Marketplace Blues Reprise
March 2009
I hate being a "one-trick pony," but as a
reprise, permit me to go back to my September 2005 article,
Marketplace Blues, and recite the first
verse of a Robert Johnson blues song, "Cross Roads":
Went down to the cross roads, fell down on my knees;
Yeah, went down to the cross roads, fell right down on my knees;
I asked the
Lord above, have mercy on poor Robert please.
by Peter
M. Polstein
Does anyone not realize that our industry is at a crossroads? The next 24
months or so are going to prove to be very difficult, replete with distractions
not seen or experienced in many years. The problems now facing the underwriting
fraternity are a result of a multiple set of circumstances never seen at the
same time—nor to this degree.
Loss Ratios, Markets, Underwriting, and Rating
We have what will be an industry net profit in the range of $14 billion—an
80 percent drop from 2007. The predicted loss ratio will exceed 104.0 percent
from 92.4 percent, and net written premium will sustain back-to-back decreases
for the first time since 1932-1933. The soft market, which continues on a spot
basis, has not been kind to the industry over the long run. The almost frenzied
tactic by underwriters to attain and retain business must, out of necessity,
require a more disciplined approach if for no other reason than to begin to
shore-up capital adequacy.
There are some who contend that the continuation of poor underwriting practices
will not have a deleterious effect. This is wishful thinking. I predict the
first and second quarters of 2009 will be no better for most than latter 2007
and 2008. There simply are too many potential losses to still be reported, predicated
on existing intelligence.
To this malaise, add the worldwide financial
crisis—brought about to a substantial degree by the guarantees of our own industry—resulting
in massive write downs, which have drained investment income, siphoned off significant
portions of equity capital base, and in many instances, severely impaired capital
adequacy. Plus, it is virtually impossible to negotiate any post-event capitalization.
The equity marketplace has dried up, and any available capital is expensive
and brings with it significant underwriting criteria.
On top of the industry's woes and the financial crisis is a unique situation
not faced by the industry: clients need to mitigate costs while maintaining
cover. But the insurance industry can no longer afford to maintain a soft or
semisoft pricing posture. The reinsurance marketplace has already begun to turn.
January 1 renewals, for the most part, saw significant differentials by underwriters
who have exercised almost a rare discipline with general increases across the
board. Substantially more treaties have been negotiated at lower risk levels
resulting from the need to shore-up weakened balance sheets and retain capital
ratios.
Analytical reports by insurer rating agencies now appear on almost a daily
basis. These rating agencies were arguably not just marginal participants in
the overall financial destruction of the banking industry due primarily to their
unprecedented rating of what were junk instruments to triple A. Their application
of ratings, along with the equally unprecedented underwriting by banking institutions
(in part not of their own volition), were factors in causing the overall problem.
Irrespective of any political ideology, this entire fiscal crisis has caused
substantial damage to our industry on more than a simple trickledown basis.
Government Response
I would point out, again without any political ideology, that the current
administration's stimulus package is unlikely to have the desired effect on
our economy, which will, in the short term, do little to assist our industry.
One thing is for sure—hammering the public with continued doom and gloom rhetoric
may reap political benefits but, history shows, does little to create a stable
economic atmosphere. Given this, our industry needs more than disciplined underwriting
to correct what will be continued losses in both the short and potential long
term.
Unfortunately, additional comments regarding AIG are in order. Unfortunately,
my worst fears, as expressed over the past year or so, seem to be coming to
fruition. Despite the initial government intervention in September 2008, with
subsequent changes and amendments to the original incursion, AIG still experienced
fourth quarter losses of over $61 billion (which would incur an annual loss
in excess of $100 billion). This is obviously cause for alarm. It is highly
likely that AIG's losses will continue well into 2009 if not further.
AIG's potential for the sale of assets continues to diminish, despite the
possible fire sale to China of its Far East "jewel" and a possible sale to a
combination of suitors of its U.S. life operations. With that in mind, our government
has again come to the rescue, as early the morning I write this, March 1. It
appears that yet another machination of survival has arrived. In this instance,
the government is providing some $30 billion in equity and is apparently taking
positions in AIG's Asian life venture as well as in its domestic company, in
addition to lowering the interest rates on the current deals and providing more
"lenient" terms. The rating agencies appear to have given tacit approval to
the deal, saving AIG the potential of substantial increased collateralization.
All of this makes one wonder just how long this will continue while the specter
of bankruptcy remains a very real threat—an event that would have had a profound
effect on all operations. When you look at the "corrections" made since September
14, 2008, you have to question whether these efforts are smoke and mirrors or
a smoking gun. Few could have envisioned this scenario just a few years ago.
More Insurer and Capital Adequacy Woes
Returning to security of insurers and capital adequacy, there are a considerable
number of companies, many of which are "household names," whose capital adequacy
is in serious question. Hartford is a new entrant into the ring of problem insurers,
serious enough to cause it to negotiate with Allianz for capital relief and
then subsequently request additional relief from the Connecticut Commissioner.
Will this and the sale of certain assets be sufficient to maintain Hartford's
rating?
Swiss Re, which recently was provided a substantial amount of equity from
Warren Buffett, continues to have serious problems. Some theorized that the
Buffett connection was simply positioning for additional interest. Frankly,
I'm more inclined to believe that Swiss Re had major reinsurance positions in
Gen Re, Cologne, and perhaps GEICO, which made the infusion imperative. To date,
there have been a very, very limited number of domestic and foreign insurers
who have reported any profits, and for those that have, the margins are but
a fraction of those seen in prior years.
Conclusion
I am still of the opinion that the brokerage fraternity needs to be more
aware than ever of the necessity of exercising good judgment and advice to its
client base on placements, which may be best supported by individual net positions.
I continue to fear that any insurer that ends up either insolvent or in runoff
will be the catharsis for errors and omissions.
Brokers, obviously, are not analysts (whose analysis has left much to be
desired during this crisis). However, I am even more firmly entrenched in the
belief that our industry needs to be more alert to the financial world and its implications.
Further, in negotiating cover, especially during the next 24 to 36 months, it
will be imperative to listen carefully to client needs and opinions. In tough
times as these, losing clients due to the simple and irresponsible position
of telling, rather than listening, is commonplace.
There will be those of you who disagree with my perception of this marketplace,
which obviously is your right. However, I caution all that the next two quarters
will be both important and telling to the future of a considerable number of
current insurers. Time will reveal who the real underwriters are.
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