increased public awareness of environmental issues, customers for green insurance products have a higher willingness to pay and generate lower costs.
8. The Conundrum of Coastal Property
From Maine to Texas, Atlantic and Gulf Coast states continued in 2008 to struggle with the burden of insuring property in booming coastal communities in the face of ever increasing catastrophic events. AIR Worldwide Corp. has reported that the insured value of properties in coastal areas of the United States grew at a compound annual growth rate of just over 7 percent in the past three years. The catastrophe modeling firm also expects the cost of rebuilding coastal properties will continue on a growth rate that will lead to a doubling of the total value every decade. Around 38 percent of the total exposure in Gulf and East Coast states is located in coastal counties, representing nearly 17 percent of the total value of properties in the U.S. Recent studies show most of the country’s coastal growth is occurring along coastlines from Texas to North Carolina. Insurers are increasingly wary of providing coverage for coastal properties, not only because of exposures with their own insured properties but also because of the assessments they could face from state-backed insurance plans should a catastrophic event occur. Still there are signs of improvement. Florida’s insurer of last resort reported in mid-November 100,000 of its policies would be placed with private insurers, bringing to 400,000 the number of policies removed from its books this year. Louisiana is on track to remove around 65,000 policies from its Citizens Property Insurance Corporation by the end of the year, as well. North Carolina suffered a setback, however, after both Farmers Insurance Group and Encompass, a unit of Allstate, said they would either exit the homeowners market or stop adding policies in the state by the end of the year. Both cited concerns over potential assessments from North Carolina’s state-sanctioned program for coastal insurance.
9. Renewed Push for Federal Regulation
With the fall and eventual bailout of American International Group it didn’t take long for supporters of federal oversight of insurance to come out swinging. Both the American Insurance Association (AIA) and the American Council of Life Insurers (ACLI) released statements saying that the recent crisis and the $85 billion line of credit given by the Federal Reserve to AIG, demonstrate the need for a federal insurance regulatory presence. National Association of Insurance Commissioner’s President Sandy Praeger immediately defended the status quo of state based insurance regulation. She said that the problem lies with the AIG financial holding company that is subject to federal regulatory oversight by the U.S. Office of Thrift Supervision (OTS). The AIG financial holding company took on more risk than they could handle when investing in collateralized debt instruments, such as credit derivative swaps on mortgage-backed securities. It is important to note that these types of investments are financial products, not state-regulated insurance products, she said. Praeger added that even if there was an optional federal charter for insurers, and some or all of the 71 U.S. based AIG insurance entities had selected to be regulated by the federal insurance regulator, the problem at the AIG parent company level would not have been prevented. What new path insurance regulation will take in 2009 remains to be seen, but many industry insiders say “optional” federal regulation will no longer be an option; but instead will be required.
10. The Sheriff Falls from Grace
In a dramatic public shaming fit for the tabloid headlines, the insurance industry’s biggest antagonist-in-chief — New York’s now ex-Governor and former Attorney General, Eliot Spitzer — was forced out of office in March by revelations he had visited a prostitute. Spitzer solidified his reputation over the last several years by going after insurance companies during his time as attorney general. In particular, he went after the practice of paying contingent commissions to brokers for a volume of business. Spitzer was able to force out then-AIG chief Maurice “Hank” Greenberg and overpower most big brokerages into agreeing not to pay the commissions.
His come-uppance, though, is more than his own ouster as governor. Many see Spitzer’s fingerprints all over the collapse of AIG. And in June, a New York court handed down something of a rebuke to the Spitzer era when it ruled that contingent commissions were not actually illegal — a contention AG Spitzer used to force settlements on most major brokerages. That decision has led to a major, ongoing regulatory debate in the state over how insurance agents should be compensated. In nine short months, Spitzer’s legacy went from Wall Street crusader, to political nadir.