Things that should keep you awake at night

June 19, 2006

The integration of the U.S. insurance market and global financial market will have a profound impact on business, according to Dave Zwiener, president and chief operating officer of Property and Casualty Operations for The Hartford. Evaluating the industry, Zwiener shared several insurance concerns that, to some extent, “keep him awake at night.”

There are issues affecting the market environment as well as the industry structure, he noted. Among the themes that emerged in his discussion with agents and brokers attending the Insurance Agents and Brokers of the West Blue Ribbon Conference were major disasters, ratings, technology, the industry’s ability to sell itself to the public, and the need for a federal regulator. Those topics also might be a few of the things that keep other insurance agents and brokers awake at night, too, Zwiener added.

Mega disasters

Just look at 2005 and anyone can see there’s been a pickup in natural and unnatural disasters, Zwiener said. “Cats have become bigger and more frequent. Eight of the 11 most expensive disasters in history affected the U.S. since 2001. The increase in frequency and severity is real, and starting with 9/11, was a wakeup call to companies like The Hartford and many others,” he said. “It exposed us to the correlation in risk.”

Prior to 9/11, Zwiener explained his company did not think of risks in life and property as correlated. However, major disasters like 9/11 taught The Hartford to examine aggregate exposure to a possible event and start thinking of risk very differently. For example, when allocating risk and capacity within a company, aggregating all types of risk in a specific location might lead the company not to write additional business at that location, whereas before, the risk would have been looked at independently and probably would have been accepted, he indicated.

Because companies now are aggregating risk across their entire portfolio, enterprise risk management (ERM) now has become a core competency at many insurance companies, Zwiener said. “ERM is front and center at our company.”

Catastrophic events have affected capital in addition to ERM, Zwiener added. Capital raising by the industry has accelerated, he said. Yet, “as events occur like Katrina and 9/11, where does capital go?” he asked. “Capital is not going to weaker players,” he said. “It goes to highly rated companies.”

Those who provide capital are not looking for 20-year returns, he added. “There’s a high pressure to perform at a high level … The bullet proof balance sheet is ever more essential in today’s world.” Consequently, rating agencies have gained a greater influence on the industry.

Raters as regulators

Since 2001, there have been no Standard & Poor’s rating upgrades and three downgrades in the personal lines industry, and then three upgrades and 10 downgrades in the commercial lines industry, according to Zwiener. The downgrades happened for a couple of reasons: First, downgrades occurred because of the Sarbanes-Oxley Act. Second, 9/11 created new systemic risk, forcing players to hold more capital, he said. According to Zwiener, companies were embarrassed by misdeeds, so that changed the rating agency’s bias, leading to more frequent downgrades. “Ratings are being held to a higher level. You can see a similar pattern in other industries,” he said.

Zwiener noted that rating agencies now are becoming de facto “industry regulators, who determine who gets capital, at what frequency, when and at what price. Rating agencies control the flow of capital based on how well companies manage risk. We need to pay attention to what the rating agencies are thinking.”

According to Zwiener, consumers currently do not give enough weight to company ratings when purchasing insurance, but he believes ratings are a value the industry could eventually sell. “With a weak rated and strong company, the policies look the same,” he said. “We’re still not there yet in the customer’s eyes.”

Tapping technology

What is important to customers is the ability to use technology, Zwiener said. “The reality is our customers are having very different experiences outside of the insurance industry, and they’ve come to expects 24-7 service, and self-service. They want to be able to edit and update data. These have become standard operating procedure in other industries.”

He questioned why the insurance industry could not be like Amazon or Bank of America in adapting technology. “How can we accelerate and meet expectations set by other industries?” he said. “The real science is learning how to take advantage of off-the-shelf technology — plug and play — and combine that with proprietary technology that you must own and protect.” The key, when faced with many choices, is to learn how to leverage the technology. Companies need to be able to extract value and data out of technology, Zwiener said.

Keep in mind that the shelf life of technology is much shorter than it used to be, he cautioned. “We’re not developing anything that lasts 30 years, so you must watch the cost/
benefit much more closely.”

Cost of doing business

One unavoidable expense — but with benefits — is the price of good employees, Zwiener said. “Our biggest exposure is people. It’s the most important thing you can have, and it’s not getting any cheaper,” he said. The challenge is finding good people and compensating them while trying to keep other costs down.

“How can we deal with insurance costs when faced with the reality that the cost of our own business must go down every year in every way?” he asked. “How do you contain compensation costs?”

Furthermore, Zwiener lamented the difficulty of attracting great talent to the industry. The Hartford has been forced to go outside the industry to train and hire new staff. “Eighty-four percent of the company came from outside the industry,” he said.

Once employees are hired, companies then must determine how they will be managed. “There is a wide disparity in how to manage a sales force,” he said. “Do you want to be hands off? How aggressive do you want to incorporate a sales culture?” Those are among the questions companies must ask today, Zwiener said.

Relationships with independent agents also must be carefully managed, he added. “Independent agents still make up the bulk of property-casualty market distribution, and their share of the market actually has grown,” he said. In 1999, independent agents controlled 53.6 percent of the distribution channel, and that number grew to 54.3 percent by 2004. Direct writers’ share grew from 6.9 percent in 1999 to 8.3 percent in 2004, “but none of us should go to sleep on direct,” Zwiener said. Instead, he advised agents to “keep an eye on direct writers,” noting that some are trying to create a choice model.

As the industry builds relationships with its staff and independent agents, it also needs to build relationships with the public, Zwiener indicated. “I’m always amazed at how poorly we’re viewed,” he said. “I view this as a noble industry. We do the right thing and work hard to put customer lives back after crisis. I believe others are holding the microphone for us.”

When the attorney general refers to insurance people as “Nazis,” Zwiener said he knows the industry hasn’t done a good job of communicating its good points. “We have a lot of work to do to get hold of the microphone,” he said.

The public relations battle will not get easier, especially with more major catastrophes, Zwiener noted. Currently, “quality capital is leaving Florida and low quality capital is entering,” he said. “There will be another event in Florida, and where is the weak capital going to be? The [news] headlines will be about insurance companies not paying claims.” He said when that happens and claims go unpaid in Florida, the industry will get a “black eye.”

Federal regulator’s role

What could help carry the industry’s voice is a federal regulator, Zwiener said. Without a federal regulator, the insurance industry has no one to be its champion in Washington. “As events happen, no one is there to speak for us,” he said. “The need for a strong federal regulator to level the playing field and to help us communicate in Washington is paramount.”

The lack of a federal regulator also hinders the industry’s ability to govern itself and maintain consistent operating procedures, Zwiener added. In looking at the disclosure issue, for example, there’s a “patchwork quilt” of different types of regulations that vary by state, he said. “Think of the administrative side of that,” he said noting companies have to develop different policies depending on the state and how specific disclosure must be.

Zwiener said the industry could have benefited from a federal regulator after 9/11. “Trying to get the first TRIA was a dog fight,” he said. “No one in Washington spoke insurance and wanted to speak on behalf of the industry. Washington [was] left unconvinced that there was a need for this. In the second go round, it was hoped that we’d be able to spend more time in Washington and [still the industry] made no progress. The lack of a federal regulator contributes to this,” he said.

“I characterize the regulatory framework of the property-casualty industry as weak at best to dysfunctional at worst,” he said. “At best, even at the state level, there’s a gap between companies and the state. There are a lot of issues that can’t be solved without a federal regulator.

“The lack of policy consistency exposes all of us,’ Zwiener added. “There are others who want to come in and say they will regulate us and structure regulation without any thought, [but using] political influence.”

Zwiener’s gave his presentation, “Things that Keep Me Awake Nights,” at the opening general session of the IBA West Blue Ribbon Conference in Hawaii.

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