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2002: insurers deal with a new crisis, old issues. (Industry Strategies).

Corporate misdeeds hit the directors and officers line and affected insurers' investments, but problems such as mold, rising health-care costs and a troubled medical-malpractice line continue to plague the industry.

The corporate debacles, such as Enron and WorldCom, and their effects on the insurance industry were the new challenges for 2002. But as for the remainder of the top 10 stories -- the saying the more things change, the more they stay the same, holds true. Health insurers struggled to balance raising premiums with rising health-care costs, the workers' compensation market was in turmoil and homeowners insurers continued to battle the mold issue. Medical-malpractice insurance turned into a crisis, controversy surrounded credit-based insurance scoring and State Farm remained the bellwether of the industry.

RELATED ARTICLE: Equity markets hit industry hard

Sinking stock prices and the defaults of some major corporate bonds adversely affected the earnings of insurers in 2002, and recovery may not be any time soon.

Life insurers felt the pain in their variable life insurance and variable annuity businesses, in which fee income is linked to assets under management. Property/casualty insurers saw investment earnings fall, forcing them to underwrite more carefully and to significantly raise premiums.

As if lower fee income for variable annuity writers was not bad enough, they and their reinsurers now face exposure unheard of in the ebullient 1990s:The guaranteed minimum death benefit in many variable annuity contracts exceeds the contract value. While the standard death benefit is the higher of the amount invested or the contract value, many insurers in recent years have expanded the death benefit to cover highest anniversary value or even annualized gains as high as 6%.

A consequence of this higher exposure surfaced in the third quarter, when Cigna Corp posted a $720 million charge to increase reserves for reinsurance contracts on variable annuities. Cigna is one of the largest writers of variable annuity reinsurance.

Some leading variable annuity direct writers were doubtlessly happy about having reinsured significant amounts of their guaranteed minimum death benefit exposure. Among them are Hartford Financial (90%), Manulife Financial (85%), Nationwide Financial (58%) and Phoenix Cos. (85%), according to equity analyst Andrew S. Kilgerman at Bear Stearns & Co. But Kilgerman said that other direct writers have little or no guaranteed minimum death benefit reinsurance. Lincoln National Corp. and Prudential Financial do not reinsure the risk, and MetLife Inc. insures only an estimated 8%, Kilgerman reported.

The worst may not be over for variable annuity writers, and "life companies' recent results suggest that profitability for the variable annuity business could be permanently impaired," said J. Paul Newsome, a certified financial analyst, and analyst Robin B.Albanese, both at Lehman Brothers Equity Research. They wrote in a recent report that even a company as well-positioned as Hartford Financial is no longer able to buy guaranteed minimum death benefit reinsurance at acceptable prices for new business, which effectively will reduce the company's margins And while Hartford Financial and others will be changing their products and potentially charging customers more in the future for guaranteed minimum death benefit-type features, "the industry apparently is unable to go cold turkey and get rid of these costly features," they wrote.

After being hit in 2002 with net losses related to under-performing portfolios and exposure to alleged accounting fraud of companies such as WorldCom Inc., insurers also began scrutinizing the backgrounds of the boards and management of companies that are potential investments. Insurers are spending more time underwriting a company's management and investigating how it expands, whether internally or through acquisitions. Insurers also reacted in 2002 by divesting equity exposure and opting for sleep insurance in the form of high-quality mortgage-backed securities and long-term corporate bonds.

Net investment income for the property/casualty industry in the United States fell only 4.1% to $18 billion for the first half of 2002 as compared with the first half of 2001, according to an A.M. Best Co. special report. The decline in underwriting losses "significantly outpaced the moderation in investment income," wrote Karen Horvath, vice president in the property/casualty division. Robust price increases fueled the results, with net premiums written up 10.9%.

Horvath expects that the growing exposure the industry faces in professional liability lines, mold and terrorism will serve to protect the hard market, at least over the near term.

--Ron Panko

D&O: Terms Tighten; Premiums Rise

Corporate governance issues surfaced as a consequence of some high-profile corporate bankruptcies tied to alleged accounting irregularities.

At issue is the damage the litany of corporate accounting irregularities has done to investor confidence and potentially to commercial insurers who wrote directors and officers and surety coverage for the companies involved. D&O insurance protects a company's board of directors against claims of mismanagement from employees and shareholders.

The Enron bankruptcy; the second-largest in the United States since 1980, was tied to accounting irregularities and refocused corporate America on D&O coverage. "Enron showed how severe a D&O loss could be. On its own, it would have been pause for change in the D&O world," said John Keogh, president and chief operating officer of National Union Insurance Co., a member of American International Group. Various sources put Enron's D&O coverage at $350 million.

Past underwriting, rising claims costs and corporate scandals caused the D&O market in 2002 to see price hikes of up to 50%. Reacting to the corporate troubles, insurers also asked policyholders to take more skin in the game in the form of higher deductibles and requesting reduced limits and eliminating multiyear contracts.

On the underwriting side, high-profile accounting scandals wore a well-trod path to the courtroom. In November, bankrupt telecommunications company WorldCom Inc. and a subsidiary of AIG reached a tentative agreement over a D&O insurance dispute.

National Union Fire Insurance Company of Pittsburgh, which had issued three D&O liability policies to WorldCom covering 2002, had moved to have the policies declared null and void, after WorldCom filed for bankruptcy.

D&O coverage disputes are also in litigation involving accounting firm Arthur Andersen LLP, which went insolvent in the aftermath of the bankruptcy of its client, energy trader Enron Corp. Insurers are also seeking to deny Enron D&O coverage.

Todd Bault, an equity analyst with Sanford C. Bernstein & Co., said the difficulties faced by both D&O and surety underwriters in 2002 are signs of fundamental weaknesses from the pre-2000 soft market coming home to roost.

"In the past soft market, there were both softening of prices and softening of terms," he said. "You had more cover granted. You sometimes had longer cover granted for D&O. For surety, there was a broadening of the things that were covered.

"Now, with claims coming in, you are seeing not only prices going up, but a tightening of terms and conditions," he added.

Changes in corporate governance practices led to scrutiny for insurers in how they account for their own businesses-especially the big, complex companies such as AIG and Citigroup.

Following a public call from Berkshire Hathaway Chairman Warren Buffett for corporations to treat stock options as expenses, several insurers, including Chubb and Citigroup, said they would. "Investors have made it clear that they want options accounted for in this manner," said Citigroup Chairman Sanford Weill.

Bault expects the accounting practices unique to insurers to remain about the same. "The big issues for the insurance industry, which revolve primarily around reserves, haven't changed," he said. "The current environment may have brought a bit more focus back to them. Reserve accounting is difficult. It's hard to measure, and can always be improved, but there is a limit in how much more accurate it can be."

--David Pilla

Medical-liability rates increase

In 2002, physicians were faced with not only higher medical-malpractice insurance rates, but also a limited number of companies offering the coverage. The industry was still adjusting to St. Paul Cos. -- the largest carrier of medical-liability insurance in the United States --cutting the line at the end of 2001, while other companies scaled back their market share or left some states entirely.

As medical-liability costs rose by double digits -- triple digits in some states -- trauma centers and hospitals closed, the most salient case being the temporary shutdown of the Las Vegas University Medical CenterTrauma Center in July. Physicians have retired, moved to another state, or changed the way they practice medicine as costs for certain high-risk specialties exceed a physician's ability to pay and still be able to operate a practice.

The American Medical Association designates 12 states that have a crisis in medical care, said Dr. Donald Palmisano, president-elect of the association. These states are Florida, Georgia, Mississippi, Nevada, New Jersey, New York, Ohio, Oregon, Pennsylvania, Texas, Washington and West Virginia.

"The system is melting down right now," Palmisano said. "People need to remember that as this problem continues, and physicians retire or leave practice, we can't just go to Home Depot and ask for six OBGs off the shelf. It takes a lot of years to make a good obstetrician or a good neurosurgeon."

Industry groups, the AMA and legislators have been pushing for reform of the medical-liability laws both in state legislatures and on a federal level. Most of these proposals are based on California's Medical Injury Compensation Reform Act, or MICRA, implemented in 1975.

MICRA places a cap on noneconomic damages -- commonly referred to as "pain and suffering" -- at $250,000, limits the time during which a claim for malpractice can be filed, provides for binding arbitration and limits lawyer fees on any medical-liability case.

Many states have been moving to pass legislation dealing with medical-liability costs.

"The biggest states that enacted something meaningful on medical-liability reform this year were Mississippi, Nevada and Pennsylvania, and what we're seeing is legislative actions based off of California's MICRA law". said Sarah White, commercial lines policy manager for the Alliance of American Insurers.

Ohio attempted to pass a medical-liability reform bill based on MICRA, after the state's Supreme Court declared limiting noneconomic damages unconstitutional. The bill, SB 281, includes a $750,000 cap on noneconomic damages for catastrophic injuries and $500,000 for all others. When the Texas Legislature convenes in 2003, it will also consider a MICRA-based bill.

On a federal level, the House passed medical-liability reform bill HR 4600 in late September, but the Senate version of that bill has not been passed, Palmisano said.

Advocates who say tort reform is not the problem, but rather increasing insurance rates and poor doctors, should note that studies have shown only 18% of malpractice cases go to trial in states with mandatory review, and of those, 80% are closed with no payment to the plaintiff, Palmisano said. If doctors operated for appendicitis, and 80% of the time the test came back for a normal appendix, the doctor's license would be pulled, he said.

"When people talk about peer review, we need some peer review on the legal system. It's out of control," Palmisano said.

John Hillman

Terrorism cover challenges remain

At the same time insurers have been saying they wanted a federal backstop to cover future terrorism losses, they've been saying they didn't know how to price terrorism risks.

More than a year after Sept. 11, in which insurers paid billions in insured losses from the disaster, President George Bush signed a federal terror bill in late November.The backstop program states insurers are responsible for terrorism losses equal to a percentage of their company's annual written commercial premium, plus 10% of losses exceeding that figure. The federal government would pay the other 90%, up to $100 billion.

Now that the backstop is here, what's changed in terms of the industry's knowledge about pricing?

"Nothing has changed, and it's as difficult as ever to price," said Ron Ferguson, retired chairman and chief executive officer of Gen Re, who now acts as a consultant for that company, and other Berkshire Hathaway companies.

Yet, expectations are that writers of commercial property/casualty, workers' compensation, business interruption, excess and surety insurance -- lines required to participate in the program -- will be reasonable in their pricing.

Based on early conversations with insurance companies, those who would write coverages for "non-trophy" buildings "will act responsibly, but will charge additional premium,' said Bruce Guthart, chairman and CEO of Kaye Insurance Associates, a New York-based commercial insurance broker.

"It's still a free market environment," Guthart said. "Carriers, at the pricing levels they're charging now, absent terrorism, are at a point now where they're believing they're going to make an underwriting profit for the first time in decades, and they're not prepared to lose that business."

The federal backstop requires participating insurers to state the price of terrorism coverage in disclosure notices, and eventually on the policy itself. The program also eliminates terrorism exclusions, unless the policyholders state they do not want terrorism coverage.

Not all insurers included in the program are particularly thrilled about the disclosure and reporting requirements of the federal backstop program, said Monte Ward, vice president of federal affairs for the National Association of Mutual Insurance Companies.

Some commercial writers didn't exclude terrorism; they just went ahead and wrote the risk, Ward said. Whether they charged more or not depended on what they were writing. Any increases were part of the overall hardening market and not necessarily attributed to terrorism.

"Now they have to pinpoint what is terrorism in their price, and that's a problem. Now they have to point it out in each policy and they're having a hard time figuring out what the price is going to be," Ward said.

If companies are going to make errors in the pricing, they may tend to be downward, rather than upward, said Joel Wood, senior vice president of government affairs for the Council of Insurance Agents and Brokers.

The backstop is a temporary bid to restore the marketplace, "not a government solution," Wood said, adding, "I don't see companies using this as an excuse to go off and draw a large premium."

State insurance departments will have the authority to determine if pricing is "excessive," but they also have a huge challenge in figuring out what "excessive" is, said Terri Vaughan, Iowa insurance commissioner and immediate past president of the National Association of Insurance Commissioners.

Dennis Kelly

Mold Still Issue for Insurers

Insurers began to react proactively to mold claims in 2002. The industry's response to billions in losses in homeowners insurance and publicity included a major initiative to address water claims quickly, filing for policy revisions and turning to subrogation to recover claim costs.

Attorneys, including Joseph A. Gerber, a senior partner with Cozen O'Connor, hammered the message to insurers about the importance of inspecting water claims quickly, using qualified experts to avoid lawsuits. "Look at the million-dollar verdicts-the actual property damage component wasn't the large part. The millions came from bad faith on the part of insurers," he said.

Reacting to the mold-claim nightmare in Texas and California, regulators from several states such as Florida, Maryland and Connecticut investigated or issued guidelines limiting first- and third-party insurance coverage for mold-related claims. In Washington, Allstate and State Farm filed forms requesting policy clarifications for mold coverage. For example, Allstate limits mold coverage to $5,000 above the cost of repair for the event causing the mold problem, with no option for additional coverage.

Commercial insurers of hotels, day-care centers and apartment buildings also dealt with mold claims. Greg Thompson, the president of Thomco, a Kennesaw, Ga.-Based managing general agency, said property water claims are driving his company's property loss ratio higher than it has ever been. Melinda Ballard, who received a $32 million jury award from Farmers Insurance concerning the handling of a water-damage claim, said although some commercial insurers are pulling back from business because of the potential liability of mold, the problem should be viewed as a business opportunity. "I believe insurers should react differently than they did in the homeowners market. Turn lemons into lemonade," Ballard said.

Mold-related lawsuits also expanded from homes to cars. In a lawsuit filed in North Carolina, the owners of a 1999 Cadillac Escalade sport utility vehicle sued its manufacturer, General Motors, alleging water leaks caused by faulty weather stripping resulted in mold growth that made the owner suffer depression and a host of medical problems.

Texas remained "ground zero" for mold claims and homeowners coverage. The Texas Department of Insurance, responding to double-digit homeowners insurance rate increases and insurers puffing back coverage, approved six new residential property forms in July, giving consumers more flexibility in coverage decisions while easing the problem with severity and frequency of claims for insurers.

In February 2002, Texas Gov. Rick Perry said in a joint statement with state Attorney General John Cornyn that the state's largest writer of homeowners, Farmers, "had engaged in unfair, discriminatory practices to charge consumers excessive and unjustified rates." John Hageman, state executive officer for Farmers, said the third-largest property/casualty insurer in the United States was "being used as a political football by people running for public office."

In Early December, Farmers reached an agreement with regulators to remain in the state's homeowners market and agreed to a $100 million settlement.

Lynna Goch

State Farm Retrenches

State Farm, the nation's largest auto and homeowners writer, took dramatic steps to return to profitability in 2002, which also affected the entire personal lines industry.

After posting $5 billion in net losses for year-end 2001--a loss bigger than most of its competitors' entire books of business--State Farm changed its modus operandi from undercutting competition to gain market share to placing moratoriums on new business, while seeking rate increases in both its auto and homeowners lines. State Farm also reported a net loss of $1.5 billion for the first three quarters of 2002, said Dick Luedke, a company spokesman.

In June 2002, State Farm, which insures one in five homeowners in the United States, announced plans to stop writing new homeowners business in 17 states and restricted sales in another six states. By August, State Farm had instructed its agents in as many as 35 states to be more selective in writing new business.

State Farm also has plans to exit the auto insurance market in New Jersey, and had planned to stop writing new auto insurance in Louisiana until it won approval for a 14% auto premium hike for standard coverage and a 19% increase for high-risk drivers. By October, State Farm had resumed writing some new homeowners insurance in at least three states--Missouri, Kansas and Florida--after raising rates.

Luedke said increased claims severity, inadequate rates and the downturn in the equity markets led the insurer to "more closely manage our growth, not stop our growth." He said the company raised auto insurance rates by an average of 10.5% and homeowners coverage by 19% for 2002.

"For the overall personal lines industry, it's a positive that State Farm has taken these steps, as it should further overall rate firming in the sector and provide opportunities for unit growth for other companies," said Richard Attanasio, senior financial analyst with A.M. Best Co. "However, while it is a positive, there are risks, as those who absorb the businesses will have to be disciplined underwriters to manage any potential growth."

Some companies have seen a tremendous jump in new business opportunities since State Farm announced its changes. For instance, in New Jersey, the third largest auto writer in the state in 2001--New Jersey Manufacturers Insurance Co.--saw the number of new applications double in two years, growing from an average of 8,126 a month in 2000 to an average of 16,000 per month in 2002, said Eric Stenson, a company spokesman.

Allstate, the nation's second-largest auto and homeowners writer, saw its premiums written grow by 7.8% for the first three quarters of 2002, compared to the same period in 2001. That included a 6.8% increase in standard auto and a 21.2% increase in homeowners.

While all insurers have been stung by the tumbling stock market dragging down investment income, State Farm has felt it more than most. "Since State Farm invests more in equities than their competitors, over the last 12 to 18 months equity markets have taken a significant toll on its capital," Attanasio said. While the total personal lines industry, excluding State Farm, had an investment leverage--or common stocks as a percentage of surplus--of 37.3% at year-end 2001, State Farm had an investment leverage of 91.5%, Attanasio said.

"We know at this point that our 2002 results will still not be where we'd like them to be. We still need more improvement, and we're confident that we will see more improvement," Luedke said.

Meg Green

State Farm 2002 Fast Facts

* Reported a net loss of $1.5 billion for first three quarters

* Insures 1 in 5 homeowners in the United States

* Raised auto insurance rates an average of 10.5%

* Raised homeowners insurance rates an average of 19%

Scoring Debate Leads to Legislation

The controversy surrounding credit-based insurance scoring has shifted from whether or not such scores correlate to higher risk of insurance losses to how to use the scores without being accused of discrimination.

Credit information measures patterns of responsibility in consumers and how the consumer accepts risk.

Credit-based insurance scores have proved to be beneficial to consumers, with many more policyholders obtaining discounts on the basis of their credit score than have received adverse action, said Lynn Knauf, personal lines policy manager for the Alliance of American Insurers.

Many states have held public discussions regarding the use of insurance scores, as consumer advocates claim these scores discriminate against minority groups, using information on age, sex, income, ethnic background or employment. None of this information, however, is used to determine a score, Knauf said. Scores are gleaned from credit reports, which don't reference age, race or any information considered as inappropriate factors in an underwriting review, she said.

Eight significant laws were passed in 2002 out of about 30 or so bills presented across the country, Knauf said. For example, Utah lawmakers approved a measure that prohibits insurers from using credit scoring as a criterion for canceling policies or denying their renewal. Washington's new law limits insurers to a 20% difference between the premiums charged to people with clean credit histories and those charged to people with poor insurance scores. And Idaho legislators passed a bill prohibiting carriers from charging a higher premium or declining to insure a person based primarily on credit history.

Under regulations enacted last summer in South Carolina, insurers can't refuse to issue, cancel or nonrenew a policy based solely on credit information without consideration of other underwriting factors. Insurers will be required to file actuarial justification for using credit information and must disclose the use of credit information to consumers.

The National Association of Insurance Commissioners is working on a model regulation for credit-based insurance scoring that contains several options. The most restrictive version of the regulations bans the use of credit information or credit-based insurance scores in any fashion du during the initial review of an auto or homeowners insurance policy application.

No states have considered this broad a ban on credit information. Maryland regulations, however, do prohibit using credit information in underwriting homeowners insurance. The regulations limit using credit scores to the initial review of an automobile policy application, prohibiting their use on any follow-up review or renewal.

The more common version of state regulations prohibits an insurance company from taking adverse action solely on the basis of the insurance score, according to the NAIC. The same limitation extends to renewals, permitting scores to be used only if they improve a policyholder's premium rate, the NAIC said.

Most state regulations prohibit adverse action if there is no score or insufficient information to develop one. Laws such as the Fair Credit Reporting Act or cancellation laws already limit an insurance company's ability to take adverse action based on credit information, Knauf said.

John Hillman

Workers' Comp Market in Turmoil

The workers' compensation insurance market continued to struggle in 2002, following one of the worst years in the market's history when it posted a combined ratio of 121, according to NCCI Holdings Inc.--an organization that tracks this part of the insurance market.

Compounding the poor results is the lack of terrorism reinsurance coverage, which most reinsurers have excluded since Sept. 11, 2001. Now employers with 100 or more employees in an urban high-rise building are considered a high risk--a category that used to be reserved for workers with dangerous jobs. That's put many of the more than 1,770 companies that write less than $100 million in annual commercial lines premium in danger of insolvency if they insure a 100-employee operation that's destroyed in a terrorist attack, said Nancy Schroeder, assistant vice president of the National Association of Independent Insurers.

"A 100-person risk is something many small companies would have competed for and would have loved to write," Schroeder said. "But now, in Illinois, for example, that could mean $100 million in death claims. The Sept. 11 events really added to the distress in a market that had already begun to harden."

While workers' comp premiums rose 13.5% in 2001, the insurance industry sought additional rate increases in 2002. The NCCI, which files loss cost ratings in 37 states, requested increases in 28 states as of November, said Pete Burton, senior division executive for state relations. For this same time in 2001, the NCCI had requested nine increases. "It's a changing landscape. You're seeing the cost pressures of medical and litigation costs pushing loss costs up," Burton said.

Perhaps the most telling barometer of the troubles in the workers' comp market is the growth of the residual market, where employers must go to buy insurance if they can't find it in the private market, Burton said. For the first three quarters of 2002, the number of applications that the residual market has received is up 31% over the first three quarters of 2001. By premium, the residual market has grown 58% in that time, Burton said.

"We are seeing a lot of larger risks looking for coverage," Burton said, noting there's been a 76% increase in policies with premiums of $100,000 or more, while policyholders with under $1,000 in premium have increased by only 2%.

Workers' comp has been an especially difficult line in California, where the State Compensation Fund of California grew 102% in direct premiums in 2001 to become the largest workers' comp writer in California and in the country.

California's workers' comp woes mostly stem, however, from the state's poor timing in adopting an open rating law, Schroeder said. After California began to allow companies to set rates without regulatory approval in 1995, carriers slashed prices to gain market share, but were able to compensate from underwriting losses as long as investment income was strong. But recent downturns in the equity markets and a drop in interest rates, plus the demise of several large carriers, have left the market in crisis.

Meg Green
Worker's Comp Combined Ratios After Dividends

1997 103.5
1998 111.3
1999 118.6
2000 120.8
2001 120.9

Source: Best's Aggregates and Averages--Property/Casualty, 2002

Note: Table made from bar graph

Health-care inflation grows

Rapidly rising health-care costs have stressed the U.S. health insurance system. Although insurers have managed to raise rates, most believe cost shifting won't work much longer. As the industry enters 2003, many are asking," What's next?"

It's a strange time for health insurers, said John Fitzgibbon, national industry director of managed care at KPMG LLP, an accounting and tax firm. While the industry is performing better financially than it has for a long time, health-care costs continue to escalate faster than they have in a long time. It's a "genie in the bottle" phenomenon, said Fitzgibbon, because rising costs are difficult to reverse. For example, costs rose 13.7% in 2002, according to a study by PricewaterhouseCoopers, and are expected to increase anywhere from 15% to 20% in 2003.

Employers are shifting the cost to employees, but employee compensation isn't going up as fast as the current inflation rate. And as the number of consumers and employers who can't afford insurance increases, health insurers are losing customers, said Dr. Don Young, president of the Health Insurance Association of America.

Higher rates from providers, state mandates, declining government funding, an aging population, the increasing costs of prescription drugs and higher utilization of benefits are all reasons for the increases. In addition, litigation costs impact premiums. Medical-malpractice litigation has skyrocketed, which puts financial pressure on insurers. It also causes physicians to practice "defensive medicine," which results in more tests and treatments than necessary, Young said.

In 2002, providers also filed lawsuits against insurers in at least eight states over payment practices. In several cases, physicians allege that insurers "downcode" or "bundle" codes for services, thereby paying less for a more expensive service or combining services and paying the cheaper bill.

So far, these lawsuits haven't been a big factor in rising health-care costs, Young said. But if a major class-action lawsuit were to move forward, it would create a large impact.

Litigation has led to a ruling that ordered Blue Gross Blue Shield of Georgia to share its fee schedule and its methods for calculating payments with doctors, which would have given the insurer less negotiating power over rates. The regulation has been loosened, however, Young said. As of Oct. 1, health plans must provide information about payments to enrollees rather than physicians. The information doesn't have to include actual rates, only general details about how the physician is being paid, such as through a capitation, fee-for-service or another arrangement. Meanwhile, Texas is currently developing rules that relate to fee disclosure.

The rising costs are also creating an opportunity for fraud. Unlicensed health plans have operated in all 50 states, and have left consumers with millions of dollars of unpaid claims. In addition to taking business away from legitimate health insurers and causing providers to make up for lost payments with higher rates, they give health insurers a bad rap.

"People may see the reports [about unlicensed plans] on the news and come to the conclusion that it's the practice of all health plans," Young said.

Something fairly dramatic must happen soon to mitigate the problem, Fitzgibbon said. He thinks forcing consumers to budget their health care, such as through direct-to-consumer health plans, and focusing on people with manageable medical conditions such as diabetes, could help.

Marie Suszynski
Factors Driving Rising Costs in Health Care (2001-2002)

General Inflation (CPI) 18%
Drugs, Medical Devices & Other Medical Advances 22%
Rising Provider Expenses 18%
Government Mandates & Regulation 15%
Increased Consumer Demand 15%
Litigation & Risk Management 7%
Other 5%

Source: Prepared by PricewaterhouseCoopers from publicly available

Note: Table made from pie chart

Bermuda Insurers Hold Their Own

The ascendancy of Bermuda's insurance industry in the wake of the 2001 terrorist attacks came as no surprise, but the influx of capital to the island--much of it to form new companies--brought wider recognition of a new reality: Bermuda is no longer a mere safety valve in times of tight capacity, but a permanent and influential part of the insurance world. Some industry observers went so far as to say Bermuda has eclipsed London as a leader, having attracted more than half of the capital that poured into the industry in 2001 and 2002.

The sequence of events after Sept. 11 doesn't necessarily mirror what followed Hurricane Andrew--the previous watershed event in Bermuda's development as an insurance center. Then, new companies sprang up, and most were absorbed by larger, more established players within a few years. But the same companies that feasted on the newcomers in the 1990s now have fewer holes to fill in their portfolios, and there are fewer truly independent start-ups in the current crop.

Michael Hallett, an equity analyst with Fox-Pitt, Kelton in New York, said companies that might otherwise look to buy up their new competitors don't have the capital to do so, at least in the short term. Besides, he said, the current market offers "pretty reasonable organic growth opportunities."

The new companies didn't find all their expectations met when they started operating early in 2002. Big, established insurers used their long-standing relationships and defended their market positions aggressively, leaving relatively slim pickings in areas such as property catastrophe, where the newcomers had hoped to grab business. The older companies also held their place as the drivers of pricing, at least in the early going. But the start-ups found plenty of ways to deploy their capital, opportunistically filling gaps in both reinsurance and primary coverage, observers said.

The Bermuda operation of Arch Capital Group Ltd., for example, "has been fairly disciplined in how they approach the market, and yet they've seen ample opportunity in how to use their capital," said Jay Cohen, an equity analyst with Merrill Lynch Global Securities in New York. And the battle between the startups and the older players is hardly over. "Given the reserve problems that many of the large reinsurance companies have, there is a clear benefit in having an unencumbered balance sheet with very little reserve risk," Cohen said.

Over time, Hallett said, some of the new companies could become lasting powerhouses, aided by "impressive management teams" and relatively clean capital. "I think you could see some of these companies emerge as leadership companies" with global franchises, he said. In early December, Endurance Specialty Holdings Ltd., itself barely a year old, formed a new, London-based subsidiary, Endurance Worldwide Insurance Ltd., to write commercial insurance and reinsurance in the United Kingdom.

Hallett noted a strong London presence among the top executives of the start-up companies--and a growing tendency for traditional Lloyd's business to be written in Bermuda. This includes high-excess coverage for Fortune 500 customers and lines such as marine, aviation and satellite.

Brendan Noonan
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Publication:Best's Review
Geographic Code:1USA
Date:Jan 1, 2003
Previous Article:Managing between a rock and a hard market. (Cover Story).
Next Article:People to watch in 2003. (Industry Strategies).

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