2001: Terror, Mold and More. (Industry Strategies).

Last year will be remembered for the terrorist attacks that destroyed the World Trade Center in New York, downed four commercial planes, killed thousands and created the biggest losses in insurance history.

Almost everything that happened in the insurance industry in 2001 was cast or recast by the Sept. 11 terrorist attacks. Property/casualty insurance, life insurance, reinsurance, underwriting, claims handling--nearly every aspect of the industry was profoundly affected. Concerns and developments that seemed significant before the disaster faded into the background after the attacks.

If 2001 had been like any other year, the medical malpractice coverage dilemma in Pennsylvania and West Virginia, which caused rates to go up and major writer St. Paul Cos. to cut back its exposures, would be a top insurance news story. Plans by State Farm and American International Group to withdraw from New Jersey's private passenger auto market would make the list, too. It would be hard to ignore China's entry into the World Trade Organization or the industry's ongoing concerns about financial and medical privacy for policyholders, critical use of the Internet and health insurers' exodus from the Medicare+Choice program.

But a majority of last year's most compelling stories described the industry in the aftermath of the attacks. Only a few stories were not directly connected to the disaster, and two of those--initial public offerings and mergers and acquisitions--could not be told without considering the effects of the Sept. 11 events.

News of mounting losses by insurers was foremost for weeks after the disaster and will continue to make headlines in 2002. Questions of whether the destruction of the World Trade Center in New York was one insured loss or two and how the federal government will respond to insurers' plea for a national reinsurance pool in case of another terrorist attack were examined and re-examined. According to MIB Group Inc., the number of life insurance applications in October 2001 in the United States and Canada rose by 8.6% over those in October 2000 and by 26% over September 2001, and the hardening property/casualty market solidified almost overnight.

Insurance analysts and underwriters estimated workers' compensation losses from the catastrophe could range from $1 billion to $6 billion, making it one of the hardest-hit insurance lines and forcing underwriters from now on to consider the likelihood of job-related injuries and disabilities resulting from terrorism. The reinsurance industry was stunned by Sept. 11 losses on policies that included no additional premium to cover terrorist acts.

Escalating losses for mold damage claims, which caused State Farm, Allstate and Farmers to stop writing new business covering water-related damage in Texas, was one of the few top issues that appeared to stand totally apart from the terrorist attacks. It gained stature because of its spread across the nation and its bridging of personal and commercial lines.

RELATED ARTICLE: Top News Stories of 2001

The aftermath of the terrorist attacks:

* WTC Disaster: One Insured Event or Two?

* Terrorism Reinsurance Pool Sought

* P/C Hard Market Becomes Reality

* Reinsurance Markets Uncertain

* Terror Attack Losses Set Record

* Life Insurance Applications Increase

* Workers' Comp Underwriting Changes

Outside of the attacks:

* Expect More IPOs

* M&As Create New Competencies

* Mold Issue Is Growing

WTC Disaster: One Insured Event or Two?

The insurance world is watching to see how the courts answer the $3.5 billion question: Should the destruction of the World Trade Center be considered one insured event or two?

Swiss Re, which is responsible for 22% of the claims on the center, filed a lawsuit in U.S. Federal Court for the Southern District of New York in Manhattan to confirm that the collapse of the trade center should be considered one loss, which it said would limit liability to $3.55 billion. Larry A. Silverstein, who signed a 99-year-Lease on the World Trade Center in July, filed a counterclaim, saying the destruction counted as two events, which would raise the total liability to $7 billion.

The lawsuit "is extremely important in its own right, because $3.5 billion is at stake, and it is the first lawsuit to be filed," said Robert Hartwig, chief economist with the Insurance Information Institute. "However, insurers aren't waiting for the outcome of the lawsuit, Insurers are already sharpening the language in property policies all across the country to prevent this dispute from arising again."

The debate is deceptively simple. On one side, Swiss Re contends events of Sept. 11 should count as a single loss. On the other side, Silverstein said the complex was destroyed when two separate airplanes from two separate airports were hijacked and intentionally crashed into two separate buildings.

Complicating the case, both sides disagree on what contract paper binds them.

There wasn't a formal insurance policy in place at the time of the disaster. Swiss Re maintains that it agreed to bind itself on the basis of a policy form provided by Willis Inc., the broker that wrote the World Trade Center business. That form, WillProp 2000, provides that "occurrence shall mean all losses or damages that are attributable directly or indirectly to one cause or to one series of similar causes. All such losses will be added together, and the total amount of such losses will be treated as one occurrence irrespective of the period of time or area over which such losses occur."

Silverstein's law firm, Wachtell, Lipton, Rosen & Katz, said that when Swiss Re signed the binder on July 9, Swiss Re twice struck out proposed language and replaced it by hand with language saying the binder would be subject to wording agreeable to Swiss Re. These alterations were "material," the Wachtell firm argued, meaning the coverage wasn't pursuant to the WillProp 2000 form.

Silverstein maintains that the agreement is bound by a Travelers Insurance binder, which did not define occurrence.

Jacques Dubois, a member of Swiss Re's executive board and chief executive officer and president of Swiss Re America Holdings, denied that Swiss Re ever committed to the Travelers form. "We signed a binder that would use the Willis form," he said. "We did not reject the Willis form on July 9. It's wishful thinking on their part. You're bound by the form you sign. We signed according to the Willis prop form."

Dubois added that regardless of what form the binder is based upon, case law in New York would interpret the catastrophe as one insurable loss.

But Wachtell argued that the leading and controlling case in point is a 1959 decision by the New York Court of Appeals in Arthur A. Johnson Corp. vs. Indemnity Insurance Co. That case involved two adjacent buildings owned by a single property owner that were damaged when walls protecting the adjacent basements collapsed 50 minutes apart as a result of a single rainstorm that flooded a construction trench in front of the buildings. The court ruled there were two accidents and, hence, two policy limits.

Swiss Re also maintained in its complaint that the lessees had knowingly underinsured the World Trade Center property. According to the complaint, Willis had recommended at least $5.05 billion in coverage, but the lessees had originally chosen to insure for $2.32 billion before subsequently increasing coverage to $3.5 billion.

* Terrorism Reinsurance Pool Sought

Right from the start, the insurance industry said it could and would pay claims arising from the Sept. 11 terrorist attacks, but it needed the federal government's financial assistance if something like that were to happen again soon.

With insured loss estimates ranging from $40 billion to $100 billion in connection with the destruction that came from the Sept. 11 disaster, insurance representatives told the U.S. House Financial Services Committee at its Sept. 26 hearing that the industry could pay claims and intended to. But that's also when the committee heard insurers' call for the federal government to establish a reinsurance pool similar to Pool Reinsurance Co. Ltd., the U.K. reinsurance pool established in 1993 following losses from bombings in London by the Irish Republican Army.

A reinsurance pool to cover future terrorism losses became a necessity after Sept. 11, because reinsurers were no longer willing to cover terrorism, making that coverage unavailable for primary insurers.

While the insurance industry didn't get the pool it sought, the House of Representatives did approve a loan program requiring insurers to pay back any government money spent to cover future terrorism losses. The one-year program, under the direction of the Treasury secretary, could be extended as many as two additional years.

The House's Terrorism Risk Protection Act, H.R. 3210, requires all federal taxpayer costs/assistance to be paid back, with federal assistance kicking in when losses reach $100 million for small-commercial insurers and $1 billion as an industrywide aggregate. The federal government would pay 90%, with 10% coming from the individual company

The first $20 billion in losses would be assessed back to commercial insurers over time, and subsequent losses would be recouped through commercial policyholder surcharges. Under the House bill, the Treasury secretary has flexibility in determining assessments and surcharges based on economic conditions, depending on whether a market is urban, rural or small. The bill also calls for a study on lifting tax penalties for certain long-term capital reserves to cover terrorism losses.

Reinsurers are not normally in the market for federal reinsurance programs, but the Reinsurance Association of America actively supported efforts on Capitol Hill to provide a federal backstop against future terrorist attacks. That is, as long as it was temporary and didn't involve tax-deferred reserves and reinsurers could participate.

A federal backstop to take some of the uncertainty out of the insurance market and put some sort of cap on potential losses from acts of terrorism is needed, said Frank Nutter, president of the RAA, a nonprofit trade association of reinsurers and reinsurance brokers.

Because companies don't know how much they could lose, they're not inclined to write coverages. Programs that provide a cap provide certainty, he said. If a company won't write insurance up to the cap, reinsurers would have a market in the space between a company's "risk appetite" and the point when the federal government would step in, Nutter said.

The House bill's provision to allow insurers to set up tax-deferred reserves is intended to let insurance companies build up a fund, without tax penalty, to deal with future terrorism losses. But the RAA always has questioned the use of reserves for any type of catastrophe, Nutter said. For one, the fund is not going to accumulate enough to cover potential losses like those from Sept. 11, and accountants and tax people like the Internal Revenue Service are opposed to such reserves, because they can be manipulated in a financial statement. "It's a way to protect money from being taxed," he said.

Even with a federal backstop, reinsurance contracts are likely to become shorter and risk specific, rather than years in length covering a bundle of risks, said Christopher J. Swift, a partner with KPMG LLP and its national insurance industry director.

The House's bill included liability reforms that were a source of contention as the House debated the bill. The bill limits lawsuits to federal courts, limits punitive and economic damages awards, and caps attorneys' fees.

Those liability protections also were causing a split in the Senate, which is debating three bills in an effort to come up with one.

Dennis Kelly

* P/C Hard Market Becomes Reality

During the first half of 2001, the property/casualty industry's pricing cycle already was turning to a hard market, with rate increases going into double digits. But as the industry was experiencing sparks of a hardening market, the events of Sept. 11 were like pouring gasoline on a brush fire. "Now you have a full-blown forest fire, where we are seeing renewals coming in at 50% increases, even 100% or more for various commercial properties," said Robert Rusbuldt, chief executive officer of the Independent Insurance Agents of America.

Despite the hardening market, insurers still face nagging issues, such as rising jury awards, weakening economic development, reserve deficiencies and rising loss costs, said Michael L. Lewis, an equity analyst with UBS Warburg.

Because reinsurers were responsible for paying about 60% of the insured losses for the Sept. 11 terrorist attacks, reinsurance prices rose, while capacity dwindled, causing primary insurance rates to increase. "Basically, it's a conservative industry that's even more so now. [Reinsurers] are sitting on top of something everyone wants--which is capacity--and are evaluating how to protect themselves and still be a viable partner," said Norm Tardif, president of the management group NiiS/Apex Holding Group.

To assess the impact of the Sept. 11 attacks on Jan. 1 renewals and the future market, the Council of Insurance Agents and Brokers conducted a benchmarking survey of its members. According to survey results, 23% of respondents saw increases of 30% to 50% for medium-sized accounts, and 35% said large accounts rose 10% to 30% on average since last year. Survey respondents also reported that primary carriers had imposed more restrictions and higher deductibles as well as eliminated blanket limits for some lines. One broker disclosed that a customer who paid $45,000 for $5 million in trucking coverage last year is paying $157,000 at renewal.

Brown & Brown's vice president, Jim Henderson, said not only are prices going up, but insurers are withdrawing capacity on layers, making it necessary to sell numerous parts of big deals. For example, one public entity faced a renewal increase of 30%. On top of that, the $500 million insurance deal would typically be split among five players, each taking a $100 million slice. "Now it's taking eight companies to provide the cover in small amounts," Henderson said.

In its "Insurance Market Overview" for 2002 for the U.S. casualty market, Willis saw more headaches ahead for workers' compensation lines. "Workers' compensation, already under pressure clue to increasing claim severity and deteriorating underwriting results, may now face price increases, carrier demand for higher deductibles and a change in underwriting strategy," according to the report. "Some insureds renewing workers' compensation catastrophic treaty coverage are being required to detail all locations with head counts of over 100."

Industry leaders see business continuing to harden for the next few years. UBS Warburg's Lewis said the current market environment may be the hardest in memory. Brian Duperreault, chairman and chief executive officer of Ace Ltd., said this hard market encompasses the entire property and casualty market and is global in scope. Chubb's Chairman and CEO Dean O'Hare said 2002 will be a transition year for his company, and the full impact of the current hard market won't be realized before 2003.

Lynna Goch

* Reinsurance Markets Uncertain

Global reinsurance markets were in turmoil at the end of 2001. Already reeling from two years of soft markets and weak pricing, many reinsurers were staggered by the blow delivered Sept. 11, when terrorists hijacked four airliners, crashing two into the World Trade Center and one into the Pentagon.

Alice Schroeder, an equity analyst with Morgan Stanley, said reinsurers are facing a "Salomon Brothers moment"--a time of reckoning for past lapses, when "these companies must deal with the consequences of their irresponsible underwriting during the past several years of a soft market, which is forcing them to pose significant, yet necessary, price increases and changes in terms and conditions on their customers during a recession."

Warren Buffett, chairman and chief executive officer of Berkshire Hathaway, told shareholders in a letter that Berkshire's insurance and reinsurance subsidiaries were "foolish" for not pricing for "man-made mega-cats" before Sept. 11. "In effect, we and the rest of the industry included coverage for terrorist acts in policies covering other risks--and received no additional premium for doing so," he said. "That was a huge mistake, and one that I, myself, allowed."

Berkshire estimates its losses related to Sept. 11 at $2.28 billion, a number that is still a guess, said Buffett. "Important questions of liability will likely remain unresolved for years," he said. "Consequently, neither we nor other industry participants can be reasonably precise now as to final losses."

About $1.7 billion of the company s loss is attributed to its General Re-subsidiary, and another $575 million to Berkshire's reinsurance group, Buffett said.

As Jan. 1 reinsurance renewals began to roll around, industry observers said that it may be some time before the market situation is clear. Answers are needed for several important questions:

* What will the federal government offer in terms of a reinsurance backup for the industry in the event of another terrorist attack?

* How far will reinsurers go to exclude terrorist-related events from coverages?

* What limits will liability coverages see, and will reinsurers withdraw from such coverages to the extent that certain liability coverages will no longer exist?

* Will the estimated $10 billion or more in fresh capital, funding new ventures and bolstering existing reinsurers, ease the capacity crunch, or will it dilute the earning power of established reinsurers?

On that last point, equity analyst Vincent J. Dowling of Dowling & Partners conjured up the "prisoner's dilemma" scenario: "What is good for each start-up is bad for the group/industry. While each spreadsheet (with projections of premiums written and loss ratio as the key variables) looks rational on its own merits, the sum of all the planned spreadsheets may not be so rational."

As to the government's role, Buffett sounded an ominous warning for the industry with regard to terrorism: "Had the attack in New York been nuclear, it is likely that most of the U.S. insurance industry, as well as reinsurers worldwide, would have been destroyed," he said. "The only viable reinsurer for truly large-scale terrorism is the U.S. government."

David Mair, risk manager for the U.S. Olympic Committee, said the current reinsurance market is somewhat like the capacity crunch in the 1980s, but terrorism has added a big twist. "You've got a finite resource in insurance company capacity or surplus, facing an infinite potential for loss, and worse than that, an infinite uncertainty of the potential for loss," he said.

"Everyone is waiting to see what the federal government is going to do, and that will help the market shake itself out a little bit," Mair said. "The events of Sept. 11 have caused what was an already-firming market to go through some more significant underwriting and price increases."

David Pilla

Terror Attack Losses Set Record

The Sept. 11 terrorist attacks qualify as the largest catastrophe to hit
the insurance industry. Estimates of total insured losses range from $30
billion to $70 billion. The following are among the insurers that have
reported estimated attack-related losses of at least $1 million:

                                       Estimated
                                            Loss
Company                             ($ Millions)

Lloyd's                                 $2,800.0
Munich Reinsurance Co.                   2,368.0
Berkshire Hathaway Inc.                  2,280.0
Ace Ltd.                                 1,740.0
Swiss Reinsurance Co.                    1,300.0
Allianz AG Holding                       1,070.0
American International Group               820.0
Zurich Financial Services         700.0 to 900.0
XL Capital Ltd.                            700.0
St. Paul Cos.                              606.0
Axa                                        550.0
Hartford Financial Services                450.0
Group
Chubb Group of Insurance Cos.              420.0
Hannover Re                                400.0
Employers Reinsurance                      400.0
PartnerRe Ltd.                             382.0
CNA                                        304.0
Royal & Sun Alliance                       217.0
MetLife                                    208.0
Marsh & McLennan Cos.                      173.0
FM Global                                  165.0
Manulife Financial                         150.0
Transatlantic Holdings                     130.0
Prudential                         75.0 to 125.0
Alleghany Corp.                            112.0
ING Group                                  107.0
Trenwick Group                              99.0
IPC Holdings Ltd.                           95.0
Kemper Insurance Cos.               60.0 to 80.0 (*)
Markel Corp.                                75.0
Everest Re Group Ltd.                       75.0
Aon                                         53.0
Odyssey Re                                  52.0
Lincoln National                           $50.0
RenaissanceRe Holdings                      47.0
London Insurance Group                      46.5
Travelers P/C                               42.0
Le Mans Re                          38.8 to 54.0
PXRE Group Ltd.                             35.0
Safeco                                      35.0
Aegon                                       34.0
Cigna Corp.                                 25.0
W.R. Berkley Corp.                          23.0
HCC Insurance Holdings                      22.8
American National                           20.2
Zenith National                             20.1
Protective Insurance Co.                    20.0 (*)
Allmerica Financial Corp.                   17.0
UnumProvident                               15.6
Annuity & Life Re                           12.0
Reinsurance Group of America                10.0
Aetna Inc.                                   9.0
Cincinnati Financial                         8.7
Canada Life                                  8.8
Principal Financial Group                    6.5
StanCorp Financial Group                     6.0
Erie Indemnity Co.                           5.8
SCPIE Holdings Inc.                          5.0 (*)
Conseco                                      5.0
Argonaut Insurance                           5.0
Max Re Capital Ltd.                          3.0 (*)
Navigators Group Inc.                        4.5
Jefferson-Pilot                              4.0
Harleysville Group Inc.                      3.6
Highlands Insurance Group Inc.               2.0
Ohio Casualty                                1.9


(*)Pretax losses

* Life Insurance Applications Increase

While the terrorist attacks on Sept. 11 triggered huge claims on property/casualty insurers, they only slightly diminished the capital position of life insurers. They also seem to have stimulated renewed interest in life insurance.

According to Tillinghast Towers-Perrin, the World Trade Center disaster added about 9% to the volume of claims that life reinsurers had anticipated in 2001, including accidental death and dismemberment lines. That compares with about 12% more than expected in the workers' compensation line, 14% in the liability line, 75% in commercial property and business interruption lines, and 458% in the aviation line, said Stephen P. Lowe, principal in the company's Hartford, Conn., office.

Lowe estimated that total claims from the trade center disaster will fall within a range of $32 billion to $56 billion. But Timothy W. Clark, director of Standard & Poor's Financial Services Ratings, said the life reinsurance industry's liability will be only about $2.5 billion. Those losses will be divided among 26 companies, he said. Direct writers ceded to reinsurers 64% of the mortality risk of life insurance written in 2000, according to the Society of Actuaries, a trend that intensified over the past decade.

The annuity business already was down during the year as the falling stock market scared away variable-annuity prospects, though the fixed-annuity business improved. Sept. 11 at first caused a further dip in life and annuity sales, but then the life business rebounded strongly in October. According to the first MIB Life Index, released in November by the MIB Group Inc., the number of life insurance applications in the United States and Canada rose by 8.6% from those received in October 2000 and by 26% over September 2001. U.S. insurers underwrote more than 1.4 million life applications in October. Before October's dramatic gains, the trend for life policies had been flat or declining, MIB said.

Part of the reason for the gains may have been the life industry's quick and public response to the Sept. 11 disaster. Sy Sternberg, the head of New York Life Insurance Co. and chairman of the American Council of Life Insurers' board of directors, publicly testified that this was a time for the industry to make good on its promises, to be compassionate and to give assurances that it had the resources to pay. When authorities were unable to issue death certificates on victims at the World Trade Center, insurers acted quickly to accept affidavits from employers instead. Many insurers made an extra effort to contact families or check to see whether those who worked in the trade center had any life insurance of which surviving family members may not have been aware.

There may be other repercussions in the life industry besides the public's rejuvenated interest in mortality-protection products, said John DesPrez, head of Manulife Financial Corp.'s U.S. operations in life, annuities and pensions.

DesPrez said Sept. 11 will cause life insurers and other companies to significantly improve their business-continuation plans. He also predicted that insurance buyers will be more likely to seek out companies that are financially stronger as indicated by their ratings and that this attention to financial strength could accelerate mergers and acquisitions in the industry.

Estate tax reform was also a big story in 2001. The law passed by Congress gradually increases the amount of an estate that is not subject to estate tax, and it lowers the tax rate until the tax disappears entirely in 2010. But unless Congress acts before then, the estate tax in 2011 will revert to the version that existed in 2001. Most observers believe Congress will eventually extend estate tax relief beyond 2010, but the uncertainties of the phase-out law kept estate planning alive in 2001, especially among families with large estates.

Ron Panko

* Workers' Comp Underwriting Changes

When hijacked jetliners crashed into the World Trade Center on Sept. 11, the disaster did more than alter the landscape of Lower Manhattan. It also brought about fundamental change to the way workers' compensation insurance is underwritten.

Insurance analysts and underwriters estimate that workers' comp losses from the catastrophe could range from $1 billion to $6 billion, making it one of the hardest-hit insurance lines.

Price hikes, more self-insurance and an increased use of captives can be expected in the workers' comp line, said Christopher Swift, a partner at professional services firm KPMG LLP and its national industry director for insurance.

The wide range in the loss estimate takes into account the long-tail nature of workers' comp benefits. The family of a worker killed Sept. 11 in New York, excluding police and firemen, would be entitled to $10,000 for funeral expenses. A surviving spouse and each surviving child, if any, would be entitled to $400 a week for the rest of his or her life, unless the spouse remarries, in which case, the benefit is cut off after two years. Children receive the $400 a week until they turn 21, but the benefit would continue under certain exceptions, such as if the surviving child is in school or disabled.

New York's police and fire departments have their own compensation system, but most of the city's rescue workers, including emergency medical services, are entitled to workers' comp in New York.

Before Sept. 11, the traditional basis for evaluating a risk profile for workers' comp was the type of work the business did and the task being performed by employees. This applies in every state, whether it's a professional athlete or a janitor, said Scott Harrison, a KPMG LLP partner and head of its insurance regulatory practice. Actuaries look at the likelihood of physical injury or disability that could result from a particular occupation.

Until Sept. 11, the location of the business was a limited factor in workers' comp underwriting, and was taken into account when cost of living and medical expenses were factored into workers' comp benefit calculations he said. "Medical costs are higher in New York, than Topeka, Kansas."

Now, risk analysis has to consider the increased likelihood of job-related injuries and disabilities resulting from acts of terrorism, Harrison said.

"Those risks exist without respect to job classification. Now every employee and every employer is a target for terror and for injuries on the job site related to some act of terror. That wasn't the case prior to Sept. 11," Harrison said. "Actuaries will have to assign some risk-based premium or rate based on that."

Assessing concentration of risks also is important, William D. Smith, president and chief operating officer of Kemper Insurance Cos., said in November during a Pricewater-houseCoopers conference in New York. "We as underwriters are faced with underwriting concentration of risks," Smith said. "Most have lost that skill."

Kemper is asking customers for more information than it did before, such as how many people are employed and where they are employed, he said.

There was a time when companies writing homeowners and property/casualty insurance used a map of a ZIP code or city block or town and would put push pins into the map to mark locations where they sold policies.

This "pin map" made it easier to see if a company had a high concentration of policies in one block, something it wanted to avoid. "Conceivably, a fire in one house could spread to another house you've insured," Harrison said.

Concentrations are tracked electronically now, but the same principle applies, and Smith's point is insurers have to brush up on assessing concentration of risks.

Address, location, whether a business is in a high-rise office building in a major city and how many people are employed, are all factors that will be considered in workers' comp underwriting. How much weight actuaries will give to physical location is not yet known, Harrison said. "Taking these factors into account may be the prudent decision for an insurance company to make."

Dennis Kelly

* Expect More IPOs

Several significant initial public stock offerings among insurers last year set the stage for more demutualizations and start-ups in 2002.

"There's a lot of new companies being started up by existing companies, both in reinsurance and in some primary companies," said M. Evan Lindsay, senior partner, insurance and financial services, for Heidrick & Struggles. On the property/casualty side, "rates are hardening, and there's lots of capital pouring into new company start-ups. I suspect those companies will be taken public after a decent period of time."

Looking back to 2001, "it was a really terrible year for IPOs," said Lindsay, but he quickly pointed out that Principal Financial Group's launch just weeks after the Sept. 11 terrorists attacks "was a good test" of the stock market's flexibility and rebound ability.

Principal, another company that decided demutualization is the way to go, converted Principal Mutual Holding Co. into a stock company. Principal's $1.85 billion IPO was the "fifth-largest" launch of 2001, said Lindsay. "It was highly successful and oversubscribed."

On Oct. 23, the day Principal launched its IPO of 100 million shares of common stock, its stock rose more than 12%, trading at $20.75 a share by late morning, and was up nearly 14% at closing. Its IPO, which was priced at $18.50 a share, began trading with a total market capitalization of about $6.7 billion.

"The fact that we were virtually the only major IPO deal out there certainly was a positive, in a sense that we got lots of attention," J. Barry Griswell, president and CEO of Principal Financial Group, said a few days after taking his company public.

Because of Principal's successful launch, Prudential Insurance Company of America "should feel good about taking its IPO out before the end of the year," said Lindsay. Prudential, which received regulatory approval in October by New Jersey regulators, anticipated an end-of-year IPO to complete its long demutualization process. According to Prudential demutualization documents, the price range for the stock was estimated at $22 to $38 a share. Prudential's estimates, if on target, would make it the second-largest insurance IPO in history. As of press time, Prudential had not yet launched its IPO.

In addition to Principal Financial, the other big IPOs of 2001 included:

* Anthem Inc., which launched what could be the most successful IPO the health industry has seen yet, according to one equity analyst. Anthem sold 48 million shares of common stock Oct. 30 at $36 each to raise $1.73 billion for the company. Goldman Sachs Group Inc., the lead underwriter of the IPO, increased the offering by 8 million shares earlier on Oct. 29, after increasing it by 11.4 million shares on Oct. 26.

* Phoenix Cos. priced its IPO of 48.8 million shares of common stock at $17.50 a share on June 20, when it began trading on the New York Stock Exchange. Proceeds from the offering were expected to be $807.9 million and used to compensate policyholders who receive cash and policy credits; for expenses directly related to Phoenix's demutualization, and for general corporate purposes. With its demutualization, Phoenix Home Life Mutual was renamed Phoenix Life Insurance Co. and is a wholly owned subsidiary of Phoenix Cos., the publicly traded holding company.

In addition to IPOs, sponsored demutualizations will become a much bigger force in 2002 and beyond, said Lindsay. "The one that's most apparent" is Nationwide Financial Services Inc.'s pending acquisition of Provident Mutual Life Insurance Co. "We will see more of these, where large, significant companies provide capital and help mutual companies go public," he said.

Under the deal--rare in the past few years of industry consolidation--eligible members of Provident Mutual would receive shares of Nationwide Financial Services' common stock, cash and policy credits totaling about $1.56 billion. The acquisition would provide Provident Mutual, a midsize insurer, with more resources to grow and remain competitive.

Both companies would benefit. Nationwide would receive a career agency force of highly qualified financial planners that it currently lacks, and Provident would gain access to Nationwide's powerful independent distribution channels. Provident also stands to benefit from Nationwide's technology platform, service capabilities and strong ratings, said Robert W. Kloss, Provident's chairman, CEO and president.

Looking ahead, many insurers will take advantage of the post-Sept. 11 hardening market, characterized by a "significant loss" in capacity, said John S. Scheid, chairman, Americas Insurance Group, PricewaterhouseCoopers LLP. "We are now seeing significant capital raising for new company formations," said Scheid, alluding to Lindsay's comments. Many companies are starting offshore underwriting units, he said, including some notables:

* Aon Corp. will invest $200 million in a new company, Endurance Specialty Insurance Ltd. The plans call for capitalization of about $1.2 billion, with investments from "several parties." One party that already committed to the venture is Zurich Financial Services, which said it will contribute $200 million through its private-equity affiliates.

* White Mountains Insurance Group Ltd. will form a Bermuda-based property/casualty reinsurer that will initially focus on property business through the broker market. White Mountains expects the reinsurer to be capitalized with at least $1 billion. White Mountains will be a founding shareholder and is expected to invest at least $200 million.

* RenaissanceRe Holdings Ltd. plans to launch a new Bermuda-based property/catastrophe reinsurer DaVinci Reinsurance Ltd. would have initial capital of $500 million, with room for expansion if demand for capacity grows. State Farm Mutual Automobile Insurance Co. will contribute $200 million, and RenaissanceRe will put up $100 million, with the balance coming from other investors. Renaissance Underwriting Managers Ltd. will manage the new company.

* Aon's biggest rival in the brokerage business, Marsh & McLennan Cos., said in September it's launching Axis Specialty Ltd., a property/catastrophe reinsurer, through its subsidiary MMC Capital Inc. Axis' initial capital is expected to be $1 billion.

Overall, as of mid-November, more than $12 billion in new capital was raised or was planned to be raised, since Sept. 11, Scheid said.

Fran Matso Lysiak

M&As Create New Competencies

Insurance industry mergers and acquisitions that led the news in 2001 placed a lot of emphasis on market share and distribution, but that emphasis is likely to change. The two most notable deals for 2001 were American International Group Inc.'s $23 billion acquisition of American General Corp. and the $1.3 billion merger of WellPoint Health Networks Inc. and RightChoice Managed Care Inc.

The AIG-American General deal was "a very significant acquisition" for AIG, said M. Evan Lindsay, senior partner, insurance and financial services, for Heidrick & Struggles. "It gave them a leadership position in the life insurance market in the United States and made them a player in the distribution of annuities through banks." Early in 2001, American General's chief executive officer claimed that the deal would eventually create the No. 1 life insurance company in the world.

On the health side, the WellPoint RightChoice merger will provide opportunities for both companies. WellPoint will gain access to a large market share in Missouri and other states in the Midwest, as well as access to the HealthLink system from RightChoice, which will improve WellPoint's technological base. At the same time, RightChoice will gain access to additional markets through WellPoint to expand. RightChoice operates in Missouri as Blue Cross & Blue Shield of Missouri.

Lindsay said there were other significant mergers and acquisitions during 2001 that could have gotten lost in the wake of the MG-American General deal:

* Bermuda-based White Mountains Insurance Group Ltd.'s $2.17 billion acquisition of CGU Insurance Group, the property/casualty subsidiary of the United Kingdom-based CGNU plc. With the sale, CGU Insurance, with 2000 revenues of $4.4 billion, assumed a new name--OneBeacon Insurance Group.

* XL Capital Ltd.'s acquisition of Winterthur International for $600 million in cash, in a deal that boosts XL's European operations and expands its worldwide risk-management business.

* Hartford Financial Services Group Inc.'s $1.12 billion cash acquisition of the individual life insurance, annuity and mutual fund businesses of Fortis Financial Group Inc. The deal makes Hartford the third-largest writer of variable life insurance in the United States, the company said.

* Swiss Re's $2 billion acquisition of the life reinsurance unit of Lincoln National Corp.

Mergers and acquisitions are likely to take on a whole new look--and meaning--because of the Sept. 11 terrorist attacks.

"Well-capped companies will try to acquire expertise in underwriting and reinsurance," Lindsay said. "Companies that don't have a strong reinsurance business will look pretty seriously at acquiring reinsurance operations, because of hardening rates and the amount of capital that's available" to do these deals, he said.

Another expert agreed. The so-called "flight to quality" takes on more dimensions, since the terrorist attacks had such a "profound impact" on virtually every aspect of the insurance industry, said Clint Harris, vice president of insurance research and publications at Conning & Co., who authors Conning's mergers and acquisitions reports.

Two of the questions insurance company executives will have when determining whether a merger or acquisition would be a good fit in 2002 and beyond, Harris said, concern the impact the merger or acquisition would have on the financial strength of the company and whether it would enhance the ability to accept risk.

Another expert offered other prognostications on mergers and acquisitions for 2002.

"I would expect to see a trend of continuing investment from foreign players in the U.S. marketplace," said John S. Scheid, chairman, Americas Insurance Group, PricewaterhouseCoopers LLP, who pointed to an increasing number of Eurpoean players entering the U.S. market, such as Aegon, ING and Allianz. He expects this to occur not only in the property/casualty segment, but in asset accumulation and annuities also.

Mergers and acquisitions also will take on a slightly different facade in future years. "Rather than the classic acquisition, many companies will be looking at acquisitions of capabilities, very much like a strategic alliance," he said. "They won't exchange stock, but partner to get a certain expertise they don't have now."

A good example of "capabilities acquisitions," Lindsay pointed out, was the Wells Fargo-Acordia transaction. In March 2001 ,Wells Fargo & Co. said it would buy ACO, the parent company of Acordia Inc., an independent property/casualty insurer. Acordia and Wells Fargo Insurance combined will have $630 million in revenue and 176 stores in 38 states--making it the largest bank-owned insurance agency in the country The deal was to be completed by the second quarter of 2002.

Wells Fargo "didn't want to acquire the risk part of an insurance operation--but the distribution part," Lindsay said, noting that ACO is primarily an insurance distribution company.

Fran Matso Lysiak

* Mold Issue Is Growing

Mold became a national issue in 2001. Not only did one of the largest property/casualty writers have to pay a $32 million settlement over a lawsuit concerning mold, but a handful of insurers halted writing homeowners insurance policies covering water damage in Texas because of the spike in mold claims.

Mold claims arise from water damage caused by everything from burst pipes to leaky roofs. While some strains, like stachybotrys, can cause severe damage to a home, the effect on health is still unproven.

Yet, mold is a growing problem for the insurance industry. "Mold goes beyond the personal lines area and becomes a complex and extremely potentially expensive issue for commercial lines insurers as well as other areas where people will attempt to prove negligence," said Robert Hartwig, the Insurance Information Institute's vice president and chief economist.

In June 2001, a Texas jury ordered Farmers Insurance Group to pay Melinda Ballard and her family $6 million for damage to her home and its contents, $5 million for emotional distress, nearly $9 million in attorney's fees and $12 million in punitive damages. The jury found that Farmers improperly handled Ballard's water claim, which allegedly allowed mold to form and eventually take over the family's $3 million home. The case had a huge impact on the property/casualty industry. "It single-handedly created anxiety and heightened interest in mold," said Mary Flynn, a spokeswoman for Farmers. After a court-ordered mediation failed to produce a settlement, Farmers was ordered by a Travis County District Court judge to pay $32 million to Ballard. Farmers intends to appeal the final judgment.

Although mold claims have been filed in every state and worrisome trends are showing up in Oklahoma and Louisiana, the mold epicenters are Texas and California. Environmental factors and the broad coverage offered in the state's HO-B policies combine to make Texas a hotbed for mold claims, with 50,000 to 60,000 mold claims still open at the end of 2001. The loss ratio in homeowners insurance in Texas jumped from 50.6 in 1999 to 82.4 in 2000, reflecting a rise in average paid losses for water-damage claims, which rose from $300 in 1999 to almost $500 in 2000, with an estimated $700 expected in 2001.

This spike in claim costs caused the top three writers of homeowners insurance in Texas--State Farm, Allstate and Farmers--to stop writing new business covering water-related damage. Farmers, the second-largest writer in the state, went a step farther and announced in early November it wasn't renewing 600,000 comprehensive HO-B policies as of the end of 2001. Farmers said it wants to remain in Texas, "but we're bleeding financially and have to stem the flow. Over the last two years, we had losses of about $600 million in Texas in the homeowners insurance line, and about $200 million of that was due to mold claims." Farmers, the third-largest property/casualty insurer in the United States, handled 12 mold claims in 1999, 499 in 2000 and by the end of September 2001, it had handled 8,000 mold claims.

In response to the rise in mold claims in November the Texas Department of Insurance announced that as of Jan. 1, 2002, homeowners insurance policies in Texas would retain coverage for removal of mold related to certain water damage covered by residential property policies, including the most commonly purchased HO-B policy. However, the ruling eliminated coverage for high-priced procedures such as testing, treating, containing or disposing of mold beyond what is necessary to repair or replace property that is physically damaged by water. Policyholders have the option to purchase additional coverage in increments of 25%, 50% and 100% of policy limits to include those procedures.

Lynna Goch

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