The Demise of the Current Insurance Market

September 2008

Back in the late 1920s, Bessie Smith wrote and recorded a blues song, "Pick Pocket Blues," which in a real sense covers some of the malaise our industry and the transactional financial business is in.

by Peter M. Polstein

It goes like this:

My best man, my best friend, told me to stop peddlin' gin;

They even told me to keep my hands out of people's pocket where the money was in;

But I wouldn't listen or have any shame;

Long as some else was taken' the blame.

I left off in June lamenting the fact that the industry continued to underwrite as if the entire fraternity had been greased, with rates continuing to slide. The transactional financial industry was continuing to report more and more significant losses, and AIG had by then posted some $20 billion in losses. Here we are in the third quarter, with the industry continuing to slide on its downward spiral, with some insurers showing minor signs of attempting to stop the idiotic downward trend. The institutional side continues to report significant losses, and AIG has now lost a startling $26 billion in its last three quarters with the potential of more in the current quarter.

Regulator Concerns

There are some regulators and certain politicians questioning: How could this have occurred? It surely sounds like the usual rhetoric, after the horse left the barn. More ominously there are some in the House and Senate who appear to be ready to attempt to place the industry under the watchful eye of the government. These folks can hardly manage the government, much less an industry they really know nothing about.

But all of this foolishness may soon come to a screeching halt.

About a week ago, Standard & Poor's placed the entire property and casualty industry on negative watch and articulated its reasoning, which was legitimate. More recently, Fitch questioned a more ominous subject—the potential adequacy of loss reserves. I personally take some concern in its initial premise that loss reserves have benefited from the past hard market. What past hard market? The one that ended more than a decade ago? It is true, however, that a substantial amount of reserving in the 1990s developed very unfavorably for the insurers, despite September 11, 2001, where some analysts believe that a more conservative approach was instituted. It will be unlikely that this will come to fruition.

As the Market Turns

The overall question remains now, as it has in the past, as to the actuarial basis by which insurers hold reserves on their books. If reserves are set at 55 percent as "expected" in order to manage their profits and losses with subsequent changes, depending on development, then we can undoubtedly look forward to the deficiencies or more which Fitch articulates for the year ending 2007. As I have stated previously, with inflation costs continuing to climb, frictional costs continuing to climb, and premium growth continuing to slide with the not unexpected consequences, this market cannot continue on the current trend.

Add to this part of the equation the continued losses resulting from the transactional business conducted outside of the normal underwriting sphere—before any regulators begin to adjust their thinking as to how all of this has occurred. I believe this market will have a substantial change by either yearend, or shortly thereafter, without taking into consideration the potential for catastrophic loss during the third and fourth quarters.

Add to that the fact that for the December 31 and January 1 renewal period, reinsurance is seeing what was described to me as an unprecedented number of submissions from the so-called standard market at levels not seen in a decade, and you have the beginning of a potentially different marketplace. All of this precedes the apparent to-be-amended methodology of rating the industry on a risk-based-to-adequacy level, whose effect may or may not be profound on a wide variety of insurers.

In the end, the real question will be how brokers and agents handle their client base when the marketplace begins to turn. Will the turn be a whisper, or could it a dramatic differential which has occurred on at least three occasions during the past 50 years? Who remembers those days when the client base was nowhere near as sophisticated as it is today?

Hopefully, many professionals have already negotiated cover on long-term plans which will mollify in the short term what may be an ugly marketplace. Simply blaming the woes of the industry on a wide variety of financial transgressions isn't going to work. Having a professional explanation with a sound and reasonable plan which will retain the confidence of the client will.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author’s employer or IRMI. This article does not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.