Ho, Ho, Ho, and Say Good-Bye to 2006
December 2006
This year has been somewhat interesting from
the standpoint of little if any catastrophic losses and the continued surge
of offshore capitalization of new and existing insurers. Yet, for the most part,
the industry has had a lackluster year.
by Peter
M. Polstein
Sure, the profits of the property/casualty industry appear heading toward
a record year, perhaps in excess of some $50 billion or more. And the combined
ratios appear to be perhaps the lowest in many decades. But, frankly, the majority
of this good fortune is primarily due to the lack of any catastrophic losses
throughout the United States. It can't be argued that the profitability is due
to deliberate and careful underwriting criteria, as the 2006 market for the
most part continued its plunge into market share underwriting.
Buoyed by what appears to be a significant profit year, mindful that it is
the first in many years, the capital marketplace has found innovative and at
times somewhat curious methodologies to liberate what had been tried and true
underwriting principles through a fairly wide expanse of securitization and
hedge deals. Most of these had their foundations in the CAT marketplace and
other financial transactional business.
Standard and Poor's Nine-Step Program
As I wrote in my last article, "Is There a Reinsurance
Paradigm?", much of what is occurring offshore and within the United States
deals with primarily unregulated insurers. There have been a number of financial
institutional people who are quietly challenging the question of reserve adequacy.
What really brought me up short was last month's proposal by Standard and Poor's
(S&P) to update their capital model, where the question of capital adequacy
has been an integral part of their nine-part framework. While the other eight
are obviously important—having to do primarily with management, competitiveness,
investments, strategy, and the like—capital adequacy must remain the most critical
and perhaps the most important element.
While S&P notes that its new model, which would be applied to each insurer
on a subjective basis, will take into consideration natural catastrophic risks,
the primary focus appears to be the estimated total amount of capital required
to cover all potential risks. S&P's spokesperson noted that while the capital
model is periodically updated, as it has been since 1991, this initiative appears
to stem from the growing complexities and potentially volatile nature of the
industry over the past few years.
Long gone is the old ratio of net written premium versus surplus with the
rest of the convention statement. S&P is taking to heart the basis by which
insurers should be tested.
What Can Result?
Let's look at the worst-case scenario, what would it mean, and how does the
individual company and industry cope. It's about time. A few of the potentially
more important questions, which may well result from this update, might be:
- A hard look at insurers who have underwritten an excessive amount of
unaggregated or aggregated limits as well as the territories that have been
impacted.
- How much reinsurance has been ceded, and more importantly to whom, where
this model will be applied?
- Then there is the question of credits for reinsurance.
- Lastly, what is the impact on those whom the capital marketplace views
are truly investment grade, where the potential for a catastrophic capital
loss is less than 1 percent?
Let me remind you of the Mission, Home, Kemper, Reliance, Continental, Transit,
and Transport situations, just to name a few!
Let's assume for a moment that S&P's model finds inadequacies in moderate
to significant proportions in a number of insurers, including reinsurers and
their retrocessions, both domestic and offshore. Would that not have a marked
effect on the overall underwriting ability of the marketplace? It could well
have a profound effect, which in turn would influence the brokerage agency industry.
Okay, let's not go off the deep end per se. S&P is but one organization; there
are Fitch, Moody's, and others. But have they found the opening shot toward
a substantially different set of guidelines, which may be long overdue?
Our industry, despite the size, can be, and has shown to be at times, fragile.
As 2007 approaches, it may well be a year of interesting and potentially substantive
changes, one way or the other.
On an Unrelated Topic
As an aside on a totally different subject, but one which may have under
the right circumstances a profound effect on clients, was the State of Pennsylvania
Supreme Court decision in late October which dramatically changed the definition
of an accident/occurrence and ruled that faulty workmanship was excluded from
the commercial liability policy's terms and conditions. I recognize fully that
it resulted from faulty workmanship on a construction related project. Nevertheless,
it was a significant benchmark decision. The obvious question is whether it
morphs outside of the State of Pennsylvania, and if so, will it have an effect
on any claim, long tail or otherwise? Irrespective of current territorial limits
in this case, perhaps it is time to think of potential appropriate language
which may be negotiated with insurers to exclude, or amend, the definition to
suit the individual client needs.
As 2006 comes to a close, I can only wish all a healthy and happy 2007.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author's employer or IRMI. Expert Commentary articles
and other IRMI Online content do not purport to provide legal, accounting, or other
professional advice or opinion. If such advice is needed, consult with your attorney,
accountant, or other qualified adviser.