Market Cycles Persist Despite Better Tools

While enterprise risk management and predictive underwriting models should theoretically dampen cycles, it's na?ve to think property-casualty insurance management teams will universally follow their indications, executives said here.

Ramani Ayer, chairman and chief executive officer of The Hartford, said “tools are only one part of the game. Management will–management resolve–is the key differentiator in terms of when we decide that terms are unacceptable and we'd better stop kidding ourselves.”

“I don't think that [management resolve] is as freely available or as widely distributed” as sophisticated tools, he added during a panel discussion at Standard & Poor's 2007 Insurance Conference.

Mr. Ayer's comments followed opening remarks by S&P Managing Director Grace Osborne, who said that while the hard market is over, S&P's stable ratings outlooks for all p-c sectors are predicated on the idea that this cycle will be different because ERM “is much stronger this time around,” and because financial discipline should play a larger role in avoiding ruinous earnings impacts of soft market competition.

Referring to the less disastrous aftermath of more muted cycles as a “soft landing,” S&P analysts repeatedly asked industry executives to comment on this theory throughout the two-day conference.

“It's a very lovely picture that… somehow we'll land in this nice, soft place and all recover, and life will be good,” Mr. Ayer said. “It won't happen.”

“It's na?ve for us all to think that somehow there's a stable equilibrium here that we'll all achieve, where there's orderly retreat on the part of the industry,” he added, noting that insurers with higher cost structures, less access to distribution and less scale advantages will see their margins erode earlier and to a greater extent.

“We all will find different ways to meet our shareholders' expectations,” he said, expressing doubt that all competitors can stay disciplined.

At a later session, Stephen Way, former CEO of HCC Holdings–who is now a partner for SLW International, LLC, a Houston-based investment and consulting firm–said that “we can sit here all day and talk about modeling….You have to separate the tools from whether they stop you from writing cheap business or…exceeding your [probably maximum losses] and risking your capital.”

Speaking on a panel of experts who described predictive underwriting tools and catastrophe models, he said that “modeling–right, wrong or indifferent–goes out the window at some point….Companies write cheap business. They expose their capital. It happens every time.”

He added that “once one, two or three companies do it, more join the club.”

Mr. Ayer was one of several executives who initially expressed some optimism about the beneficial impact of better tools.

He also suggested that more transparent financial reporting–allowing investors to react to rapidly deteriorating performance–along with the potentially disciplining force of “rating agency intrusiveness” could mean less severe cycle downturns in the future.

Mr. Way said there are limits to transparency, noting that public companies typically report only on renewals. “They tell you how disciplined they are–[that] they let the bad business go because they have better underwriting than everyone else”–but don't discuss new business they're picking up at rates that may be declining 30 percent.

Mr. Ayer worried that “capital formation in the business today is faster than the rate of available growth”–an imbalance potentially spurring competition. On the other hand, he noted that existing players are paying more attention to capital utilization than they ever have and returning it when growth prospects are lacking.

Mr. Way said the industry needs a major overhaul in its thinking on capital.

“The biggest single problem in the industry is that we still judge it by the ratio of premium-to-capital,” he said, noting that a company with $1 billion of capital in a soft market may be writing only $500 million but actually taking on $1 billion worth of exposure.

“If you half the rates, [a premium-to-capital analysis] suggests you can write double, and if you double the rates that you have to raise capital….you should raise capital when you half the rates, and write double the premium if rates go up,” he said.

“The industry's got it all wrong. Until we get that first part right, the rest of this is all mumbo jumbo,” he said, referring to the talk about better tools.

He also said that while tools could be valuable for small standard policies, they don't work for specialty business or large accounts, where extreme competition persists. On that business, “brokers tell you what it's going for, and then you can decide if you want to write it,” he said.

At the earlier session, Stephen Lilienthal, chairman and CEO of CNA in Chicago, said currently, the most pronounced accelerations in soft market conditions are in the large risk and specialty market segments.

Overall, he said, “ERM has made us better,” noting, for example, that companies have become more diversified and “more segmented” in their approaches to business, that they use higher quality data and have made smarter technology investments.

Still, Mr. Lilienthal said history paints a dimmer picture. During his 35-year career, he said, only 10 were in hard markets. “The rest are times we have to learn to live with. I don't think we live in hard markets. We live in soft, competitive markets” sprinkled with hard-market “moments,” he said.

At another session, Joseph Brandon, CEO of General Re, also focused on what hasn't changed. “I think this cycle is going to end badly, just like every other cycle,” he said, adding that while tools have made the industry smarter, “we'll probably just make different mistakes.”

With fundamental economics unchanged, price declines are inevitable when there's greater supply (induced by recent profits) and relatively flat demand, he said.

Patrick Thiele, CEO of Bermuda-based PartnerRe, said he's optimistic reinsurers will maintain discipline, noting that many had “come through the fire” of the record underwriting losses of the last cycle.

Noting that U.S. casualty loss trends have declined for four years, however, he said he's not optimistic the industry will react quickly to the reversal or spot the next big casualty loss-driver.

“Something will happen in society–some income disparity or some social ill will need to be addressed,” he said, adding that the industry hasn't made progress when it comes to identifying loss-trend changes on a real-time basis.

But Munich Re CEO Nikolaus von Bomhard said the problem during the last cycle was not simply one of not being able to read trends early. “Strategy took over. People wanted market share,” he said, noting that the actuaries “had a hard time being heard” at companies where executives had “their foot on the gas.”

External pressure for top-line growth persists, he added. After explaining why a top-line growth strategy is not the right one to run a reinsurer, “three sentences later, we get the question, 'Where is your growth?'”

“It's an uphill struggle,” he said.

He added he is skeptical about the prospect of a soft landing to current cycle. “I see underwriting teams being poached” as competitors attempt to leverage relationships to access blocks of business. The only way to get that business away from incumbents is to take it at lower margins, he said.