Now What! A Look Back at Lessons Learned from the 1990s

When we look back at the 90s in the property/casualty business, we see many events that should give us guidance in the years ahead. There are some very clear observations!
• Staying power is the key competitive advantage.
• Innovation is a close second.
• Trends towards consolidation will intensify, making “the relationship advantage” even more important.
• Expect the unexpected.

Staying power—key advantage
The property/casualty business is a very tough business. While every business has its challenges, the property/casualty business has some unique characteristics that make performance over time very difficult. These challenges are detailed in this article.

First among the challenges is a tort environment that makes the underwriting of casualty lines very unpredictable. While the current tort environment poses significant risk to the United States’ competitive position as well as to the property/casualty business, attempts to improve the system are either defeated or, at the very least, hard fought. Attempts at the federal and state levels to achieve reform as respects to asbestosis, medical malpractice and class action litigation are all met with stern resistance. Yet the current system is projected to cost the U.S. economy some 2.4 percent of GDP in 2005, whereas many of the leading United States’ trading partners operate in environments where these costs are less than half of 1 percent of their GDP.

Second, over the last decade, overall investment returns have been weak, single digits, and particularly so for a capital-intensive business competing on a global scope. Balance sheets became more threatened by the aforementioned twin killers: equities that corrected harshly from March/April 2000 to the first quarter of 2003 and liabilities that exploded because of an out-of-control tort system.

Third, and closely related, medical inflation, a major driver of loss costs jumped dramatically in the late 90s. Because medical inflation is a leading cause of claim severity in third party litigation involving bodily injury, growth in loss costs has exceeded 15 percent for the last three calendar years. And there is very little hope, near term, of bringing these costs under control. The following chart represents a tracking of medical premiums (a good surrogate for health care cost inflation), wages and overall inflation.

So how does an insurance company achieve a series of compelling, competitive advantages under these circumstances? No. 1, expense ratio has to be a key. If a company can see more business, from more sources than its competition, more efficiently, it will perform better than its peers who cannot. In addition, if that same company can service that business more efficiently than its peers, it will have a dual advantage, which over time will allow that company to build reserves for future liabilities and yet outperform its peers with a lower combined ratio. If that advantage is sustainable, the ability to grow reserves is compounded.

But it can’t stop there—this business is just too tough. A property/casualty company cannot stand on its own. While today’s financial service company cannot be everything to everyone, it must be great at what it does best, but most importantly, it must be great at a few key things that gives the “whole” sustainability through spread and diversity.

Diversity within the property/casualty sector is not enough. Each business is too closely correlated to produce sufficient balance and growth in earnings, without the interruption posed by downside risk. The property/casualty sector must be part of a financial service enterprise that understands each component, yet runs in a “counter-correlated” manner, achieving balance and earnings growth through sufficient diversification; however not so diverse as to limit potential synergies which are made possible through selected cross-marketing.

Staying power can only be achieved by having a number of compelling and sustainable competitive advantages coupled with the balance that a well-diversified, smart, integrated set of financial products can bring, along with the management to maximize their opportunity.

Commercial Lines: Changing of the Guard

Innovation is almost as important
Innovation does not happen by itself. It is the result of hard work. Clients change, and their needs change. Laws change giving rise to new or increasing exposures. Being the first in a market requires commitment on the part of the leadership and culture throughout the organization. Innovation does not stop at just the product level. New services, which help clients understand and mitigate new exposures, can be as relevant as the product itself. Innovation does not stop there either. We must think creatively about distribution, geographic presence and the training and development of staff. Frequently, doing it better means doing it differently, more creatively.

For example, just in the first quarter of 2004 alone, we have developed two new products. Safety Act Homeland Protection, tailored for manufacturers of products, is designed to prevent or mitigate damage to persons and property caused by terrorist activity. The other product is aimed at the catastrophic exposures presented by venues which house sizeable attendance. We are listening to clients, brokers, attorneys, trends analysts, any source that can give us insight in new ways to service clients.

Advantage of a continuous relationship
In a world that is constantly changing, dealing with a partner on a continuous basis is valuable. The extra value that comes from a continuous relationship is multifaceted. Communication is easier. Expectations are realistic. Knowing whom to call is a value that is hard to quantify but nevertheless increases during times of uncertainty and change.

The property/casualty business will continue to change. The worst element of that change is financial failures. As noted at the outset, this is a tough business. Failure is much easier than success. Look at the recent spate of failures: Reliance, PHICO, Legion, Kemper and others. Employees and clients are left short-handed in those situations. Add to that, consolidation among survivors and one senses the challenge. Travelers/St. Paul, two successful property/casualty carriers are joining forces to form a “new,” and bigger force. Even in this case, clients and employees (those who provide service and relationship management) will all undergo change.

The best trait to assure the capacity to have a long-term relationship is to be with an organization that has the balance sheet, business diversity, experience and energized management that deliver as one. Frequently, the capacity to endure a long-term relationship is limited to a very select group. But it is never more valuable than during times of uncertainty and change and should not be taken for granted.

The chart on the previous page speaks volumes about the strength and power of commitment, the value of staying power and the recognition that great companies only stay great by getting better and improving constantly. What will the next five to 10 years look like?

Expect the unexpected
Sept. 11, 2001 changed America. The range of expectation will never be the same. America and the world have seen and experienced so much since that date. The composition of risk has changed parameters. The definition of catastrophe has been redefined. While risk changes and evolves in our new world, the importance of financial security remains constant and paramount. Property underwriters whose principal catastrophe focus traditionally has been centered around wind events and earthquakes now must add “black-outs” as well as exposures arising from a host of potential terrorist activities. Margins, reserves and shareholder equity have never been more important to clients than in today’s very uncertain world.

So what do these lessons teach those whose professional career is in the program business?

The quality of your partners needs to be of the highest standard. Balance sheet strength, diverse earnings, history and experience in the business, management depth and commitment to the business demonstrated by a powerful track record, all are musts in today’s environment. The program business has many unique aspects that raise the hurdle for success. Expense ratios, underwriting depth, technology, reinsurance challenges are all issues most markets run from over time. Commitment can only be determined by a proven track record, not by any untested promises. Those program administrators (PAs) who have an interest in long-term growth and promise must pick partners, the most important choice, that have the “staying power” to allow PAs to meet those objectives.

Kevin H. Kelley, CPCU, is chairman and CEO of Lexington Insurance Co. He is also a senior VP at American International Group Inc.; director, president and chairman of Landmark Insurance Co.; a member of the board, Medical Excess LLC; chairman, Risk Specialists Cos. Inc.; and chairman of the board, Starr Excess Liability Insurance Co.