Fitch Ratings has released its’ “final” analysis of the P&C industry’s results for 2003. The report focuses on reserve deficiencies, and while the results look better than those from a year ago, the overall message is troubling.
Here are the highlights and my comments in italics…
–total reserve deficiency at the end of 2003 was between $43 and $61 billion…the industry continues to be unable to predict future costs with any accuracy; this will give investors pause as they consider whether to provide funds to the P&C industry, leading (over the longer term) to capital constraints and therefore a tighter market
–most of this is due to under-reserving in the accident years 1994-2003, with the bulk between 1997 and 2002. historically poor reserving in this period has been due to a failure to predict the rise in health care costs. Many reserves for claims occuring in the late nineties assumed a health care inflation rate of 7-8%, an assumption that continues to drag down financial results, and has even contributed to the demise of several P&C carriers, including Atlantic Mutual.
–asbestos is responsible for between $15 and $25 billion of the total, reflecting the industry’s continued head-in-the-sand approach.
How do we put this in context?
1. The P&C market appears to be softening, with rates for short-tail lines (those where claims are usually reported within a few months of the end of the policy term) falling while longer term lines (liability, Workers’ Comp) leveling off or declining somewhat. This softening cannot continue if carriers are going to add to reserves – without higher premiums to make up the deficit, the reserve deficiency will continue to hang over the market.
2. Health care costs receive barely a mention in the Fitch report. Health care costs are the primary driver of most claims, and this lack of attention on the part of a premier rating agency and industry expert does not bode well for the industry as a whole – if they do not know what is causing the problem, they will not be able to address it. And the industry has not demonstrated ANY awareness of or commitment to addressing rising medical costs, even as trend rates in P&C exceed 12%.
3. Asbestos, asbestos, asbestos – the word that brings chills to the executive suite at many an insurer. Some carriers have “bitten the bullet”, while others seem to be adopting a “hope and pray” approach to dealing with their reserving problem. That approach, especially when viewed in the context of the softening market, will likely mean additional financial struggles for some P&C carriers and reinsurers.

Best’s has released their latest report on the profitability of the Property and Casualty insurance industry. The net is 2004 has been a very good year, despite the large number of catastrophic events most notable of which were the four hurricanes that devastated the southeastern US.
The industry appears to have been profitable on an underwriting basis to the tune of over $4 billion for the nine months ended 9/30/04. This is a very strong performance, as the industry typically loses money on an underwriting basis, relying on investment income (from investing premiums in debt and equity instruments) to deliver profits.
If not for the estimated $20.5 billion in covered losses from the hurricanes (most of which was incurred by US insurers), 2004 would have been a stupendously profitable year. But, as one wag put it, that’s why they call it insurance.
This silver cloud has a grey lining. Historically, senior management in the P&C industry has a pathologic aversion to profits, which they demonstrate by cutting premiums and writing lots of bad business whenever they start to make lots of money. Expect this condition to perpetuate itself in the new year. In fact, Best points out that it may already have started…
“(the) industry’s operating performance measured by return on revenue improved to a healthy 10.3 percent as of nine-month 2004 results, up from 8 percent in the comparable 2003 period. However, operating results moderated from the 13.8 percent return on revenue reported for the first six months of 2004 due to reduced underwriting income…”

Coventry’s pending acquisition of First Health passed a key milestone with the Feds’ approval of the merger. This is now a “done deal”, not that there was much doubt it was going to happen.
News from sources familiar with First Health indicate that Pat Dills, Lee Dickerson, and Ed Wristen (FH senior leadership) will be departing the organization in the (very) near future. Art Lynch, present head of sales for FH, will remain on board, and will likely assume additional responsibilities.
One interesting tidbit related to this is the pending issues resulting from Coventry’s ability to access HealthNet contracts. Huh? Read on…
FH acquired the WC assets of HealthNet earlier this year. As part of the deal, FH received access to HealthNet’s WC contracts with their providers – this was perhaps the most attractive piece of the deal to FH, which had long been under pressure to improve California network results. Well, sources indicate that the FH-HealthNet contract does NOT include any change in control language, leaving HealthNet contracts (at least in theory) accessible by Coventry.
If these sources are correct, one has to wonder what HealthNet was thinking…rumors had abounded earlier this year about FH’s shaky future.

Tom Lynch’s WorkComp Insider has a great synopsis of the weekend’s WC blogging activity.

As goes California, so goes the nation. Particularly bad news if the trend one is watching is health care. California’s health care premiums have just passed the $10,000 per family threshold, a level some experts think will finally lead to calls for significant change.
Don’t bet on it.
The frightening thing about this increase is it reflects a lower than expected trend rate of 11.4%…2003 costs were up a whopping 15.8%. When 11.4% is good news, you know we’re in trouble.
The study, sponsored by the California HealthCare Foundation and Kaiser Family Foundation, also covers national health care premium trends. And those numbers aren’t a beam of sunshine either.
The national health care trend rate is 11.2%. Since 2000, health care premiums are up 61%.
Sixty-one percent.
For those who are interested, a summary of the report presents the highlights, including employer contribution rates and trends, specific plan trend rates, and future cost projections. Make sure you are sitting down when you read this.

Risk and Insurance magazine, an industry publication focussed primarily on the property and casualty industry, has an interesting interview with Marsh CEO Michael Cherkasky. Cherkasky, a relative newcomer to Marsh who joined the organization when they acquired Kroll (investigations and security firm), was perhaps the best stroke of luck Marsh could have had.
Cherkasky worked with NY Attorney General Spitzer at the state level, and they know each other well. His appointment to CEO will go far to deflect Spitzer’s attacks, as their relationship appears to be positive.
The interview details Marsh’s plans for the future, and is required reading for any risk manager, broker, or regulator wondering what the impact of the contingency commission-sham bidding scandal will be on brokers.
One excerpt is particularly telling…
(Risk and Insurance editor Jack Roberts) “Do you think that if other competitors don’t accept that model-that all sides of the transaction ought to be transparent-that that will give Marsh a competitive edge?
(Cherkasky) – “We absolutely do. The attitude of caveat emptor-let the buyer beware-that’s not going to be our attitude. We think that will be a competitive edge and that we will be very tough to compete with if you don’t do it that way. But that’s up to the marketplace. We’re going to adopt that because that’s what we believe is going to be effective in the 21st century under this regulatory environment and we’re confident it’s going to make a fair return for our shareholders.”
That competitive return will likely be considerably less than it was pre-Spitzer, but better lower returns than none at all.

Weiss Ratings has recently released their report on insurance industry profitability, and the news is both good and bad. Good if you compare it to past year’s reports, bad if you are expecting robust returns.
The report notes: “Of the 544 insurers studied by Weiss for the year ending 2003, 69 percent experienced either negative margins or profit margins of less than five percent.”
Makes the grocery business look like a great investment.
Breaking down the numbers further by category, here are the individual industry sector results:
HMO – 3.8%
Life Insurance – 8.2 percent
Health Insurance – 5.5 percent
and the overall winner for most profitable insurance sector is…
P&C at 8.3 percent
Not surprisingly for those who have been reading our blog, the culprit appears to be the industry’s inability to contain rising health care costs.
Melissa Gannon, Weiss VP, notes: “”Although the industry has enjoyed an increase in revenues by raising premiums, insurers have also had to deal with the rising cost of medical care as a result of more open networks, an aging population, expensive medical advances, and an inefficient healthcare system.”
While some in the media believe we are all wintering in St Bart’s except for those brief holidays in the Alps, the truth is we continue to work very hard to combat health care costs, and do not appear to be making much progress.
Note – For those unfamiliar with Weiss, they are perhaps one of the more critical rating agencies, but their tough standards have been validated time and again as the more recognized entities have missed such debacles as Kemper Insurance’s sudden demise.

The ongoing investigations into broker and insurer malfeasance continue to send shockwaves throughout the insurance industry. And, these investigations are causing those doing business outside the “broker-insurer-underwriter” world to revisit what have been long-established “ways of doing business.”
While Mr. Spitzer and colleagues have started their investigations at the sales end of things, they may well find themselves uncovering many other instances of inappropriate or unethical payments.
For example, managed care vendors often pay TPAs an “administrative fee” that is a percentage of the revenues they receive from the TPA’s clients. Typically these fees amount to 10-15% of total revenues, but fees in the 25% range are not unheard of. There is speculation in the WC industry that one large managed care firm pays one large TPA upwards of $10 million in “fees” annually.
These fees are rarely fully disclosed to the TPA’s clients, and when there is disclosure, it is obscured by legalese, buried in the depths of a lengthy contract, and often mistaken for innocuous boilerplate.
One very large WC TPA claims it has provided full disclosure by including language similar to the following.
“The TPA does not receive any payment from the managed care vendor, except it reserves the right to charge the vendor for administrative expenses related to implementing managed care programs.”
Clearly it is incumbent upon risk managers, TPAs, underwriters, and brokers to fully and completely disclose these arrangements. It is just as clear that until and unless the light of day is shone on a few of these deals, they will continue unabated.

The analysts continue to question the acquisition of First Health by Coventry Healthcare.
Wachovia analysts are among those who appear to be reserving judgement in their latest pronouncements (as noted in Maryland’s “Business Gazette”):
“The deal “marks a turning point in Coventry’s evolution,” the Wachovia report said. Coventry has historically been a regional managed care company operating locally concentrated health plans in several markets, and its customers have largely been small employers with some municipalities and local divisions of larger employers.
“With the acquisition of First Health, Coventry will change the profile of the company dramatically,” the report said. “For investors, the combined company will look like another multimarket managed care company trying to compete.”
First Health has a national preferred provider organization and a workers’ compensation business and does some pharmacy benefit manager services, areas that require different management skills than Coventry is accustomed to, according to Wachovia. In addition, First Health has had difficulty competing with the largest managed care companies such as UnitedHealth, Aetna and BlueCross BlueShield plans. ”
The challenge of integration will be met by one of the stronger management teams in the industry. The Gazette’s article goes on to note:
“We have always been impressed by Coventry’s management and are confident that the company’s internal candidates will be strong,” according to the Wachovia report. The analysts cited McDonough’s previous stint as CEO of a division of UnitedHealth, which has similar products to First Health.
Thomas A. Carroll, an analyst with Legg Mason in Baltimore, called Coventry’s leadership “one of the best management teams in the business.”
So what are the issues facing Coventry?
— Coventry is a regional HMO firm, with particular strength in small group fully insured business; FH is a national firm with a very large customer (MailHandler’s program as well as other large self-insured customers, and is also a major player ($194 million in 2003) in a business (Workers Compensation) that is foriegn to Coventry.
–Further, FH deals primarily with large-self insured group health customers, a market segment that Coventry has not pursued aggressively.
–Weak management at FH. Statements in the analyst’s reports as well as by Coventry management during the investor telecon on the day the acquisition was announced lead me to believe Coventry does not view FH management as up to the task. This, coupled with the large payday for 16 FH executives (splitting over $20 million between them) leads me to speculate the senior level at FH will not be around much longer.
–There were also rumblings in the market that FH was looking for an acquirer for some time; the Gazette goes on to quote Wachovia’s report; “Even without the acquisition, we have doubts about First Health’s ability to grow or even maintain recent results,” the analysts wrote. While Coventry “has bought ‘fixer-upper’ plans in the past, the repair of [First Health] will require a different set of tools.”
Coventry’s management takes a markedly different view from these reports, a view that is best summarized as “the acquisition of First Health by Coventry = the whole is greater than the sum of the parts.” After the hit the stock has taken, Coventry responded with a detailed explanation/defense of the deal at an analysts’ meeting in early November. Again, the main point appears to be that the new markets and national scope will enhance Coventry’s future earnings potential.

The investigations begun by Eliot Spitzer of broker-insurer business practices have not only spread from property and casualty insurance to other lines, but to other states, and now it appears there may be international repercussions as well.
The investigations and subpeonae appear to be increasing on a daily basis, with each morning beginning with an annoucement of additional targets. Employee benefits insurers and brokers are now coming under scrutiny, while the number of P&C carriers facing subpoenae has increased again today with St. Paul/Travelers the latest subject. Chubb is also under investigation, while also facing allegations concerning their relationship with their auditors, Ernst and Young.
Expect this to continue, as Attorneys General throughout the country seek to ensure their consituents are protected, simultaneously demonstrating their diligence. This last comment may be viewed as cynical, but undoubtedly any regulator worthy of the post will want to be sure they are viewed as aggressively pursuing this hot issue.
Undoubtedly the ramifications will continue to be felt – latest rumors have the Mercer Consulting entity splitting off from parent Marsh…
Notably, the highly publicized nature of the charges has drawn the attention of federal regulators, with the recent release of a GAO report on federal regulation of financial services. Included in the report is a discussion of the potential for changes in the role of the feds in insurance regulation.
This issue will not go away anytime soon.