Accentuating the possible: insurers look to 2004 with hopes for a more stable property/casualty market, expectations for newly merged competitors in the life market and a multimarket awareness of the need to control health-care costs.

Coming from a year of fighting to survive in a difficult financial environment that has been building for several years, insurance industry leaders predict some of the developments and steps taken in 2003 will serve them well in 2004. Yet, coping with the increasing complexity of issues bombarding insurers--a combination driven by technology, regulation, science, society and a new perception of catastrophes that could happen--will require education, strategy and maybe a few brave initiatives.

On the plus side for property/casualty writers, the strong underwriting discipline many employed in 2003, if maintained, could create much-needed stability in the market. If that discipline continues into 2004, it "would do away with this maniacal underwriting cycle that we seem to go through," said Ernst Csiszar, South Carolina insurance director and president of the National Association of Insurance Commissioners. "What the industry needs is the ability to provide its customers with the strategic look forward, so you don't have these huge rate swings,' he said. "You don't have this 'I write a line of business one day, but I don't write it tomorrow'--this whole notion of being in and out of lines of businesses just because the results are so poor."

The drop in stock-market returns and the low interest rates that have characterized the 21st century so far are two of the factors that forced the focus on underwriting profitability. In 2003, "the commercial marketplace maintained a disciplined pricing environment," said John Amore, chief executive officer of Zurich North America. "The driving force in that discipline appears to be a combination of better capital management by the companies and continued pressure on company balance sheets."

Amore predicted the pricing trend will continue through 2004, partly because of the failure to achieve legislative reform in tort liability and asbestos liability. "This did nothing to take the pressure off of the acceleration of loss costs that we have seen since the mid-1990s, which, in turn, continues to put pressure on the price-to-exposure elements that companies are managing," he said.

In personal lines, strong underwriting will be supported going forward by the refined underwriting tools available in 2003, said Edward B. Rust Jr., chairman and chief executive officer of State Farm Group. "Tools such as refined insurance scoring, credit information and other work that has been done in finding valid correlations between information and characteristics and loss potential," along with improvements in loss mitigation, are the developments from the past year that will have the greatest impact on insurance over the next few years, Rust said.

But even strong underwriting discipline and pricing may not be enough to withstand the megacatastrophes of the future. The biggest business challenge going into 2004 is how to respond to major natural disasters, Rust said. "For those who were hurt by [Hurricane] Isabel, it was a traumatic experience, but from an economic standpoint, Isabel could have been far worse if it stayed at a category 5 and moved across southern Florida."

Beyond hurricanes and earthquakes, insurers have to be concerned about other mass-scale issues. It could be "the next type of disease like SARS, which may be much worse and spread much faster," said Susan Rivera, president of Ace INA Holdings. "There's potential for more catastrophic large-scale issues out there than we tend to think of. People tend to look at the past to predict the future, but 9/11, SARS and the power outage have us posing the question: What else is out there?"

Technology also creates new and unimagined risks. Technology affects "how smaller risks can impact a broad marketplace. The reach that our policyholders have continues to grow as they deploy technology to improve their efficiency and the way in which they reach out to the world," Amore said. New emerging risks involve "change emanating from technology; social conditions, as we've seen with terrorism; and the legal and regulatory reforms that are ongoing."

As risks evolve, insurers are faced with the shifting interpretations of policy contracts, which become another form of risk. "We went back and forth in Texas on mold: Was it covered? Is it covered?" Rust said. "The uncertainty in today's environment makes it very costly. We're concerned about the judicial interpretations and legislative/political responses to the issue of the moment."

The Issue That Binds

An issue that poses significant concerns for health insurers and some property/casualty insurers as they approach 2004 is the rising cost of health care. "That's the theme we all need to work on as we move forward--the continuing escalation of health-care costs and, thus far, the industry's unwillingness to collectively put our arms around what is quality health care," said Scott Scrota, president and chief executive officer of the Blue Cross and Blue Shield Association.

Ace INA's Rivera noted that P/C rate increases will continue "because the underlying drivers of loss trends have not been abated. The hard market will last until we have major tort reform or we see medical inflation in check."

If medical costs are left unchecked, Serota predicted they will double in the next I0 years, but he is optimistic that effective steps can be taken. "First, we need to come to an understanding of what is driving health-care costs," he said. "We also need to divide it up into manageable bites and take action on those that are actionable. All aspects of the industry share responsibility and the role of assisting in solving the problem, and we all have to agree to partner and put our heads together to take on that task."

2Education on Many Fronts

As insurers work to contain health-care costs, a challenge in 2004 will be to educate consumers. "As the industry moves to more consumer-directed products, we need to be sure people have the information necessary to make decisions--not just about cost, but also about quality, performance and a variety of other issues," Scrota said. "Another challenge is that we must begin to instill in all of us greater personal accountability. When we boil it all down, probably among the most significant contributors to the health-care cost situation are the choices each of us makes every day about our own lifestyle, such as exercise and diet."

From a P/C perspective, Rivera said insurance buyers need to understand medical inflation doesn't cost only health plans. "It affects general liability. It's more expensive to care for paraplegics and quadriplegics. It affects workers' compensation," she said.

Understanding how rising healthcare costs affect all of insurance is only a part of the education challenge for insurers, Rivera said. "Our biggest challenge in 2004 continues to be the market education of brokers and clients, so that they understand our need to get an adequate return for the risk we are assuming, the volatility and variability of those risks, and what are the underlying drivers of loss trends," she said. "Our goal is to have a price that's fair and compensates us for the underlying loss cost trends. We need to educate them that we are charging an adequate price R)r the risk and not going for the whims of the marketplace."

To mitigate loss trends in personal lines also requires education of clients. "Part of the relationship between the company, its agents and policyholders is working with that customer to make sure the customer is educated," said State Farm's Rust. For example, a homeowners policy-holder needs to have an appropriate deductible for the value of the house, so the insurance policy is for indemnity, not maintenance. "It's not only important for the company to follow tip [if the home's value needs to be increased], but for customers to be aware of those issues," Rust said. "Like a medical checkup, it's important to have an insurance checkup periodically."

Bigger and Bolder

Driving the life insurance marketplace in 2004 will be the major reconfigurations that appeared in 2003. Mergers and acquisitions, such as Prudential Financial and American Skandia, flourished, with announced deals including Manulife Financial and John Hancock Financial Services, and Axa Financial and the MONY Group. "The consolidation and absorption of two old-line insurance companies is a significant event in that it indicates the recently demutualized companies may not have long life expectancies as independent institutions," said Sy Sternberg, chairman of the board and chief executive officer of New York Life Insurance Co.

"It's hard to imagine the other recently demutualized companies would not find that it would be in their best interests some time in the future to look to the public markets and find they can do better for policyholder value by being acquired," Sternberg said. "In other words, organic growth and staying independent ;ire not going to be the best choices for their shareholders, and they very well may go the way MONY went and John Hancock went." Sternberg predicted, however, there would not be a lot of consolidation taking place in the short term. With the serious capital problems that some companies faced in 2003, "you may have as many companies prepared to sell, but not that maw prepared to buy," he said.

One of the capital problems life insurance companies, particularly those with international operations, are facing is low interest rates. In the case of New York Life, the domestic portfolio is relatively mature, so low new-money rates can be balanced with older investments, but the international portfolio is relatively new. "As such, we're dealing with a portfolio rate that is very close to the new-money rate, and in several foreign countries, such as Taiwan, we have guarantee levels that are close to that investment level," Sternberg said. "We have to manage and modulate the products we sell now to ensure we don't penetrate those levels. That is probably the greatest challenge we have."

Pressured to Perform

Another challenge for insurers in 2004 is managing breakthrough technologies. "We must look at what technology is available, what's changing and who will pay for these advances," said Blue Cross and Blue Shield's Serota. On the health side, the Blues recently conducted research about a phenomenon Serota called "supplier-induced demand." For example, if more scanners are available, providers will provide more tests. "We'll have to examine ways to deal with some markets that are 'over-technologied' and others that don't have sufficient technology," he said.

Serota also said administrative technology can be a boon or it can be a huge cost drain "if we don't figure out ways to have a national plan or process to determine what we want technology to accomplish." He said the Blues and several other organizations are strong supporters of a Health and Human Services-type commission "to look at information technology, measure future programs and regulations against a model and determine whether the technology is duplicative."

In 2003, New York Life increased its overall technology expenditures "because we feel there are a lot of critical things to be done," Sternberg said. "Five years ago we were trying to decide how to respond to the Internet. We were coming up with a good deal of infrastructure development. Now we're coming on to our second round of upgrading of those capabilities."

New York Life's main objectives in using technology are to provide support for its agents and expand service to its customers. The most technology-driven business, however, is investment management. "You've got the mutual fund companies like Fidelity and Vanguard continually driving technology in that area, and our approach is to stay up with them," Sternberg said.

Safeguarding Confidence

Some mutual fund companies have also created a confidence challenge for writers of variable life insurance and variable annuities. The recent mutual-fund investigations should be a warning to insurers to examine their own practices, starting with the board of directors, the chief executive officer and the senior management team, Csiszar said. "The reality is that we've had too many of these things, from accounting shenanigans to now the mutual funds, to the Enrons, to the WorldComs," he said.

"What is at stake here is the confidence of the consumer. Our entire financial system is based on paper. We don't have any real assets behind the dollar or any other world currency these days. What we have is paper. And what we have is promises," Csiszar said. "And when an investor, when a policyholder, when a depositor in a bank, loses that confidence, you're putting the entire financial system at risk."

People and Planning

Maintaining customer confidence and the integrity and productivity of a company depends on the people who are the company. Finding and keeping good people is a challenge for 2004. "The demand for talent--how do we attract better talent, how do we train them effectively and how do we keep our top performers are the biggest issues we face going forward," said Amore of Zurich North America. "And that's really driven by the fact that the complexity of our business continues to grow. In just the past few years, issues like the advent of terrorism exposure and the application of technology have demanded enhanced levels of analysis and sophistication from insurance professionals.

"Furthermore, the movement of science on all fronts--genetics and biogenetics, to name just a few--combined with the general pace of development in modern society is really placing many more demands on the talent that we have and the talent that we will need in the future. Plus, there is an ongoing need to become a more productive and quality-oriented industry, and these place even more pressure on the talent. So, in terms of challenges in 2004, I'd suggest that the recruitment and management of talent will represent a major issue, both for our company and our competitors," he said.

Dealing with rapid change will require a focused approach. "Insurers need to have an R&D department, with people who focus on thought leadership, to always be looking at the latest thing from the plaintiffs bar, science, new types of claims," Rivera said. "We're not going to have a crystal ball. Truly unexpected things will be forgiven. But things we have seen in the past we should learn from. We're not happy and somewhat disappointed that we missed Sept. 11 and the catastrophic risk and accumulation of risk that presented itself there. It's really up to us to think outside the box."

--Barbara Bowers. Lori Chordas, Meg Green, Ron Panko and Sally, Whitney contributed to this article.

John Amore

Position: Chief executive officer

Company: Zurich North America

Headquarters: Schaumburg, III.

Primary Products: Commercial property/casualty insurance for multinational, middle-market and small-business sectors in the United States and Canada

"Recruitment and management of talent will represent a major issue, both for our company and our competitors."

Susan Rivera

Position: President

Company: Ace INA Holdings, which generates two-thirds of the revenue for its parent, Bermuda-based Ace Ltd.

Headquarters: Philadelphia

Primary Products: Global insurance, reinsurance and financial products

"The hard market will last until we have major tort reform or we see medical inflation in check."

Edward B. Rust Jr.

Position: Chairman and chief executive officer

Company: State Farm Group

Headquarters: Bloomington, III.

Primary Products: Auto and homeowners insurance

"Part of the relationship between the company, its agents and policyholders is working with that customer to make sure the customer is educated."

Ernst Csiszar

Position: Director of insurance

Organization: South Carolina Department of insurance

Headquarters: Columbia, S.C.

"What the industry needs is the ability to provide its customers with the strategic look forward, so you don't have these huge rate swings."

Scott Serota

Position: President and chief executive officer

Company: Blue Cross and Blue Shield Association, the trade association for the 41 independent, locally operated Blue Cross and Blue Shield plans

Headquarters: Chicago

Administrative technology can be a boon or it can be a huge cost drain "if we don't figure out ways to have a national plan or process to determine what we want technology to accomplish."

Sy Sternberg

Position: Chairman of the board and chief executive officer

Company: New York Life Insurance Co.

Headquarters: New York

Primary products: Life insurance, annuities, mutual funds, long-term-care insurance, managed accounts

"It's hard to imagine the other recent demutualized companies would not ... find they can do better for policy-holder value by being acquired."