S&P: Commercial Lines Outlook Still Negative

Two years into the hardest market in decades, the insurance business is still paying the price for the “irrational exuberance” of its recent years, in the words of Robert Partridge, a managing director at Standard & Poor’s.

Partridge told an opening morning session at S&P’s annual insurance seminar in New York that the industry’s longtime underpricing of its products, especially in what are now deeply troubled lines, like asbestos liability, is among the legacy issues that “now hold it back.”

Will the hard market last?
“Clearly,” said John Iten, an S&P director, “the market needs to stay hard for the next few years. It won’t get help from the investment side.”

Iten, a sector specialist in commercial lines for the rating organization, said that current levels of profitability do not measure up to standards for existing ratings.

Lower interest rates require underwriting profits, Iten noted, adding that pricing has already peaked in property lines, but ongoing price improvements are still needed in casualty lines.

He pointed to three lingering questions: Will price improvements outpace loss costs? (S&P ratings are predicated on 2004 price improvements of 5-10 percent.) Can the industry remain firm on prices and conditions? And what will newer competitors do?

The commercial lines insurance outlook remains negative, according to Standard & Poor’s, despite it’s earlier forecast that the overall picture would stabilize by midyear 2003. Accounting for the delay are such nagging problems as rate inadequacy, in workers’ comp, A&E, D&O and terrorism coverages; adverse reserving developments, especially for asbestos claims in the 1997-2000 period; the continued growth of alternative markets such as self-insurance and captive arrangements; a rise in reinsurance and loss costs; and lower investment income and depressed equity markets.

This, reported Iten, despite recent and expected improved terms and conditions, and substantial rate increases across the board (except in property). Rate hikes in 2003 are likely to reach 10-20 percent and in 2004 5-10 percent,
he said.

The S&P outlook for personal lines, on the other hand, is “stable”. Combined ratios for auto and homeowners should improve again in 2003 and auto pricing continues to outpace loss costs as it has since the third quarter of 2001. Then, too, the sector’s substantial erosion of capital should maintain pricing discipline, and changes in Texas policy forms should brighten the outlook as well.

Iten pointed out that 30 property/casualty groups have been downgraded between May 2002 and May 2003 by Standard & Poor’s, while none have been upgraded. The major changes were Allianz U.S. (A+ to A-), Chubb (AA+ to AA), Hartford (AA to AA-), Kemper (A to B-), Liberty Mutual (A+ to A), St. Paul (AA- to A+), State Farm (AAA to AA), and Zurich U.S. (AA- to A+).

S&P’s ratings outlook distribution for the one-year period ending May 2003, reflecting as it does improvement in the personal lines sector and deterioration in the commercial lines sector, demonstrates why it has been difficult for the industry to reach a stable level overall, Iten said.

Continued areas of concern in this regard, he added, are pricing trends, reserve deficiencies, asbestos exposure, reinsurance recoverables, workers’ compensation insurance, directors & officers coverage and the terrorism risk.

The roots of reserve inadequacy, according to S&P, boil down to one of two causes: a change in the environment affecting ongoing claims payments that could not have been anticipated, or ongoing under-pricing of prior policies and/or changes in terms and conditions that are finally being recognized through a reserving action.

Turning to the changing legal environment for asbestos liability, Iten said the issue has clearly been driving “a lot of rating changes in the past few years,” but overall “it’s a hard issue to get your arms around.”
• The S&P analysis on the asbestos front is this:
• The focus of plaintiff lawyers is expanding far beyond asbestos products manufacturers and installers to “premises and operations” defendants.
• There has been a huge increases in claims filed, driven by a rise in unimpaired claimants and the number of defendants
sued by each.
• The recent Fuller-Austin decision could accelerate the timing of insurer payments. The California Superior Court held that
insurers must immediately fund a bankruptcy trust being created for both current and future asbestos claims.

It’s a question whether salvation will come in the form of the measure recently introduced by Sen. Orrin Hatch, which proposes a $108 billion trust fund ($45 billion to be contributed by insurers and reinsurers) adminstered by a new U.S. court of asbestos claims.

In the current environment, reinsurance recoverables, which S&P dubs “an issue of willingness in addition to ability,” move to front row center. It’s an area, according to S&P, that should take into account the primary companies’ ceded IBNR reserves, that determines to what extent reinsurers have recognized these liabilities, that has primary insurers setting up accounts for uncollectible reinsurance, and that makes capital adjustments as deemed appropriate.

Workers’ compensation, remains “a market in turmoil.” Iten said the line still requires major rate increases, though troubled California’s overall combined has improved from 143 to 123 in the past year or so.

The industry, according to S&P, is still recovering from the “serious under-pricing” of workers’ compensation in the late 1990s. Meantime, medical cost inflation accelerated and rate reductions led to serious under-reserving, which led to the industry strengthening its reserves by $1.8 billion in 2002. There was also increased use of self-
insurance arrangements, which now account for 40 percent of all workers’ comp premiums and equivalents.

The D&O market has experienced an unexpected increase in severity and frequency of losses, accompanied by lower investment income. The market has been volatile, with failed IPO’s commonplace.

S&P reports a tremendous increase in class action lawsuits: 478 in 2001 versus 190 on average for each of the last 10 years. The previous peak of 236 was in 1998.

The D&O market has seen average increases of 50 percent and in some cases (high-tech and telecoms) of 100 percent. More stringent conditions are also commonplace, such as increases in retentions, the elimination of
multi-year policies and reductions in limits.

Partridge and Iten spoke during a panel session that also featured Arun Kumar, managing director, Morgan Securities, and Dominic Federico, president and CEO, ACE Limited.

Topics Trends USA Commercial Lines Workers' Compensation Business Insurance Reinsurance Directors Officers