The Shake Down of 2004

This year will no doubt go down in insurance history as a year to remember. For the most part, the year slid by with minimal excitement … that was until the fall of 2004 when the industry was hit by not one, not two, but five hurricanes. Yes, five, including Hurricane Spitzer who may very well change the industry forever.

So, who made the most “news” in 2004? Well, the possibility of federal regulation was hot on the agenda of industry trade associations throughout the year, and several industry mergers took the spotlight. Independent agencies lived through merger-mania yet again with Brown & Brown leading the way. And we cannot forget the endless squabbles over the American tort system, which was brought to life by the cries of doctors nationwide and throughout the presidential debates.

Here are the highlights for Insurance Journal‘s Shake Down of 2004, which brings together the top 10 newsmakers of the year.

Spitzer Shakes Up the Industry
New York’s Attorney General Eliot Spitzer is the hands-down winner as the most important newsmaker of 2004. If it weren’t for the Sept. 11 attacks, he’d also be chosen for the decade and so far for the century.

Although Spitzer is a modern lawyer, his crusade traces an historic path. He’s the latest in a long line of reformers, the best known being the “Muckrakers” of the early 20th century. Lincoln Steffens, a crusading magazine editor exposed municipal corruption in “The Shame of the Cities” (1904), leading to numerous anti-corruption laws and reform of the civil service. Upton Sinclair’s frightening portrayal of the Chicago stockyards in “The Jungle” (1906) led to the passage of the Pure Food and Drug Laws. Ida Tarbell nailed the Rockefellers with her “History of the Standard Oil Company” (1904), which helped Teddy Roosevelt put teeth into the anti-trust laws. Spitzer’s probe may well lead to federal regulation of the insurance industry.

There’s a certain majestic symmetry. Spitzer’s first target was Marsh, formerly headed by Jeffrey Greenberg. More investigations in conjunction with the Securities and Exchange Commission target AIG, headed by Jeffrey’s father Maurice “Hank” Greenberg. ACE Limited–CEO younger son Evan–has also been deeply involved. No, the Greenbergs aren’t the Rockefellers, but they hold (or at least held) analogous positions of power.

Like his predecessors, Spitzer can’t ignore wrongdoing, abuse of power, and harm to the public. He’s determined to pursue it. He did the same when he investigated abuses in the securities markets. Unlike the muckrakers, however, who employed the mass media of the day to inform the public, Spitzer wields real power. As the head of New York’s legal department, he commands a large staff of well-trained lawyers and investigators, who can examine alleged abuses and bring real charges before real magistrates and Grand Juries. His influence goes far beyond influencing public opinion, although he’s certainly done that as well.

Unfortunately the insurance industry in general and high profile companies like Marsh, AIG and ACE in particular, make very tempting targets. Many consumers viscerally mistrust the industry to begin with. Not only because they haven’t a clue how it works, but also because they relate bad experiences they or their friends have had over their homeowners policy or their car insurance to the entire industry.

Spitzer’s investigations have nothing to do with personal lines–at least not yet. He’s targeted the sophisticated commercial side of the business, where big brokers, Marsh, Aon, Willis and others, have for years operated by their own rules. No one has ever tried to hide the fact that contingent commissions have long been part of the industry, but no one actually openly discussed them either. There was room for abuse, and Spitzer has found some.

He’s also apparently found outright fraud in the form of bid rigging. No industry can tolerate such practices and expect to maintain public support. It’s the essence of Spitzer’s job to expose it and prosecute it. How deeply it goes, and how many people and companies are involved only time will tell. For the moment it appears minimal. Accused individuals have largely been “suspended” by their companies and a number have pled guilty. Jeff Greenberg dutifully fell on his sword by resigning as Marsh’s CEO.

Spitzer, however, has unleashed tidal forces that will not stop there. Investigations have begun in many other states. The health benefits industry is under fire. The SEC has stepped up its own investigation of finite insurance contracts. Armies of lawyers are poring over reports in the hopes of filing civil damage claims against companies cited in the investigations.

When the dust finally settles, the industry will probably be subject to some form of federal regulation. The probes, however, could well help smaller agents and brokers by prying open some of the doors the big boys have kept closed. Hank Greenberg thinks brokers will become “leaner and meaner.”

The commercial insurance market, however, won’t change much. It’s essentially a zero sum game. Corporate and institutional risk mangers know what their risks are, what coverage they need, and pretty much what they can afford. This demand stays relatively constant. On the supply side, capacity will continue to determine premium rates, as it always has. Only the rules and the players may change.

Horrible, Horrendous Hurricanes Happen
One’s normal, even two, possibly three, but four? No way, and yet that’s exactly what happened to Florida in 2004. For the first time since 1886 four major hurricanes–Charley, Frances, Ivan and Jeanne–struck one state. Between Friday, Aug. 13 (an unlucky day indeed) when Charley came ashore on Florida’s west coast and Monday morning Sept. 26 when Jeanne moved north–over the exact same track as Frances, something that has never happened before–the state was under siege.

For more than six weeks the nation’s TV screens were filled with pictures of monstrous waves, flying roofs, crushed trailer parks, downed power lines and endless lines of cars heading to safety. It will take a long time to clean up and rebuild. Other states in the region also suffered, mostly from heavy flooding.

The storms brought death to more than 70 people in Florida and thousands more on Caribbean Islands, notably Haiti. According to the Insurance Services Office, combined damages are estimated at more than $50 billion with $22 billion to $23 billion in insured losses–more than Hurricane Andrew.

Bad as the hurricanes were, the effects could have been a lot worse. Timely and frequently updated warnings from the National Hurricane Center made sure everyone knew the storms were coming and guided local authorities in making preparations that ultimately saved many lives and reduced damages.

Also remarkable was how well the insurance industry weathered the storms. No major insurer or reinsurer has so far reported an economic hit that threatens its financial stability. There were some severe drops in third quarter earnings, but no one’s rushing to form new companies. While a number of insurers and reinsurers are raising new capital, they have reasons for doing so other than shoring up reserves battered by the hurricanes. The industry passed a major test with strong marks.

The SMART Thing to Do?
State vs. federal regulation has been tossed around for some time and 2004 was no exception.

The proposed federal State Modernization and Regulatory Transparency Act (SMART) offers several stipulations including halting state requirements for approval or prior review of rates and complying with a new system of nationwide competitive pricing within two years of legislation enactment. While the legislation would make it necessary for states to modify insurance laws, it falls short of forming a federal insurance regulator or a federal charter option which was desired by some insurers.

The draft bill was the product of House Financial Services Committee Chairman Mike Oxley (R-Ohio), and Capital Markets Subcommittee Chairman Richard Baker (R-La.). The nationwide competitive rating system would be phased in using a flex band approach. The flex band would permit up to a 7 percent increase or decrease in rates for the first 12-month period and a 12 percent increase or decrease during the second 12-month period. Credit, title, mortgage, gap and medical malpractice insurance would be exempt from the national rating system. The draft legislation also notes that states may continue to regulate the use of all underwriting or rating factors or classifications including prohibiting the use of race, religion or other criteria. The measure seeks to make states more uniform in their regulatory requirements and procedures in market exams, financial surveillance, licensing, product approvals and other areas. It establishes two and three-year deadlines for states to meet the requirements.

A gathering of several state insurance commissioners in the fall allowed for a discussion of SMART, Insurance Journal reported.

According to Alabama Insurance Commissioner Walter Bell, “There are no more important issues than federal vs. state regulations and proponents have dug in on both sides.” According to Bell, if the industry were federally regulated, companies would have to pay double taxes. Bell said insurance company revenue allows for a majority of the general fund income and that when companies opposed the double taxation those states would lose most of their budget.

Louisiana Insurance Commissioner Robert Wooley added that he didn’t expect the U.S. Congress to pass SMART anytime soon. Wooley said that when Louisiana tried to regulate insurers they began to leave the state and found out the hard way that competition is the answer to regulating it.

The St. Paul Travelers Cos.
Competition often brings folks to the realization that combining what you both do best makes more sense than trying to outdo the other. That is what The St. Paul Companies and Travelers Property Casualty Corp. did in 2004, accounting for the industry’s biggest merger in some time.

Jay Fishman, chairman and CEO of The St. Paul was pegged to serve as CEO of the combined company, while Travelers’ Chairman and CEO Robert Lipp was named as the new company’s executive chairman until Jan. 1, 2006. At that time, Fishman is likely to become chairman and CEO.

According to Lipp, “In other financial services industries there has clearly been a trend towards more consolidation. In the property/casualty business that trend has really not occurred to the same extent as it has in other industries. I think the ability to be on the front-end of that power curve and to be able to choose a partner that is culturally similar, rather than potentially having two companies come together scrambling to keep up with that curve, was highly desirable.”

As Fishman pointed out, “This combination of two industry leaders positions us to better fulfill our commitment to serve independent agents and brokers and our insured customers.”

At the time of the merger earlier this year, company officials expected to have total assets of $107 billion, shareholders’ equity of $20 billion, total capital of $26 billion and net written premiums of $20 billion. The company reported net income of $340 million for the third quarter 2004.

A.M. Best Co. reported that it “possesses significant market share, ranking second in the United States in commercial lines as well as in personal lines agency companies.” Best felt the combined companies would benefit from cross-selling opportunities through the ability to offer complementary products, suggesting Travelers would be particularly strong in general commercial lines and St. Paul in specialty commercial lines. According to Best, the merger also offers greater geographic spread and diversification of business, with Travelers’ presence being particularly strong in the Northeast and East Coast, and St. Paul in the Midwest and South.

Insurers, Banks Scoop Up Businesses
To say 2004 was a busy year for Brown & Brown Inc. would be an understatement.

The Florida-based company acquired Pashley Insurance Agency; Niagara Risk Management Associates; Niagara Benefits Group; Doyle Consulting Group; Doyle Consulting Group of New Jersey; Blumberg Associates; J. Gregory Brown & Co., Insurance and Financial Services; Manchester Insurance Agency; Waldor Agency; Statfeld Vantage Insurance; Barker, Heslip Bradshaw Agency; and Risk and Insurance Consulting Services; and that was just in the first three months of the year.

In announcing its first quarter results earlier this year, Jim Henderson, president and COO commented, “So far in 2004, we have completed 12 acquisitions, representing 16 entities with estimated annualized revenues of $52 million, which exceeds the amount of annualized revenues that we acquired in the full year of 2003. We are also pleased with the activity in the acquisition pipeline and the heightened level of interest, perhaps driven in part by market conditions. Additionally, consistent with prior years, purchasing agency assets with cash continues to be the most favorable financial approach for us, with agency pricing based on sustainable earnings.”

The purchasing binge was not just restricted to Brown & Brown.

As Insurance Journal reported in a November story, public brokers and banks were at the front of the parade of buyers. Hartford’s BMG and Pennsylvania’s WFG Capitol Advisors reported that public brokers have accounted for nearly 50 percent of all acquisitions to date in 2004. Joining Brown & Brown in the buying frenzy were Arthur J. Gallagher, Hilb Rogal and Hamilton, Hub International and USI among others.

Along with the public brokers, banks had an active 2004. BMG research reported that banks were buyers in some 15 percent of transactions, while WFG reported that number to be closer to 21 percent. An American Bankers Association (ABA) survey found that of 391 banks questioned, 49 reported snatching at least one insurance agency during the year.

According to BMG, among the most likely sellers are those agencies that have a principal owner in the 55 to 65-year-old range who lacks a perpetuation plan. Reportedly, the top producers and employees often depart if not offered an opportunity within a reasonable amount of time to share in a piece of the pie.

Tackling the Trial Lawyers
The ongoing wrangle over America’s unique tort system continued to make news in 2004, as in years past. Funding asbestos claims, controlling class actions, putting caps on medical malpractice awards for pain and suffering and generally reforming the system continue to be proposed, and continue to get nowhere.

According to the American Tort Reform Association (ATRA), the civil justice system imposes an annual “tort tax” estimated to cost consumers $233 billion in 2002, with each U.S. citizen paying $809 annually or $3,236 for a family of four.
While there were a number of proposals, and bills introduced, nothing significant happened at the national level. At the state level there was some progress. This is probably where such legislation belongs, as the state courts handle the bulk of personal injury litigation. A number of individual asbestos settlements were reached as well, but a national bill to establish a trust fund for the victims of asbestos related diseases seems as far away as ever. Reform prospects certainly aren’t being helped by the ongoing investigations into industry practices either.

The insurers are locked in Sisyphean struggle with the American Trial Lawyers Association (ATLA), whose pervasive presence opposes almost every effort to change the system. The trial bar exercises so much influence not only because it is both well organized and funded, but also because the majority of state and national legislators are fellow lawyers. While some reform may be possible, a fundamental change in the system is not, as neither the legislatures nor the courts can envision any other way of doing things, especially one that would eliminate the need for vast numbers of plaintiff and defense lawyers.

Progressive Takes a ‘Drive’
With more than 1,200 of Progressive’s largest independent agents and brokers in attendance in Las Vegas this fall, the Progressive group of insurance companies unveiled its new brand developed expressly for them: Drive Insurance from Progressive.

According to the company, “Drive will send a clear message to consumers: Independent agents and brokers offer expert advice and personal service, choice, low rates and superior claims service provided by Progressive.”

The Drive brand is intended to help agencies grow their business through: a distinctive new name combined with the existing Progressive name and logo; and a new marketing campaign highlighting the expert advice, choice and service agents deliver. The campaign includes national television and print advertising and a new consumer Web site devoted to the Drive brand, as well as opportunities for agents and brokers to participate on a local level in a way that complements their current marketing efforts. These opportunities would include consumer referrals and online “find an agent” listings on the Drive Web site.

According to Bob Williams, agency group president, “Since we began advertising in the early 90s, agents have told us they value our brand building activities, but they’ve wanted to participate more actively in them. Drive leverages Progressive’s brand equity while highlighting the value that independent agents and brokers provide.”

Matt Collister, a spokesperson for Progressive, told Insurance Journal that Driveinsurance.com went live on Dec. 11. The company also plans to have national television advertising for the new brand in January during the NFL playoffs.

“By and large, the feedback we’ve gotten from our agents has been positive about the program,” Collister said.

PCI Formed, Csiszar Joins as President
It wasn’t just major companies coming together in 2004 to grab some of the headlines.

Members of the Alliance of American Insurers (AAI) and the National Association of Independent Insurers (NAII) combined their trade groups earlier this year, forming the Property Casualty Insurers Association of America (PCI). Combined, the group represents more than 1,000 members nationwide, writing nearly 40 percent of the nation’s auto, homeowners, business and workers’ comp insurance.

Jack Ramirez, who served as the former president of NAII, indicated that “Times have changed and the need for two organizations has lessened.” Rodger Lawson, former president of the Alliance, added, “Consolidation in the industry has left everybody concerned about the importance of having a very strong voice.”

According to Lawson, the Alliance previously fielded a team of approximately 75 to 80 employees, but only about half of that would transition into the combined association. Under the merger, PCI would sport a team of some 140 employees.

As the year went along, PCI’s Board of Governors named former South Carolina Director of Insurance and president of the National Association of Insurance Commissioners (NAIC) Ernie Csiszar as its new president and CEO. Csiszar took on his new role in October.

Csiszar, who emigrated to the United States from Romania, was appointed director of South Carolina’s Department of Insurance in 1999 following a successful career in business and academia. He has noted in the past that the insurance industry has mischaracterized the debate regarding federal vs. state regulatory control.

In an address in November to the International Insurance Foundation (IIF), Csiszar indicated that the industry was in serious need of reforms in order to stay an effective risk-transfer mechanism for the nation’s economy. “The fragmentation of insurance markets is neither efficient nor effective,” Csiszar commented. “The fragmentation of our regulatory system is also extremely taxing on consumers and the economy.”

He warned that the recent industry investigation by New York Attorney General Eliot Spitzer should not sidetrack the industry push for regulatory modernization. “The specter of the allegations of illegal activities is not going away for some time,” Csiszar said. “We need to coalesce around this opportunity to push reforms in individual states and in Congress.”

WTC Dispute — Lose One, Win One
When Swiss Re, the lead insurer, filed an action for declaratory relief against Silverstein Properties, the master leaseholder, in October 2001, shortly after the destruction of the World Trade Center, it initiated an epic battle resulting in two, and possibly three, separate trials.

In the first trial, which ended last April, the jurors found that the attacks, although carried out by two hi-jacked airplanes, constituted a single “occurrence” within the meaning of a binding form prepared by Willis–the WilProp form. As a result Swiss Re, a number of Lloyd’s insurers, Chubb and several other companies were held responsible for one, rather than two, payments.

The second trial, which concluded Dec. 6, reached the opposite result, giving Silverstein the victory. The jury determined that those insurers who could not prove that they relied on the wording of the WilProp form, but on one prepared by Travelers, were liable for two recoveries. The eight companies involved, including Allianz, Travelers, Royal & SunAlliance and the Hartford could end up paying as much as $2.2 billion.

As in love and war, however, nothing is certain. Silverstein has appealed the first verdict, and Allianz has indicated it may well appeal the second (backed by France’s SCOR Group, who reinsured the coverage).

The actual amount of the loss also remains to be determined. It’s currently being examined by a specially appointed arbitration panel, but without Swiss Re’s participation. This could necessitate a third trial next year. Most of the parties have more or less indicated that they are willing to settle the matter. However, since they haven’t been able to settle much of anything since the case began, it seems somewhat unlikely that they can do so now.

Converium and the Rating Agencies
Swiss reinsurer Converium made news in 2004 by coming close to a meltdown. Until July, the company, formed in September 2001, when Zurich Financial Services spun off its reinsurance operations, had been a financially sound, “A+” rated, reinsurer. But then it announced that its second quarter results would fall short of expectations due to higher than predicted U.S. casualty losses, primarily related to the underwriting years 1997 to 2001. It cited problems in “umbrella, professional liability and excess and surplus lines casualty.”

The hole turned out to be chasm with approximately $400 million needed to fill it. Converium dutifully went to its shareholders and eventually raised the Swiss Franc equivalent of $420 million through a rights offering.

That’s not, however, the end of the story. The crisis precipitated a host of consequences, starting with rating agency downgrades. Best and S&P, who had previously rated the company in the “A” category, subsequently lowered the ratings to the high “B’s,” and its U.S. subsidiary Converium Reinsurance North America Inc. (CRNA) all the way to “B-.” The downgrades, coupled with the company’s restructuring plans, triggered a landslide of cancellations and non-renewals. Converium, which S&P had ranked as the world’s 9th largest reinsurer in 2003 with $3.827 billion in net premiums written, will be lucky to record half of that next year.

Are the rating agencies to blame? No, both Barry Hancock, Standard & Poor’s European regional practice leader, and Martin Kauer, until recently Converium’s CFO, addressed the subject at the European Insurance Summit in October. While they agreed that using ratings as a trigger to shift business is a regrettable side effect, they also endorsed the role of the rating agencies as providing a vital function. “Rating agencies are a reality, and we have to live with them,” Kauer said.