P/C Insurance CFO: Hard Sell

Explaining the industry's dual accounting system -- and its fearsome risks post 9/11 -- is proving to be a daunting task for CFOs at property/casua...
David KatzJuly 3, 2002

Before the advent of Regulation Fair Disclosure, the CFO of a property/casualty (PC)insurance company could quell a rumor about business losses with a simple answer to an analyst on the telephone.

Without Reg FD, for instance, Chubb Group’s finance chief, Weston Hicks, would have easily been able to explain Chubb’s recent asbestos settlement with PPG Industries. Hicks simply would have told the analyst that Chubb’s $34 million contribution to the PPG settlement was relatively minor, that it wouldn’t affect Chubb’s future earnings.

In fact, Hicks could have simply — and quietly — set Chubb apart from other insurance companies that paid hundreds of millions to settle the suit. Travelers Property Casualty, for example, paid $240 million in the settlement, while the Hartford ponied up somewhere between $120 million and $150 million.

But with Reg FD in force, Hicks and other Chubb executives either had to talk fully about the PPG settlement, or not at all. “You can’t tell one analyst that you don’t have a material exposure,” the finance chief explains.

Chubb management had been wary of talking publicly about the asbestos settlement. But once the other two insurers put out their press releases, the die was cast. In the end, Chubb management decided to issue a statement explaining the company’s liability — one day after the Travelers and Hartford had issued their own releases about the PPG case.

Ironically, Regulation Fair Disclosure was not particularly fair to Chubb management, which had little choice but to make a big issue out of a minor matter. As Hicks says, Reg FD forces an insurer to put out press releases that are the corporate equivalent of stating, “No, I don’t beat my wife.”

Delicate Operation

Admittedly, Reg FD (which became law in October 2000) affects all public companies, not just insurers. But CFOs working at public P/C insurance companies shoulder a unique reporting burden in that they have to walk investors through two sets of books. Besides providing GAAP numbers to the market at large, public carriers are required to report statutory accounting results to state insurance commissioners.

Those statutory requirements end up holding insurers to much more conservative accounting standards than their counterparts at non-insurance companies. In their reports to insurance regulators, for instance, insurers must book expenses immediately. That’s a marked difference from GAAP methods, which allow companies to wait to recognize expenses until matching revenues are earned.

This need to book a big loss immediately can have “a direct impact on capital and cash flow” that non-insurers would never have to explain, notes Robert Hartwig, chief economist and senior vice president of the Insurance Information Institute (I.I.I.).

While such straightforward accounting might provide P/C insurers with a good story to tell during these scandal-plagued days, the dual sets of books also present finance chiefs with a daunting investor-relations challenge.

Break Out the Tranquilizer Guns

Industry watchers point out that property/casualty CFOs have always had a complex accounting story to tell. But these days, those finance chiefs must tell that story while also finding ways to calm investor anxieties about the increasingly volatile risks that insurers face.

The knock-on effect from terrorist attacks and the Enron bankruptcy — not to mention asbestos-related lawsuits — has hit insurers hard. The estimates of insured losses associated with 9/11, for instance, continue to rise. On June 18, the Insurance Services Office upped its estimate of covered property losses caused by the attacks from $16.6 billion to $20.3 billion.

Granted, regulators are allowing insurers to exclude terrorism on new policies. But according to several estimates, carriers are still on the hook for about $40 billion for losses related to the September 11 attacks.

Then there’s the Enron collapse, which has spurred shareholders of other troubled corporations to sue directors and officers. The corporations, in turn, bring those D&O claims to insurers like Chubb.

D&O claims aren’t likely to go down anytime soon, that’s for sure. U.S. participants in a Tillinghast-Towers Perrin study of 2,130 companies said they paid an average of $5.65 million to D&O claimants in 2001. That’s a big increase over the average $3.23 million payout in 2000. What’s more, SEC Chairman Harvey Pitt’s recent call to make CEOs and CFOs civilly liable for the information in annual reports and 10-Ks will no doubt lead to more D&O suits.

Admittedly, insurers have responded to mounting claims costs with some pretty stiff premium increases. For example: D&O carriers hit corporate buyers with an average 29 percent premium boost last year, according to the Tillinghast study.

Indeed, premiums for P/C coverage in general have soared since then. According to a recent poll, more than half of 200 respondents saw their premiums ascend by 50 percent to 100 percent, with 8 percent of the respondents reporting boosts of 200 percent or more.

How High the Boon?

High as those premiums have climbed, however, insurance CFOs are pondering whether they’re steep enough to cover the potential cost of future claims. That’s particularly true in the current low-interest-rate environment, in which insurers’ bond-heavy portfolios are struggling to cough out adequate investment income.

Carriers can’t count on big capital gains and interest income to subsidize premiums these days, notes the I.I.I.’s Hartwig. He predicts that P/C industry investments will kick out 5 percent to 6 percent less income this year, following a 9 percent drop in 2001.

The rising cost of reinsurance also threatens the once-stable earnings of insurance companies. Premiums for reinsurance (that insurance companies use to spread risk) is rising by 25 percent to 30 percent, with some lines “running up to multiples of their former selves,” according to a recent report by Standard & Poor’s.

Those higher reinsurance rates are eroding some of “the benefits that primary insurers may be getting for raising rates,” says Catherine Seifert, an S&P equities analyst covering the industry.

The only consolation for carriers is that they don’t tend to buy much reinsurance relative to their overall risks. For instance, a carrier taking in $100 in premiums might spend only $10 on reinsurance to lay off some of the risk, according to Hicks. Still, he says, “primary insurers depend on reinsurers to spread risk, and the cost is going up significantly.”

Overall, however, the biggest challenge facing finance chiefs at P/C companies helping investors understand the strengths of insurers — despite their inherent riskiness and their arcane accounting. “To be blunt about it,” says Chubb’s Hicks, “the average investor has no more chance of understanding a P/C company’s accounting than of performing open-heart surgery.”