Change in the wind.

Although 2006 was a relatively quiet year for insurers on the actual weather front, plenty of volatile activity swept across the regulatory and legal landscapes, leaving significant change in its wake. Hardest hitting, perhaps, were the November elections, which rolled in a new Democratic majority in Congress that is likely to grant insurers some parts of their agenda, but deny others. In August, Congress passed the Pension Protection Act, giving life insurers previously impossible product possibilities, and health insurers worked all year to tame the implementation of Medicare Part D, which went into effect Jan. 1.

The National Association of Insurance Commissioners saw progress in the development of the Interstate Insurance Product Regulation Commission and approved a proposal to provide short-term relief from redundant reserves for some life insurers. The industry also felt the effects of activity in other areas such as capital markets, broker recovery and mergers and acquisitions. The most significant insurance events of 2006, chosen for their lasting impact on the industry, are described in the following pages.

Acquisition Trend Continues for Insurers

Expanding an insurance business one contract at a time is a slow process compared with buying existing businesses. And becoming big brings economies and capabilities. So the question for 2007 may be whether consolidators will be able to find the right deals.

Some 71% of respondents to a 2006 survey expect consolidation in the global insurance market to accelerate through 2009. The survey, by consulting and accounting firm KPMG LLP, quizzed 200 board-level executives of both life and property/casualty insurers worldwide.

In a recent three-year period, 36% of European respondents reported acquiring at least one business, while only 26% of North American insurers and 20% of Asia-Pacific insurers reported doing so. Recent acquisitions included MetLife buying Travelers' life and annuity business from Citigroup, Swiss Re buying GE Insurance Solutions, and the United Kingdom's Aviva buying Iowa-based AmerUs.

Perhaps the most promising buys may be of businesses that some insurers no longer want. Consultants say the U.S. market is still heavily populated with small and medium-size companies that will try to divest noncore operations.

What Acquirers Seek

* Good Price

* Attractive Target

* Local Knowledge

--Ron Panko

NAIC Gives Life Insurers Reserve Relief

The life insurance industry took a big step forward in its effort to move to a "principles-based" approach to setting reserves when the National Association of Insurance Commissioners in September approved an industry proposal that provides short-term relief from redundant reserves for writers of both universal life with secondary guarantees and term life.

The American Council of Life Insurers' proposal bridges the gap between Jan. 1, 2007, and the date that principles-based reserving is adopted in all 50 states.

One piece of the proposal allows the use of lapse rates in calculating reserves for the no-lapse guarantee on the UL policies. The second piece calls for splitting the existing 2001 Commissioners Standard Ordinary mortality table, which would primarily lower reserves for term-life writers.

Work is now focused on getting the mortality table changes adopted in all 50 states and the District of Columbia for use on policies issued in 2007 and later, said Paul Graham, ACLI vice president of insurance regulation and chief actuary.

--Fran Matso Lysiak

Pension Act Provides New Opportunities

Passed in early August, the Pension Protection Act grants a seven-year window for most defined-benefit plans to become fully funded. Among its other provisions, the measure gives clarification to the "safest available annuity standard" to encourage more employers to offer lifetime annuities as a payout option from 401(k)s and makes permanent the retirement provisions of 2001's Economic Growth and Tax Relief Reconciliation Act.

Another provision allows insurers and investment firms to provide investment advice to 401(k) and Individual Retirement Account participants, even when their own products are among the investment options. And perhaps most significantly for life insurers, the final bill opened the door to "life care annuities," hybrid products that combine the features of long-termcare insurance with life insurance and annuities. The provisions would allow both life insurance and annuity products to include riders for long-term-care coverage and would greatly expand the tax-free exchange of life, endowment and annuity contracts for long-term-care contracts.

--R.J. Lehmann

Past Hurricanes Still Affect Insurers

For a year with an almost nonexistent hurricane season, 2006 was very much shaped by catastrophic storms. That's because Hurricane Katrina and her 2005 brethren, Rita and Wilma, cast a long shadow.

One key development in 2006 was that the first wind vs. flood case was decided in Mississippi--in favor of the insurance industry. While the case was not complete precedent for the issue, experts said it was a good sign that the flood exclusion would be upheld in future cases seeking homeowners coverage for storm surge.

Another lingering effect of 2005's storms was the rising cost and lack of availability of reinsurance, which drove up homeowners premiums. This was compounded by catastrophe modelers increasing the probable maximum losses in their models because of Katrina and rating agencies increasing capital-adequacy requirements--both of which drove the need for more reinsurance. The light hurricane season in 2006, experts said, is unlikely to change this situation in the near-term future.

--Rick Cornejo

States Approve Interstate Product Compact

Regulators at the National Association of Insurance Commissioners praise the progress of the development of the Interstate Insurance Product Regulation Commission.

The seeds were planted in 2000, when regulators adopted their Statement of Intent: The Future of Insurance Regulation. The roadmap proposed substantial regulatory reforms to modernize state insurance regulation, and a way to get there, creating a single point of filing for life insurance, annuity and other wealth-protection insurance products.

By May of 2006, Alaska became the critical joiner of the compact, meeting the operational goal of 26 states or premium volume representation of 40%. Since then, the Interstate Insurance Product Regulation Commission has been established, its bylaws adopted and its executive director hired.

Moving ahead to early 2007, all the framework is due to be in place, enabling the commission to accept product filings.

--Eleanor Barrett

E.U. Reinsurance Directive Adoption Begins

The European Union's planned adoption of its Reinsurance Directive by the end of 2007 will give added impetus to the long push by European reinsurers for an end to U.S. collateralization rules.

The directive will bring in a single reinsurance protocol across the European Union, allowing any E.U.-based reinsurer to operate effectively as a domestic reinsurer throughout the Union. The European Union itself is to expand Jan. 1, 2007, from 25 members to 27, with the admission of Bulgaria and Romania.

The directive was approved at E.U. level in 2005. Member states are required to incorporate it into their national laws by December 2007. Ireland, which is seeking to promote Dublin as a financial services center, was the first to adopt the directive, in July 2006.

Pressure on the United States to change its rules has come from the European Union and from such entities as Lloyd's and the International Underwriting Association.

--Robert O'Connor

Capital Markets Provide Financing Innovations

The melding of reinsurance with capital markets picked up the pace this year, with severe market dislocations caused by two straight years of record hurricane losses. The property/casualty segment saw a record year for catastrophe bonds in 2006. According to A.M. Best Co.'s annual reinsurance report, published in August 2006, cat bond issuances for both life and nonlife more than doubled in 2005, and appear set to overtake that production in 2006.

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Private equity also picked up the pace as a source of reinsurer formations. Hedge funds and sidecars--specialty reinsurers that isolate a reinsurer's more volatile risks--added to the sudden growth of capital-market strategies in the global market. All of these trends are expected to continue into 2007, as reinsurers seek to manage their risk concentrations better. Reinsurers are also relying on these techniques to better allocate their capital in response to cyclical turns in specific lines of business.

--David Pilla

Election Results Influence Insurers' Agenda

The Democrats' takeover of Congress is a mixed bag and will affect insurers long beyond 2007. A permanent terrorism insurance backstop seems likely, as Sen. Chris Dodd, D-Conn., who helped create the backstop, will take Senate Banking over from Sen. Richard Shelby, R-Ala., who opposed it. A vote on the backstop is high on Dodd's agenda.

Federal chartering is less certain. Some Democrats support it, but some insurance trade groups fear Democrats will be inclined to scrutinize industry practices, rather than loosen state oversight.

Rep. Charles Rangel, D-N.Y., who will take over Ways and Means, may consider proposals to overhaul Medicare's Part D drug program, and to restructure Medicare Advantage plans.

--Chris Grier

Health Insurers Tackle Medicare Part D

Last year marked a major milestone for millions of seniors with the rollout of Medicare Part D, and "2006 had a solid record for the program in terms of beneficiary satisfaction, problem resolution and cost effectiveness," said Karen Ignagni, president and chief executive officer of America's Health Insurance Plans.

Even though the industry had to wade through a myriad of challenges including systems glitches, Jane Galvin, director of regulatory affairs for the Blue Cross Blue Shield Association, said Part D was "an enormous undertaking by many segments of the health industry."

More plan sponsors are set to come on board in 2007. The federal government also is proposing some changes to the Part D program. But time will tell, said Galvin. "We'll have to see what changes may arise given the recent change in the Congress."

Galvin said the first priorities in 2007 will be to find individuals who haven't yet enrolled in the Medicare Rx program and help them find a good option.

--Lori Chordas

HHS Estimates of Medicare Part D Enrollment
(Millions)

Projected vs. Actual

Projected Part D Enrollment = 29.3 million

            Dual Eligibles   Enrolled in    Enrolled in
            (auto-assigned   Medicare       stand-alone
            to Part D        Advantage      Prescription
            plans)           Prescription   Drug Plans
                             Drug Plans
                             (excluding
                             duals)

Dec 2005         6.2             4.4               1       11.6
Jan 2006         6.2             4.5             3.6       14.3
Feb 2006         6.2             4.8             4.9       15.9
Mar 2006         6.4             5.1             6.4       17.9
Apr 2006         6.4             5.2             8.1       19.7
June 2006        6.6             5.5            10.4       22.5

Note: Table made from bar graph.

Source: Projected: HHS Medicare Prescription Drug Benefit Final Rule,
Jan. 28, 2005; Actual: HHS, Dec. 2005-June 2006

Brokers Expect Smoother Road Ahead

Commercial insurance brokers continue efforts to stabilize their businesses. Restructuring measures, including layoffs, consolidating locations and exiting noncore functions, are paying off in the form of significant cost savings.

Regulators relaxed some restrictions on contingent commissions, allowing brokers to accept fees from carriers when acting as underwriting manager. Other revenue initiatives have not been as successful as some hoped.

Meanwhile, mid-tier brokers not affected as much by the bid-rigging scandal have gained ground as more clients diversify their brokerage needs and successful producers poached from competitors begin to yield results. Personnel defections have slowed, although a mass exodus of top producers from Benfield Group to Aon Re in the third quarter could cost Benfield $18 million.

The brokers expect savings, investments in new market segments and acquisitions to improve margins in the coming years. Competition for middle-market accounts is expected to be most intense. Still, even for Marsh, which suffered the most from the bid-rigging scandal, the road ahead gets progressively smoother.

--David Dankwa

2006 Net Income Compared With Same Quarter in 2005

Marsh & McLennan Cos.

1st Quarter   $416 million, [up arrow] 210.4%
2nd Quarter   $172 million, [up arrow] 3.6%
3rd Quarter   $176 million, [up arrow] 155%

Aon Corp.

1st Quarter   $198 million, [down arrow] 1%
2nd Quarter   $193 million, [up arrow] 1%
3rd Quarter   $106 million, [down arrow] 13%

Willis  Group Holdings

1st Quarter   $140 million, [up arrow] 109%
2nd Quarter    $72 million, [down arrow] 36.8%
3rd Quarter    $89 million, [up arrow], 45%

Source: Company reports