Sabal Insurance Group will be closing early on Wednesday, November 26th, at 3:00p.m., and will be closed Thursday and Friday to celebrate the Thanksgiving Holiday. We will resume our normal operating hours on Monday, December 1st.Florida may have dodged a bullet avoiding a major storm in the 2008 hurricane season, but insurance industry groups have warned lawmakers about the need to address the state’s underfunded Hurricane Catastrophe Fund.
“We are extremely thankful to have weathered the 2008 season with no major hurricanes,” said Bob Lotane, a spokesman for the National Association of Insurance and Financial Advisors in Florida. “However, we hope that this does not mask the very deep-seeded problems in our hurricane insurance matrix.”
Florida was not hit by any major hurricanes, but Florida Insurance Council executive vice president of the Sam Miller noted that there were more storms overall in the area.
"Just because Florida was spared does not mean that hurricane activity is down,” he said. “The fact is we remain in the middle of a 20-year cycle for increased hurricane activity,"
Lynn Knauf, director of personal lines for the Property Casualty Insurers Association of America, offered an even longer estimate for the cycle at as many as 50 years. Florida was one of several coastal states that the PCI noted faces significant problems, and the group called on lawmakers to respond accordingly.
“To help protect homeowners, state governments should stabilize the financial condition of these coastal insurance markets as property exposure continues to grow,” said PCI Southeast Regional manager William Stander.
The hurricane season is officially over Nov. 30, but Mr. Miller noted that next year’s hurricane season is not far away and the Catastrophe Fund faces a shortfall of $10 billion to $15 billion. In addition, the turmoil in the economic markets would make raising additional funding through bond issues more difficult.
The most likely solution, Mr. Miller said, would be to reduce the Fund’s total obligations from its current limit of $28 billion to the $16.5 billion ceiling that was in place prior to a 2007 law expanding the fund.
That law, he noted, only expanded the fund for the 2007, 2008 and 2009 seasons. “It’s going away anyway,” he said, which in addition to the acknowledged shortfall should make it easier for lawmakers to accept eliminating it early. “It isn’t real anyway,” Mr. Miller said.
By rolling back the Cat Fund, the state would effectively push insurers to purchase more reinsurance from the private market, Mr. Miller noted, and the Council called on state lawmakers to allow insurers to include these increased costs as they calculate rates.
This is especially the case for the state run insurer, Citizens Property Insurance Corp., said Mr. Miller. Lawmakers froze Citizens rates in 2007, and there is already concern that Citizens must raise its rates to avoid assessments on taxpayers in the aftermath of a major storm.
“We urge policymakers and regulators to address the serious underfunding of our catastrophe fund in addition to inadequate rates being applied in the state-run insurance company and also with the private insurers taking policies from it,” said Mr. Lotane. “The solvency of not only these entities is at risk but, in fact, the solvency of the state as well should our good luck regarding catastrophic storms turn around.”
The insurance industry can expect some consolidation going forward, as big companies get bigger and weaker companies struggle to survive the current economic challenges, an expert said today.
Speaking during an Ernst & Young teleconference, “Financial Crisis And The Insurance Industry,” Robert W. Stein, global director of Actuarial Services, Ernst & Young LLP, said weaker companies will likely not survive going forward, and that will lead to increased consolidation in the industry.
Mr. Stein warned, “There are issues on the banking side as to whether the rise of mega institutions is always a good thing, but it’s quite clear that we will see the big getting bigger, and I think with that will come a little bit of increase in complexity and risk profile—perhaps undesired, but nonetheless part of the ‘getting bigger’ situation.”
He predicted that many insurance companies will restructure and sell non-core businesses to raise capital, which will lead to a change in business profile throughout the industry.
David Schieldrop, managing director, Barclays Capital, commented, “Out of difficult times comes opportunity for some.”
He said a lot of properties are coming to market while valuations are under “severe stress”. He said the current mergers and acquisitions environment is a “once in a generation opportunity” for people to acquire some of the largest franchises in the industry, and he mentioned the expected sale of several American International Group properties as an example.
He noted that with valuations as stressed as they are, though, there is less incentive to sell. The activity over the next year will likely be AIG and other distressed situations, Mr. Schieldrop said.
American International Group Inc. said it is terminating voluntary deferred compensation programs to eliminate an incentive for employees to leave the company in order to get back pay, and as a result will distribute approximately $500 million to such individuals in the first quarter of 2009.
AIG said 14 voluntary deferred compensation programs involving 5,600 employees and independent agents and representatives are affected by the decision.
The company explained that these individuals earned but volunteered to defer receiving these funds until a later date.
In each case, an employee could leave AIG for any reason and be entitled to this deferred pay. The cash-strapped company—which has been forced to accept government ownership in return for a federal bailout loan—has been fighting to keep staff in place as it struggles to stay afloat.
“AIG has decided to terminate and pay out the deferred pay plans to remove the incentive for employees to leave in order to obtain their deferred pay,” said Andrew Kaslow, senior vice president of human resources.
“Many AIG employees have seen their life savings wiped out in the financial crisis,” Mr. Kaslow said. “Employees are now concerned about obtaining the pay they have earned but deferred so they can pay for retirement, college tuition or other expenses.”
Under the majority of AIG’s deferred pay plans, participants can only access deferred pay when they retire or leave the company. AIG said it is concerned that employees will leave AIG so they can obtain their deferred pay.
“This is a concern at a time when AIG is working to maintain the value of its businesses, whether those businesses are to be sold to repay AIG’s Federal Reserve loan or to be continued as part of a restructured AIG,” said Mr. Kaslow.
AIG said it plans to distribute close to $6 million to seven executives under the terms of the deferred compensation program. In a filing with the Securities and Exchange Commission, the company said that under its Senior Partners Plan there was an aggregate of $5.96 million in deferred pay, with six executives receiving $3.04 million of that pot.
At the top of the list is Jay S. Wintrob, executive vice president of retirement services, who will receive $1.9 million. Win J. Neuger, chief investment officer, will receive $607,953. David L. Herzog, the chief financial officer, will receive $371,422. The remaining four will receive a total of $161,860--ranging from more than $100,000 to $8,564.
Investors are wondering if Warren Buffett has lost his touch.
They are bailing out of Berkshire Hathaway Inc stock and have lost some confidence that the insurance and investment company, run by one of the world's most admired investors since 1965, can pay its debts.
Berkshire stock has lost close...
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An executive with an American International Group subsidiary denied suggestions today that the company is holding onto business by engaging in aggressive price cutting that is prolonging the property-casualty soft market
John Q. Doyle, president and CEO, AIG Commercial Insurance, made his remarks during a panel discussion at the 20th Annual Executive Conference for the Property-Casualty Industry presented by National Underwriter Company and sponsored by Ernst & Young and Dewey & LeBoef.
Mr. Doyle said he was curious that AIG is being singled out when his company’s top line was down seven percent during the third quarter. Some companies criticizing AIG, he said, had increased their top line during the quarter.
Panel moderator Sam Friedman, editor-in-chief of National Underwriter, said the industry has sent mixed signals regarding the soft market.
Some participants, he said, indicate that pricing is beginning to harden, while others have singled out AIG for driving prices down as it attempts to hold on to business and combat damage to its reputation by pricing aggressively.
Mr. Friedman noted that it is odd to hear some in the industry single out one competitor, rather than speaking broadly about the market.
Mr. Doyle remarked that there seems to be “no shortage of experts” in the industry regarding what is going on at AIG. He added that while challenges at the parent company have inflicted some brand damage, the strengths of AIG Commercial remains the same.
Regarding the state of the market, the experts on the panel did not share a consensus on whether the soft market has come to an end.
Mr. Doyle said pricing is still down, but there has been modest improvement since early July. He explained that there is still no shortage of capacity in many lines, adding that as capacity leaves, or as consolidation occurs, prices will move.
George Fay, executive vice president, Worldwide Property-Casualty for CNA, said he has met with producers, and they indicated that prices are already stabilizing, and cited some lines where prices are rising. He said producers are already telling customers to expect increases, and they also said the market will likely harden over the next six months.
Stanley A. Galanski, president and chief executive officer, The Navigators Group, Inc., said he was not as optimistic that the end of the soft market is here, but he added the industry is getting closer.
The executives mentioned access to capital as one area of potential concern going forward. Mr. Friedman noted that AIG, The Hartford and CNA are among insurers that have gotten a capital infusion of some sort, and he questioned where the industry will get capital from in the future.
Mr. Doyle noted that AIG’s p-c outlets have not needed to access the capital that the parent company received, but he said inability to raise capital could change the market very quickly if a catastrophe event were to take place.
Determining how much capital insurers have is difficult, Mr. Galanski noted, given the state of the debt markets.
Mr. Galanski also shared some lessons learned during the recent financial struggles. He said companies should:
• Understand that underwriting matters.
• Not underwrite what they do not understand.
• Understand the downside of risks.
• Understand that a handful of people can destroy a major company that took years to build.
• Understand that size does not necessarily equal strength.
At a separate discussion at the conference, Pierre L. Ozendo, member of the executive board, chairman, and chief executive officer of Swiss Re American Corporation said the industry will emerge from the current financial problems, but it may be at the cost of some companies failing.
He stressed that companies need to manage capital for preservation, that solvency and security matter, and that risk management and risk modeling need to become competencies for all financial firms. He added that the economics of the industry remain sound, but challenged, and said the underlying strength of the industry would prevail.
All panelists agreed that sound underwriting is a must for the industry to weather the current environment.
Insurance executives said today that the current mood in Congress, given the U.S. financial troubles, indicates some form of federal insurance regulation has become a matter of “when,” rather than “if.”
Their comments came during a panel discussion at the 20th Annual Executive Conference for the Property-Casualty Industry produced by National Underwriter Company with sponsors Ernst & Young and Dewey & LeBoeuf
Panel member Stanley A. Galanski, president and chief executive officer, The Navigators Group, Inc. said the pace towards federal regulation is fast.
The feeling among some legislators, he said, is that insurance is part of financial services, and Congress is determined to fix it. Mr. Galanski compared the current environment in Congress to the mood just before Sarbanes-Oxley was passed.
Future federal regulation may not even be “optional,” according to George Fay, executive vice president, Worldwide Property-Casualty for CNA. He said he believes there will be federal regulation of insurance that all companies will have to comply with to some degree, possibly in addition to state regulations.
Mr. Fay suggested larger companies will likely be able to adapt to this environment more easily than smaller companies.
John Q. Doyle, president and CEO, AIG Commercial Insurance, wondered what a federal regulation system in the U.S. would look like. He noted that, around the world, regulators are primarily interested in solvency, whereas in the U.S., there is more concern over consumer issues. He said he would be interested to see if the U.S. regulatory system would change its focus under federal regulation.
At a separate session during the conference, Pierre L. Ozendo, member of the executive board, chairman, and chief executive officer of Swiss Re American Corporation, said the United States should look to an Optional Federal Charter as a way to effectively prepare for regulatory systems around the world that will become more global with respect to coordination and cooperation.
Answering a question regarding whether the current U.S. insurance regulatory system is ready to coordinate on a global scale, Mr. Ozendo said an OFC would allow the U.S. to have a regulator that would be able to hold discussions with regulators in Europe and elsewhere.
Sam Friedman, editor-in-chief of National Underwriter, questioned whether federal regulation would be more effective than the states given the problems that have occurred in the federally-regulated banking sector during the current financial troubles.
Mr. Ozendo responded that there is no way to determine exactly how effective the government would be at regulating insurance, but he maintained that federal officials are the only ones with the “sheer power” to get a system that is stuck moving again.
Mr. Galanski furthered Mr. Ozendo’s point regarding international cooperation, stating he believes the debate in Washington has moved from state versus federal regulation to federal versus international cooperation.
Mr. Doyle did not say whether he would prefer a state or federal regulation system, but stressed there needs to be more effective regulation with respect to insurance.
Mr. Fay said he is not a fan of more government involvement in insurance. A future problem, he said, could be fixing problems ahead created by the very government that is trying to solve current issues.
Speaking beyond regulation, to solutions to the financial troubles in general, Mr. Fay said he would like to see some time pass by before major changes to the financial services landscape are made. He said it would be beneficial to wait until the true problems are identified, and the country can effectively analyze how it got to this point, before effecting solutions on the insurance industry.
U.S. lawsuit costs rose 2.1 percent in 2007, will jump 4 percent this year and the sour economy will push the upward trend through 2010, according to a study by Towers Perrin consulting firm.
Last year’s increase was attributed to a rise in personal injury cases mostly from automobile accidents—the first increase since 1999. The auto property damage frequency index, based on insurance industry figures, was 0.897 last year compared with 0.891 for 2006.
The “2008 Update on U.S. Tort Cost Trends” from Towers Perrin reported that a $5.1 billion climb from tort costs in 2006 marks the first escalation since 2005 and follows a 5.6 percent decline in 2006.
Further, Towers Perrin said it estimates that U.S. tort costs will increase 4 percent in 2008 and an additional 5 percent in both 2009 and 2010.
It said this is due to the continuing fallout of the 2007 subprime mortgage debacle and the current global financial crisis—as well as such factors as the impact of ever changing fuel prices on personal auto liability costs and the potential for increased activity in the area of employment practices liability, the company said.
“The current global economic climate could very well lead to a surge in tort activity here in the U.S,” Russ Sutter, a Towers Perrin principal and author of the report said in a statement.
“For 2008 and beyond, we see the list of potential defendants growing to groups such as mortgage brokers, appraisers and investment banks, as well as peripheral defendants, such as auditing firms and attorneys advising the targeted firms,” said Mr. Sutter
He continued that the implosion and “resulting government involvement in firms such as Bear Stearns, Lehman Brothers, Fannie Mae and AIG will undoubtedly lead to further litigation in 2008 and 2009,” noting that, “What remains unclear is how many dollars will change hands as a consequence of this litigation.”
From a statistical standpoint, the U.S. tort system cost $252 billion in 2007, or $835 per person—$9 per person more than in 2006. The 2008 report analyzes U.S. tort costs from 1950 through 2007, with projections through 2010.
The methodology used in the study incorporates three cost components: benefits paid or expected to be paid to third parties (losses), defense costs and administrative expenses, Towers Perrin said.
Administrative expenses are identified separately in the report.
Key findings:
• Overall economic growth in 2007 was 4.8 percent. As such, the ratio of tort costs to gross domestic product (GDP) shrank in 2007, marking four consecutive years of a decline in the ratio. Since 1950, growth in tort costs has exceeded growth in GDP by an average of approximately two percentage points.
• The total tort costs from commercial lines in 2007 increased 1 percent over 2006. The 2007 costs, however, were below levels seen each year in 2003 through 2005. The reduction from those prior years appears to be attributable to a reduction in the number of claims, according to the report.
• The smaller increase in commercial tort costs can be attributed in part to asbestos. Insured asbestos losses increased approximately $1.2 billion in 2007. This was lower than the comparable increases in 2004, 2005 and 2006 ($7.3 billion, $7 billion and $1.8 billion, respectively).
Towers Perrin said it is forecasting growth in U.S. tort costs of 4 percent in 2008, with higher growth (5 percent) in 2009 and 2010.
According to the report, several issues will determine the future trends in U.S. tort costs, including:
•Gasoline prices — Increases in the price of gasoline have resulted in a decrease in miles driven in 2008. Whether the price of gas increases further, and whether the public’s reaction to the price is a temporary or permanent shift in driving habits will impact future personal auto liability costs.
• Credit crunch — Springing from the subprime mortgage crisis in 2007 and continuing through 2008, the survey found the credit crisis has led to significant litigation activity, particularly on a class action level. As of year-end 2007, most of this activity was in the directors and officers area.
For 2008 and beyond, the firm said it sees the list of potential defendants growing to groups such as mortgage brokers, appraisers and investment banks, as well as peripheral defendants such as auditing firms and attorneys advising the targeted firms.
Medical malpractice legal claims costs, according to the report, have decreased in inflation-adjusted dollars since 2004. Tort reforms in several states have contributed to this result. It was noted that some of those reforms, however, such as in Illinois and Georgia, have been overturned or are currently being challenged in the courts.
In addition, the growing emphasis on “never events” (serious and costly errors in the provision of health care that should never happen, such as surgery on the wrong body part or a mismatched blood transfusion), and the potential strict liability that hospitals face from such claims, could change the recent trends, according to the report.
For the first time in Aon Risk Consultant Inc.'s ongoing nine year actuarial study of general liability and professional liability (GL/PL) claims against America's long term care providers, the countrywide frequency of claims and their severity are stable. The American Health Care Association (AHCA) stated that a combination of effective state tort reform laws, a trend towards settlements based on arbitration, and increased facility-based quality improvement efforts are indisputably working on behalf of elderly Medicaid beneficiaries and the taxpayers who finance the nation's Medicaid program. Aon's The Long Term Care 2008 General Liability and Professional Liability Actuarial Analysis is supported by AHCA.
"The facts and statistics in the new Aon analysis are powerful and profound, and excellent news for U.S. seniors and taxpayers," stated Bruce Yarwood, President and CEO of AHCA. "The long term care profession is enormously pleased that state tort reform laws and other initiatives designed to help ensure the nation's Medicaid resources are working as intended - to protect our most vulnerable seniors."
The Aon 2008 analysis states the following:
"Across the United States, the climate of long term care liability is constantly changing. In the mid to late 1990's, soaring liability costs prompted providers to devise a number of strategic initiatives. Early efforts focused on tort reform legislation, withdrawal from expensive markets, , and operational improvements. These efforts have continued and expanded to include an increased focus on quality of care, and alternative dispute resolution strategies, including arbitration.
After years of quickly rising costs, these initiatives have resulted in stability in most areas as evidenced by the following key findings from this year's study:
* For the first time in Aon's nine years of reporting on long term care liability costs, countrywide frequency and severity are stable; * Tort reform driven reductions in liability costs have been lasting. Several years past the last major tort reform actions, frequency and severity are stable at their post reform levels;
* Despite stability in the national trends, turbulence remains in higher cost jurisdictions like Arkansas, Tennessee, and California, where the loss costs per occupied bed are multiples of the countrywide average; * Arbitration appears to reduce the time to settlement, with lower defense costs and smaller indemnity payments; * Survey respondents who had received an AHCA Quality Award had 34% lower liability costs per bed; * Defense costs continue to increase as indemnity amounts stabilize.
Other key findings are as follows:
Liability Costs Plummet in States with Tort Reform Laws
Liability costs have dropped significantly in states that have passed tort reform in the past several years. As a group, the average loss cost of Florida, Georgia, Louisiana, Mississippi, Ohio, Texas, and West Virginia dropped from $7,190 in 1998 to an estimated loss cost of $1,230 in 2005. The loss cost for these states has increased slightly through 2007 to $1,270.
Arbitration
Providers are increasingly seeking alternatives to tort litigation, and arbitration reduces the time to settlement by more than two months on average; the average indemnity amount for claims subject to arbitration is 31% lower than for claims that are not subject to arbitration; and the average expense amount for claims subject to arbitration is 20% lower than for claims that are not subject to arbitration.
Yarwood concluded, "We are encouraged by the correlation between those facilities that have earned AHCA's quality award and lower per bed liability costs. While there remain several areas of concern, the positive overall trend lines are unmistakable."
The 99 Restaurant chain has been ordered to pay $5 million to a Quincy, Massachusetts woman who lost in her arm in a drunk driving accident.
The Essex Superior Court jury on Thursday found that the chain's North Andover facility served the equivalent of 11 12-ounce beers to an ...
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A Florida Supreme Court ruling has resulted in a request to raise workers compensation rates by 8.9 percent.
The National Council on Compensation Insurance filed it Friday, citing last month's ruling. The justices struck down a cap on fees paid to lawyers for injured workers. The council predicted the decision ....
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Property/casualty insurers’ expense growth outpaced their premium growth in 2007, and this gap is expected to continue this year as net written premium growth remains relatively flat, Standard & Poor’s Corp. said in a special report.
Because of soft market conditions, net written premiums increased only 1.3% in 2007 while expenses increased 4.4%, according to the report. New York-based S&P had expected the industry’s expense ratio for 2007 to increase to 26.2%, up from 25.6% in 2006. Instead, it increased to 26.4%.
In 2006, net premiums written increased 3.8%, while expense growth increased 8.0%.
“Salaries and commissions make up the bulk of expenses for the U.S. property/casualty industry,” the report said.
Four recognized categories of hospital-acquired conditions, "never events" that have received more attention in recent years, make up 12.2% of total medical professional liability costs, according to the 2008 Hospital Professional Liability and Physician Liability Benchmark Analysis released recently by risk management services provider Aon Corp. and the American Society for Healthcare Risk Management (ASHRM), both in Chicago.
Hospital-acquired infections, hospital-acquired injuries, objects left in surgery, and pressure ulcers account for one out of every six claims, the report says.
On Oct. 1, the Centers for Medicare & Medicaid Services ended reimbursement for 10 specific hospital-acquired conditions often referred to as "never events." The new research shows that never events are more than just a freak occurrence, says Greg Larcher, director and actuary of Aon Global Risk Consulting and author of the analysis. The study shows that they make up an alarming portion of medical malpractice cases.
"The increased awareness surrounding these nonreimbursable conditions may cause a rise in the frequency of related hospital professional liability claims, not to mention other hospital-acquired conditions not currently addressed by CMS regulations," Larcher says. "This study marks the first time these conditions have been benchmarked, and provides a baseline moving forward for this essential piece of the liability picture."
The study also includes an analysis of professional liability costs for the surgery, obstetrics, and emergency departments. Various supplementary database segments appear in this year's analysis as well, including facility ownership, number of beds and teaching hospitals.
"For the fourth straight year, we are not seeing an increase in the overall number of liability claims," Larcher says. "That said, the not-for-profit segment of the database reflected an increase in claims for the second year."
More than 100 health care organizations representing more than 1,200 facilities, ranging from small community hospitals to large multistate publicly traded health care systems, provided loss and exposure data for the study. The hospital professional liability benchmark database includes 77,705 claims representing $9.3 billion of incurred losses.
The Bermuda-based, but UK-listed, insurer Hiscox expects strong growth in 2009, thanks to rising premiums in some of its core markets and increased business due to credit and capital problems at some competitors, it said on Monday.
Shares in Hiscox rose as much as 6.2 percent after the company said in a trading update that the upturn meant it would increase capacity at its Lloyds of London insurance market syndicate by £50 million ($78.86 million) to £750 million ($1.183 billion) having previously predicted a fall to £550 million ($867.8 million).
Hiscox had forecast that tough competition would lead to a downturn at its global markets unit, which is dominated by its operations on the Lloyds market, and at its international reinsurance operations.
"The tide has turned," Chairman Robert Hiscox said. "Whereas we were depending on retail growth in UK and Europe to offset the fall in income from internationally traded business and reinsurance, rates have now switched from softening to hardening in some major areas such as reinsurance, offshore energy and large property."
Income from premiums fell 8.3 percent to £920.1 million ($1.451 billion) in the nine months to the end of September as strength at the group's UK and European operations failed to fully offset weakness at its global markets division and operations in Bermuda.
The company said it expected strong growth at its international reinsurance operations in 2009, however. "Just as with global markets, rates are now hardening and business flows are increasing due to brokers spreading their business to wider markets," the company said.
Bermuda-based Hiscox shrugged off the effects of the credit crisis, but said it had reduced its exposure to international and larger businesses where market conditions were challenging.
"This time it is not an insurance famine but a famine of capital due to a worldwide financial crisis," said Chairman Robert Hiscox. "We have sound capital and the opportunity to use it extremely well."
Shares in the company were 5.1 percent higher at 297.5 pence (app.$4.70) by 0909 GMT having earlier risen as high as 300.5 pence.
Credit Default Swaps ("CDS") are part of a $62 trillion market, that have gone from obscure to infamous in a matter of months, if not weeks. Yet along the way, many people were left without a clear understanding of what CDS areparticularly, in what ways CDS are like or unlike insurance. In brief, a CDS is like insurance insofar as the buyer collects when an underlying security defaults or loses value in some other way defined by the contract. It is unlike insurance, however, in that the buyer need not have an "insurable interest" in the underlying security.
Defined as Similar to Insurance
A CDS appears a lot like insurance on an investment, in particular a debt obligation. As one court explained,
A credit default swap is an arrangement similar to an insurance contract. The buyer of protection . . . pays a periodic fee, like an insurance premium, to the seller of protection . . ., in exchange for compensation in the event that the insured security experiences default.
Merrill Lynch International v. XL Capital Assurance, Inc., (S.D.N.Y.). The triggering event that causes the Seller to pay is usually called a "Credit Event"usually, though not always, defined to involve a default on the underlying security. Upon the occurrence of a Credit Event, the Buyer and Seller settle up in one of two methods. Under both methods, the Seller will pay to the Buyer the face value of the underlying debt security. In return, under a "physical settlement," the Buyer will deliver the underlying debt security to the Seller, and under a "cash settlement," the Buyer will offset the Seller's face value payment by the actual market value of the underlying security, sometimes determined through an auction.
Despite the differences between a CDS and insurance outlined below, pursuing recovery under both can be quite similar. The language of the agreement is very important. Although standardized forms exist and are commonly used, very often much of the controlling language will be drafted specifically for each swap.
Yet Not Quite Insurance
Yet although courts and other reference sources almost invariably describe CDS as similar to insurance, there is a broad consensus that, on the whole, CDS are not the equivalent of insurance policies.
The two main reasons most often given to support the conclusion that CDS are not insurance products are that (1) the Buyer does not have to own the underlying security, or otherwise have any insurable interest in that security, and (2) the Buyer does not in fact have to suffer any loss in order to recover on the CDS. As noted, under some CDS terms, a "Credit Event" can take place that does not involve an actual default for the underlying security, and, of course, if the CDS Buyer does not own the underlying security, it will not suffer a loss even if there is a loss for actual bondholders. In addition, a Credit Event could cause the Buyer who does hold the underlying debt to recover an amount that is greater than, or less than, any actual loss it suffers. The Buyer's recovery is determined by the contract termsthe amount of any loss it suffers is irrelevant.
CDS also differ from insurance contracts with regard to tax, accounting, bankruptcy and in regulatory jurisdiction. To date, for example, CDS have not been subject to state insurance regulationsalthough this might soon change. New York State has begun issuing guidelines to regulate that portion of the CDS market where the Buyerdoes own the underlying asset, does therefore have an insurable interest, and does suffer a loss upon default. CDS that share these characteristics do not support the two main reasons that CDS are generally considered not to be insurance, and New York insurance regulators believe they will be able to assert their powers over this part of the market.
With the industry’s capital drained this year by natural catastrophes, financial market losses and falling rates, “the end of the soft market in insurance has arrived,” according to Evan Greenberg, chairman and chief executive officer of ACE Limited.
While the insurance industry was overcapitalized at the beginning of the year, disasters—both natural, in terms of storm losses, and man-made, given the financial meltdown on Wall Street—have set the stage for a turnaround in insurance pricing, Mr. Greenberg said during an earnings conference call, in which he announced a 92 percent drop in third-quarter income for his Zurich-based company.
“Additionally, downgrades and government ownership are impairing the ability of a number of companies to operate in the same manner as they have in the past,” limiting their abilities to effectively deploy capital, he said.
“I believe the soft market is now over,” he declared, predicting that “this fact will work its way to the trading level in the next few months.” He noted that rate declines have “slowed or stopped” in many parts of the world, while they are beginning to rise in poorly performing lines like energy.
At ACE, management has “mandated as a rule flat pricing—no reductions,” he said.
Mr. Greenberg’s comments echoed statements by AXIS CEO John Charman, who during his company’s earnings call said: “We believe a hard market in 2009 is a near certainty.”
Mr. Charman and other executives of companies created in Bermuda are heralding the end of the soft market in both the insurance and reinsurance segments—noting that reinsurance, in particular, is viewed as a capital alternative at a time when the cost of capital is high and insurers are becoming more risk averse. Not only is capital supply strained, but demand is higher, he said.
The two executives also addressed questions about changes in the market brought on by problems at American International Group—both in terms of opportunities for other companies, as well as the aggressiveness of competition they’re seeing from AIG on individual accounts.
“In my view, AIG is the haystack, not the straw that broke our industry camel’s back,” according to Mr. Charman.
Mr. Greenberg said that “ACE will be one of the companies that strives to take advantage of…opportunities,” referring more broadly to opportunities “created by casualties” in the insurance world. “The exact size, shape and timing are unclear, as events are unfolding rapidly,” he noted, stating that ACE expects to “emerge bigger and stronger.”
Mr. Greenberg addressed a specific question about business coming to market and seeking an alternative to AIG by citing the surge in submission flow for ACE—reporting that ACE’s submissions in October so far have surpassed submissions last year for the entire fourth quarter.
Tracking activity by month, he said submissions jumped 12 percent in August and September over last year, 31 percent in early October, and 50 percent in all of October. Large-account submissions are up 80 percent, he said, attributing all the activity to “weakness at other insurers.”
Not all those submissions can yet be converted to quotes, however, he noted.
“When it comes to the one large player who is under stress, they are an outlier right now in the pricing environment,” he said. “They are aggressively cutting pricing in an irresponsible way, and it’s worrisome.”
At ACE, net realized and unrealized investment after-tax losses of $1.3 billion, along with $311 million in losses for Hurricanes Gustav and Ike, helped push the third-quarter bottom line gain down to $54 million, or 16 cents per share, compared to $656 million, or $1.95 per share in last year’s third quarter.
Excluding $450 million of net realized losses for this year’s third quarter, net operating income was $504 million, representing a decline of 27 percent from third-quarter 2007.
Mr. Greenberg, who said he believes that ACE continues to perform “quite well” during a period of “seismic change” in the financial markets, pointed to flat operating income for the nine-month period and a combined ratio of 97.9 to demonstrate ACE’s earnings strength.
ACE, which also reported nine-month net income of $1.2 billion, will not be providing earnings guidance in the mid-December timeframe as is usually the case, Mr. Greenberg announced.
“Our business mix may very well change,” he said, noting there is too much uncertainty with respect to the economic slowdown and stress in the financial markets to predict exactly how the mix will change at this point. Guidance may be delayed to as late as early 2009, he said.
AXIS RESULTS
Meanwhile, AXIS Capital Holdings Ltd. reported a third-quarter net loss of $249 million, or $1.79 per diluted common share, compared to a third-quarter 2007 net income of $270 million, or $1.65 per diluted common share.
The company cited Hurricanes Gustav and Ike as well as investment losses from the “unprecedented financial market volatility and disruption to the financial system” as reasons for the quarter’s results
For its insurance segment, AXIS reported an underwriting loss of $22 million, compared to third-quarter 2007 underwriting income of $111 million. The combined ratio was 102.8 compared to 63.3 in 2007. AXIS said it saw net losses of $115 million from Hurricanes Gustav and Ike.
The company reported net realized investment losses of $89 million for the quarter, which included other-than-temporary impairment charges of $50 million, of which $29 million related to fixed maturity holdings in Lehman Brothers.
Realized losses on the sale of investments were $41 million, including a $60 million loss on the sale of Fannie Mae and Freddie Mac preferred equity, partially offset by realized gains on the sale of certain fixed maturities, AXIS said. In the third quarter of 2007, net realized losses were $1 million.
Third-quarter 2008 gross premiums written were $403 million, down 16 percent from third-quarter 2007. Reported net premiums of $236 million were down 25 percent from a year ago.
“We reduced gross premiums written in many of our property-casualty lines of business this quarter as a result of continued competitive market conditions,” AXIS said in a statement. “Our political-risk premium also decreased this quarter, reflecting the reduction in available transactions as private capital flows slowed amidst the ongoing global financial crisis.”
AXIS added that it will reserve capacity for expected increases in pricing that “we expect when liquidity returns to the financial markets.”
In the reinsurance segment, AXIS reported an underwriting loss of $164 million for the quarter, compared to underwriting income of $88 million last year. The combined ratio was 141.4 compared to 77.1 in the prior-year quarter.
The reinsurance segment reported gross premiums written of $323 million, up 17 percent from the third quarter of 2007, driven by reinstatement premiums written of $29 million following Hurricanes Gustav and Ike.
AXIS said third-quarter 2008 net investment income decreased $68 million, or 57 percent, from the third quarter of 2007 to $51 million, driven by a reduction in investment income from the company’s alternative investment portfolio of $68 million, “the majority of which emanated from unrealized losses on our credit and hedge funds.”
For the first nine months, AXIS reported net income of $220 million, or $1.40 per diluted share, compared with $749 million, or $4.53 per diluted share, in 2007.
A financial manipulation scheme cost American International Group Inc investors at least $544 million, a judge has estimated, a finding that could mean the five former executives convicted in the fraud will face lengthy prison terms when sentenced.
The case is unrelated to AIG's mortgage-related losses that led to a near collapse of the company in September and an $85 billion emergency line of credit from the U.S. Federal Reserve.
Four former executives at General Re Corp, a unit of Warren Buffett's Berkshire Hathaway Inc, and one former AIG executive were found guilty by a federal jury in Connecticut in February of fraud and conspiracy. The charges stemmed from a reinsurance deal in 2000 that prosecutors said misled investors about AIG's financial condition.
A sentencing date has not yet been set, but the judge's written ruling on Friday on the size of the investors' losses means that each defendant is expected to face stringent sentencing guidelines when their penalties are determined.
In economic crimes, victims' financial losses are central in calculating sentencing guidelines for defendants. The judge's finding that the fraud had more than 250 victims also ratchets up the potential prison time each defendant may face.
Federal sentencing guidelines are advisory for judges, who can depart from them if they choose.
Based on the judge's calculations, the sentencing guidelines in the case likely will be "through the roof," said Douglas Berman, a law professor at Ohio State University and expert in white-collar sentencing matters.
"We're looking at a suggested guideline range of at least decades" of prison time for each defendant, he said. "There is a separate question of whether the judge will consider it necessary and appropriate to impose a prison sentence that is so long, particularly because these are first-time offenders."
Convicted at trial were General Re's former chief executive Ronald Ferguson, former chief financial officer Elizabeth Monrad, former assistant general counsel Robert Graham, former senior vice president Christopher Garand, and AIG former vice president of reinsurance Christian Milton.
Prosecutors, in court papers, have sought "substantial" prison terms. Defense lawyers have pleaded for leniency.
At the center of the case was a finite reinsurance transaction that prosecutors said allowed AIG to improperly boost loss reserves by $500 million in 2000 and 2001, artificially bolstering its share price.
In estimating the investor losses, U.S. District Judge Christopher Droney rejected calculations by a government expert that they could be as high as $1.4 billion. The judge concluded that the same expert, using a different methodology, made a "reasonable estimate" of losses between $544 million and $597 million.