Bigger buyers in strongest position, but price hikes for mostheading downward

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To offer readers deeper insights into the trends shaping thecommercial insurance market, as well as to give everyone a head'sup on the challenges ahead, National Underwriter assembled a panelof experts from across the industry spectrum for a roundtablediscussion.

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The starting point for discussion was NU's Spring 2005 “State OfThe Market Survey,” sponsored by Zurich in North America. The panelassembled on May 17 in Jersey City–the day after NU released thesurvey's results. (A full report appears in the May 16 edition, “ATale Of Two Markets.”)

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In a lively discussion that lasted over two hours, moderated byyours truly, the panelists tackled developments in pricing andcoverage, as well as hot-button issues such as terrorism and theimpact of regulatory probes by New York Attorney General EliotSpitzer.

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The panel included a multinational broker, an influentialindependent agent, a top rating agency analyst, a leading industryeconomist, a Fortune 500 risk manager and representatives fromZurich.

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The individual players are profiled throughout this eight-pagespecial report, and highlights of our roundtable discussionfollow:

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Sam Friedman, Editor, National Underwriter:

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IS THE MARKET SOFTENING?

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Bigger buyers we surveyed, on average, reported seeing premiumsflat or in decline, and they expect more of the same in their nextrenewal. Does that reflect your experience?

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Richard Sarnie, risk manager at EngelhardCorp.:

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We did see slight declines–maybe up to 10 percent of premiumyear-over-year–and that came after a hard market, if you want tocall it that….We had taken substantial increases in retention tosoften the blow of the hard market, and now we're very happy wherewe're at.

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We're not even entertaining offers from our insurance partnersto keep the same level of premiums coming in for lower retentions.We say, “No, we'll take the money, thank you.” Maybe we'llnegotiate on terms and conditions, but we will take the premiumreductions.

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Sam Friedman:

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The survey also found that while most risk managers are enjoyinga buyer's market, a far higher percentage of smaller insureds areseeing premiums rise, sometimes by double-digits. Why thediscrepancy?

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John Ormerod, marketing director, Zurich GlobalCorporate in North America:

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Some make the broad statement that this is a softening market,but it isn't true across all lines. Rates are still going up formany lines of business, but the level of rate increases is smaller.The rate ultimately depends on the risk profile of the individualinsured company.

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Richard Sarnie:

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I think your smaller buyers probably didn't have the luxury ofraising retentions to the levels that Engelhard is currently at orany company about our size could take, should take or would take.That affects their ability to keep their rate increases incheck.

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One of the things that the hard market did for us is that I wasscreaming right along that Engelhard needed a captive. We formed acaptive [in Vermont] right after 9/11….It's just another avenue forus to consider. We're looking at ways to maximize its benefits andadding in other risks that maybe in the past we would havepurchased insurance to cover, and now we're not.

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Our insuring partners aren't going to like this, but we maydecide we don't need to be sending our money to a third party–we'lljust keep it to ourselves.

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Paul G. Smith, broker at Willis:

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I would agree with the survey's findings and I would agree withRich [Sarnie] that the larger buyer had more options available tothem. The hard market also put a new emphasis on risk control andclaims management.

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John Ormerod:

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In the last hard cycle in the mid-1980s, we saw lots ofbusinesses move to self-insurance in one form or another–whether itwas deductibles, captives or whatever.

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Guess what? We have seen the same thing in this hard market.It's one way the larger buyer can protect his company from thepricing fluctuations of the market.

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I think those same alternatives are not available for commercialcustomers in the middle-market and small businesses.

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Richard Sarnie:

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I've never been a buyer of insurance–I've always managedrisk–but a lot of my colleagues, when they were thrust into thehard market, forgot what it was like to negotiate, and I think thesame thing happened with the brokers.

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After that experience, if the large commercial insurers want thepremium dollars to keep coming in, they're going to have to reducetheir price or buyers will move off to another insurer or anotheralternative market.

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William Stiglitz, IIABA president-elect,independent agent at HGH Insurance Group:

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We operate much smaller accounts–probably the largest in ourwhole office is $250,000–and really and truly our customers arelooking to transfer risk.

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Manually-rated business is not seeing this softening that we'reseeing at the upper levels, and I think that's very true becausewe're so automated now that at the middle-market level, and evenfor small business, the credits aren't available like they used tobe.

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They're pretty much slotted in–this is the rate–although thereare still some options available at that level. We're encouraging alot of our smaller businesses to look at higher deductibles, forexample.

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However, I have seen heavy bidding on two really decent accountswith good loss ratios–one on a renewal and one piece of newbusiness. I was literally on the phone between the underwriter andthe insured cutting my price and cutting my price and cutting myprice–so that is happening on the good accounts, but you are havingunderwriters take a good, hard look.

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We're also seeing an attitude from most of our carriers onexisting accounts that we are not going to lose this piece ofbusiness. We will do what it takes to retain it.

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The problem is trying to determine where that middle ground isto make sure your client is being served well and your company ishappy, and that's a difficult game to play right now.

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Paul G. Smith:

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I would agree that carriers do not want to lose their renewals,and they're basically doing what they need to do to maintain theirposition on an account.

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Very little business is really moving from one carrier toanother over price–it's coming to new carriers as a result of termsand conditions and other factors. It's really not price that'sdriving it from one insurer to another.

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John Ormerod:

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There is an awful lot of uncertainty in the market as a resultof pricing changes and the activities of the various attorneysgeneral. In periods of uncertainty, people like to stay where theyare.

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There's some testing of the market, but we have very highrenewal retention rates and it's really tough to get new business.People are just waiting until these storm clouds move over.

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William Stiglitz:

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It's tough to write new business. People for the most part arevery happy with where they are, and they're going to give theiragent the last look.

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The market is turning softer, but it's not going to turn thatway for everybody. It's got to be a good account, good loss ratio,good management, good financials. On any account of decent size,carriers are asking for financials–and they want something morethan a [profit and loss statement] a guy drew up on a napkin.

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Ray Thomas, president and CEO, Zurich NorthAmerica Small Business:

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Technology has really changed margins relative to thesmall-business customer. Agents in particular, as opposed tobrokers, operate generally in a service center environment andreally look for that capability because of the costs involved.

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…It is indeed a tale of two markets because [risk managers]really want incredible attention from [brokers and carriers]relative to securing their business, whereas a florist doesn't wantto see their independent agent or underwriter–the small-businessowner is saying, “All I want to know is I have sleep insurance so Ican rest easy that my business is covered.”…

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The small-business customer of the future is from the Netgeneration. They love operating through the Internet. They wantvery little of their time spent on visits from their agents. Theyreally want you to be able to service them on an electronic basisand they want to do it with speed. It's a new dynamic in thisbusiness.

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William Stiglitz:

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Just in the past year I have been able to write probably threeor four small accounts strictly through e-mail. I have not seen theclient. I may do a drive-by to take a picture if I have to. Otherthan that, they do not want to see you.

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Richard Sarnie:

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We don't shop everything all the time–even during the softmarket–which is why when the hard market hit, Engelhard really didnot see the increases that we were reading about.

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I'm hoping the market does not get back into cash-flowunderwriting. That doesn't do any of us any good….It doesn't makeme happy when I have a gazillion markets knocking on my doorsaying, “I can cut 10 percent. I can cut 20 percent, 30percent…”

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We want to do business with large, financially secure insurerswho are going to be there in the good times and the bad. No insurerhas ever lost his account at Engelhard because of price.

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We don't market our account every year. We may test the marketjust to gauge the price, but I want to be underwritten for me andmy risk, not what my neighbor's doing or what the market'sdoing.

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Sam Friedman:

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IS THIS A RATIONAL MARKET?

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Our survey found that even a substantial minority of big buyersin every line reported some price hikes, so have we entered a'rational market' in which loss history still carries a lot ofweight and sound risk management makes a big difference?

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Steve Dreyer, managing director, Standard &Poor's:

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I wouldn't use the word “rational” here. Look at the brokeragebusiness for a second, with the compensation structure turnedupside down by the Spitzer probes. The upheaval in that wholebusiness model has got to have some fallout. It seems to me thatthe negotiating positions on all sides are now completelyaskew…

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On the other hand, the information insurers are getting isbetter. It's enabling them to slice and dice a lot better. That's agood thing. Most conversations that we have with insurers abouttheir ratings these days are about pricing, and that wasn't trueeven two years ago. It was more about capital or earnings or someother more traditional financial issue.

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Now, it's all about pricing and how do you, Mr. InsuranceCompany, get comfortable that you're charging the right pricebecause historically you've blown it. In the future you may blow itas well, but can we be confident that you have controls in place toavoid repeating the mistakes of the past?

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Michael Murray, assistant vice president,financial analysis at ISO:

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“Even though the Fed has raised rates eight times since lastJune, interest rates are still pretty close to 40-year lows, andwhile the stock market rose substantially in 2004, it was actuallydown at the end of the first quarter and it's lost ground eversince.

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So I don't think there's really any danger of an outbreak ofcash-flow underwriting that drives insurance prices lower, ascarriers compete for premium dollars to invest because theinvestment earnings just aren't there to be had.

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However, if the stock market comes back very powerfully and/orinterest rates skyrocket, the soft market could get very soft muchmore quickly than anybody anticipates.

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Sam Friedman:

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WHERE ARE WE HEADING?

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What is your assessment of the current market and itsdirection?

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Michael Murray:

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There's been a lot of talk about the market becoming morerational, but it seems to me that we've heard all the talkbefore.

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In reality, as the market transitions from a soft market to ahard market and back to a soft market, there are inflectionpoints–brief interludes where everything appears to be in balanceand fair and rational.

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Too much of the discussion about what's driving this pricingcycle has been focused on insurer profitability, and recentprofitability does seem to fit with the idea that prices may beheaded downward somewhat.

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But profitability doesn't really explain what sparked the hardmarket we're coming out of. When we look back at the data and layit out quarter by quarter, the strongest relationship we found isbetween surplus and pricing–between capacity and pricing.

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…More than anything else, this cycle seems more capacity-driven,and that makes things interesting because at year-end 2004, surpluswas at $393.7 billion or so, and that's a record–not just innominal terms, but also after adjusting for inflation.

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With all that surplus out there and the possibility that someinsurers are thinking, “If I had more business coming in to feed mymachine, I could spread my costs better and I could get my rate ofreturn up,” prices could head south even though the industry's GAAPrate of return last year was just 9.4 percent.

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Sam Friedman:

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So, you're suggesting that rational or not, competition willstill drive prices down?

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Michael Murray:

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Competition on the part of individual market participants isusually rational. The problem is what economists call “a fallacy ofcompetition”–a situation where individual actors each doing what isin their own best interests results in harm to them all. When anindividual player in the market sees an opportunity to profit bycoming down just a little bit on price to attract more business,they have an incentive to do exactly that.

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The problem is every individual player in the market faces thatsame choice, and that's what gives rise to soft markets that getsoft to the point where the pain becomes unbearable.

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At that point, individual players begin to stand back a little.When enough do, prices start to rise from their cyclical lows and,eventually, the whole process repeats–that's what makes it acycle.

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Sam Friedman:

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But you're not optimistic we're going to see stable pricinggoing forward under current market conditions?

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Michael Murray:

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We've already had some talk about how difficult it is to get newbusiness, right? That means people are out there prospecting fornew business and they're not able to find it. The implication isthat the market has not actually become permanently rational.

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Maybe it's like a broken clock–it's right twice a day, and we'rein one of those little interludes, and we're in for more of thesame kind of cyclical behavior we've seen in the past.

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I subscribe to this view because I haven't yet had somebodyexplain to me what's fundamentally different about human nature andhuman behavior….It's still people who decide how to priceinsurance. Even when underwriting and pricing decisions areautomated, people set the parameters.

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Mark St. Aoro, senior vice president and chiefcompliance officer, Zurich North America, specialties markets:

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Zurich is really driven by rational factors in our underwriting.We have separate rating tools for many of our specialty lines ofbusiness, including EPLI, fiduciary, health care and someE&O.

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For D&O, our Management Solutions Group uses an underwritingmethodology based on numerous data points, including a company'smarket capitalization.

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We assess a company's critical components, such as expectedclaims frequency, expected settlement values and stock pricevolatility trends. We also show an insured how they compare withpeer companies. This brings greater transparency to theprocess.

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Sam Friedman:

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So, your rate-setting is not market-driven?

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Mark St. Aoro:

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For all the lines my group writes–excess casualty, D&O,employment practices liability, etc.–we determine the technicallycorrect price for an individual account and that's what we base ourpricing decisions on.

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It's not market-driven pricing, but what we believe are theactual costs of doing business.

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We do individual account underwriting to determine the correctprice–not what the market says the price should be. That's reallyembedded into our underwriting workstations as well as ourcorporate reporting.

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Richard Sarnie:

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That's why Zurich writes my primary D&O, frankly. I sat downwith their people, who explained how they priced it.

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They underwrote Engelhard not on what the market is, and that'swhat I look for in an insurance partner–somebody who is going tounderstand my risk almost as well as I do.

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Gerald K. Chiddick, vice president, CommercialBusiness Group, Zurich North America:

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We look at the individual risk elements and exposures, and thendetermine what coverage is most applicable at a technically correctprice.

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We're focused on profitably writing risks, and we're reallykeying in on developing much more rigor around our underwritingprocess.

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Sam Friedman:

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THE AGENT'S VIEW:

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From an independent agent's perspective, are you able to marketindividual risks to your carriers and bargain over price and terms,or are you stuck with whatever rate the manual says to charge?

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William Stiglitz:

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Everything is so slotted now at certain levels. We're told byour companies at this level you have to go to the machine. You maybe able to send an e-mail to an underwriter, but we have no cluewho the underwriter is. They're great people and they respondquickly and they do a great job, but on the other hand, very seldomdo I ever pick up a phone…

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We do get the loss runs and things like that, but at a certainlevel and below we're just not doing that. It's just notavailable.

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Now, you do have some options in there as to credits you cangive at some point, but again that's the thing that's usuallyaccomplished by e-mail. In most cases it's pretty well slotted.

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The independent agent is pretty well told what they can andcannot do. What's available for heavy bargaining and so forth?That's becoming more compartmentalized.

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Sam Friedman:

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How does that scenario play out with the bigger brokers andbuyers?

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Paul Smith:

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It's almost the opposite with the larger accounts. Over the lastthree years there's been a real discipline brought back to theunderwriting process–a peeling back of the onion of sorts, lookingat what the actual exposures are and what the loss history is.

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There are some things out there we really need to look atbesides pricing that are underwritten very specifically to anaccount.

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What type of risk management department do you have? What's yoursafety process? What's your claims process, risk control? Howquickly are your workers' comp claims sent in?

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Things like that make a big difference in the underwritingprocess.

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Sam Friedman:

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IS COVERAGE EXPANDING?

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A softening market doesn't just revolve around price. What aboutthe coverage being offered today? Are limits rising, retentionsdropping and terms expanding?

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Paul Smith:

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We've talked an awful lot about pricing, but terms andconditions are absolutely on the table for large accounts, drivingpricing either up or down depending on what your needs are.

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There's no such thing any longer as renewal at expiring terms.Many of the large insurers are changing their policy forms,requiring a comparison of policy forms that previously might nothave been necessary. There are major differences in the terms andconditions, and it's our job to determine what they are and explainthem to the ultimate buyer.

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Sam Friedman:

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What impact does that have on the renewal timetable?

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Paul Smith:

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The underwriting process does take more time and effort thesedays on behalf of the risk manager because they have to gather moredata, more loss information…but I think it creates a betterunderstanding of the account.

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Underwriters also want to get together with their risk managersmore frequently. They feel they can do a better job when they canlook someone in the eye, establish a relationship, get to know themand really get to know the firm a lot better than they have in thepast.

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Sam Friedman:

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THE BUYER'S VIEW:

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Is the feeling mutual? Do risk managers want to sit down withtheir underwriters or just let their brokers handle thenegotiations?

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Richard Sarnie:

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I want to meet the senior management of my insurance partners sothat they know who they're dealing with and so that if there is anissue, I'm going to pick up the phone and I'm calling the presidentof the company.

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The broker is my outsourced risk management group. My whole riskmanagement staff is myself and my assistant risk manager for aglobal Fortune 500 company, so I rely very heavily on my broker toput together submissions, line up the meetings and make sure wedon't just meet with some junior underwriter.

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However, while my broker facilitates the deal, he does not makethe deal happen. My broker does not pick the markets and does notnegotiate on my behalf.

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It's the broker's job to make sure the transaction takes place.I look at all the quotes and make the deal happen and move on.

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Paul Smith:

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I would say the longer-term oriented risk managers think likeRich [Sarnie]–the ones who want to look at something over longerthan a one-year period, who know where they want to be in two oreven 10 years–they absolutely want to establish that type of arelationship. They want to meet with their underwriters in order tobe assured they're going to be around to pay claims down theroad….

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Then again there are others who are short-term oriented. Theysay, “Hey, look! I've got a 10 percent decrease! Isn't that great?What about next year? Let's cross that bridge when we get to nextyear.” So, buyers fall into various categories.

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Sam Friedman:

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THE SPITZER FACTOR:

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I'd like to shift gears to the impact of the probes by New YorkAttorney General Eliot Spitzer and other law enforcement agencies.How have the scandals over alleged bid-rigging, contingency feeabuse and misuse of finite reinsurance to boost balance sheetsaffected the market?

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Richard Sarnie:

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I want to make sure we're clear on what subject we're talkingabout, because there are two separate issues. One is contingentcommissions, and then there's the bid-rigging and the criminalaspect of the Spitzer probe.

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My frustration with my colleagues in the risk management area isthey seem to have melded the two together as if brokers who tookcommissions are all crooks. Time out! We all knew there wasback-end money going out the door for volume. We knew it and neverhad a big issue with it. It's just like any other largemanufacturer.

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We negotiate volume discounts all the time–it's part of thebusiness. But bid-rigging is another story.

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Sam Friedman:

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Is there any difference in broker-buyer relations now that thebig brokers are no longer accepting contingency fees?

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Richard Sarnie:

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With the contingent commissions going away, obviously that'shuge….My fees aren't going up–I've already made that quite clear. Iunderstand you've given up X amount of millions of dollars, butthat's your issue, not mine.

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I think it's going to make brokers leaner and meaner andbetter….I think risk managers are going to look at some of thesmaller brokers, and hey, maybe it'll force my colleagues to getout and meet their markets and understand a little bit more aboutthe transactions.

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What is it going to do to us? Nothing. It's still business asusual for us. We're not shopping our broking business. We weren'timpacted by the bid-rigging, but hey, if we're going to get somemoney back, great! To me, we're looking at it as found money.

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Paul Smith:

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From a Willis perspective, [abandoning contingency fees] isfabulous news because we think it's going to create a much morelevel playing field. So at the end of the day, if the big threebrokerages have given up [contingency fees], that means we need tobe upfront, sit down with prospects and clients, and say here iswhat we need to service their account.

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Within the Fortune 500 or 1000 risk management community, we'reshifting to more of a fee-for-service, as opposed to acommission-oriented environment. It's more a la carte. If you needthis much risk control, claims, whatever the case might be, we canprice the services much more accurately.

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Sam Friedman:

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AGENTS DEFEND FEES:

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Willis–the first to voluntarily give up contingency fees–hascalled for a ban on such compensation altogether. What doindependent agents make of that suggestion?

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William Stiglitz, president-elect,IIABA:

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In October 2004, the Independent Insurance Agents & Brokersof America passed a resolution calling for disclosure on the partof brokers as to their financial arrangements. But the fact is thatin NU's survey, 91 percent of clients said they have not requestedinformation regarding their broker's compensation rate.

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I have not had one client ask about it, and I have been aroundthis country and asked the same question, and out of most largegroups I may get one hand raised about their clients asking howtheir agent is compensated.

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Sam Friedman:

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So, you stand behind contingency fees?

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William Stiglitz:

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We feel there is value in some fee-based arrangements, but forthe most part–for the business independent agents deal with–we arepaid a fair commission. We don't think it's an outrageouscommission by any means.

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Our profit-sharing agreements with our companies have beendeveloped over a long period to reward excellence and placingbusiness, and we think our clients also are rewarded by that. Thecompanies that we place business with are able to provide certainservices and they are looking for good business. They are rewardingall of us.

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This is the sales culture of America, and to attack it basedupon what happened in the case of a few bad brokers is absurd, so Ithink we should continue on as we are.

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I do think we will see some fee-based business creep into theagency system, but only on large accounts. For the most part, wewill defend our way of compensation until the very end. We feel itis fair. Customers have been treated right.

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Richard Sarnie:

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I have no issue with contingency fees–as far as whether brokersgive it up or not. We chose to go on a fee basis with our brokerpartners. Every year we negotiate the fee based on what services Ineed, and I want my broker partner to make a fair profit on me,just like we want to make a fair profit. We're a for-profitcompany, just like our insurance partners are.

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However, locks keep honest people honest. Hopefully, riskmanagers who were giving their broker the keys to their car andsaying, “Hey, drive it and let me know when you get back withit”–maybe they'll realize they need to be driving the car.

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Steve Dreyer:

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The whole bid-rigging scandal has tarnished the integrity of theindustry, period. It's unfortunate, but that is what has happened.The payment of contingent commissions in general–whether thatsystem was right or wrong, for the big brokers at least, it'shistory now….

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The broker companies will all survive, and they will be leanerand meaner. How they deal with the challenge is really what we'refocused on right now.

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Sam Friedman:

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What about the impact on insurer-buyer relations?

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Steve Dreyer:

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From the insurer's side of the equation, you have to bring inall of the other investigations now–the questions about finitereinsurance deals and allegations about cooking the books and allof that….No matter where this all ends up, the scandals areimpugning the believability of insurer financial statements.

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Why is that so important? You're buying a balance sheet when youbuy an insurance policy. So we have the commercial p-c industryrating outlook at negative right now despite the sector's verystrong earnings.

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Why are we still negative? It's because we haven't seen the endof this, and the probes go well beyond [Eliot] Spitzer. He was thecatalyst, but there are many others involved now–the SEC, insurancecommissioners, perhaps even the FBI.

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Sam Friedman:

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TERRORISM RISK LOOMS:

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Let's focus on one major, looming exposure–terrorism. What doesthe standalone market look like, and what will happen if theTerrorism Risk Insurance Act is not renewed by year's end?

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Ray Thomas, Zurich:

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I can tell you that if nothing happens [in Washington], therating agencies will be sitting with that negative outlook for usfor the next 20 years.

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There is no way we can be protected with that kind of unknown infront of us without some type of federal help or backstop.

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Michael Murray, ISO:

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I think there has been some progress toward development of aprivate market solution for terrorism insurance, but I don't thinkanybody believes there's enough private capacity to really dealwith the problem in the absence of a federal backstop.

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If you take that as the premise, probably the best way to guesswhat's going to happen if TRIA lapses is to look at experience inthe wake of 9/11 before TRIA.

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After 9/11, everybody's perception of risk changed overnight.Before TRIA was enacted, insurers started to grapple with thequestion of whether we can cover this risk. In some situations,state law mandates that you cover it, but in other situationsterrorism can be excluded, and I think that's largely what happenedafter 9/11 and before TRIA.

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That might conceivably happen again if there is no extension ofTRIA, and some policies written already have contingent languagethat would exclude terrorism in the event that TRIA is notrenewed.

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Ray Thomas:

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Wouldn't it be interesting to go back to the 9/11 event andpretend there was no coverage for terrorism?

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In other words, when you have a specific exclusion forterrorism, what would have happened to the U.S. economy relative tothat $30 billion in insured losses on 9/11? So I do thinkWashington should seriously consider the consequences of pullingthe rug out from under the industry.

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Richard Sarnie:

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You are assuming insurance is the only solution to coveringterrorism risks. I agree TRIA should be renewed, but I don't buy[terrorism coverage] in the free market. I insure it to my captiveand rely on TRIA to back me up.

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So if TRIA goes, obviously we're not going to be able to handlethis the same way, but my point is that the answer is not“insurance at any cost.”

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We're going to look at it and see what we can dedicate thesedollars to–better security, better this, better that. We're goingto control our own destiny and not worry about whether the freemarket is going to provide us with insurance.

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William Stiglitz:

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There's no free market stepping forward and saying we'll writethis risk, so the federal government is going to have to step upand do this. Otherwise, terrorism is just going to be excluded whenit can be.

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Sam Friedman:

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IN CONCLUSION:

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I want to thank all of our panelists for speaking so frankly andinsightfully about the state of the market. National Underwriterwill publish the results of the Fall 2005 survey, looking ahead tothe critical Jan. 1 renewal season, in our Nov. 21 edition.

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Roundtable participants included (top, l-r): John Ormerod,Zurich; Bill Stiglitz, IIABA; Sam Friedman, NU; Paul Smith, Willis;Richard Sarnie, Engelhard; Mark St. Aoro, Zurich; and MaynardRobison, The Response Center. (Bottom, l-r): Raymond Thomas,Zurich; Steve Dreyer, S&P; Michael Murray, ISO; and GeraldChiddick, Zurich.

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In a lively discussion lasting over two hours, a panel includinga broker, independent agent, rating agency analyst, industryeconomist, Fortune 500 risk manager and representatives from Zurichin North America tackled pricing and coverage trends, as well ashot-button issues such as terrorism and the impact of recentregulatory probes.