Grabbing the Headlines in 2002

Who made the most “news” as opposed to the most “noise” in 2002? There were lots of candidates, but the ones we’ve selected usually made news because they faced problems or took initiatives that weren’t unique to their own experience, but involved more general issues facing the industry as a whole.

2002 was a strange year. The hard market returned, sometimes with a vengeance. For the most part P/C insurers and reinsurers imposed stricter underwriting standards on new and renewal business in a real effort to reduce loss ratios. Other than floods and tornadoes, there weren’t too many costly disasters; however, long-tail liabilities continued to weigh on many companies.

Quite a few recorded decreases in earnings, and some reported huge quarterly losses. Most of the problems were caused by the need to increase reserves, and here the industry got caught in a double whammy. Firstly, investments were badly hurt by falls in global equity markets that significantly reduced their value. Then interest rates in the U.S. hit their lowest point since the 1960’s, which, although it made it less costly to borrow money, also meant lower returns on debt instruments.

Secondly, the seemingly endless progression of asbestos and environmental claims continued unabated, while “toxic mold” and rising D&O liabilities added more pressure. These all combined with the lingering affects of Sept. 11 to drain off needed capital. While many new ventures fared well, companies that faced increased reserve requirements found their ability to write new business and recoup past losses, reduced by the drain on their capital.

It’s really pretty meaningless to impose a descending order of importance, but generally how the nominees handled 2002 says a lot about them and about the industry. So, in no particular order, and, as someone has to go first, and someone has to be last, here they are along with the reasons we selected them and some rather arbitrary categories to help sort them out.

The ‘Usual Suspects’
American International Group would make the list based on its $175 billion plus capitalization alone, together with the fact that it’s the world’s largest business insurer, but the company deserves recognition on other fronts as well.

“Recovered” doesn’t do justice to what AIG earned in the third quarter—net profit of $1.84 billion, or 70 cents a share, compared with $326.8 million, or 12 cents a share in 2001; net P/C premiums up 42 percent to $7.0 billion; life insurance premiums and deposits up 16.5 percent to $11.9 billion. That’s like saying the U.S. “recovered” to win World War II. Plus it doesn’t look like a lucky quarter. CEO Maurice “Hank” Greenberg commented that, “There are no signs that the market will soften in the foreseeable future. If anything, rates in many classes of business will continue to rise for some time.”

Greenberg’s own future made news as well, as analysts, forecasters and commentators continued to speculate on who might eventually succeed the man who’s generally acknowledged as the most powerful insurance exec in the world. He also made news by overcoming his long time aversion to public appearances and used his position to stump for government terrorist insurance before Congress, and, in an effort to make AIG more transparent, he even began holding earnings conferences.

AIG also continued to address the terrorist threat. It’s beefed up its already impressive offerings on extortion, kidnap and ransom coverage with terrorist coverage, and most importantly continues to emphasize taking remedial measures to guard against losses from these threats before they occur, an approach that benefits everybody except the terrorists.

Swiss Re
It was a bittersweet year for the world’s second largest reinsurer. It certainly made more news in mass circulation dailies, television, radio and on the Internet in the last year than it probably made in the previous 100, thanks to its ongoing $7.2 billion poker game with Larry Silverstein over the extent of the WTC losses.

Its North American contingent, led by U.S. CEO Jacques Dubois and head lawyer Barry Ostrager, aggressively pressed their case against Silverstein both inside and outside of Judge John Martin’s Manhattan court room, eventually involving Willis in the dispute. It’s paid off so far for three of the 22 insurers who bound coverage on the WTC. They won a summary judgment that the attacks constituted one event, rather than two. More high drama can be expected in the New Year.

Swiss Re should also be recognized on other fronts. Even though it made news by losing its “AAA” rating from Standard & Poor’s, it’s still an undeniable industry leader, and the sponsor of the Sigma reports, some of the best analyses available on industry concerns.

LLOYD’S
No year would be complete without news from this venerable institution, and make news it did. Very few companies would jettison a 300-year-old system and replace it with a new, and as yet untested, approach, but then very few companies would need to. Lloyd’s hasn’t survived this long by staying the same, even though sometimes it looks that way.

In September its members approved a major restructuring which will scrap the three-year accounting system and abolish two regulatory boards, replacing them with a single Franchise Board. This latest development pretty much completes the top to bottom reordering of the London market that began with the admission of corporate capital to Lloyd’s syndicates in 1994.

The most widely reported consequence came in April when Lloyd’s issued pro forma results based on annual accounting. Unfortunately it had to pick 2001, which, as Lloyd’s CEO Nick Prettejohn observed, was “an exceptional year by any measure.” Lloyd’s WTC losses were nearing $3 billion, and it projected overall losses for the year at $4.5 billion, which would put it right up there in the next category.

Fortunately, Lloyd’s has attracted a record amount of capital to offset the losses. Its capacity for this year is over $17 billion, and some syndicates are getting investments from people like Warren Buffett’s Berkshire Hathaway, which isn’t known for backing losers.

The ‘Train Wrecks’ – reserving, restructuring and retrenching
There are a number of potential candidates in this category, as numerous insurance and reinsurance companies went off the cliff trying to handle the double whammy—increasing reserves as their capital investments decreased in value. The four “winners” were selected because their problems are emblematic of those the entire industry faces.

Zurich Financial Services (ZFS)
Any company that manages to lose $2 billion in six months should be on somebody’s list. True, Allianz lost $2.5 billion in one quarter, but “only” $933 million over the first nine months. ZFS on the other hand has been hit across the board. While its mid-year report showed gross premiums up 10 percent to $30.554 billion, its then announced that asset management fee income dropped 40 percent; net investment income, including capital gains and losses, dropped by $661 million—18 percent, and its combined ratio ballooned to 119.7 percent from 105.6 percent last year. It posted a first half 2002 operating loss of $1.828 billion, compared to a $1.338 billion profit in the 1st half of 2001.

ZFS’ new CEO James J. Schiro, an American and former head of PriceWaterhouseCoopers, has been handed the task of trying to get the company back on track. He replaced longtime chief Rolf Hüppi, who was forced out after nearly 40 years with the company, the last 11 as chairman and CEO, following a series of profit warnings last year that presaged this year’s disaster.

Schiro’s first task is to restore ZFS’ capital base. To do so he launched a rights issue aimed at raising $2 to $2.5 billion. He’s also selling off a number of assets, including $100 million worth of ZFS’ investment in Endurance Specialty. So far he’s winning praise from analysts for his efforts to rebuild investor and customer confidence in the company. The Wall Street Journal cited ZFS in a recent article as one of two European P/C insurance stocks that could be “poised for a rally.”

The St Paul
In addition to suffering earnings woes for the same reasons as ZFS, if less serious, the St. Paul got hit by another kind of double whammy. It settled asbestos cases related to Western MacArthur for $987 million, around $380 million after-tax, and accordingly posted a second-quarter net loss of $223 million, or $1.09 per diluted share. But that wasn’t the end of the litigation.

The ever-present legal fraternity turned around and filed several class action lawsuits against the company for making the settlement. The suits charged that the St. Paul’s officers and directors had issued false and misleading statements concerning its business and financial condition, because they failed to warn investors about the asbestos claims, which in turn caused the share price to drop. It’s unclear whether these were the same lawyers who filed the asbestos claims, but it’s certainly a possibility.

The St. Paul’s on again, off again launch of Platinum Underwriters Holdings IPO, spinning off its reinsurance business, finally happened. It succeeded in raising $675.9 million, a lot less than the $1.24 billion it had originally hoped. It did manage to sell an additional 3.96 million shares to RenaissanceRe, giving it a 9.9 percent interest with an option to acquire around another 5 percent. Given RenRe’s impressive earnings record that may have been the best move the St. Paul made this year.

Royal & SunAlliance
The sources of the U.K.-based insurer’s problems are complex. Two years ago CEO Bob Mendelsohn decided to concentrate on making R&SA a “global presence” in the P/C market led by its U.K. and U.S. divisions. It planned to gradually sell off its life operations and other non-core assets, but the world failed to cooperate.

Winter storms in the U.K. and Canada cost the company around $350 million that year. The decision also coincided with the end of the technology boom and the accelerating decline in investment values. Then it ran headlong into Sept. 11 and the growing asbestos and environmental loss estimates.

The disposal of assets became more of a necessity than a strategy, as the company scrambled to rebuild reserves. It concluded a 10 percent quota share treaty with Munich Re, which at least gave it some breathing room to write renewals, but any significant growth appeared unlikely. There’s speculation that the quota share could be raised to as high as 25 percent. The rating agencies downgraded its credit ratings—S&P’s in November of 2001 and again last August; A.M. Best in February and again in August.

Also that month the Financial Services Authority, the U.K.’s financial and insurance regulatory body, hit R&SA with a £1.35 million ($2.1 million) fine over misrepresentations in pension sales that it failed to address quickly enough. The company, to the extreme displeasure of its shareholders, slashed dividends by 50 percent, and the share price tumbled from just under 600 pence a share (around $9.35) in Jan. of 2001 to around 100 pence ($1.56) in Sept. 2002. Mendelsohn was forced out and Group COO Bob Gunn took over while the search for a permanent replacement continues.

Ironically, the company’s fortunes may have turned. It reported a $739 million nine-month operating profit, a 47 percent rise over the same period in 2001, which included Sept. 11. Perhaps more importantly, Gunn announced a major restructuring of the group’s operations, including splitting the U.S. divisions into a Business Insurance Division and a Personal Insurance Division, and selling off more “non-core” operations.

GE ERC
David Schiff, in a recent edition of his Observer, called it “The Insurance Company No One Wants,” and as usual, he seems to be right on target. General Electric, its parent company, obviously doesn’t want it, or it wouldn’t be trying to sell it. Warren Buffett was rumored to want it to go along with General Re to create the world’s biggest reinsurer, but those rumors seem to have been just that, unless GE cuts its $8 billion plus asking price.

The rating agencies on the contrary are happy to have it around so they can downgrade its ratings, mainly because they may no longer be “core holdings” of GE, but then they aren’t going to buy it either. The situation worsened as the year wore on. Even though ERC is the world’s fourth largest reinsurer with over $9 billion in gross revenues, it can’t seem to make money. According to S&P’s, which just downgraded ERC from “AA+” to “AA-” because of the deterioration in its operating performance, GE has had to strengthen its reserves by “more than $4.5 billion (excluding [yes, ‘excluding’] World Trade Center-related losses) for business written largely since 1996.” Even a company with a market cap of around $270 billion can’t keep writing blank checks.

GE’s new CEO, Jeffrey Immelt, who succeeded the legendary Jack Welch, has made no secret of the fact that he doesn’t like the reinsurance business, and doesn’t think ERC fits into GE’s business model. On Nov. 21 the company said it would put ERC’s life operations on the block at the same time that it announced that it’s reinsurance division would probably lose $1.9 billion this year.

The real problem remains the P/C units. So far, other than the Buffett rumor, there have been no indications that anyone is particularly interested in acquiring it.

Good news and bad news
Willis
The world’s third largest insurance broker has taken some bold steps over the last two years under its American CEO, Joe Plumeri. It launched a successful initial public offering last year, and has seen its shares rise in value from the $13.50 offering price to trade in the $28-$30 range. KKR and the six insurance companies that coordinated the 1998 management buyout have lessened their control over Willis, and Plumeri’s presence has boosted its fortunes, as it continues to expand.

That’s the good news. If there were a “Some days chickens, other days feathers” award (and maybe there should be) Willis would get it. It’s charged with answering the question: How can you be the lead broker on the WTC, and not know what form the coverage was bound on, especially when one of the forms in question is your own?

Willis is not a party to the ongoing dispute between Larry Silverstein and Swiss Re, et.al., and Silverstein has denied any intention to name them. Nevertheless the broker’s actions and reactions to the events of Sept. 11 have put it squarely in the middle of the case. Its own “WilProp” form refers to a “series of events” which the two suicide bombings plausibly were, while another form that it subsequently said was used, the Travelers form, has no such language.

Willis’ efforts to explain the situation haven’t been very enlightening, and for at least three companies Judge Martin found the WilProp form to be controlling, and granted them summary judgment. If that happens to the rest of the WTC insurers, or if they win a verdict in their favor, Silverstein might change his mind about suing Willis.

Farmers Insurance Group
News just in! The company will continue writing homeowners insurance in Texas, at least for its existing policyholders, retracting an earlier decision to withdraw from the state.

Farmers’ troubles started with the verdict in the Ballard case that awarded the plaintiffs $32 million, because the company wouldn’t pay a water damage claim involving toxic mold in their home in the aptly named town of Dripping Springs. That kind of money woke up every trial lawyer in the country.

It also initiated a convoluted cat fight between Farmers, the Texas Department of Insurance (TDI) Commissioner Jose Monte-mayor, the Attorney General and various consumer groups with Ms. Ballard in a leading role. The AG’s office began investigating Farmers in February, and filed a suit in August alleging that it had used “deceptive, misleading and discriminatory practices” in violation of Texas’ statutes.

Montemayor launched his own investigation in July after Farmers stopped writing new policies for houses with water damage claims in the last three years, and on any houses more than 30 years old that hadn’t had their plumbing renovated. His office issued a “cease and desist” order in August. Farmers retaliated by suing Montemayor, and, with the rancor escalating, announced in September that it would withdraw from the Texas homeowners market.

While the fight centered on events in the Lone Star State, the repercussions were felt around the country. Mold claims, which were virtually unheard of before the Ballard decision, cost insurers over $1 billion in 2001, as lawyers jumped on the bandwagon hailing mold as “the new asbestos.” Premiums started to rise, especially in Texas, where homeowners can expect to pay an additional average premium of $444 to cover mold claims. Farmers applied for a 6.9 percent increase in homeowners’ rates in California in January, and sought increases in other states as well.

The settlement brings the lawsuits to an end and keeps Farmers in Texas, at least for renewals. It was made on condition that the company admitted no wrongdoing, which angered consumer groups, even though policyholders will receive $100 million in compensation through a combination of rate decreases, refunds and restitution.

NAII
The National Association of Independent Insurers was in the forefront of the battle to get back-up terrorism insurance through a balky Congress. For that alone they deserve recognition. Other organizations, the IIABA, the NAMIC, the AIA and the RAA also deserve credit, but the NAII has been a consistent advocate for the industry on all fronts. In federal and state jurisdictions across the country it has taken positions and defended the industry on such thorny issues as credit scoring, toxic mold, auto replacement parts, privacy regulations under Gramm Leach Bliley, workers’ comp pricing and claims handling, medical malpractice, auto rates and a host of others.

It has taken the lead in defending state regulation of the insurance industry from threatened inroads by state courts, who grant nationwide class action status on what are essentially local lawsuits, and federal bank regulators, who claim that their statutes give them the authority to regulate the terms and conditions of insurance sold through banks (bancassurance).

The bad news? Well, the NAII was on the losing side of the recent dispute over insurance sales by banks in West Virginia, and its efforts don’t always succeed. But it may be the strongest voice the insurance industry has to counter the efforts of those who would make it a scapegoat for all the ills of society. The industry needs the NAII, and we salute them.

Some special category awards
Aviva: The “Silliest Name Change” Award for dropping CGNU in favor of something that sounds like a Latin American cheer.

Chubb Corp: The “Hypocritical Stance Award.” Although this one actually goes back to last December, it’s still relevant. How can you scream about the unfairness of allowing companies to shift operations or set up in Bermuda, and then contribute a couple of hundred million bucks to do the same thing?

State Farm: The “Egg on Your Face” Award for ever allowing the Campbell case to happen. Anybody reading the Appellate Court’s decision would gather enough eggs to make one huge omelet.

AFLAC: The “Corporate Symbol Award” for recognizing the amazing marketing power of ducks.

Gerling, Conseco and several others: The “Meltdown” Award. Our sympathies to the employees and shareholders of companies who were so badly hit by the double whammy that their continued existence has been put in doubt.

That’s all folks – Happy New Year.

Topics Lawsuits Carriers USA Texas Agencies Legislation Profit Loss Excess Surplus Reinsurance Homeowners Market Lloyd's Property Casualty AIG