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 Big “I” National News

P-C Trends
The Future’s Two Faces
Ratings agencies differ in their outlooks for the insurance industry.

Economic uncertainty, hurricane losses and continued softening prices have taken insurers on a turbulent ride during the second half of 2008, and with a little more than two months left in the year, two ratings agencies have contrasting perspectives about the insurance industry’s future.

Fitch Ratings and Standard & Poor’s RatingsDirect both recently issued updated outlooks for the insurance sector. While both companies recognize that tough market conditions have led to a less than ideal situation for the industry, they disagree on the effects these conditions will have in the long-term.

Fitch’s outlook, which encompasses insurance sectors worldwide, is predicting a drastic increase in insurers’ losses during the third quarter and has adjusted its ratings for the industry’s various sectors accordingly. Four of the 18 insurance and reinsurance sectors that ranked negative on Fitch’s Rating Outlook are in the United States, including health, life, non-life and title.

“The negative outlook reflects the significant falls in global credit and equity markets, and unprecedented market volatility and uncertainty,” Fitch says. “Of greatest concern…are declines in the market value of investment holdings that have led to significant declines in economic capitalization and profitability for many insurers.”

Volatile market conditions are also contributing to the negative outlook and there’s potential for further reductions, according to the company, as market values continue to drop and more impairments are realized.  Declines are being felt across the board with insurers, reducing their financial flexibility.

“Limited capital markets access can be especially problematic if an insurer finds itself in a position of needing to raise capital to offset investment losses, but cannot,” Fitch says.

Fitch’s negative ratings on insurance sectors mean the company expects more downgrades than upgrades to occur in the next 12 to 24 months, however it says it doesn’t necessarily expect all, or even a majority, of the ratings within each sector will be downgraded.

S&P is also posting a negative outlook for the industry, more specifically for U.S. commercial lines. The sector was downgraded from stable to negative in August and, according to S&P, the rating remains intact for two reasons --- a continually unfavorable pricing cycle that’s expected to lead to underwriting losses by next year; and adverse developments in the asset market that are causing the deterioration of the sector strong capital position. Yet, despite market conditions and expected losses, S&P maintains that the industry is well capitalized and on solid ground as it nears the end of 2008.

“The property-casualty industry finished the second quarter with $505 billion of statutory capital, down only slightly from $518 billion at year-end 2007,” S&P says. “Moreover, at the beginning of 2008, the capital of most of the companies we rate was significantly redundant for the respective ratings. As a result, even though in our view current conditions in the capital markets preclude their use as a means of replacing lost capital, most companies that have suffered significant losses had sufficient redundancies to tolerate them.”

According to Fitch, downward rating pressures are likely to be most significant for the life insurance sectors --- especially for the U.S. --- given the intertwining between insurers in the sector and other financial institutions.

“Fitch believes life insurer exposures to variable annuity and unit-linked-type products, which offer guarantees typically linked to equity performance, further expose the sector to market risks and capital volatility,” the company says. “Further, and while varying greatly from company to company, some life insurers have material liquidity exposures tied to businesses dependent on institutional funding, securities lending activities, products with ratings triggers and within products such as deferred annuities, in which deposits can be withdrawn at the digression of the policyholder.”

For non-life insurers, the outlook is a bit less bleak, since their products are not deposit-based or connected to institutional funding, and tend to be relatively inelastic since buyers are required to purchase them either by law or lender, according to S&P.

“Few p-c insurers use commercial paper other short-term debt in their capital structures, so the current difficulties in the credit market should only potentially affect companies that have long-term debt maturing over the next few months,” S&P says. “Even then, in our view, many companies have the ability to repay maturing debt with internally generated funds rather than having to access the capital markets.”

Michelle Payne (michelle.payne@iiaba.net) is IA’s managing editor.







L-H Trends
IRS Announces 2009 Retirement Plan Limits
New contribution amounts will affect the way agents and their customers plan for retirement.

After significant declines in the stock market this year, most people saving for retirement realize they need to increase their contributions in order to partially offset the losses in their portfolios.   

This week the Internal Revenue Service announced the amounts that can be contributed to retirement plans for 2009. The increases apply to 401(k) and other defined contribution plans, and the maximum benefit that can be funded through defined benefit plans will also go up. The maximum annual contribution an employee can make through salary reduction to a 401(k) plan will increase to $16,500 from $15,500 in 2008, while the maximum annual “catch-up” contribution employees age 50 and older can make to a 401(k), and certain other defined contribution plans, will rise to $5,500 from $5,000. In addition, the maximum annual total contribution, including employer contributions, to defined contribution plans will be $49,000 per participant in 2009, up from $46,000 this year. The maximum annual benefit that can be funded through a defined benefit plan will increase to $195,000 from $185,000   and the amount of employee compensation that can be considered in calculating pension benefits and contributions to defined contributions will rise to $245,000 from $230,000.

These increases are good news for independent insurance agents for two reasons: 1) they allow customers to set aside more through their own retirement plans and allow companies to maximize their tax-deductible contributions, lowering their income tax liability; and 2) independent agents can increase contributions to  their own retirement plans. Also, for agency principals considering selling their agency, there are opportunities to utilize retirement plan contributions as part of the perpetuation plan. For example, typically purchasers of agencies prefer to have some of the sales price treated as compensation so the buyer can immediately deduct the some of the cost versus spreading the expense over 15 years. The disadvantage to the seller is that they want to have as much of the sales proceeds as possible treated as capital gains because of the lower tax rate. However, if the sales transaction involved both compensation of $100,000 for five years and the balance as capital gain payments, utilizing a retirement plan, the seller could have as much as $48,000 annually go to their retirement account and have a taxable income of only $77,000. And, of course, the same is  true for the agency's commercial clients who are considering selling their businesses.

Also announced this week, monthly Social Security and supplemental security income benefits for more than 55 million Americans will increase 5.8% in 2009, the largest since 1982. Social Security and supplemental security income benefits increase automatically each year based on the rise in the Bureau of Labor Statistics' Consumer Price Index for Urban Wage Earners and Clerical Workers. This year's increase in the CPI-W was 5.8%. The 5.8% cost-of-living adjustment will begin in January 2009 with increased benefits for 50 million Social Security recipients. Higher  payments to more than seven million supplemental security income beneficiaries will begin on Dec. 31. Some other changes that take effect every January are based on the increase in average wages, according to the Social Security Administration. Based on that increase, the maximum amount of earnings subject to the Social Security tax (taxable maximum) will increase to $106,800 from $102,000. Of the estimated 164 million workers who will pay Social Security taxes in 2009, about 11 million will pay higher taxes as a result of the increase in the taxable maximum.

Dave Evans (dave.evans@iiaba.net) is a certified financial planner and IA l-h contributing editor.




 


P&C Trends
Peaks and Valleys
Why are peaks in carrier profits followed by peak impairments?

Last week, Insurance News & Views reviewed data on peaks in insurer impairments and the seeming, albeit lagged, correlation with peaks in property-casualty insurer profitability. Several readers observed the seeming incongruity of a peak in profits being followed several years later by a peak in insurer impairments and asked for an explanation. 

One explanation is that it’s not the peak in profitability that brings the subsequent troubles for a higher than average number of p-c insurers, but what happens after the peak in profitability. History shows the peak in industry profitability is generally a marker for a turn in the p-c insurance cycle from hard to soft. In general, after peak profitability is reached, investors seeking the highest returns see the higher p-c industry profits and consequently put money into p-c insurance businesses. With an influx of investment, the p-c industry then has more capacity to write new premiums. When that happens, there is more competition for a generally fixed amount of insurance purchasers. As the supply of insurance offered increases and  demand remains largely fixed, by accepted principles of supply and demand, insurance prices decrease. With decreasing prices, assuming losses remain relatively unchanged, loss ratios increase. With increasing loss ratios, inevitably the industry will experience more insurers that  become impaired as increased loss ratios exceed the ability of some insurers to pay policyholder claims.

The graph below shows the p-c industry’s hard markets since the Great Depression. The definition used for designating a “hard” market is when the change in p-c insurer net written premiums from the prior year is greater than general inflation, plus five percentage points (that is, change in NPW > CPI+5%). Also included in the graph are the four peaks in insurer impairments since 1978 (from last week’s graph). While the relationship of p-c insurer impairments to hard insurance markets is not as clear as it was with peaks in profitability, generally, the “good-times-brings-competition-which-lowers-prices” axiom is easily identifiable.




Source: A.M. Best Aggregates and Averages and Bureau of Labor Statistics (CPI)

In coming weeks IN&V will take a look back at some relationships between p-c insurer results and other macro-economic measures.

Paul Buse (paul.buse@iiaba.net) is president of Big I Advantage^SM and a licensed p-c agent.

Agency Management 
Knowledge is Power
Management reports enable proactive, rather than reactive, management.

As a staff grows and department management replaces central management by one owner, it becomes too easy to lose control of the agency's performance. A management information system (MIS) is designed to maintain control by the agency owners. It was actually originally created for an absentee owner who needed to know everything going on in the  agency. Not only was it necessary to provide all pertinent information to the owner, but it had to be done in as briefly as possible. The end result was everything an agent needs to know about the  agency in three pages or less.

Here is an outline of the reports that comprise the MIS:

Weekly Production and Productivity Reports
1.  New business written during the week
2.  Lost business that week
3.  Productivity = Prior week backlog + current week incoming - current week backlog
4.  Claims activity
5.  Customer problems
6.  Systems problems
7.  Carrier news

Monthly Management Report
1.  Agency financial results and comparison against prior year and against budget
2.  Department results
3.  Balance sheet
4.  Aged accounts receivable
5.  Cash Report
6.  Production report by department
7.  Claims by department
8.  Marketing (if agency has a marketing department)

The total length of this management report rarely exceeds three pages. Supporting documentation is either available or is attached to the report (depending on the desires of the agency owners). When this report is first constructed, you may not have comparison data available. However, this will become your base year against which you can measure your results in the coming years. If you implement these reports (or those components that apply to your agency), you will begin generating that valuable information to determine your agency's health at any time.

To read the entire article, click here.

Al Diamond (al@agencyconsulting.com) has spent more than 30 years in the insurance industry working for stock companies, direct writers, agencies and as an independent businessman.




Agency Management
Twelve Reasons Not to Sell Your Own Agency
A cautionary tale on why it’s smart to hire a consultant when selling your business.

Have you ever bought or sold an agency? Did you use a consultant to structure the deal or did you do it yourself? If the latter, there's a good chance you might have left a considerable amount of money on the table and didn't even know it. Good merger and acquisition consultants don't come cheap but they will usually save you money far beyond their consulting fee.

To kick things off, let's start with a true story where the names and circumstances have been changed to protect those involved.

Once there was a very successful agent. His name was Silas Competent. His agency was called Ace Insurance Agency and it lived up to its name! He ran an excellent agency in a mid-sized metropolitan area for many years. Competent was proud of his operation and it grew at a nice rate through the years. He had several producers and was the sole owner of a C Corporation. His agency premium grew to more than $30,000,000. His loss ratios were excellent. And his integrity was unquestioned by those in the insurance industry.

Acme Insurance was the underwriter for the Ace Insurance Agency and all the underwriters at Acme were told, "If you get a submission from Ace Insurance, you make it work. They have made us so much money for so many years that we can afford to do most anything for them within reason and within the law."

Competent was living the American dream. His family home was located in the area and he was involved and a strong contributor to his community. This support was both financial and through community service. He was well respected and trusted by all of his neighbors. However, the one weakness of the agency was perpetuation. Competent thought the answer was apparent as his son Joshua was nearly through college and would take the agency over. The American dream would go on.

Joshua, sure enough, came into the agency and was there for several years prior to the time his father wanted to retire. In the intervening years, Competent’s dream of a condo in Arizona became a reality --- as well as a ski home in the mountains. Not a lodge, a home. Life was good! He had his retirement in the value of the agency. Thank goodness he had never taken any of those offers to sell his good business. Likewise, he was glad he had not succumbed to the pressure from his good producers to "give" them a share of the agency for all their hard work. Yes, it had cost him a few good producers over the years, but it was worth it. No producer had ever left and caused him really serious damage. Besides, look what he had now!

Finally, Competent decided to retire and live the good life! He had given the transfer of ownership to his son a lot of thought and needed little professional advice to initiate the transfer…or so he thought.

To find out what happened to Competent and learn the 12 reasons not to sell your own agency, click here. 

Howard Candage (hcandage@insurancemergers.com) is president of H. E. Candage, Inc., a company he founded in 1996 to improve the image and effectiveness of insurance and the practice of risk management.