Managing the Enterprise.

Overview: Ten key trends are reshaping the property/casualty industry.

By underwriting and diversifying risks, insurance companies hold a unique and indispensable role in both the nation's and world's economy. However, insurers will be tested in the new millennium to respond to a new and growing set of business risks and opportunities posed by financial service deregulation, Internet transparency, globalization, empowered customers, and rapid technological advances. Many of these emerging issues are displayed in our cover page.

We expect unprecedented change over the next several years. Successful property/casualty companies will properly gauge industry trends and effectively manage their enterprise. They will exhibit unquestioned financial strength, deliver on risk-adjusted performance, and leverage their competitive advantages to respond to more discerning customers, distributors, and investors. The key industry trends are:

1) Financial Services Converge. As expected, market forces overcame bipartisan politics, allowing U.S. financial service deregulation to become a reality. In March, the world will learn which banks have filed applications with the Office of Comptroller of the Currency to acquire insurance companies; however,A.M. Best expects that most cross-sector acquisitions will initially involve banis buying life/health insurers.

Banks and investment security firms will be more cautious in their acquisitions of property/casualty insurers and will probably pursue marketing alliances. These alliances will leverage the Internet, branches and call centers and provide broad financial-service products to customers that prefer "one-stop" or "event-driven" shopping.

2) Internet Transforms Business. The financial-services industry is poised for rapid Internet growth facilitated by online commerce. Over the next five years, virtually all leading property/casualty insurers will sell a portion of their personal and standard commercial insurance online. By 2004, A.M. Best estimates that $10 billion to $20 billion of personal auto and standard commercial insurance will be sold online. Personal auto buyers will enjoy flat-to-declining rates for years to come, facilitated by price transparency on the Internet, the migration of market leaders to alternative low-cost delivery systems and the new virtual Internet companies that exploit areas of inefficiency.

3) Globalization Accelerates. Globalization of the financial-services industry is ready to take off as the world's capital markets evolve and local industries begin to operate across geographic boundaries. Large European financial-services giants are expected to acquire or joint venture with U.S. asset managers and banks. Globalization will continue to favor non-U.S. financial service groups with larger market capitalization, stronger stock currencies, lower costs of capital and longer-term strategies. We expect more "bolt-on" acquisitions by Bermuda-based and European insurers over the next two years. Commercial lines deregulation will provide insurers the opportunity to globalize products and claim services.

4) Customers Are Empowered. In the commodity segments--personal lines and small commercial--insurers will have to respond to consumers' demands for real-time convenience, service and low cost. In the mid-to-large commercial segments, risk managers demand innovative products, including integrated insurance and capital-market products. Innovative insurers are responding to risk managers' desire for customized solutions to specific business risks, including structured-finance and risk securitization deals.

5) Technology Advances. Much of the property/casualty industry trails financial-service competitors in developing open-architecture Web sites, electronic-commerce capabilities and robust customer databases. Many insurers are saddled with complex legacy systems and organizational structures that remain product-focused rather than customer-centric. The industry's expense ratio will remain above 28% as the industry's technology spending shifts from remediating legacy systems to investing in Internet-linked systems. Y2K system issues will likely have a limited impact on the industry's financial strength. For the most part, property/casualty companies' systems will prove to be Y2K compliant; the greatest uncertainty relates to vendor compliance. As Y2K system problems and business interruption prove to be less severe and widespread among industries in the United States, we expect less liability risk to be borne by the property/casualty industry than first expected.

6) Middle-Market Dislocates. As expected, middle-market insurers will report combined ratios in the 120 range in 1999 and 2000, fueled by aggressive and undisciplined workers' compensation pricing strategies, and problems associated with the Unicover pool and other low-level reinsurance programs. Fortunately, rates are beginning to harden in California and other markets; however, A.M. Best expects market dislocations from aggressive carriers that over-extended themselves financially. Rate relief in the middle-market will carry into 2000 but will quickly moderate. Pricing will continue to be constrained by excess capacity and risk managers poised to self-insure.

7) Competition Intensifies. Innovative competitors are developing business models that are exploiting areas of industry inefficiency and rapidly gaining online traffic and customers. Leaders in personal-auto coverage will be pressured to reduce cost and compete online. Proactive companies with strong branding, services and product are realizing that first-mover advantage is critical. They are forging preemptive marketing alliances with other financial-service providers and Internet companies that possess superior marketing, distribution and customer reach. National and local marketing alliances will be most important within the personal and small commercial segments, where product differentiation is minimal. Risk-managers' demands for integrated-insurance and capital-market-based products, and for customized solutions will favor more sophisticated financial-service concerns that act as insurer, as well as reinsurer, guarantor, counterparty and investor.

8) Consolidation Takes Off. Roughly one-third of the 1,100 property/casualty insurance groups operating as of 1998 are "at risk" of losing their operating autonomy or withdrawing from the market by 2003.A.M. Best's current consolidation study reveals that the number of industry groups shrunk by roughly 5% during 1999 and is keeping pace with earlier predictions. Deregulation, wider access to information, and global competition, will increase the pace of industry consolidation. These factors will expose undifferentiated, high-cost providers, forcing them to merge or face a future of declining business. Segments and groups ripe for consolidation include:

* Medical malpractice insurers.

* Inefficient regional carriers.

* High-cost independent-agency companies that consistently rank below the top three within their agent plant.

* Domestic reinsurers that lack global reach.

* Middle-market insurers that have significantly underreserved loss reserves.

9) Excess Capital. A.M. Best estimates that the industry remains over-capitalized by $100 billion, or 30%, relative to our minimum Secure rating level of "B+"--even after accounting for a 100-year catastrophe event. Despite the current glut of surplus, new funds and more capacity will be provided by the capital markets as risk securitization gains broader investor acceptance. Market leaders will deploy excess capital to fund "bolt-on" strategic acquisitions to consolidate their market positions. A.M. Best expects greater consolidations of "books-of-business" as insurers become more disciplined in allocating capital to areas of specific competence or competitive advantage, and withdrawing capital or divesting businesses from areas with little prospect for adequate returns. More insurers are realizing the importance of value creation and achieving performance levels and returns on capital consistent with their stakeholder expectations.

10) Lackluster Results Persist. The industry's after-tax return on equity will fall from its five-year high of 13% in 1997 to 5% in 2000. The combined-ratio will deteriorate by seven points to 109 during the same period as commercial underwriting results bottom-out, and personal auto steadily slips from premium cutting and the reduced benefit from prior-year reserve redundancies. A lack of premium and investment leverage, combined with declining interest rates, is also hurting ROEs. Investment yields will remain below the 5% level in 2000. Barring an extraordinary bull stock market in 2000, industry surplus could contract as reduced net income is offset by elevated stockholder dividends paid from over-capitalized insurers. The industry's premium growth in 2000 will improve to 3.7%. Rate hardening in commercial classes, particularly workers' compensation and commercial auto, will be more fully reflected in insurers' income statements in 2000. Personal auto growth remains resilient as more insured vehicles and greater-insured values from today's favorable economy serve to offset reduced average premium rates. Beyond 2000, the industry's premium growth will flatten as commercial rate hardening will be short-lived and cheaper personal auto is sold on the Internet.