Dr Alan Punter discusses market results and developments in 1999 and the pressures for change.

In the end, 1999 was not the apocalypse that some feared. There was no millennium melt down. The Y2K situation seems to have passed without incident - and was certainly not the major catastrophe that some predicted would irredeemably weaken the insurance industry.

On the natural catastrophe front, neither did 1999 present us with the “big one” - a California quake, Florida hurricane, Japanese windstorm or earthquake that would set new records for insured losses to outdistance those established by Northridge, Andrew, Mirielle and Kobe earlier in the decade.This absence of headline grabbing events in 1999 did not mean that all the news was good. There were some significant losses of both life and property, such as the crash of EgyptAir flight 990, earthquakes in Turkey and storms in France. Overall, 1999 was one of the worst years for losses in the aggregate - the “smaller” losses were more frequent and expensive.

Against this deteriorating loss experience, premium rates failed to harden, and, in fact, softened further in most classes over the year. Even the almost complete disappearance of the Australian retrocessional market meant that companies bought less lower level excess of loss protection and did not unduly restrict capacity or strengthen rates.

The results of many insurers and reinsurers reflected this combination of rising losses and falling rates, with companies reporting worsening combined ratios. As in 1998, the continued bull run on the world's stock exchanges bailed out many carriers.

Although the rise in share prices did wonders for carriers' investment portfolios, the insurance sector as a whole did not benefit from the general tide; many carriers ended the year with share prices well down on their historic highs. However, the slide in insurance company share prices halted in late 1999 when the Financial Services Modernisation Act was passed in the United States, allowing the combination of insurance and banking services - a move anticipated by the merger between Citibank and Travellers to form Citigroup in 1998.

The return on equity for the insurance industry is around 8% to 9%, which compares with 13% to 15% for Fortune 500 companies and the better performing banks.

To improve their ratings on the stock exchange, insurers and reinsurers will have to start producing higher and more stable returns on equity. They can only achieve this by better underwriting discipline, a reduction in overall loss ratios and better capital management, targeting an optimal balance by lowering permanent capital and increasing contingent capital (such as reinsurance or securitisation).

Consolidation within both the carrier community and broking operations continued in 1999, but without many of the mega mergers and acquisitions that we had become accustomed to in recent years.

One of the signs of hope for the future was the launch of a new UK insurance company, the Underwriter, and its early success in attracting premium income. Consolidation activity, however, must continue. The global pool of non-life premium is showing virtually no growth in real terms, yet shareholders of carriers and brokers expect to see continued growth in revenues.

Consolidation of both clients and carriers tends to have the effect of reducing the demand for risk transfer. Corporates with larger balance sheets buy less insurance by raising their deductible levels, increasing their use of captives or going direct to the reinsurance markets.

Similarly, merged insurance companies also increase their capacity and appetite for risk retention and lower their cession rates on a strategic basis - although there is still opportunistic buying down of retentions on a tactical basis in the current soft market conditions. As insurance companies become larger they will tend to reduce the amount of pro-rata protection in favour of a more excess-of-loss approach, which again reduces the total amount of reinsurance premiums transacted.

As well as this shift from proportional to non-proportional covers, there is also growth in the use of treaty rather than facultative protections. Another current trend is for insurance companies to centralise their reinsurance buying; some are using in-house captives with alternative risk transfer protections to smooth results. Additionally, the number of multi-year contracts is growing, probably another sign that the market will not soften but harden, over the next few years, as buyers try to lock in to current low pricing.

Against this background of change, London still differs from other insurance centres in that it is a true international market or crossroads for all types of (re)insurance, particularly marine and aviation and facultative and treaty reinsurance. It also still provides leadership and innovation in other specialist classes, such as professional indemnity, financial institutions and energy.

It is a mixed market, comprising not only Lloyd's but also the many London market companies (which actually write more business than Lloyd's) and marine P&I clubs. The stakeholdings taken in Lloyd's by Bermudian companies evidence and endorse London's role as a leading world market. Bermudian entities now have 12% of Lloyd's capacity through corporate member groups and control over 18% of capacity through managing agencies. Other carriers, such as Danish Re, have established new operations in Lloyd's; some London market companies have moved their underwriting desks into the upper galleries of the Lloyd's building.On the technology front, 1999 saw the final coming together of the various UK and European network initiatives. Thus RINET, LIMNET and WIN were combined to form WISe (Worldwide InSurance e-commerce). However, there is little concrete evidence in the London market of significant progress being made in e-commerce. One explanation is that, over the past year or two, participants have focused their IT budgets on preparing for the introduction of European monetary union and ensuring their existing systems were Y2K compliant.

The joint initiative between Lloyd's and the International Underwriting Association of London (IUA) to re-examine the ways in which business is conducted within the London market is to be applauded.

Discussions now also include the major brokers, but there are no tangible proposals yet on the table. Another major Lloyd's initiative, currently in the consultation stage, is developing broker relationships. Under these proposals, Lloyd's is contemplating widening its distribution network by increasing the number of brokers allowed to bring business to Lloyd's.

Continued softness of premium rates has inhibited any major growth in the securitisation of insurance risk. Fewer deals were completed in 1999 than 1998 - but innovation flourished with securitisation of new exposures, introduction of novel triggers and a placement of a greater variety of deal structures. However, realisation of the full potential for securitisation will only come when capacity reduces and/or prices harden in the conventional insurance market.

The value of insurance as a “product” and the quality of “service” delivered by the industry are both under increasing scrutiny by our clients. The results from the Quality Insurance Congress published at the last two conferences of the US Risk & Insurance Management Society (RIMS) have shown that risk managers have a uniformly poor opinion of the level of service they receive from all sectors of the industry.

Also under challenge, from within and without the industry, are the cost levels embedded in operating our current processes. Two separate reports into the operations of the London market by Booz.Allen and Coopers & Lybrand, both in 1995, gave cost estimates of around £1 billion per annum to operate the administration of the London market. These costs are borne by carriers, market associations and (the major share) by brokers. More recently, McKinsey quoted a figure of $140 billion as the total frictional costs of the world's insurance industry.

Whatever the true cost, it represents mostly non-value adding functions. Reducing it will require combined and concerted efforts by all players in the insurance industry to eliminate any and all duplicated or unnecessary functions in the life-process of a risk, from order to placement to claims payment.

We need to examine all the processes and flows of information or funds to see if they are necessary and whether they add value. We also need to decide who in the market is best positioned to perform each function efficiently and economically, be it broker, carrier or an outsourced body. In conjunction with process review of the London market, it is also necessary to adopt, implement and gain the maximum benefits from the appropriate use of computers and internet technology in supporting all aspects of the business flows.

Dr Alan Punter is an executive director of Aon Capital Markets.