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Critical Issue Report Giving away the store Listening to the siren call of investment income has harmed both the insurance industry and its customers By Phil Zinkewicz A man walks into a clothing store and says he wants to buy some white shirts with wing collars. The proprietor says they cost $13 each. The man is outraged. “Why, at the store down the street, they cost only $10 each,” he says. The proprietor answers: “Then buy them there.” Red faced, the man responds in frustration, “But they’re all out of them.” Says the proprietor: “Oh well, when I’m all out of them, I give them away.” The property and casualty insurance industry has been known to give its products away as well, but not because of a product’s unavailability. Rather, when a P-C insurer gives away its wares, it’s usually for very unwise competitive reasons. Two examples come to mind, which raise the question, “What is competition in the insurance business, anyway?” In the early 1980s, when interest rates were soaring to unprecedented heights, insurers’ greed (there’s no other word for it) caused them to completely ignore underwriting judgment. Underwriting results became less important, almost unimportant, when compared to investment returns. Insurers forgot three basic facts: (a) they were in the business of insurance, not investment speculation; (b) much of the business they were writing was long-tail, so there was no way to estimate actual losses that would appear a few years down the line; and (c) when it comes to bottom-line ink, black may be beautiful, but it can bleed red very quickly. By the end of that decade, that mode of “competition” had caused some insurers to fall by the wayside, while others lost their independence as they were, one by one, taken over by other entities. A second example of insurers’ strange competitive behavior can be seen in the handling—or mishandling—of the 1980 Las Vegas MGM Grand fire. The fire took the lives of 85 people and injured hundreds of others. The MGM Grand was insured for only about $30 million, and the expected lawsuits from the fire promised to significantly surpass that amount. The insurance industry—again, with interest rates soaring and beguiled by the lure of investment returns—came to the rescue. Much to the surprise of just about every observer of the situation, a group of insurers led by insurance brokerage Frank B. Hall wrote a “retroactive” insurance policy for the MGM Grand to the tune of about $170 million. True to the spirit of Las Vegas, the insurers were betting that litigation regarding the fire would drag on for years, allowing them to capitalize to a much greater extent on the investment earnings they would realize on the $40 million in premium paid. The insurers lost their bet. The MGM Grand, anxious to settle litigation as quickly as possible, took the retroactive policy to be a “blank check,” and claims were resolved at the high end of the spectrum much more rapidly than insurers had anticipated. The result: Insurers took a bath. In an effort to save face, insurers will argue that those two developments were the result of competitive forces. But all too often, the insurance industry creates its own competitive forces. For example, in the mid-1970s, having come off three years of a “soft” cycle with low rates and terms and conditions favorable to the buyer, insurers began to raise rates more than just considerably—“skyrocketing” was the term used then. Tiring of the roller coaster ride that typified the industry at that time, corporate insurance buyers decided to capitalize on a concept that had been little used before—the offshore Bermuda captive insurance company. Determined not to cave in to insurers’ demands for rate increases, corporate insurance buyers began to self-insure via these captives. Not long after that, those corporate buyers began to use their captives to write third-party business and thus became competitors of traditional insurers. An ensuing soft market stunted the growth of these captives for a time, but the hard market of 1984-85 gave impetus to the movement, and the captive industry became a permanent alternative to the traditional insurance industry. These were new competitors for the traditional insurance industry that had to be reckoned with. Today, the Bermuda insurance market has also become an arena for the influx of new capacity in the insurance marketplace, and again traditional insurers are facing new competition. This was seen clearly after September 11, 2001, when more than $20 billion was committed to the global insurance industry, primarily from Bermuda and capital markets. After Hurricane Katrina and its sibling hurricanes in 2005, 12 new reinsurers representing as much as $10 billion of combined capital were formed in Bermuda. Initially, these 12 carriers have been concentrating on reinsurance, although several have expressed an interest in eventually entering the excess insurance market. The result: more competition for the traditional insurance marketplace. At this year’s Standard & Poor’s annual meeting, during the CEO forum, one panel participant addressed the subject of new capital coming into the insurance business. “In 1992 and prior years,” he said, “when new capital came into the insurance business, it was usually intended to support the traditional insurance marketplace. Following 1992, the new capital that came into the business consisted of new players, with clean balance sheets as start-up operations.” In short, more new competition for the traditional insurance arena. What does all this mean to the property and casualty insurance industry? Well, for one thing, it means that often the insurance industry is its own worst enemy, and that it does not have a handle on what competition is, or how to deal with it. The Random House Webster’s dictionary defines “competition” as “the act of competing,” but that’s too simplistic for insurers. In the insurance industry, the word “competition” usually comes with modifiers such as “healthy” competition, “unfair” competition, “bottom-line” competition, “cutthroat” competition, and the list goes on, indicating that insurers may sing the praises of competition, but they fear it as well. At that same S&P CEO forum, another panelist alluded to current market conditions, where insurers have been able to hold the line on rates as well as terms and conditions, resulting in an underwriting profit for the industry in 2004, the first in 26 years, as well as an underwriting profit for 2005. But he cautioned: “If we have a moderate hurricane season, I’m afraid we’ll have a bloodbath later in the year,” meaning that competition would increase and drive rates down. One would have thought that an insurance executive would welcome a moderate hurricane season in light of the losses of 2005. But that word “competition” once again strikes fear in the hearts of insurance executives. However, if you take away all the adjectives, perhaps a substitute word for competition would be more appropriate. Instead of “competition,” perhaps we should think of it simply as “behavior.” There was a time, maybe 50 years ago, when insurance executives “behaved” as if they were in the insurance business—the business of risk. Today, they behave more as if they’re in the business of dodging the bullet. The hurricanes of recent years have demonstrated that the Southeast is volatile, so they decide to “compete” more in the heartland areas of the United States. But those areas are vulnerable to tornadoes and windstorms. If the Midwest becomes volatile this year, where will insurers move next? More important, where will the new “competition” take up the slack as insurers pull out? A hundred years ago, the San Francisco earthquake shook the insurance industry and produced losses never before known. But, in the aftermath, insurers didn’t desert San Francisco. In fact, insurers were responsible for rebuilding the city, making what it is today. Insurance executives then knew they were in the business of risk, not in the business of trying to capitalize on momentary opportunities such as high interest rates and stock market fluctuations. Giving the store away for temporary gains is detrimental not only to the store, but also to the people who patronize that store. If insurers are going to “compete,” they should compete on the basis of the products and services they offer and the business they know. In other words, they should re-learn how to behave. * The author |
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