Pricing in the soft commercial insurance market won't turn around for another two years at least, thanks to a variety of factors, the head of Arch Worldwide Insurance Group predicts.

“Barring any massive unforeseen event, capital markets related, it's going to be a combination of reserve margins disappearing, over prior years, which leads to–if you're going to maintain not crazy results–underbooking the current year,” Mark D. Lyons, chair and chief executive officer of New York, N.Y.-based Arch, told National Underwriter. “There simply hasn't been enough pain yet” to turn rates around.

“A lot of people refer to that as the 'cheating phase,'” he added, following a speech here last month at the Conference of Special Risk Underwriters.

“Since no company goes broke because of a couple of expense ratio points, the continued focus needs to be on the loss ratio, since that can wildly fluctuate between companies due to differing underwriting strategies–and that leads to financial troubles,” Mr. Lyons observed.

“Margins are what the industry should be focusing on instead of the top line, since explosive growth in a soft market leads to financial problems down the road,” he added.

Mr. Lyons also commented on the insurance market cycle, noting that “as an industry, we forget about what it was, say we'll never do it again, and we make the same insurance mistakes.”

As an example, he cited an article in National Underwriter from the early 1990s.

“NU published an article about insurance cycles–about how the lessons are ingrained and [the cycle] won't ever be repeated,” he recalled. “At the very bottom was a note that the article was originally published in 1919. So our collective memory is pretty short.”

He explained that insurers that grow “explosively” in hard markets ultimately have superior profitability and are “holding on for the next time. It's managing that down side of the cycle that's critical.”

He jokingly added that the insurance industry has “always done a fabulous job of returning capital–they just return it to the wrong people.”

Mr. Lyons described what he sees as six key risks going forward:

o Insured exposures risk–real versus measured risks.

o Insurer risk management risk–which includes long-tail events not considered.

“A couple of years ago we were getting a 1,000-year event every week. So whether it was Marsh's [contingency fee abuse] issues or [Eliot] Spitzer's [insurer bid-rigging] debacle, or the credit crunch… There is a lot of tail risk we don't think about that has a lot of impact,” he said.

o Capital markets risk–if a material event occurs, will the capital markets be repaired? Will insurance-linked securities return in the event of a natural catastrophe?

“What will happen is an unknown,” Mr. Lyons said. “When there are more unknowns, what are we? The insurance industry is supposed to be the risk accumulators for the Fortune 1000 and on down, yet we have the lowest returns over a 30-year period than any of those subject industries–basically 6.5 percent. And we're the ones absorbing the risk on everybody else.”

o Rating agency and regulatory framework risk–including increased capital requirements, more onerous regulatory frameworks, potentially duplicative federal and state regulation.

o Legal broadening risk–the long-term impact of the Obama administration's judicial appointments on the erosion of tort reforms and the creation of new liabilities.

o Irrational marketplace risk–management rationalizations, overcapacity and focusing on the top line rather than profitability as the main driver.

“We see that there are growing new markets,” he said. “Some [writing those new exposures] are talented and knowledge rich, but some are not. Some are 'innocent capacity,' which means massive price cuts, underbooking results and having a disaster waiting to happen down the road. Luckily that's a minority.”

Mr. Lyons added that the trailing 12 months premium for the industry had this growth until 2007, “after which it dropped, and through three months of 2009 the industry is down roughly 3 percent in net written premiums in the aggregate,” he added, citing Dowling & Partners.

As for underwriting profit, he asked, “What does the industry pride itself on? Being underwriters. What's the core competency? Abysmal.” In 35 years, he said, only four years have seen underwriting profits.

Regarding Lloyd's, he said the world's oldest insurance market “competes with all of us.” Lloyd's, he said, shows an upward trend in capacity–how much it allows across the syndicates.

“It's been increasingly attractive for people to buy into Lloyd's,” he said. “Now almost four-times as many are buying to get into Lloyd's as those trying to get out of Lloyd's. It is the most expensive price to get into Lloyd's in history.”

Is the price justified? “It appears to me that from 2000 forward, the depth of the negative returns has been deeper for Lloyd's than in the U.S.–but they did have some extremely good years as well, such as 2006's 27 percent return,” Mr. Lyons said.

He added that in the 2000-2001 year of account, there were minus-22 percent returns and next year minus-18 percent. The 2002-2004 returns were much better at an average of about 13 percent. For the 2008 year, Lloyd's itself is projecting either a small loss or small gain, he noted.

Overall, he concluded, prior-year reserve margins are running out for insurers, noting that 2008-2009 results were heavily influenced by this and that it could be a “source of pain” in 2010-2011.

As an industry, he said, there is probably enough for 2010-2011, although for many companies, “in 2011 it will fall short. The only way to have good results is to massively underbook the current year, because there's no more cookie jar to draw from. That's not a responsible practice.”

He said cash flow is being reduced because of low interest rates, depressed premium volume and prior-year paid losses coming due. There is a risk of inflation on expenses as well. Inflation, he said, is a massive uncertainty.

Inflation fears are a factor, he added, because of “underpriced primary products and grossly underpriced excess products, as well as a higher demand for salary increases and higher costs for everything.”

Mr. Lyons said that capacity exists, and that a lot of capital–line capacity–has been reported.

Special Reports /

Arch CEO Sees No Market Turnaround Ahead

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