With the market currently at its most competitive since 1989, what lies in store for commercial lines property/casualty insurers this year? Stanton F. Long offers his view.
The headline throughout the US insurance industry in 1997 was declining prices, and 1998 is already shaping up to be more of the same. There is speculation every year that this will be the year when insurance prices start to rise. Theoretically, it is possible that in 1998 carriers will suddenly begin charging more in premium than the present low levels. No one, however, has formulated a cogent explanation as to why such a sea change will occur.
In fact, the current forces and trends that define today's insurance marketplace began to appear before 1991 and have already set the major contours of insurance practice for 1998. Although insurance companies rely on their ability to predict the future, primarily through the study of prior years' losses, no amount of training or experience provides a basis to confidently predict the peaks and troughs of insurance pricing cycles. The best we can do is extrapolate from present trends - trends that point more toward increasing failures of weak, poorly managed property/casualty companies than they do toward higher prices.
Premium growth 1991 to 1996
During the period from 1991 to 1996, written premium in commercial lines for the entire US property/casualty industry grew on average only 2.3% per year. Adjusted for inflation, written premiums for the industry have actually declined 0.5% per year since 1991. The 1997 results, when finally tabulated, are likely to be about the same.
Thus, we have experienced a seven year trend of no premium growth. This is not to say that exposure to risk has also declined. Quite the contrary, exposure has grown while the amount of written premium has not, simply because prices have declined. Today, commercial lines property/casualty premiums and exposure are out of balance. Many companies can purchase insurance for less than the amounts historically spent on claims. When that happens, market pressure increases until some type of correction occurs. However, an examination of the principal reasons for the disequilibrium does not provide a basis to believe a major correction will occur in 1998.
Why prices have declined
The current commercial lines market is the most competitive it has been since 1989, according to a July 1997 insurance rate survey conducted by global investment banking and securities firm Goldman Sachs. This is not surprising when one considers that, by Insurance Information Institute reports, the premium-to-surplus ratio in 1996 reached its lowest level in 20 years: $1.00 of premium for every $1.05 of surplus.
Said another way, more capital is chasing fewer premium dollars. Barring a series of major catastrophes or a dramatic drop in the financial markets (on the order of 40% or more), there is nothing on the horizon that signals a change.
Perhaps what has not been fully appreciated is that claim costs are rising faster than inflation. Watson Wyatt Worldwide, the actuarial consulting firm, reports that claim costs have grown 4.1% per year from 1991 to 1996, outpacing inflation by 1.2 percentage points. Relying on reductions in loss frequency in 1998 to further reduce costs is not reasonable for most commercial accounts because of the cumulative loss-control improvements achieved in their results since 1991. With vague promises about further cost reductions continuing to characterize marketing activities, it appears that some underwriters are not aware of the bad claim news that may already be in the pipeline. In any event, a continuation of declining prices and consequently lower premium is the most reasonable assumption for 1998.
The ratchet effect on carriers of declining prices and rising costs was not the only insurance headline for 1997; the phenomenon spurred far-reaching US regulatory activity. As carriers become weakened, regulatory activity expands. Customers looking for a new carrier in 1998 have cause for concern.
In 1996, regulators took over eight insurance companies. Property/casualty companies accounted for 25% of these failures. In 1997, despite a surging US economy, there was a significant increase in failures as 23 companies were judged too weak to continue to manage themselves. Of the 23 state takeovers in 1997, 19 (more than 80%) were property/casualty companies. It was not just small or obscure companies that were dissolved. Golden Eagle Insurance Co of California reported $1.3 billion in assets at the time it failed, and Home Insurance Co of New Hampshire listed $3.4 billion.
In addition to formal failures, merger and acquisition (M&A) activity in the property/casualty industry remains high. Conning & Company, an asset management, private equity and research firm for the insurance industry, reports that 49 M&A deals were consummated through the first half of 1997, versus 44 in the comparable 1996 period. Such consolidations of the slow and weak by the nimble and strong are bound to occur until the entire industry is restructured and the premium-to-exposure ratio is in balance.
Furthermore, regulatory and political activity in the healthcare insurance industry affects, by extension, casualty insurance through medical coverages in workers' compensation, automobile and general liability policies. Mandated medical coverages are the hot issue. As the "baby boomer" generation takes charge of problem solving in healthcare, there is increasing consideration, by this entitlement-minded demographic contingent, of mandated medical coverages with little or no contemplation of costs or who should pay.
The result: Medical cost inflation is back. It is reasonable to assume that medical costs will rise 5% to 15% in 1998 unless new, sudden and unexpected discipline pops up simultaneously in Washington, DC, and the state capitals. Whichever insurance companies can best manage healthcare against the rising entitlement tide will be among the winners in 1998.
So who wants to be in this business under these conditions? I certainly do. One of my spheres of responsibility is executive management of a claim organization that each year handles more than one million notices of loss and pays in excess of $6 billion. Despite the surging economic tides across the property/casualty industry as a whole, there are exhilarating crosscurrents within the claims management discipline. Two of these are overall US jury attitudes and the benefits of new technology. Both are worth watching in 1998.
The disposition of a claim often depends more on what a jury (or other legal decision-maker) might do than on any other factor. Most plaintiffs today pursue the "sporting theory" of claims with an implicit question, "How much can I get?" rather than, "What is fair, just or reasonably owed to me?" Claims professionals, usually non-lawyers, are called upon to respond. Is it best to negotiate a settlement or to press forward with the concomitant risks and expenses of a formal defense?
According to recent jury verdict research, the median compensatory jury award for alleged personal injuries declined from $65,000 in 1990 to less than $56,000 in 1996. More important, the probability of a plaintiff obtaining a favorable verdict declined from 56% in 1990 to 48% in 1996. Careful disaggregation of the numbers shows that the decline occurred in soft and easy-to-exaggerate, subjective injury claims.
In fact, back strain was the most frequently cited injury in plaintiffs' verdicts from 1990 through 1996 and accounted for 17% of the total. During that period, the median compensatory jury award for alleged back strains declined from $13,508 to $10,000. This 26% improvement, even without adjusting for inflation, is significant. By comparison, death and serious, objective injury awards increased much faster than inflation over the same time span. Thus, skilled and insightful claims professionals have a clear opportunity to influence amounts paid by staying abreast of what is happening in the courts and adjusting their practices accordingly.
Claim performance measurements and expense control
Expense control is a constant concern for insurance executives, influencing every aspect of carrier operations. During this seventh year of price decline, we can expect to see an intensified search by carriers for new ways to lower costs in proportion to price declines. As a consequence, new ideas, strategies and approaches to claims management will emerge.
It is now a routine part of insurance evaluation for customers to stay updated on their carriers' staffing changes since these can influence customer service. More and more agents, brokers and their customers ask about cutbacks in adjuster skill training and new technology development. Moreover, buyers who do not ask about such issues as claims caseloads per adjuster are the exception today. Carriers, by turn, are keeping far closer tabs on their claim department's performance results. The trick is in knowing what to measure, and in measuring it accurately.
At bottom, an insurance program's structure and a host of performance measurements influence the program's effectiveness. But several of the traditional measurements used in the industry can be downright counterproductive from a customer perspective. One particularly insidious practice in some quarters is the measuring of claim expense on the basis of "paid-to-paid" ratios. My company, and presumably some others, have developed approaches that lead to better results for customers and the carrier. However, some change-resistant insurance professionals persist in using the paid-to-paid ratios in selecting a claim service provider.
In simple terms, the paid-to-paid ratio compares loss adjustment expense (or some portion thereof) to losses paid. When losses decline for any reason, including good claims management, executives come under fire because "the ratio" has deteriorated. To correct the "ratio," two alternatives are available to the claims executives. Reduce staff or other aspects of overhead until losses reappear, or de-emphasize settlement discipline by allowing settlements to become more expensive. For example, constraints on investigation expense raise the cost of settlements while improving "the ratio," as do curbs on legal analysis of possible defenses and all forms of trial expense. In short, paying more in losses makes the expense side look more reasonable and less subject to question.
In the final analysis, "the ratio" survives because of the inherent difficulty in measuring closed claims. No one knows what a claim "should" have cost but for adjuster and defense efforts. There are no reliable industry statistics on predictable outcomes. Indeed, when claim facts are presented under controlled circumstances to actuaries, underwriters, customers, agents, brokers and claims professionals, their assessment of "values" varies by several hundred percent. In a recent controlled test, evaluations on a case study claim ranged from $30,000 to $300,000, depending on individual opinions of "controlled" facts. (The case actually settled for $21,000 though participants were not aware of the actual outcome.)
In claim operations where paid-to-paid ratios are the primary measurement criterion, many experienced staff members learn better than to take the risk of a trial or incur expenses for defense efforts. They also know to pay out enough in settlements to keep the ratio in balance. Given what is happening in courts across the United States, a claim performance measurement that discourages adjusters from winning, paying nothing or lowering settlements is, in effect, anti-customer. It ultimately strips away the notion of fair claim payment and widens the disparity between premium and exposure.
Better performance measurements and more fact-based decisions are needed. I hope to see the day when concerns about runaway juries on the eve of trial are fully replaced by actions that deter the litigation industry from exaggerating claims. We might start with better, earlier investigations and more statistically based trial decisions, accompanied by a penchant for expense control. Being obsessed with both ought to be everyone's goal.
Because amounts paid in losses are typically 60% to 80% of the cost of insurance while expenses are approximately 7% to 20%, carriers can well afford to invest in ways of measuring claim performance that give weight to loss-cost payments. All in all, today it is possible to measure claim performance on a basis that encourages better ultimate results. If I were selecting a claim service provider for myself, internal performance measurements are the first thing I would assess, and in considerable detail.
After years of technology investment with disappointing returns, most businesses and industries are finally reporting a nexus between new systems technologies and increased profits.
For years, too many senior insurance executives viewed information technology primarily as a way to improve productivity and cut costs through more efficient, standardized information processing. The justification for investment in systems was the savings to be achieved through staff reduction. Despite heavy investment, overall staff reductions seldom materialized. In truth, development cost overruns were more common than budget reductions. Replacing staff with machines and software as a rationale for systems development proved to be illusory at best.
Carriers with success stories in systems development held as a goal the delivery of long-term benefits to customers (as well as to their own expense ratios). The winners quickly came to see systems more as an educational and management tool than as a record-keeping device. Those carriers still struggling to establish and maintain coherent processing and record-keeping systems have built a disadvantage for themselves in customer service.
The carriers to watch in 1998 are those that invested, years ago, in systems to support their professional staff. For example, carriers with systems that assist claims adjusters to establish and maintain up-to-date investigative, adjuster and medical use protocols have a competitive advantage. As a result of these wise investments, best practices can be employed faster and more frequently because adjusters are released from menial tasks and prompted by systems to spend more time on the art of claim resolution.
Advanced technologies in the modern adjuster workstation create the ability to provide more accurate and immediate claims management information to customers and underwriters, which they in turn use in better managing overall exposure to loss. The customer and carrier both win. Thus, systems development as an educational and management tool ultimately increases productivity and reduces unit costs without sacrificing service standards. Through application of greater technical skills and deeper knowledge of customers' businesses, claims management has become both more relevant and less costly.
All in all, 1998 looks promising for the low-cost, high-quality providers and their customers. Insurance companies of all sizes that have anticipated changing conditions and updated their operating procedures will outperform the pack. According to a recent Conning & Company report, some small, focused or niche marketers have already been able to achieve double-digit growth. These nimble competitors are succeeding at gaining local market share. On the national scene, the large consolidator with abundant low-cost capital and the ability to invest in effective technology will remain attractive to customers and reasonably profitable. In between lie change-resistant companies that face the high risk of falling behind in technology and workforce development, consequential financial deterioration and worse.
The purchaser of insurance, if inclined toward long-term relationships, ought to evaluate a carrier's adaptability, nimbleness and overall management capabilities - in essence, its competitiveness - along with the more traditional factors of product and service costs, financial strength ratings and marketing sizzle.
For my money, the quickest insight into all these factors is service capabilities. Excellent service presupposes that a company has the confidence and wherewithal to make sizable investments in professional skills and new technologies, even as prices continue to decline.
Stanton F. Long is vice chairman of Travelers Property Casualty.