Standard & Poor’s Annual Insurance Conference
Despite recent adversity and scrutiny faced by the insurance industry, financial ratings for companies appear on the upswing.
“For the first time that I can remember we have a period where none of the sectors that we follow currently has a negative outlook,” said Steve Dreyer, Standard & Poor’s managing director and moderator of the S&P 2005 Annual Insurance Conference in New York.
“I think the industry and our customers are going to be better off unquestionably, to the extent that any illegal activity has been chilled by virtue of this kind of exploration,” Dennis Glass, president and chief executive officer of Jefferson-Pilot Corp.
Stephen Lilienthal, chairman and chief executive officer, CNA Financial Corp., and Brian O’Hara, chief executive officer, XL Capital Ltd., joined Glass on the panel and generally agreed the insurance business in North America will be stronger as a result of recent investigations of some practices, though it may take some time for the dust to settle.
Spitzer motivation
Responding to the hard-lined perspective that New York Attorney General Eliot Spitzer is out to bring down the insurance industry and is anti-business, O’Hara recalled Spitzer’s own defense: “I find the great majority of people in the insurance industry to be hardworking, upstanding professionals, pillars of their community. The insurance industry is an integral and valuable part of the overall economy which is what motivates me to make sure that the industry operates correctly and that there be a level playing.”
O’Hara hopes that can be the industry’s perspective as well. “This really was a small circle of people who were doing improper practices and by and large we have a valuable service that we provide. It’s now up to the industry to put its best foot forward.” He said the industry is capable of policing itself to ensure foul practices are not allowed to take root.
Reaffirming the industry’s strengths is a matter of instilling core values and ethics and facing up to the negative outlook in the press. The problem, according to O’Hara, is the industry has no voice. “It’s a one way street with the media and the regulators. So we just have to bide our time through the storm, see where the other shoe falls and let the dust settle,” O’Hara said, welcoming the transparency the scrutiny will bring to the industry.
Lilienthal agreed and felt this kind of “evaluation of regulation” was overdue. What’s making it difficult for companies to comply, according to Lilienthal, is the tardiness of this regulation. After an initial “catch-up” period, compliance should moderate.
“In the short term, I think you are going to get a very cumbersome and intensified process and analysis with a lot of internal focus. But we come out of it better and there will be greater clarity in the rules we are playing by.”
SOX modification
A survey by Christian and Timbers appearing in Business Week in May of this year cited 34 percent of corporate executives feel the Sarbanes Oxley bill should be repealed. KPMG released the results of a recent study, also appearing in Business Week, that indicated 72 percent of executives surveyed said the costs outweigh the benefits.
“I don’t understand why anyone would want to repeal it,” Glass said. “We’ve just gone through it and most of us have gone through it OK.” Adding, “Jefferson-Pilot came out of it more comfortable than when we went into it.”
However, as presently written, SOX poses a real challenge for many insurance companies.
CNA was still in the process of bringing things together from a systems and operational stand point this year and dealing with SOX in addition proved to be quite a chore.
O’Hara said, “I felt we were stampeded. … It was the first year of implementation and there was an atmosphere of-‘if you don’t get a sign off from your auditor, it’s a death sentence.'”
Companies spent significant time and energy managing the requisites of section 404 this year. “It seemed like the entire year was inward looking, hoping not to have this “death sentence” come down,” O’Hara said. “It has been quite an onerous year both monetarily and from an activity stand point. It was not productive and did nothing for our shareholders.”
The sense of urgency was intense this year but, in retrospect, perhaps some of the fears were unwarranted. O’Hara claimed to have seen a number of companies labeled “material deficient” and nothing happened to them.
“They were non-events because investors really care about the core business, earnings and future. Of course, if the material deficiencies were about rampant fraud, that would be different.
“It’s all about disclosure and the level of quality in your control,” said O’Hara, vowing next year his sense of urgency wouldn’t be as intense. “If we can satisfy ourselves and our auditing committee, I will sign off and let the chips fall.”
Ironically, a lot of recent discrepancies weren’t even going to be caught by section 404. “Fraud isn’t going to get caught by it,” said O’Hara.
When comparing costs and benefits, the great majority of CEOs seem to feel SOX goes too far. “The scope was ridiculous,” O’Hara said.
Lilienthal saw SOX as somewhat inevitable. “I think the Sarbanes Oxley bill was something we needed to go through,” although he admitted not enjoying either the process or the cost. He said smaller publicly traded companies could have choked on SOX.
With no possibility of repeal, pursuing modification seems to be a popular direction.
Risk management
911 and events like Enron and WorldCom brought about the need to look at a broader spectrum of manageable risk. The idea of enterprise risk management ascended.
“I came to find there isn’t anyone walking the face of the earth now that actually possesses the requisite breadth of skill, knowledge and experience to cover the gamut of risks that we run,” O’Hara said.
The relation of risk management to cycle management is key, according to O’Hara, particularly in property and casualty. “By really studying the movements in the market place in terms of rates, coverage and competition, one can keep a breadth of the changes and more readily make necessary adjustments.”
The idea of a centralized risk management, according to Glass, is “second in line to making it the responsibility of the business unit heads.”
Legislation
“It was nice to get the class action reform act passed last year,” O’Hara said. “It will be helpful, but the real issue is the impasse at the Senate on President Bush’s appeals court nominees.”
He said the biggest contributors to the Democratic senators are the plaintiff attorneys. “No question about it. They are the people providing the pressure on the Democratic senators to block the appellate judge appointments.”
Conservative judges tend to uphold appeals and liberal-leaning ones turn them down, according to O’Hara. He recalled the Reagan and first President Bush years. There was a declining casualty loss cost during that time due to the high number of conservative appellate judges. Then when Clinton was elected and then re-elected, the balanced tipped the other way. Behind a long pattern of liberal appellate judge appointments came a high number of large settlements.
TRIA
The Terrorism Risk Insurance Act, which has not yet been renewed by Congress, was also on the minds of the executives.
“TRIA is up in the air,” Lilienthal said. “I’ve given up political forecasting.”
Non-renewal of TRIA could mean significant problems for high value property and workers’ comp, according to the panelists.
O’Hara said the current administration doesn’t see “eye-to-eye” with the insurance industry regarding TRIA. “The Republicans are saying ‘find a free market solution to the terrorist problem.’ I think a lot of us would gladly do that if it were a free market with workers’ comp you cannot exclude terrorism-nothing can be excluded. In property, you can exclude terrorism but in a number of states, including New York, you cannot.”
The workers’ comp market is expected to react by discontinuing to take risks. The reaction from the high value property market will be either raised prices or withdrawal. A visible impact on the economy will be unveiled if TRIA is not passed and would prompt closer attention at the Senate, O’Hara said.
Future
The industry is undergoing a transformation, particularly with regard to transparency, the panel continued. “We see this as a great opportunity,” O’Hara said. “The fundamentals of the business overall are still sound. The biggest correlation to deterioration of underwriting practices is investment income … the greater the expectation of investment income, the weaker underwriting practices become. But with sub-4 percent, 10-year fixed income return, I don’t see any pressure from the investment side. The pressure is on underwriting performance, and I think that is a very healthy fundamental.”