Fitch Warns Insurers On Pricing Backlash

By Susanne Sclafane

NU Online News Service, Jan. 17, 3:53 p.m.EST?The managing director of Fitch Insurance Ratings inChicago warned property-casualty insurers today that the next softmarket will be tougher for the industry overall.

Keith Buckley, addressing a conference call audience, predicteda return to soft pricing beginning no earlier than late in2003.

"There could be a backlash against industry that makes next softmarket tougher than it otherwise would have been if it wasn't for[the] whipsaw [of] increased rates post 9/11," he toldlisteners.

While Mr. Buckley didn't predict exactly how this backlash wouldplay out long term, he did remind listeners about the "structuralchanges" that came out of the 1980's "whipsaw" in commercialinsurance rates--in the form of big movements to captives andself-insurance.

Recalling the "whipsaw" of property-catastrophe prices in theearly 1990s, he commented that while "CAT bonds haven't taken off,"their development as a result of reinsurance price hikes "made ittougher for reinsurers to continue charging the rates theywere?because of fear of losing out to the capital markets."

"When you get these whipsaws, policyholders don't like it andthey react to it?in ways that right now are tough toanticipate."

Fitch held the conference call to present key conclusions fromits just-released insurance industry outlook reports for the p-c,life and health sectors.

The p-c outlook, available on the rating agency's Web site(www.fitchratings.com), includes estimates of key financial resultsfor 2001 and 2002, with segment projections for the commercial,personal, and reinsurance segments.

Overall, Fitch is predicting 10 and 14 percent increases in netwritten premiums for 2001 and 2002, respectively, combined ratiosof 115.6 and 107.8, and a surplus drop to roughly $290 billion forboth years.

Noting some uncertainly about whether some of the losses from9/11 and some "kitchen-sink" charges for loss reserves and otherissues will be recognized in fourth-quarter 2001 or the first-halfof 2002, Mr. Buckley also gave the "run-rate" combined ratios forthe two years, excluding those factors. The "run-rate" combinedratio estimates are 108.0 and 105.2.

Mr. Buckley highlighted declining investment income as a "verysignificant" trend that he feels is being overlooked by manyindustry commentators.

Projecting investment income of just under $37 billion for 2001,he said the figure is roughly 10 percent below 2000. "That's due tovery low interest rates throughout the year, as well as very weakcash flow for the industry."

"Many are focusing on the hard market and the top line, but notas much on the effect that investment income will have on earnings.Our sense is that low interest rates will offset and mask some ofthe benefits of hard market [and] that earnings growth will notnearly parallel top-line growth."

Referring to the surplus decline, he noted that the $290 billionsurplus level implies a premium-to-surplus ratio of 1.2, comparedwith ratios below 1.0 in recent years. "That's still a very strongnumber, but if you start breaking it apart between the personal andcommercial lines sectors and pulling out large companies like StateFarm, Berkshire, it's safe to say we're no longer in an excesscapital position," he said.

Pulling together Fitch's underwriting and investment incomeprojections for 2002, he noted that they imply a return-on-surplus,excluding realized gains of about 2 percent. Even very favorableassumptions, likely removing "kitchen-sink" charges and assumingrobust instead of flat investment income growth, would only pushthat return up to 5 percent, he said.

Fitch is maintaining a negative outlook on the commercial andreinsurance sectors, while the rating agency has moved its outlookon personal lines to stable from negative.

From a ratings perspective, he said, that companies in thecommercial and reinsurance sectors that simply ride earnings cycleup over next year or two are not prone to ratings upgrades,explaining that normal cyclical fluctuations in earnings arealready factored into Fitch's ratings analyses.

To boost their ratings up, companies will need to do "somethingenduring"?indicating that they really have been able improve theirbusiness franchises in ways that will position them better for nexthard market, he said.

In personal lines, Mr. Buckley noted improvements in the autoline drove the outlook change, but said homeowners is still a"pretty lousy line from a profitability perspective."

"In many ways, it always has been," he said. "We're not sureit's any worse at this point than it has been?, but it's somethingwe're taking a look at," he added, noting that the question ofwhether homeowners has become chronically worse is one that hassparked some internal debate at Fitch.

Mr. Buckley also said that while [claims for] "toxic mold is awildcard" for the homeowners line, it was not enough to warrant anegative outlook for the personal lines sector.

In addition to reviewing the financial projections, Mr. Buckleymade the following "kitchen-sink" remarks about restructurings,financial services convergence, and financial black holes.

? Black Holes: "We're more and more thinking about some of thepools that are out there as the black holes of industry," he said,referring not just to the Unicover workers' comp pool demise in thelate 1990s, but to the recent blowup of Fortress Re, an aviationpool. "There's definitely a better need for tighter poolmanagement, possibly better regulatory oversight, and betterscrutiny by industry participants that get involved in thesepools," he said.

? Commercial Lines Restructurings: "We think a lot ofrestructuring will come for companies that experience a reinsurancesqueeze--where the impact [of] heightened reinsurance costs or lostcapacity will be more pronounced on their financials than thebenefits they get from a hard market. They may be forced to exit orcut back lines of business."

? Financial Services Convergence: Referring to Citigroup's moveto divest Travelers, he said, it is probably a good sign thatownership of p-c companies by banks is "a dead issue."

Mr. Buckley also predicted that a terrorism pool will not comeany time soon. He said that there is "no general sense of urgency"in Congress surrounding the issue of a lack of terrorism coverageand its impact on the economy.