Tillinghast Predicts Further Insurance Industry Consolidation in 2004

2004 Predictions: P/C Insurance Market May Be Softening, But Only Minimal Effect Next Year; Life Securitization Deals Break New Ground

New York, N.Y., December 9, 2003 — The insurance industry is at a critical juncture, with issues surrounding consolidation, pricing, legislative reforms and capital concerns shaping the market for 2004, according to year-end industry predictions from Tillinghast – Towers Perrin (Tillinghast).

“The poor economic environment, stock market volatility and credit losses of the past few years have taken their toll on the insurance industry, with some of the weaker players dropping out. Following a period of always being in reactive mode in an environment that no one expected, we may now be at a turning point where companies have learned how to better navigate in uncertain conditions,” says Patricia Guinn, Towers Perrin Executive Council member and Managing Director of Tillinghast and Reinsurance. “A tier of stronger players have emerged that are now ready to focus on growth strategies.”

Tillinghast foresees the following key issues for the insurance industry in 2004:

A Mature Market Brings Further Consolidation

Given operating and financial pressures, insurers are trying to do one or both of the following to improve their business: (1) gain market share through acquisition and/or expanded distribution and (2) raise capital or otherwise make more efficient use of capital to streamline their business to focus on core competencies. “On average, we expect to see one significant insurance transaction per month over the next 24 months. Future deals will be about scale, distribution and restructuring,” says John Nigh, M&A Practice Leader. “Sizable deals like St. Paul-Travelers and Manulife-Hancock are going to force consolidation among other players. Companies that previously considered themselves big will now be mid-sized.”

Steve Lowe, Global P/C Insurance Practice Leader, predicts that the U.S. commercial P/C market will soon be dominated by a handful of major players, complemented by specialist firms operating in market niches. He notes, “In both personal and commercial lines, a strong brand will become more critical to success. Greater scale will be required to support the distribution of mass-market products. Going forward, size will be defined by companies like AIG and the new St. Paul-Travelers combination.”

Property/Casualty Insurance Market Challenges:

  • No Relief in Sight for Tort Costs. According to a recent Tillinghast study of the U.S. tort system, tort costs jumped almost 13% between 2001 and 2002, and we will continue to see double-digit increases for some time to come. “Don’t expect a comprehensive federal solution while the pain is still localized,” says Mr. Lowe. “Tort relief will be piecemeal in 2004, focusing on key issues like class-action abuses and asbestos reform.”

  • Reserve “Surprises” Will Persist. Destabilization in claim costs, manifesting themselves as an abrupt uptick in claim indicators or unanticipated claims from newly emerging risks, often lead to reserve and pricing problems — and there appears to be no shortage of these. “We expect more companies to announce reserve adjustments in the coming year and there will be further withdrawals from certain areas — especially professional areas such as architecture, construction and engineering,” says Amy Bouska, North America P/C Insurance Practice Leader.

  • A Different Kind of Softening Market? Though many pundits are predicting a softening market, “don’t expect price cutting in 2004; there is just no appetite for it. Prices should begin to level out because they are perceived to be adequate, but they won’t fall because the mood of the underwriters hasn’t transitioned from fear to over-confidence,” says Mr. Lowe.

This softening insurance market may, however, prove to be different from its predecessors regarding the use of alternative financing. “While the pace of insureds forming self-insured programs including captives will likely slow in a softening market, the reduction in the number of insurers due to consolidation and insolvency will lead to the continued formation of captives and other self-insured arrangements,” says Jim Swanke, North America Risk Financing Practice Leader.

Captives will also play an increasing role as insureds deal with Sarbanes-Oxley’s imperatives to manage their total corporate risk profile. “The Act is forcing most companies to reevaluate enterprise risk management,” says Mr. Swanke. “We’ll see companies taking larger risk retentions across all lines in order to attract insurance industry participation for more catastrophic or difficult coverage lines.”

  • More Thoughtful Underwriting. As insurers gain more confidence and work to better align business with capital, Tillinghast experts expect to see a “new religion” around underwriting. “We’re looking for a meaningful integration of underwriting discipline with company goals in 2004,” says Ms. Bouska. “Enterprise risk management and aggregation risk management — even in the casualty lines — are clearly the new order.”

  • Rating Agencies: More “Interventionist.” After a year like 2003, rating agencies will look beyond traditional balance sheet issues toward a broader, business management focus, according to Ms. Bouska. “Rating agencies will become much more interventionist,” she says. “P/C insurers will need to be perceived as strong, and underwriters will be expected to have more ‘skin in the game.'”

  • Has the Terrorism Risk Insurance Act (TRIA) Brought Resolution to Terrorism Coverage? While the threat of terrorist acts remains real, coverage for terrorism insurance seems to be falling off the radar screen. “Right now, it’s probably among the top 10 issues on carriers’ minds,” says Mr. Lowe. “However, the issue should rapidly move up on the list to be front-and-center by the fourth quarter of 2004 when carriers begin to write contracts for January 1 renewals, which will include coverage beyond the life of TRIA.”

As for an extension of TRIA beyond 2005, Mr. Lowe predicts it won’t happen. In the meantime, the workers compensation market remains a major concern. “A terrorist event in an urban work center could cost $50 billion in workers comp costs in a city like Boston or Chicago where there are more generous benefits. That’s a figure a pooling arrangement cannot handle,” he says.

Life Insurance Market:

  • Securitization Taking Root in 2004. Life insurers will increasingly look to securitization to both improve their return on capital and look for permanent solutions to reinsurance capacity concerns. “There will be a flurry of deals in 2004,” says Jack Gibson, Tillinghast North America Life Insurance Practice Leader. “The size of these deals will range from $300 million to $3 billion. Securitizations will primarily be limited to larger companies and packaged deals, as transaction costs will be an impediment to smaller deals. Several of these deals will break new ground in terms of the products covered and the way the deals are structured, as companies look for new ways to improve capital efficiency using securitizations.”

  • Annuity Sales to Increase. Tillinghast experts expect to see roughly a 10% increase in annuity gross sales in 2004, reflecting favorable demographics for the product, an improving economy with a buoyant stock market, and the continuing appeal of attractive guarantees in the variable annuity market. “The impact of the 2003 tax reform legislation has been limited to date, although the success of President Bush’s savings account proposal could negatively impact sales in the second half of 2004,” says Eric Speer, Managing Principal for the Americas. “We also expect to see some shift in emphasis to payout annuities, sales of which have otherwise been slow to materialize.”

  • Life Sales Still Under Pressure. Under current conditions, the outlook for life insurance sales is not as positive, and sales in 2004 will be lucky to grow by a few points over 2003. “It is difficult to see how the life market can grow substantially without a rebound in variable life sales, which have been in a big slump. Also, ongoing challenges to life insurance product tax advantages are a concern,” says Mr. Speer.

  • Risk and Capital Management Becomes More Sophisticated. Tillinghast experts agree that there will be a marked increase in the importance and visibility of risk and capital management, requiring the use of more sophisticated financial modeling techniques. “More companies are developing innovative ways to use financial models for broader applications that can help senior management optimize strategic decisions related to risk and capital management,” says Mr. Gibson. “While there’s no ‘magic bullet’ for enterprise risk management, insurers need to use enhanced financial modeling techniques to analyze risks across the entire enterprise. The major challenge will be to communicate the results to management quickly and clearly so that findings can be readily interpreted and acted upon.”

“The whole insurance industry is ripe for realignment, and most companies won’t have the option of sitting on the sidelines,” says Ms. Guinn. “A few major players will aggressively build scale and invest in brand strength, while others will be placing more focused bets in segments where they can create competitive advantage.”

About Tillinghast – Towers Perrin

Tillinghast provides actuarial and management consulting to financial services companies and advises other organizations on their self-insurance programs. Tillinghast is a premier independent advisor to the insurance industry; its major clients include most of the world’s top insurance organizations. It operates as one global business, through a network of 42 offices in 20 countries. Tillinghast is a division of Towers Perrin, one of the world’s largest management and human resource consulting firms. The Towers Perrin family of businesses also includes Towers Perrin Reinsurance, a leading global reinsurance intermediary. Together, these businesses have over 9,000 employees in 24 countries. More information about Tillinghast is available at www.tillinghast.com