Editor: Tom, you have a very rich background in the insurance industry. Would you cite some of the highpoints of your background both as an audit partner of the former Arthur Andersen and also in working with Commissioners of Insurance and relevant industry organizations?
Mulhare: If you look at just three highpoints for me in terms of major projects, I led the team on behalf of the NAIC (National Association of Insurance Commissioners) that assessed Lloyd's ability to handle the claims that were expected to come out of 9/11; I was also the audit partner on the development of the rehabilitation plan for Mutual Benefit Life and just recently we completed the first audit (in 99 years, according to their website) of the New York Liquidation Bureau.
Editor: That must have been quite an interesting challenge to review that number of years.
Mulhare: "Interesting" is a great word - just in acknowledging that we got through it. It was a great effort by both the Liquidation Bureau as well as Amper's team.
Editor: Is there anything further you'd like to mention?
Mulhare: At Amper we have taken as our model much of what we had done at Arthur Andersen focusing on, from an audit point of view, middle market insurance companies as well as doing consulting work for companies of all sizes.
Editor: The insurance industry appears to have been spared some of the upheaval experienced by the banks in the recent downturn. Do you expect the insurance industry to continue to dodge the bullet?
Mulhare: If you compare insurance companies to the banks, I think your statement is accurate. If you talk to the people at the insurance companies, 2008 was a very difficult year. You already had a soft premium market so the top line was already eroded. Even though their portfolios are much more diversified than other financial institutions, they all took some kind of a hit. So, yes, it's been less onerous than for other financial institutions, but it's been a difficult year. If this is not an exceedingly long recession, I believe that they will continue to do better than other financial institutions and continue to be reasonably stable, but if this recession continues for a prolonged period of time, any weaker player will definitely be impaired.
Editor: How do you view the P&C section of the industry as compared with the life and health sections? Which is more vulnerable?
Mulhare: Certainly the life insurance area has turned out to be more vulnerable in the short term. In the case of the companies that had issued contracts guaranteeing certain minimum returns (annuities), the hits to the portfolio from the market decline, and certainly their own stock prices, which have suffered because they are viewed as being part of the whole financial services sector, have made for a difficult financial environment. It has also been difficult in terms of trying to raise additional capital to meet their financial needs.
P&C insurance firms, in general, are stronger, but again some companies will be at risk if this is a prolonged recession. They have a soft premium market, are suffering from the same damage to the portfolios as the life companies even though they're well diversified, but they have held to their traditional underwriting standards.
Editor: Not only are insurance companies vulnerable in terms of additional claims but, as you mentioned, their portfolios are also shrinking. What risks do you see for the continued viability of some of the firms?
Mulhare: If you talk about reserves to cover claims, P&C companies came off a couple of strong years and from what I can see, they are trying to keep their reserves at an adequate level. With their investment portfolios, companies have taken some hits, but the rest of the portfolios of middle market companies are probably relatively stable now. Nevertheless, they are experiencing lower interest rates and potentially less dividend income and are faced with much uncertainty in the equity markets.
Editor: Do you expect most of the claims against P&C insurance companies to come from the D&O policies or Errors and Omissions claims or are there other areas of business underwriting which gave them exposure?
Mulhare: Certainly with respect to D&O claims there is a high expectation that they are going to continue for a while, given the number of lawsuits relating to financial services industry problems.
Insurers might see an increase in workers' comp claims because of all of the layoffs, which has traditionally been the case. There is also a question about mortgage and other homeowners' insurance policies. I think we're going to see a lot of creative lawsuits because of the loss people have incurred. On the other hand the recession has made us all drive less so from an automobile personal lines carrier there may be some benefit to these specialized carriers.
Editor: Have any of the companies that you deal with undertaken to underwrite exotic products such as AIG has done in terms of credit default swaps (CDSs) or credit default obligations (CDOs)? What is the general word about the industry's willingness to move into such untested areas?
Mulhare: Our clients are sticking to their knitting. They are very focused on their niches and have not gone outside of proven and time-tested areas. Those financial services type products AIG offered were outside the purview of their insurance companies. This is the issue being debated now in terms of exactly what regulatory agency should have had responsibility for overseeing that development and potentially stopping it.
Editor: Even though the CDSs were a kind of insurance, didn't they come within the purview of the insurance commissioners?
Mulhare: No. They are what are referred to as non-licensed insurance products, which fell outside the definition of insurance as you and I would know it. They certainly used the word "insurance" but again insurance would have meant that they would have been licensed by state regulators and there would have been a regulator to oversee that particular company and product, and they would have had to put up reserves for it, so there was a very different scenario from what you see actually happened with these products.
Editor: What kind of safeguards in each of the states provides a safety net for claims should an insurance company default in honoring a claim?
Mulhare: There are two levels of safeguards. Each state has a guarantee association - usually a life and health guarantee association and a separate P&C guarantee association. An impaired insurance company would be placed in the hands of the state of its domicile to see whether it can be rehabilitated, basically to see that it had enough capital and could pay claims. Potentially you can put it back in the marketplace if rehabilitated or you could liquidate it if it is not a viable entity. The various states, depending on their statutes, will pay up to a certain amount on a particular claim, and if there's enough capital in the company, the full value of the policy may be paid. Then there are the national associations - life and health guarantee organizations and a P&C organization - that are charged with coordinating among the various states the payment of claims for multistate insurers as well as the collection of fees from the various states to help fund whatever the rehabilitation or liquidation plan is for a failed insurance company. For all that one hears about the splintered approach to insurance regulation, it's a pretty effective network. In the case of the now defunct Mutual Benefit Life, I witnessed how particularly New Jersey and NOLHGA (the National Organization of Life and Health Guarantee Association) did a very credible job of coordinating amongst the states and really protecting the policy holders' interests.
Editor: Are you seeing acquisition opportunities for many of the larger insurance companies? For instance, it is thought that AIG will be selling many of its insurance subsidiaries.
Mulhare: Yes, valuations have gone down a lot. What I do see is people holding onto their cash. If you are a public company, your own stock price is down so the attractiveness of a stock acquisition is not there. If you are a private company, you're holding your cash. People are waiting to see where the bottom is before they're going to take advantage of some pretty attractive pricing.
Editor: What kind of underwriting standards for the future do you expect to emerge from the present financial crisis? Do you anticipate that business will be paying much higher premiums?
Mulhare: The hope on the part of the industry is that the market will firm, but currently, the premium market is soft from a primary carrier's standpoint. From an underwriting standards standpoint looking at your mainline products, auto, whether personal or commercial, real estate, whether residential or commercial, and workers comp, etc., I don't expect underwriting standards to change nor is there reason to change them because those lines have not been the issue.
Editor: How do you prove to an insurance company if you're an independent company looking for insurance that you do have a strong enterprise risk management system?
Mulhare: A potential insurer should request the following of the insured: explain to me your process, first, then how formal is your process? How do you track your risks? How do you track emerging risks? And how well do you measure your risk profile? It's going to be very much a show-me process. You should have metrics, you should have examples of how you cope with risks, you should have a way of showing what risks different levels of management get to see so that the insurance company doing the underwriting will get a flavor for whether your firm's plan for handling risk is - best in class, an above average plan or average plan, leaving you susceptible to some surprises. Another key factor is: does your compensation system support your system of enterprise risk management, i.e., what are you doing to make sure that people are compensated for following your risk management plan?
Editor: Is there anything more you'd like to say on the subject of insurance?
Mulhare: I think it's unfortunate that insurance is getting painted with the same broad brush as other parts of the financial services industry. Especially on the P&C side, it has weathered this part of the storm better then most, but unfortunately, as we all know, the storm is not over.
Published March 31, 2009.
