What's in Store for 2004 for Alternative Risk?
January 2004
This month's captives risk management column
looks at how the 2003 predictions made here fared and comments on what is predicted
for the upcoming year.
by Michael
R. Mead
M.R. Mead &
Company, LLC
At the beginning of a new year for capital and surplus and reserves and underwriters
and executives, it behooves me to offer some thoughts on what may well be in
store in the peculiar area of captives and alternative risk mechanisms. To put
some of this in perspective, let me take score of what I predicted last year
at this same time, and offer my hindsight criticism for your benefit and amusement.
The commercial property-casualty market will not see reduced pricing or
increased availability of coverage and limits in 2003. I feel confident in that
statement.
This prediction proved to be on target. I am tempted to repeat the prediction
for 2004, but I feel that some areas will see increased availability of coverage,
but it will be limited. Pricing will not show any meaningful reduction for companies
that would traditionally consider a captive as an alternative. The medical profession
will continue to face some tough choices, and it will share the pain with regulators,
legislators, and others. In a major election year, I fear that some quick and
easy—though conceptually flawed—solutions will be put forth. In the heat of
promoting perceived action by their elected officials, I doubt if serious time
will be devoted to thoughtful reform of the system.
Risk retention groups will get more attention as risk sharing/fronting partners
are all but universally opposed to getting involved with medical malpractice
and other professional lines of coverage.
Risk retention groups (RRGs) will receive a great deal of deserved and undeserved
attention. RRGs are a terrific alternative risk finance mechanism, but they
have limitations. The Risk Retention Act limits coverage to selected liability
coverages, specifically excluding workers compensation and private automobile
lines. Also, property lines are not included.
Regulators and the aforementioned public officials are currently examining
the Act to determine if expansion, particularly for property lines, is appropriate.
Already much of the debate is out of focus due to the well-publicized collapse
of a large auto warranty RRG, domiciled offshore under a grandfather provision
of the original 1981 Act. This failure, while unfortunate, owes little if anything
to the Act and risk retention group structure or regulation. Poor management
is lamentable but should not wrongly taint the entire industry, which was in
no way involved.
The new record-keeping and reporting requirements both onshore and offshore
will cause many deals to be deferred or canceled as there will not be enough
time or people or systems to comply. Without adequate resources and facing low
returns, insurers will renew a few accounts and take a pass on most new submissions.
This did not develop. To the credit of regulators, underwriters, and all
involved, extra time was taken, and in my experience few deals were deferred
or canceled due to new requirements or regulations. Any rejection of new submissions
was essentially for sound underwriting reasons, or the slow realization of the
proposed captive owner that a captive may not be the solution originally hoped
for. I trust that this will remain the case in the coming year.
The risk sharing partner community is changing, and not necessarily for
the positive for captive owners. The remaining partners must become more selective
in putting forth their paper, and they will do so. Their shareholders will demand
it. They will want to see larger deals, with great loss pictures and substantial
financial resources put at risk.
Consolidation and mergers in the industry have continued involving major
insurers to a degree unimagined a year ago when the above prediction was made.
I suspect that the coming year will see a continuation of the trend. Many observers
acknowledge the weakness of some large, key insurers. Any pressure to make their
unknown liabilities for asbestos shown on balance sheets could be the death
knell. Thus, this observation remains valid for the coming year.
A backdrop for the coming year is the ongoing challenge to the regulatory
system. When risk sharing firms review their successes and failures from last
year and opportunities for the coming year, they will be watchful of the changes
that may arise from regulatory change. As the National Association of Insurance
Commissioners (NAIC) presses its member state Directors of Insurance harder
for reform to fend off the mounting call for federal regulation, it will have
to step up in making the call about unrecognized asbestos liabilities. The loser
could be a major insurer.
As I have urged elsewhere, regulators and lenders are going to have to reconsider
their requirements for the ratings of insurers. This is also a discussion for
another day, but I will continue to call for action in this area.
This point, which remains an open discussion, is closely related to the above
comments about state regulation. As some openly urge substitute federal regulation,
others are questioning the wisdom of unregulated, privately-held rating bureaus
to kill an insurer by dropping a rating a small degree. I await a clear explanation
of the difference in ultimate security between an A.M. Best rating of A- and
one of B++. And why does a lender demand evidence that it does not clearly understand.
Acceptance of B paper by regulators and lenders would materially ease the tightness
in the marketplace.
As a proponent of alternative risk financing, it behooves me to say that
not everyone should be in a captive. Your best bet may be to pay the premium,
if you can get a quote. ... Alternative risk finance has always meant that you
pay your own way. Inherently, that means that you must have the resources to
do so. Increasingly as the market withdraws, limits coverage, and raises retentions,
the alternative participant will be required to put in more resources, to the
point that the deal may not make sense.
While this is not an answer, or prediction, it is a fact that is as important
in the coming year as it was in the last. Paying a tax deductible (probably)
premium may always be your best option. Captives are not the answer to every
premium/deductible/increase or coverage restriction. They should investigated,
but with a sensible eye to the true costs of risk transfer.
While the commercial property/casualty industry is enjoying good profits,
it is a very long way from restoring adequate surplus. It may be 5 years before
adequate capital and surplus are restored to pay claims that exist today. Each
time an insurer goes by the boards, it leaves more claims to be parceled out
to the survivors.
Since a year has passed following that statement, one could conclude that
we have but 4 years remaining until the next downturn in rates and premiums.
In fact, with the shifting tides of asbestos reserves, professional liability
claims increases, challenges to the regulatory system, and consolidations, I
feel far less comfortable in making a prediction this year. The discomfort does
not reside in fearing a quick return to soft pricing; I don’t see that occurring
for some years.
My discomfort is based on the number, variety, and scope of challenges facing
the industry. Captives, et al., will remain a popular, sensible choice for the
informed risk manager. Indeed, their number and uses will grow in the coming
year, at least to the degree that we saw in 2003. But the larger industry faces
some interesting times. Stay tuned.
The author has an ownership position in three captive management
companies, but is not in a captive management position.
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