ACE Does Not Expect Price-Gouging In New TerrorismInsurance Market

Price-gouging for terrorism coverage is unlikely because it isin the best interests of the insurance industry to set premiums at“reasonable” levels so that the risk is spread as widely aspossible, one leading industry executive contends.

At the same time, pressure from rating agencies and regulatorsshould discourage carriers from irresponsibly “giving away”terrorism coverage, according to Brian Duperreault, chairman andchief executive officer of ACE Ltd., and chairman of ACE TempestRe, based in Hamilton, Bermuda.

“Pricing levels won't be as extreme as everyone is talking aboutbecause it is not in the industry's best interest to set rates sohigh that we end up with adverse selection, with only the mostexposed insureds taking the coverage,” he said at a recent mediabriefing in New York.

“You want to have a spread [of risk], because if you don't havethat spread, you'll have a high concentration of risk amongrelatively few buyers with the most exposure,” he explained. “It'sin the best interest of the industry to cover everybody so youspread the risk around. Therefore, you can't charge so much thatyou'll drive everybody but the most desperate buyers away.”

He said that “if the risk is reasonably priced, buyers will takethe coverage. And our feeling is that it will be reasonably priced,because it's what's best not only for the buyer, but for the sellerin the long run.”

Mr. Duperreault was equally skeptical about warnings thatinsurers might be tempted to “throw in” terrorism coverage atunsound rates to secure a larger piece of business.

“There are market forces that will mitigate against that,” hesaid. “Rating agency pressure and state regulatory pressure willwork against insurers not collecting premium for terrorism exposurebecause of solvency concerns. That doesn't mean there won't bepeople who will try to give it away for nothing to get an account,but common sense, fear of the exposure, and oversight fromoutsiders should discourage anything widespread.”

It will take time for the industry to come to grips with thedemands of the Terrorism Risk Insurance Act, which mandates thatcommercial property-casualty carriers offer the coverage anditemize the premium for that specific exposure, but which does notmandate that policyholders buy the insurance.

There will be wide variations in individual pricing of terrorismrisks, Mr. Duperreault noted. “One has to recognize that not allinsureds are created equal,” he said. “While the vast majority havea very low exposure, no one has no exposure, and some have a veryconcentrated exposure.”

He added that “there are no experts on this. We're all stillsorting this out.”

However, he said he believes that the establishment of a federalreinsurance backup, by limiting a primary carrier's maximumprobable loss to a set percentage of their book of business, willdraw the private reinsurance market to cushion the blow of anypotential terrorism strike.

“There will be a reinsurance market that will open up forterrorism, even though reinsurers don't have to do anything [underthe new federal law],” he added. “There will be an emergingreinsurance market that will look at the size of deductibles[primary carriers will retain under the law], and will step in andhelp cut that back.”

Evan Greenberg, vice chairman of ACE Ltd., as well as CEO of ACETempest Re and ACE Overseas General, added that “reinsurers arelooking at this [exposure] in a new light, and my belief is thatthere will be a terrorism reinsurance market, but capacity andpricing are unclear. There are feelers going out as to whatcarriers might be willing to offer.”

Mr. Greenberg added that “Tempest Re is in the cat business. Ifwe can define the exposure, clearly structure the coverage so weknow what the impact on our balance sheet might be, and can get aprice to make it worth taking the risk, we will be a player in thisbusiness.”

As for the general property-casualty market, there are nofactors at work that would discourage further price hikes orundermine underwriting discipline, according to Mr.Duperreault.

“There is still a huge amount of pressure on rates, pushing themhigher and higher,” he said, citing a low-interest-rate environmentand an unreliable stock market as key factors. Without a sustainedturnaround in investment returns, insurers have no choice but towrite insurance at a net gain, and a substantial one at that, hesaid.

“If you're trying to raise capital in this market and WallStreet has turned its back on you, you have no alternative but toboost underwriting profits,” he said, adding that he expects 2003“to continue to be a very hard market” for buyers.

However, he noted, “whether that translates into a reasonablereturn on equity is still a big question,” defining a “reasonable”return as somewhere around 15 percent–a big jump for an industryturning in single-digit ROEs.

“Insurers need to write at a 91 or 92 combined ratio to get that15 percent ROE, and that's assuming everything else is perfect, andwe don't live in a perfect world,” he said. “We have old lossesstill emerging, reserves being boosted, and a poor investmentclimate all depressing the rate of return.”

He added that with “the industry's combined ratio running around105, there is still a lot of room to go to reach that crossoverpoint to earn a reasonable return.”

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, December 16, 2002.Copyright 2002 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.