The debate over climate change captured the world’s attention, including the insurance industry’s, in 2007, while major hurricanes spared the United States’ coastline. The soft market took hold of virtually all segments of the insurance market and even buyers in catastrophe-prone regions saw some rate relief. The sub-prime mortgage meltdown seems to have spared much of the industry but the directors and officers market is likely to feel the heat. The safety of products made in China and elsewhere was called into question and manufacturers and parents dealt with hundreds of product recalls. Agency compensation was again a topic of concern as a handful of carriers banned the use of contingent commissions at the beginning of 2007 while a few carriers introduced new supplemental incentive plans to reward profitable agents. One of the world’s largest insurance brokers made headlines for producing less than stellar results, while wildfires, floods and other natural disasters prompted several legislative initiatives in states and on Capitol Hill. And as of press time, renewal of the Terrorism Risk Insurance Act was still up in the air. The following are the top 10 news stories of the year, as selected by Insurance Journal‘s editors.
1. Climate Change
2007 marked a turning point on climate change. In February, the Intergovernmental Panel on Climate Change issued the first of three reports. It confirmed: 1) the temperature in the atmosphere and the oceans has grown warmer and can be expected to continue to do so. 2) The amount of greenhouse gasses, mainly CO2 and some methane, has increased markedly since 1750. 3) These gasses are the most significant cause for the temperature increase. 4) Human activity is primarily responsible for their production. Examinations of the likely impact and the remedial steps needed to slow or reverse it followed. Al Gore also played a major role in this debate, going from politician to Oscar winning filmmaker — for “An Inconvenient Truth” — to Nobel Peace Prize winner (shared with the IPCC). But his political stances have alienated a lot of people, particularly in the United States. The insurance industry, however, has taken a leading role in documenting climate change and in attempting to halt its advance. Munich Re and Swiss Re have entire departments dedicated to assessing the impacts. Lloyd’s 360 Project recently analyzed the phenomenon. Their actions are driven by the realization that unchecked global warming could eventually wipe out the industry. A report published this month by Risk Management Solutions, the United Kingdom’s Tyndall Center, the Organisation for Economic Co-operation and Development, and France’s CIRED, analyzed rising sea levels, coupled with extreme weather events. The conclusion: “Total property and infrastructure exposure is predicted to increase from $3 trillion today — 5 percent of current global GDP — to $35 trillion in the 2070s — 9 percent of the projected global GDP.” The United Nations Environment Program sponsored a conference in Bali earlier this month aimed at formulating the world’s response to the challenge it faces. At the top of the list are carbon emissions. Only time will tell if the measures the UN recommends are widely adopted, and whether they will be enough.
2. Hurricanes Hardly Happen
Despite some deadly storms — Dean in August, Felix in early September and Noel in October — no serious hurricane struck the United States in 2007. As a result, insurance company balance sheets are flush at year’s end, calls for premium reductions have increased and reinsurance treaty renewals will probably be at lower levels. Such short-term memory loss could be a mistake. Risk Management Solutions recently forecast: “The average risk of landfalling hurricanes in the Atlantic Basin for the next five years — known as ‘the medium-term view’ — remains at approximately the same level as has been predicted for the past two years, which is significantly above the risk averaged over the long term.”
3. Soft Market … Everywhere
The soft market catapulted into full swing in virtually all lines of insurance in 2007. Although the absolute level of rate decline varies substantially by line of business the rate of deterioration is accelerating, and appears to be spreading into coastal and catastrophe-prone areas of the country although insurers are still charging rates commensurate with the risks they assume. Commercial premium rates declined 11.8 percent on average for all sizes of accounts, while personal auto insurance increased just 0.4 percent during the first-half 2007 compared with its level a year earlier. Similarly, despite ongoing problems in some coastal property insurance markets exposed to hurricanes, the property insurance rose just 0.8 percent through June 2007. In the face of the soft market, insurers are still reporting strong underwriting results, in large part because no serious hurricane struck the United States in 2007.
4. Subprime Mortgage Credit Crunch
Over the last five years a combination of rising house prices and clever financial innovations, led mainly by investment banks and hedge funds, fundamentally altered the way home mortgages were structured. Home loans were “packaged” into investment vehicles — CDO’s (commercialized debt obligations), SIV’s (structured investment vehicles), etc., and sold on to investors. Despite the fact that no one really knew what had been “packaged,” the rating agencies considered them as low risk securities, often rating them triple “A.” When balloon payment provisions caused homebuyers to default, seriously depressing house prices, financial institutions began refusing to deal in them. Global credit markets began to dry up and central banks pumped billions into the currency markets in an effort to keep the vital system going, so far with limited success. Is the insurance industry affected? Ask Swiss Re, who wrote off close to $1 billion in a “mark-to-market loss,” arising from its exposure to two credit default swaps. In addition to direct loss exposures, the insurance industry depends on the credit markets for short-term cash needs. The crisis continues to make commercial paper harder to obtain and more expensive. The industry also faces potential directors and officers liability insurance claims from investors targeting the banks and other financial institutions that packaged and sold the original securities. Finally, some fear the crisis could precipitate a global economic recession.
5. Terrorism Coverage
Just two weeks before the end of the year, the fate of the federal terrorism insurance program was still unknown. The current Terrorism Risk Insurance Act will expire on Dec. 31, 2007, and as of press time Congress had yet to pass legislation extending the program. In mid-December the House of Representatives passed legislation extending TRIA that accepted most of the provisions of the Senate’s version. However, the House also added several provisions which may not please either the Senate or the White House. Despite the compromises agreed to by the House, its final House bill could still face a veto by President Bush. The White House said it would go along with the Senate bill but has insisted that there be no expansion of the program and that any extension require an increase in private insurance.
6. ‘Made in China’ Loses Its Luster
Quality control problems hit goods “Made in China” during 2007. Tainted toothpaste, lead paint on toys, poison dog food and similar product control lapses shook consumer confidence. The strict health and safety regulations in force in the United States and the European Union triggered a number of product recalls — around 20 in the United States in August alone. China’s manufacturers, however, and their subcontractors, are only nominally regulated. China’s drive to make money, coupled with rampant corruption and an inefficient and archaic legal system, appears to invite shoddy practices. As U.S. courts have no enforcement authority in China, the onus falls on importers and sellers to assure quality standards are met. Insurers become involved when product liability lawsuits are lodged against the companies that sold the goods. While the insurers will defend the lawsuits and pay the claims, they usually exclude product recall expenses from policies.
7. Agency Compensation
Compensation plan structures for independent agents took a turn in 2007 with a handful of major insurance carriers banning the use of contingent commissions at the beginning of the year. Insurers no longer able to compensate agencies through contingents sought out other ways to reward their profitable agencies. Travelers and Chubb were among the insurers that announced plans to replace contingent commissions with new supplemental compensations programs in 2007. The new compensation programs are even better for agents, some said, because they allow agents to know sooner what their year-end bonus might be. But at least one mega-broker, Willis Group Holdings, rejected the incentive arrangements because, it says, they fail to fix the conflicts associated with the contingent commissions they are meant to replace. While mega-brokers such as Willis, Marsh, Aon and Gallagher no longer accept contingent commissions, a number of mid-size brokers do. To level the playing field, Marsh & McLennan Cos. President and CEO Michael G. Cherkasky proposed a “2.5 percent enhanced commission,” structure mostly for small- and mid-size commercial accounts. The enhanced commission would be fixed, not based on contingent placement of business, and would be fully disclosed to clients. No word yet on whether Cherkasky’s proposal will be an accepted practice in broker compensation, but there’s interest.
8. Fires and Floods
As of the first week in December no Katrina, tsunami, earthquake or similar disaster has occurred. However, there were a number of “lesser” events. Fires in California destroyed more than 2,500 homes, severe storms and flooding struck Washington state in early December and hurricanes ravaged Haiti, Southern Mexico and Central America. The worst floods since 1947 hit the United Kingdom in June and July causing an estimated $4 billion in insured losses. Windstorm Kyrill roared through Holland, Germany, Denmark and on into Eastern Europe leaving around $4 billion in insured losses in its wake. In the United States a number of disaster-related legislative bills passed through Congress in 2007. From a national reinsurance catastrophe fund to revamping the National Flood Insurance Program, solutions to floods, fires, earthquakes and hurricanes met Capitol Hill with a vengeance — though without solutions. A number of states also saw disaster-related legislation introduced. The world is still a dangerous place.
9. Regulation Rumbles
Regulators like incremental changes rather than revolutions. Nonetheless two major upheavals are on the table. New York’s Insurance Superintendent Eric Dinallo has proposed doing away with the collateral trust fund requirements for reinsurers and replacing it with a system that treats the highest rated U.S. and non-U.S. reinsurance companies the same as New York reinsurance companies. The European Commission has set 2012 for final adoption of the long-delayed Solvency II insurance accounting rules. When the European Union members enact them, they will establish a new standard based on risk levels, rather than capitalization. How to reconcile Solvency II with the U.S. system remains to be worked out. The U.S. regulatory system was again a topic of discussion. Federal legislation that would establish national standards for state regulation of the surplus lines and reinsurance markets made its second appearance in Congress in 2007. Rep. Ginny Brown-Waite, R-Fla., and Rep. Dennis Moore, D-Kan., reintroduced the “Nonadmitted and Reinsurance Reform Act of 2007,” which aims to provide a uniform system of surplus lines premium taxation, elimination of duplicative compliance requirements for multi-state surplus lines transactions and direct access to the surplus lines market for large commercial insurance buyers. The bill would also allow ceding insurers and reinsurers to resolve disputes pursuant to contractual arbitration clauses. The legislation stalled after passing the U.S. House of Representatives in June. The industry again saw the introduction of legislation that would allow insurers to choose federal rather than state-based regulation under an optional federal charter system. Sens. John Sununu, R-N.H., and Tim Johnson, D-S.D., both members of the Senate Banking Committee, reintroduced “The National Insurance Act of 2007,” using the dual-charter system in the banking industry as a model. A House version was later reintroduced by U.S. Reps. Melissa Bean, D-Ill., and Ed Royce, R-Calif. Neither the House nor the enate version made it out of committee.
10. Marsh Meltdown Hits MMC
Marsh & McLennan (MMC) is still arguably the world’s largest insurance intermediary. But while its non-brokerage divisions, Mercer, Oliver Wyman and Kroll, are all doing relatively well, Marsh, the brokerage division, and MMC’s original business, has faired poorly. So poorly that MMC President and CEO Michael G. Cherkasky fired its CEO Brian Storms in September, and called Marsh’s third quarter earnings performance “unacceptable.” Changing conditions, the loss of contingent commissions following Eliot Spitzer’s investigations, an $800 million fine, more competition and its own internal restructuring have combined to seriously weaken Marsh. Cherkasky, whose own position isn’t all that secure, announced a number of initiatives aimed at correcting the situation, including a 2.5 percent commission “override” (see “Agency Compensation” above). He also pulled Daniel Glaser out of AIG to head Marsh. Stay tuned for further developments.