2002: Capitalism At Its Best (And Worst)

Prediction: 2002 will be better than 2001 for insurers. With a combined ratio this year expected to top 120, virtually no profits, record underwriting and catastrophe losses, declining investment income, shrinking capacity and a recession underway, this is an easy prediction to make.

Its hard to imagine how things could get any worse. Even in the event of another major terrorist attack next year, the much-ballyhooed federal reinsurance backstop should cap the industrys liability at about $10 billion.

Insurers are headed in the right direction for 2002. Caution is the industrys new watchword. Rates, retentions and limits are up, and the Feds are expected to come to the rescue.

But higher prices, limits on exposure and a government backstop are not enough. Full recovery from the devastation of the Sept. 11 attacks will require the infusion of massive amounts of capital to alleviate shortages in a wide variety of market segments.

For insurers and investors to seize upon profit opportunities so quickly after the tragedy is an unseemly but vital stage in the recovery process, not unlike the actions of many other businesses.

Almost immediately after the horrific terrorist attacks of Sept. 11, entrepreneurs large and small around the world and in many different industries began to wonder how they could profit from the tragedy. Before the smoke had cleared over New York City, street vendors in Manhattan were hawking World Trade Center memorabilia, factories in China were pumping out U.S. flags 24-hours a day and architects were touting their plans for rebuilding on the World Trade Center site.

Moving so quickly to cash-in on such a tragic event may seem exploitative and insensitive. Yet in each case these entrepreneurs were performing an essential role in the recovery of the United States from the psychological and economic trauma caused by the attacks.

The recovery of the global property-casualty insurance industry from the devastating financial blow of Sept. 11 is no less dependent on the motivated self-interests of profit-seeking entrepreneurs and investors. Some $40 billion in global claims-paying capacity went up in smoke that fateful day, while another $30 billion or so in the United States alone could evaporate this year through a combination of poor underwriting results, reserve additions, a slew of expensive natural disasters and stock market losses.

What p-c insurers need is money–and lots of it–fast.

The industrys outlook for 2002 depends very much on successfully securing this capital. Without it, unique opportunities will be missed and the instability stemming from the Sept. 11 losses will last much longer.

At first glance, the odds of anyone putting a dime into the p-c industry seem remote. The industry this year is likely to see a combined ratio in excess of 120–a record–and the industry as a whole continues to hemorrhage red ink in several of its largest and most important lines. The World Trade Center disaster added 15-to-40 points to the third-quarter combined ratio of many major U.S. insurers with commercial lines or reinsurance operations.

And lets not forget that there is an open-ended, armed conflict underway against an elusive enemy bent on destroying the very people and property we insure.

Such a hostile environment would drive the average investor away. But investors in the insurance world understand better than most the tradeoff between risk and reward.

Attracted by the potential for outsized profits from high prices, investors worldwide had within seven weeks of the attacks already positioned at least $7.8 billion in capital for deployment in the insurance industry. Billions more will flow into the industry in the year ahead.

Most of these funds will be used to support specialty lines insurance and reinsurance operations in market segments suffering from capacity shortages. Initially, however, little of this capital will be allocated to cover potential losses from terrorist acts.

The outlook for 2002 depends on much more than successfully attracting capital, of course. The seeds of the industrys most enduring problems were sewn years (and in some cases decades) ago.

The cost of risk to businesses, for example, fell by 37 percent–from $8.30 per $1,000 of revenue to just $5.20 per $1,000 of revenue between 1992 and 1999 (see graph). Neither improving loss-cost trends nor bullish investment performance can justify that quantum decrease. Consequently, years worth of chronically underpriced business continue to assault the industrys balance sheet.

Purging the pricing sins of the past (while chasing the cost drivers of the future) is proving to be a long, painful process, but one that is finally meeting with some considerable success. The cost of risk to business is expected to rise by 17 percent this year and 37 percent in 2002.

Much older is the industrys ever-festering asbestos problem, but it, too, could be reined in next year. Insurers stand a decent chance of persuading Congress that paying billions to unimpaired claimants is simply wrong. Many companies are bolstering their asbestos reserves as well.

The insurance industrys recovery in 2002 from the trauma of Sept. 11 and its other ills will likely become a textbook example of how capitalism should work. It will not be pretty.

Our customers will object to higher prices, having become accustomed to artificially and unsustainably low rates through much of the 1990s. Some insurers and investors will be unfairly characterized as profiteers.

At the end of the day, however, society as a whole benefits because of the peace of mind and reduction in uncertainty that freely available insurance brings.

Robert Hartwig, Ph.D., is vice president and chief economist at the Insurance Information Institute in New York. He can be reached at bobh@iii.org.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, November 19, 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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2002: Capitalism At Its Best (And Worst)

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