Aint No One Here But Us Chickens
I know an insurance industry analyst whose father is a chicken farmer. He says his father has always complained it was his fate to husband the stupidest creatures that God had placed on the planet–chickens. "I often think that its my fate to analyze the stupidest companies that God ever created," the analyst adds, wryly.
Of course, he is referring to the fact that the insurance industry just doesnt know how to deal with prosperity. A short run of profits historically has led to soft markets and cutthroat competition.
Has the industry finally learned its lesson? Or a decade from now (perhaps sooner), will a new generation of CEOs, underwriting managers and underwriters (just itching to whip out their pens) forget the lessons of the booming 1990s?
History would indicate that the industry will end up repeating its mistakes.
During a spate of interviews I conducted recently for this week's World Reinsurance Report, the new catch phrase for reinsurers appeared to be: "Underwriting Discipline." A few years ago, it was: "Lets get back to underwriting basics."
But Ive been covering this industry for a long time, and Ive heard these words before. In the early 1990s, I heard executives say that there was so much blood on the carpet, the industry had finally learned its lesson.
In the mid-1980s, Felix Kloman, formerly with Tillinghast, equated the insurance industry to lemmings, diving together over the cliff.
During the soft market of the 1980s, the industry involved itself in "cash-flow underwriting." In the 1990s, Ive heard the same phenomenon called "market-share mentality." Whatever you want to call it, it is an inevitable prescription for industry losses.
Perhaps cycles are the natural order of things and are a way for the industry to cull the weakest of its members–but at what cost? Every time the industry enters a phase of "adjustment," it does itself incalculable damage. Reinsurance prices rise precipitously because reinsurers want their "payback." Insurers subsequently pass large premium increases onto commercial and personal insurance buyers. The stories are legion of massive rate increases being charged even to buyers with good records.
At the World Insurance Forum in Bermuda this past February, several commercial insurance buyers complained that the wildly varying peaks and troughs of the insurance cycle contradict the intent of insurance–to smooth the balance sheet.
The aviation industry, for example, is howling over rate increases imposed by their insurers, which experienced losses over the entire decade prior to Sept. 11. In April, I wrote an article quoting a reinsurance executive saying that the industry is aware of the fact that airlines have serious financial problems, but "to put it bluntly, thats not our problem." Since aviation insurers have had losses for a decade, its only fair that the insurance industry should be "reflated." In other words, the industry was expecting its payback.
Frankly, I think it is the industrys problem to accommodate the needs of buyers. The industry undercharges for 10 years and then expects buyers to absorb an instant return to rates based on technical underwriting, rather than rates subsidized by investment income, as had been the case in the 1990s.
I question the concept of "payback" as a way of conducting business. How about just charging the proper underwriting rate–that is, the technical rate–for a line of business?
It appears that executives have seen the light, as least temporarily. Without much investment income, theyre finally being forced to make money on underwriting–a novel concept.
Rick Smith, president and chief executive officer of Global P&C Re, a business unit of GE Employers Reinsurance Corp. in Overland Park, Kan., said recently that the last time the property-casualty industry in the Americas had an underwriting profit was in 1975. Thats mind-boggling!
He said there is a huge need, especially in this low interest rate and poor equity market environment, for the industry to change its standards and write to an underwriting profit. Mr. Smith admitted that its a "wild concept" for the industry to actually make a profit on the products it sells.
In any other industry, such as manufacturing, for example, a decision will be made to sell a product at a loss–as a loss leader–to gain market share. But such a game is more risky in the insurance industry because there is no guarantee that underwriters actually know the costs of the goods they sell, especially one with a long tail. It's all guesswork. Playing a game with a loss leader in manufacturing is a little less risky than playing a game with market share in the insurance and reinsurance industries.
I was encouraged to hear Mr. Smith and Clement Booth, a member of the board of management at Munich Re, say that theyve non-renewed quite a bit of their business that didnt fit into technical underwriting guidelines. But thats easy to say in a hard market when reinsurers can be choosier about the business they underwrite.
Mr. Smith emphasizes that its important not to be afraid to walk away from unprofitable business. "Weve got to be willing in a soft market to take a business from $4 billion of written premium and shrink to $2.5-to-$3 billion if that is what it takes to maintain underwriting discipline." Blimey! This would mark a sea change for this industry!
I would suspect that such a volte-face is going to require the leadership of the largest reinsurance companies. If they again follow the market down, then we can expect another foolish, shortsighted soft market.
"I think reinsurers in the past, ourselves included, sometimes made the mistake of saying to underwriters, 'Write quality, but also grow the book above inflation.' These kinds of mixed messages should be avoided," said Mr. Booth.
Warren Buffett at Berkshire Hathaway has said that hed rather his underwriters play golf than write underpriced business in a soft market. Such an attitude will fly in the face of the work ethic expected of any employee, and is going to require a change in management attitude. It might raise the expense ratio, but this is less costly than the loss ratio.
The pursuit of top-line growth in a soft market has led many companies to get involved in areas they didnt quite understand, and they're paying the price. (I can think of a few companies that are probably wishing they had sent their underwriters on golf outings, rather than getting involved with the financial guarantee market or film guarantees, for example.)
So lets see if the industry can adhere to a new way of doing business–making an underwriting profit, with underwriters laying fallow during a soft market.
Any bets on how long it will take those chickens to come home to roost?
Lisa S. Howard is international editor for the National Underwriter in London. She can be contacted at lhoward@nuco.com.
Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 2, 2002. Copyright 2002 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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