Greed Is Not Good For Insurers

“All progress is based upon a universal innate desire on the part of every organism to live beyond its means.” So said Samuel Butler, the English novelist and satirist.

The well-respected insurance analyst, V.J. Dowling, of Dowling & Partners in Hartford, describes four phases of the insurance cycle–pain, cheating, fear, and restoration. According to his classification, the commercial lines and reinsurance industries are now in the restoration phase, when prices are at levels where profits are generated, which replenish funds lost in the soft market.

For the property-casualty industry as a whole, this is probably the most dangerous part of the cycle, as it is in this period where companies overreach, anger their customer base and spur risk managers to explore and develop other mechanisms for risk transfer. And once they become comfortable with these newer options, they may never return.

Three of the enduring legacies of past over-reaching are:

The captive movement (currently accounting for about a third of commercial lines business).

The Bermuda-domiciled multiline insurers (created in the mid-1980s).

The Bermuda catastrophe reinsurers (created in the past decade).

The restoration phase probably should be divided into two separate phases–with the first being a true restoration phase, where prices return to adequate levels. The second part is the “greedy” phase, where prices are set at levels that generate above-average profits. From the customers perspective, such prices are frequently judged to be exorbitant.

What can be done? On an industry-wide basis, probably nothing. As the above quotation from Samuel Butler suggests, it is the natural condition for human beings to reach beyond what they have. But “greed” does not come with capital letters and garish neon signs.

Human beings, in general, as psychologists tell us, do not seek twice or three times what they have. They tend to desire a little bit more–say 10, 20 or 30 percent more in salary and a similar increase in wealth.

Paupers realistically do not want or expect to go from rags to riches, but they would like not to have to worry every day about where their next meal comes from. At the other end of the income spectrum, a millionaires next goal normally is not to be Bill Gates or Warren Buffet, but to have the next million.

In desiring a bit more, people do not feel that they are greedy. Such a desire for more is generally justified on moral grounds. Most people find it easy to believe that they are under-appreciated for the wonderful human beings that they are, and underpaid for the conscientious work that they perform.

So, too, for human beings in insurance and reinsurance companies. They are not “greedy.” The fact that they would seek to take advantage in a hard market is likely to be seen as both morally and economically justified. After all, they have struggled through the many lean years of the soft cycle, why shouldnt they be entitled to a little extra?

As so often happens in economics, as we all learned from Adam Smith, the aggregate impact of individual actions produces a market result not intended by each separate economic actor. The net effect of this “moral” behavior of insurers and reinsurers in the “greed” phase of the cycle is to anger their customers and spur their search for better mousetraps.

The eventual outcome, as occurred following the medical malpractice crisis of the 1970s, the liability crisis of the 1980s, and the property-catastrophe crisis of the 1990s is a shrinking (usually of a permanent nature) of the insurance /reinsurance franchise.

Given the seeming inevitability of the greed phase of the cycle, what should individual insurers and reinsurers do?

By practicing some restraint, insurers and reinsurers can establish a better reputation as a quality suppler of insurance services for themselves in the market. Remembering that it is almost always cheaper to retain than acquire a customer, industry players who keep a lid on prices could be well rewarded in the long run by foregoing short-term profit.

Sean F. Mooney, CPCU, is senior vice president, research director and economist at Guy Carpenter & Company in New York.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 3, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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