E&Y Says 2009 May Be "Transformational"

In its recent 2009 Insurance Outlook - U.S. Property and Casualty report, Ernst & Young (E&Y) offered some encouraging words. The company noted that although the P&C industry suffered what it termed "significant isolated damages" recently, it also declared it had suffered "no serious general impairment."

While acknowledging that 2009 is not without risks from continuing volatility in investment and underwriting performance, E&Y also said this may be the beginning of a "transitional if not transformational environment" in insurance. Citing the need to find opportunities in a challenging landscape, the company identified what it called "seven key actions" for 2009. Here is the list, along with selected excerpts from the report:

1. Redirect focus on premium pricing. In most P&C segments, pricing levels have been soft for the past four years. Early indications of pricing negotiations give strong support to at least a firming of the market in most lines. Additionally, losses in directors and officers (D&O) and errors and omissions (E&O) products will certainly result in significant price increases in those market segments.

2. Monitor claims inflation risk. The environment for P&C insurers through 2009 is likely to continue a volatile pattern that drives claim costs. In spite of the deepening recession and the rising concern of deflation, in the longer term, the industry must account for the massive deficit spending undertaken by the federal government. The most significant factor in the broader economy will be the long-term impact of the federal bailout and economic stimulus packages that have already added to government deficits.

3. Prepare for changes in regulatory oversight. It is almost certain that the P&C industry will face increased regulation as an outcome of the current crisis in the financial services industry. While the case for federal oversight is more apparent in the life industry, where geography matters little in product design or consumer preferences, the P&C industry's geographic variations present a formidable hurdle for centralization. Some form of compromise legislation may apply to P&C companies: maintaining rate and consumer protection regulation at the state level, but developing federal mechanisms to monitor solvency and provide an alternative to guaranty funds.

4. Prepare for changes in accounting requirements. With the Securities and Exchange Commission's 2008 pronouncements regarding the convergence of U.S. generally accepted accounting principles with international financial reporting standards, companies are beginning to prepare for the anticipated change to a market-consistent framework. Implementing principles-based and market-consistent accounting challenges nearly every established system and operational facet of an insurance company. Under such a system, income statements and balance sheets become more volatile as assets and liabilities are increasingly subject to market valuations.

5. Address effective expense control. Long-term reversal of expense growth requires an emphasis on effective service outcomes in three critical operating areas: underwriting costs (including policy administration), acquisition expense (primarily, fees to brokers and agents), and claims-adjustment expense. Many of the largest P&C insurers undertook cost-reduction initiatives during the second half of 2008. However, a longer-term, sustainable approach to insurance spending must be applied to make a real difference.

6. Rethink risk modeling. When it comes to modeling priorities, line managers and corporate functions will have increasing responsibility to ensure that lessons learned are incorporated into models. Adjustments may be needed in order to improve the modeling of changing economic and capital-market conditions.

7. Watch for new M&A activity. The total insurance properties currently available for sale exceed the M&A activity of the last several years combined. Depending on the speed and pace of economic recovery, 2009 may be one of the more significant years in the insurance M&A market.

The full report is available at www.ey.com/insurance.