Arthur J. Gallagher CEO: This Rate Environment Unusual but Better

September 12, 2012

Speaking at a recent conference, brokerage Arthur J. Gallagher’s CEO J. Patrick Gallagher described how different today’s commercial insurance rate environment feels, even to an industry veteran like himself. And he said this cycle is much better for insurance clients.

“This is my fourth cycle and it’s the first one that I’ve seen that is actually going the way this one is going,” Gallagher told the crowd at the Keefe Bruyette & Woods Insurance Conference, held in New York last Wednesday.

“We are seeing indications that the rates are continuing to firm,” he said. “Take a look at combined ratios and you see why that has to happen. This is not a balance-sheet-driven correction.”

Arthur J. Gallagher CEO J. Patrick Gallagher said the current commercial insurance rate environment is better for clients.

“Typically what you would get is a spiked recovery which is very traumatic to our clients. It’s not a good thing for clients at all,” he explained.

If one goes back in history, Gallagher said, “in 1979, if you had a 100 percent combined loss and expense ratio, you could still turn in 15-16 percent ROE. But Today, 100 percent doesn’t cut it. Underwriting companies absolutely know that they need to get some rate at this time and frankly they are getting it. So what we are seeing is a slight increase.”

“If you go all the way back to the fourth quarter 2003,” he said, “we’ve seen rate reductions sequentially every single quarter all the way until about four quarters ago.”

And over the last four quarters, he said, the industry has seen rates firm, stabilize, and then firm and now continuing to firm.

“Now, I am not saying we are going to have a classic hard market. As I said, a classic hard market is the spiked recovery. You can go back to 1975, it spiked. You can look at 1984-85, it spiked. In 2000-2001, it spiked. And when that happens, it disrupts clients considerably,” Gallagher said.

“What you have now is people recognizing their income statements need repair, not their balance sheet. So when you take a look at how this plays out — one versus the other — in a classic hard market, you get a short-lived radical price increases. Clients lose a lot of their coverage. They end up taking substantial deductables or not being able to buy the coverage they want,” he noted.

In a classic hard market, “a lot of business moves to the surplus-lines carriers and there’s an urgent need to grow profitability, meaning they are pushing clients out — they are not renewing them. There is a lack of capacity.”

But in today’s unusual rate environment, Gallagher said, “what we are seeing is market-driven increases that are being driven to make sure that loss costs are covered. There is not a dearth of coverage. We are not seeing a lot of clients being cancelled or pushed out. And carriers are understanding that they have to get back to profitability. There is in fact adequate capacity.”

‘The Current Environment Is an Unusual One for Me’

“So the current environment is an unusual one for me quite frankly,” Gallagher said at the conference.

“In my history, at a point in time like this in the market, if CEOs of insurance companies — and I won’t name names — told me that they were seeing firming and I went to a production meeting in one of my offices, my street producers would tell me, we are cutting rates left and right, forget what they are saying, no one is getting rate increases. And that would build over time and all of sudden it would slam-shut into one of those spiked recoveries, which essentially came when most carriers recognized their balance sheets needed a huge repair.”

The current environment is better for clients, Gallagher assessed. “If you think about the fact that we’ve cut rates since 2003, that’s eight, nine years of rate cuts. Rates are back essentially to where they were in 1999. This is a better environment for clients than to let the balance sheets get to the point where they need a spiked recovery.”

It’s also certainly better for the carriers, he said. “I think they know that. And it’s literally a great environment for brokers. I would much rather have this environment, although everyone says ‘Oh, the hard market is so great.’ The fact is it completely disrupts our clients. They last for 24-to-36 months max. And everybody at the end of a hard market is angry with their broker and their carriers.”

“So this is a better environment than what we’ve seen in a really, really long time.”

Gallagher also shared his thoughts on today’s economy. He said he is cautiously optimistic. “The job market has not been overly robust — we know that. And the business confidence is kind of in a neutral space,” he said.

“But we are seeing economic growth at the client level. Most of our clients took a real beating in 2008, 2009 and into 2010. And those I interact with every month are feeling better about their business eking out a little growth this year, and we are seeing that in the positive audits that the insurance companies are receiving.”

Berkley: Reserve Deficiencies Are ‘Right Around the Corner’

Also speaking at the Keefe Bruyette & Woods conference was William R. Berkley, chairman and CEO of W.R. Berkley Corp., who said the industry will see more significant price increases — sparked by reserve deficiencies that will soon become more apparent.

“We think prices are about to change. In fact they have changed. Prices have changed really beginning in 2011,” Berkley said.

“Rates change not because there is a shortage of capital. Rates change because in fact the redundant reserves that people could keep bringing in to subsidize their results are starting to diminish. Many companies, 13 I believe, had shortages in reserves in this prior quarter.”

“The fact is whether it’s 9, 13, or 17, doesn’t matter. Because as we saw with SeaBright — who had very modest reserve deficiencies — when it came to selling the company, it certainly looked like their modest reserve deficiencies that were shown were in fact substantially worse than they appeared. So we think the deficiencies are right around the corner, and deficiencies create fear.”

“Prices continue to rise,” Berkley said. “We expect they will continue to rise. I would expect you will see more significant price increases. So there will be price increases on top of measurable price increases. Thus you will start to see a building of more-than-adequate pricing.”

The key to making money, he advised, “is optimizing when you grow.”

“So you want to grow the most when the prices are going up. So you take in the most well-priced business you can. And you let the business go as prices start to decline. And as prices turn, you start to take in as much businesses as you can.”

This is a nitty-gritty business, Berkley told the conference attendees. “It is a business where you have to understand the characteristics of each and every line of business. So many people try to say, ‘This is different because of…’ But they have no idea what they are talking about. They don’t understand how the lines of business work.”

To be successful, one also has to understand that insurance is different in every locale, he advised. “And I don’t mean Indonesia and the United States, or Buenos Aires and New York City. I mean Des Moines, Iowa, and Lincoln, Nebraska. I mean Minneapolis, Minnesota, and Dallas, Texas. Knowing the locale is much a competitive advantage as it is knowing the specialty you operate in.”

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