Will Hard Market Spark More Captives?
Corporate insurance buyers faced with skyrocketing premiums, lower limits, and tighter terms and conditions will be tempted to turn to the alternative risk-transfer market for coverage rather than pay the piper or go bare.
However, forming a captive might be easier said than done. It's true that new captive domiciles are popping up and growing fast here in the United States to supplement the mega-markets already established in Vermont and Bermuda. But before risk managers rush in to self-insure, there are many hurdles they will have to clear.
For one, a traditional advantage of forming a captive–gaining direct access to the reinsurance market–is a big question mark now with reinsurance so hard to come by. Fronting carriers are also harder to find and more expensive to secure.
In addition, captive domiciles being overrun with "tire-kickers" are becoming more selective in screening prospects because time and resources are limited.
Meanwhile, a mini-brouhaha erupted this summer over a rating analyst's suggestion that captives could be a "time bomb waiting to explode" if their financing wasn't up to snuff. After a war of words in the pages of National Underwriter over the assertion, the consensus seemed to be that as long as captives are well-financed and managed, they are at least as reliable in paying claims as any insurance company.
But that is a big "if." Risk managers cannot simply dump the premiums they paid in a soft market into a captive and expect to be securely covered. Soft market premiums were subsidized by skyrocketing returns on Wall Street that have disappeared and are not expected to return anytime soon. Companies must have outstanding loss control and a professional service infrastructure in place to brave the captive market.
The Bottom Line:
While some of the more sophisticated risk managers will move into the captive market with relative ease, the vast majority of buyers will ride out the hard market, limiting their self-insurance adventures to taking larger deductibles and higher co-insurance. The luckiest risk managers are those who were savvy enough to establish a captive program years ago, and who stuck by their independent facilities despite the temptations of cheap coverage in the soft market.
Capital Harder To Come By
Last year, one of the top 10 stories was headlined: "Capital Pours Into P-C Market." Indeed, billions of dollars were invested by those betting their chips on a pricing rebound that they expected would make the industry far more profitable in 2002.
However, the reality is that the money that poured in did not necessarily replace all the tens of billions that rushed out in Sept. 11 claims. In addition, a number of major carriers had to pump hundreds of millions of dollars into reserves to pay for claims from prior years.
Meanwhile, low interest rates and poorly performing equity markets cut into investment income for insurers. Such income fueled the soft insurance market during the boom times of the 1990s. Now, however, Wall Street doldrums are forcing carriers to write insurance for a living again, and that's no picnic even with the double-digit rate hikes.
The industry's return-on-equity is nowhere near where it has to be to attack major growth capital. In addition, rating agencies warn that many carriers are still seriously under-reserved. With Wall Street likely to remain in the dumps indefinitely in a sagging economy, carriers are going to need to write at combined ratios in the low-90s to attract the attention of skeptical investors. They've got a long way to go to reach that target.
The Bottom Line: It's going to take at least another year of substantial price hikes and outstanding underwriting performance to turn heads in the investment community. That means a drought, rather than a flood of capital in 2003. Any further terrorist attacks or major natural catastrophes would exacerbate the industry's cash crunch and extend the hard market into 2004 and beyond.
Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, December 30, 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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