Chris Don reports on the messages that emerged from day one of the European Insurance Forum 2003.

Delegates at the opening session of the European Insurance Forum in Dublin on 18 March sailed into a perfect storm as speakers charted a market in turmoil. Against a gloomy backdrop of plummeting investment income, a worsening ratings environment, far-reaching regulatory change, and long-term challenges over incurred but not reported (IBNR) losses, senior figures from the world of insurance and reinsurance conjured up a forbidding outlook. Ashen-faced delegates could have been forgiven for thinking there must be easier ways to make a living.

Cautious optimism was also expressed, however, that although the insurance sector had entered one of the most threatening phases in its long history, those with the flexibility to adapt to radical change would weather the storm.

Different cycle
Dennis Mahoney, the chairman and CEO of Aon UK, chaired the conference on day one and provided a frank and realistic appraisal of the challenges facing the industry.

"The cycle this time is different", he said. "Asset depletion - or some might call it asset meltdown - is a very serious problem, and there is a crisis on the asset side of the balance sheet."

Following a long period of capital surpluses, delegates heard, capital surplus in the insurance sector was now a thing of the past. Insurance entities would have to get used to less income, and "things will get worse as rates continue to go up."The statistics made sobering reading the morning after St Patrick's Day: $250bn has left the market and only $30bn has entered it. In other words, around a third of insurers' and reinsurers' capital had left the market.

Mr Mahoney continued: "Future prospects are worse. Earnings are about to be gobbled up by pension funds. And corporate bonds are on the slide."He cited the example of three leading Netherlands insurers which suffered significant losses from holdings of corporate bonds in a Dutch supermarket chain that went into major decline.

The implication was that uncertainty in the equities market had extended into other supposedly safer and more secure forms of financial investment. This posed serious consequences for insurers' investment portfolios. Meanwhile in a recent report, Berkshire Hathaway's investments and portfolio management guru Warren Buffet commented that derivatives were "weapons of mass destruction."

According to Mr Mahoney, it was also beginning to look as though insurers may have been writing mortgage impairment policies "by the back door."With reserves deficient by as much as £120bn ($189bn), reinsurance chief executives could be losing sleep over a host of looming issues; cigarette-related disease, electromagnetic fields, workplace stress, cyberexposure, IBNR, utmost good faith and carriers looking to make up losses in the reinsurance sector.

The retreat from risk was gathering pace. An explosive growth in the number of captives was one manifestation of this. Another was the case of Citigroup spinning off Travelers, with the giant US banking group simply unwilling to retain the risk volatility of owning an insurance company. Meanwhile, reinsurance titan Swiss Re had cut dividends for the first time since 1906. The insurance and reinsurance markets, Mahoney argued, had now entered "the perfect storm".

This was a grim enough assessment. And yet, in seeming to suggest that things had got as bad as they could possibly be, it could yet prove over optimistic. It was only half jokingly that Mr Mahoney concluded that in the current unpredictable environment it may not be too long before the industry recast the familiar acronym 'ROE' as 'Replacement of Executives'.

A painful inevitability
Gary Schmalzriedt, the president and CEO of ACE European Group, was equally realistic about the challenges and potential pitfalls confronting today's insurance and reinsurance entities. According to Mr Schmalzriedt, the events of September 11 had changed the world forever and made radical change for the sector a painful inevitability.

The Terrorism Risk Insurance Act of 2002 (TRIA), which provides up to $100bn of catastrophe coverage against terrorist attack on US soil, was another major challenge for insurers, Mr Schmalzriedt noted. The insurance markets were "in turmoil trying to work out how the Act will be implemented."The nightmare was how to approach TRIA; there was not enough income in the insurance markets to cover exposures. The other major issue was tort reform and the need to change attitudes regarding medmal in the US, with the first possible implication being a liability cap of $250,000 for "pain and suffering damages". There were also numerous corporate governance issues to be addressed in the US following the Enron scandal and an acute need for additional D&O covers.

Total asbestos payouts from the first wave of claims had so far amounted to around $50bn, and that could rise to $250bn. According to Mr Schmalzriedt, however, the second wave was made up of "bogus claims"generated by legal entities. He expressed the belief that the insurance industry would be "looking to the US government to help out."The insurance market also suffered in his view because - from 1996 to the early part of the new millennium - insurers had experienced five years of inadequate pricing.

The equity markets had collapsed, particularly in Europe where a higher proportion of companies' portfolios were skewed in favour of equities. The problem now was that investment income could no longer hide underwriting failures. Subsequently, the large majority of reinsurers had increased the reserves on their balance sheets to the combined tune of $7.6bn.

In a slightly more positive vein, Mr Schmalzriedt noted that Lloyd's had increased capacity by 18% and US business was still flowing into the 300-year-old institution, mostly in the form of reinsurance quota share arrangements. The Lloyd's chairman, Lord Levine, had highlighted the need for reform and the Chairman's Strategy Group was pursuing a modernising agenda. Blue Mountain promised a more efficient way of doing business; electronic claims files were being promoted as a means of creating major cost efficiencies; and LMP, which floundered somewhat after WTC, was still an ongoing project, with potentially positive implications for the way the market operated.

Referring specifically to Lloyd's, Mr Schmalzriedt said: "I hope they put some people out of business. The franchise board is overseeing reinsurance leverage, which has caused problems. It needs systemic change in ACE's opinion. Expect rate increases to continue, certainly for property business. There will be continued tightening of terms and conditions, which is important, as there will be more defaults."

The name of the game
The reinsurance point of view, expressed by Clem Booth, a member of the Board of Management at Munich Re, also focused on 'asset erosion' and 'capital market weakness.' Mr Booth reminded delegates that September 11 was followed within two weeks by the $2bn loss from the chemical factory disaster in Toulouse, which further contributed to an outflow of capital from the insurance market. He also raised the spectre of economic deflation. Such a prospect would have received odds of one in a hundred in the not too distant past, he said, but the economic probability had now increased. Mr Booth added: "There has been insufficient pricing in both hard and soft markets."Actuaries, like accountants, were now more cautious in their forecasts.

"Risk management is going to be the name of the game,"he commented. Risk management tools would be essential in "saving the industry", while brokers would be important providers of "quantitative and qualitative advice".

The future would not be "about selling, but about providing access to capital and securing it on a reasonably rated basis, which will be more challenging."He concluded that the winners in the reinsurance market would be those who identified where they wanted to play and who focused and prioritised, and that great businesses in future would be built "not by output, but by input and knowledge."

In an entertaining presentation, taking The Wizard of Oz as a metaphor, Schlumberger risk manager Chris Lajtha questioned the insurance industry's ability to deliver on its promises. After following the 'Yellow Brick Road' to the 'Emerald Insurance City', "Dorothy discovered it was built on dodgy foundations. She was concerned at her reception, not finding well-oiled corporate machines, but plenty of underwriter silos."

This state of affairs impeded the creation of "integrated liability insurance"packages. Following the period of spectacular losses for insurers from 1996 to 2000, Lajtha argued that companies "will be spending time distinguishing between legacy carriers and non-legacy carriers."He added that risk managers "will assign disproportionate importance to giving business to alpha carriers."From a risk manager's point of view, the number of significant carriers was "less than the fingers on both hands,"so risk management and risk retention would become increasingly critical. It would also be more important to communicate to shareholders that "self-volatility"was something to be prized and that resources would be allocated accordingly. "There is a major confidence crisis in the insurance business,"Mr Lajtha concluded.

Looking to the future, there was consensus that the market was experiencing a period of unprecedented change. In the short term, the markets had already discounted the effect of war in the Gulf. In the longer view, there would be more risk retention, more group captives and more industry-wide pools. It would become increasingly important to manage clients' expectations more effectively and the nature of intermediation may change. Insurance companies were, effectively, becoming brokers and tapping into capital markets that retained potentially trillions of dollars of capital. The insurance sector has experienced the full force of a perfect storm and although the ship's mast may have buckled, the voyage continues - for now.

By Chris Don
Chris Don is a director at insurance-specialist marketing company Signum Marketing Communications and a specialist writer on re/insurance issues.