“Episode V-The Cycle Strikes Back”

When we last left our hero Luke Underwriter, he was riding high, having seemingly conquered the evil forces of the soft cycle that had not so long ago threatened to overwhelm the insurance galaxy, turning companies’ hard earned profits into dust and destroying their value with endless losses.

But Luke has come to realize that, although he may have won a battle, the war continues. The soft cycle it seems may have been only temporarily vanquished, and is once again on the rise, seeking to spread its debilitating lax standards across the insurance universe. Even as Luke’s mentors, the Knights of Fiscal Responsibility, led by Maurice “Yoda” Greenberg head of the powerful AIG Federation and Lord Obi Wan Levene of the Lloyd’s syndicates, celebrated their victory, dark clouds were reported—the devious lords of the Mar-Ket Share Empire are plotting their return.

At first Luke and his fellow warriors couldn’t believe the threat was real. After all, their companies, groups and syndicates had just recorded the stellar year of 2003 with record profits, stronger balance sheets and lower ratios. The grim year of 2001 and the great disaster with its huge losses finally seemed to be behind them. New capital had come into the market. Equity values were on the rise. Reserves had been strengthened, and all of the knights said they were firmly committed to underwriting discipline and maintaining profitability.

Surely the first three months of 2004 should have confirmed this. AIG reported a 35.9 percent increase in first quarter net earnings to $2.66 billion. But even as Yoda was releasing the figures, he accompanied them with a warning that “a number of insurance companies, however, appear to be pursuing strategies focused on market share growth and cash flow underwriting.” Coming from a leader as widely respected as Greenberg this worried the people on the street greatly.

The hallowed rater of industry fortunes (and misfortunes), A.M. Best, celebrated the 2003 vintage—net income over the prior year rose by 236.4 percent to $30.8 billion; total industry surplus rose by 22.2 percent, while the combined ratio fell to 100.1 percent. Best congratulated Luke and his colleagues on a job well done. “Driving the industry’s strong financial performance are significantly improved underwriting results,” it said, “as underwriting losses for the full year 2003 of approximately $4.8 billion represented a near 85 percent reduction from 2002.”

Yet Best also saw looming perils. It noted a deceleration in premium increases, and warned that several market segments were vulnerable. The study even made mention of the years 1997-2001 when the dark force of the Mar-Ket Share Empire held sway, before Luke and his colleagues returned to the light and reasserted the primacy of earning money on underwriting, rather than relying on investments to provide profits.

Some reports still remained optimistic. “We do not see a return to undisciplined behavior, however,” wrote Willis, the industry’s third largest broker, releasing its survey of premium rates. “Underwriters continue to be charged with producing a pure underwriting profit.”

But Aon, the second largest broker noted declines in commercial property rates—a drop of 10 percent on average. Aon’s report cautioned that, “While the insurance market has gone some way to repairing the battered balance sheets and under reserving of previous years, competition among insurers continues to grow as they fight it out for market share, which in turn has driven rates down further.”

In the same week the Council of Insurance Agents & Brokers reported that the commercial property and casualty market “continued to ease across most lines during the first quarter of 2004, with the average premium increases for all sizes of accounts returning to the levels they were at the end of 1999, when the last soft market cycle was coming to an end.”

The CIAB survey found large accounts had experienced the sharpest increases in premiums during the hard market conditions of the last two years, and they also experienced the greatest drop in premiums. The survey showed 45 percent of the large accounts holding steady or having premiums drop by 1 percent to 10 percent, while 12 percent dropped from 10 percent to 20 percent, and 4 percent dropped by 20 percent to 30 percent. On average, premiums for large accounts decreased by 3 percent.

In reaching a conclusion fraught with danger signals, the CIAB reported that, as has ever been the case, the hard/soft market cycle is still a fact of life for the industry. As rates soften in most lines, “brokers expressed concern that it is only a matter of time before insurers push aside the stricter underwriting standards of the last few years and start going after new business by premium-cutting. And if that happens, several said, the financial stability of carriers moves back to the top of a list of concerns.”

Right now Luke is shoring up his defenses in the hopes that there’s still time to control the evil cycle before it can once again threaten his world. Captain Nick Prettejohn of Lloyd’s has indicated on several occasions that the syndicates’ current level of capitalization should remain stable, rather than increase. He realizes that while more capital ensures more financial soundness, it also must be put to use.

Has the industry really “learned a lesson?” If so, it will be the first time, and would truly signal that the hard/soft cycle has finally been conquered. Or, will history repeat itself? Will Luke succumb to the Dark Side? Will Yoda and Obi Wan be left to fight on alone, as the deadly red ink rays of the Mar-Ket Share Empire assail their citadels? Can Luke prevail once again? The answer will have to wait for Episode VI, the next chapter, which has yet to be written. There are already two possible titles—”The Triumph of the Stable Market,” or “Premium Wars—the Not So Phantom Menace.”