Time to Act.

Insurers need to move quickly from the planning stage to the execution stage to respond strategically to the rapidly changing financial landscape, said Larry Mayewski, group senior vice president, Rating Division, A.M. Best Co. The majority of insurers are in a position to do so because they are working from a strong financial solvency position, Mayewski said.

Defining events of 1999: The passage of financial-services modernization--even though its significance may be more symbolic than substantive. The agreement to eliminate most of the walls keeping banks, insurers and securities firms out of each other's businesses codifies a decision the market had already made and begun acting on. Nevertheless, the compromise has long-term ramifications for everyone in financial services.

Reform will speed up the financial-services industry convergence that has been taking place for several years. This is likely to occur more through strategic affiliations than outright mergers and acquisitions, although it wouldn't surprise me to see a couple of blockbuster deals in the near to medium term. Banks may be only too happy to open up distribution outlets for and share information with their insurance partners, but few will have the appetite to take on a substantive amount of insurance risk through underwriting.

Also, acquisitions involve very tangible costs, and companies undertaking major acquisitions have to feel confident that the deals not only make strategic sense but will generate returns that exceed their cost of capital. Insurers that pursue acquisitions, therefore, are likely to be large, well-capitalized companies that can take advantage of economies of scale. For small and midsized companies, affiliations may offer the best of both worlds: the opportunity to benefit through diversification and cross-selling without taking on aggressive financial leverage, inordinate costs and unfamiliar risks.

Another significant event in 1999 was UnitedHealthcare's decision to abandon its prior-approval requirements for medical-treatment decisions in its HMO. This move to return medical decision-making to the hands of doctors changes the shape of the managed-care playing field and raises the question of how other HMOs will respond. Aetna has said publicly that it wants to move more aggressively down this path.

Utilization review has been a cornerstone of managed care. If other companies follow UnitedHealthcare's example and we see that managed care's mission of reducing unnecessary medical treatment has been successful, the implications for health insurers will be tremendous. With all of the negative publicity surrounding managed care--particularly HMOs--UnitedHealth's decision may help improve the industry's image. This is critical in a business built on trust.

Surprise of 1999: That would have to be the regulatory takeover of General American related to the company's short-term funding agreements.

The surprise here was not that General American was engaged in this potentially volatile business or that a large amount of liquidity might suddenly be required. Our analysts stress-tested this company's exposure under scenarios requiring $2 billion to $3 billion of liquidity over a matter of weeks and determined that General American--a strong company with an outstanding franchise--deserved its Secure rating.

The biggest surprise was that General American--knowing the size of its exposure to these funding agreements and the likelihood of a negative investor reaction to a downgrade--so misjudged Moody Investors Service's response to its activities that it put itself in a position to have its rating lowered.

The company had other options. It could, for example, have managed an orderly liquidation of its funding agreements or enhanced its liquidity through a third party. The one-notch downgrade from Moody's led to a run on the bank and a need for upward of $6 billion in liquidity in a matter of weeks. This went well beyond any realistic stress test.

Defining events of 2000: As I said before, I wouldn't be surprised to see a major financial-services combination--possibly on the scale of a Citigroup--perhaps involving a major European player or a bank, broker or insurer combination.

This prediction doesn't require much in the way of a crystal ball, since financial reform has largely been not a question of "if" but of "when." Most companies have been planning for the day the walls come down, and some already have been taking action within the existing framework.

What do you foresee happening to the industry with respect to financial solvency?

On both the property/casualty and the life/health sides of the industry, solvency remains strong. However, companies will have to respond strategically to rapid changes in the financial landscape. It is time for insurers to move from the strategic-planning stage to the execution stage.

While there will always be some insolvencies, the real issue is less one of solvency than of long-term viability. For companies that are not well positioned to compete, it may not become an issue of honoring their existing obligations but of attracting new and profitable business.