According to A.M. Best Co., the unprecedented events of Sept. 11 have forever changed the way the insurance industry defines risk as both property and liability lines have been exposed to catastrophic risks that cannot be priced using traditional actuarial methods. The affordability and availability of reinsurance have been severely impaired, and most reinsurers are unwilling to cover terrorism risks. Primary insurers are limited in their ability to change pricing and coverage terms and equity markets have become directly correlated with insurance losses.
Efforts to create an industry-wide solution to the new threat of terrorism foreshadow an acceleration of commercial lines deregulation, financial services convergence and the integration of insurance with capital markets. Against the backdrop of weak financial trends, this new risk environment has accelerated the hardening of the U.S. property/casualty market, according to A.M. Best Co. in its 2001 Review/Preview report on the property/casualty insurance industry.
According to the report, those that thrive in this new risk environment will possess unquestionable financial strength, having reestablished a strong commitment to conservative fundamental insurance practices or never having left them.
Sound operating fundamentals are enabling successful insurers to effectively manage the inevitable underwriting cycle. Ultimately, these front-runners are better positioned to capitalize on renewed flight-to-quality trends and benefit from the hardening market. Those with higher-quality books of business and stronger balance sheets will outperform the industry when the soft market returns.
The report also points out that numerous lines of business have become exposed to catastrophic risks once thought confined to natural occurrences. Underwriters must now think in terms of target potential and consider the huge clash potential, in addition to traditional loss exposures. An industry-wide solution is needed to stabilize the risks facing the industry.
It appears market hardening is accelerating as pricing for Jan. 1 reinsurance renewals could rise by as much as 100-200 percent. The effects of Sept. 11 will not be fully recognized until 2002, when premium growth is expected to reach 10 percent. A.M. Best expects higher insurance prices will continue through 2003. Thereafter, new capital threatens to derail the pricing train.
A.M. Best also figures to see a renewed flight to quality that will benefit financially strong insurers and reinsurers. A.M. Best expects this trend to be greatest in the reinsurance and large commercial markets.
Since Sept. 11, approximately $16 billion of new capital has entered the insurance market. While the entrance of new capital is a positive sign for the industry, it has important implications for the sustainability of the hard market.
The fourth quarter is likely to become a dumping ground as insurers write off the year and take the opportunity to clean up their balance sheets. Reported combined ratios are expected to bottom out in 2001, with personal and commercial lines projected at 112.5 and 118.0, respectively. On the other hand, results should improve as catastrophes return to historical levels, reserve additions moderate and price increases are more fully earned, albeit in a more modest recovery than typical of past hard markets.
To date, A.M. Best reports convergence of financial services with the property/casualty industry has been limited to distributors rather than underwriters. The changing risk environment has introduced even greater volatility that will keep the property/casualty and financial services industries from combining. A.M. Best expects selected “bolt-on” acquisitions by Bermuda-based and European insurers. Once the issue of coverage for terrorism risk is clarified, additional suitors will emerge. At the same time, consolidation within the domestic property/casualty industry will accelerate.
Finally, the Internet has become an important business-to-business tool, linking companies with both captive and independent agents.
As agents are better prepared, more efficient application submission and real-time quotes are two areas that continue to quickly evolve.
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