AIMU - Address of David French to Marine Insurance Association of Seattle

ADDRESS OF

DAVID S. FRENCH

CHAIRMAN

AMERICAN INSTITUTE OF MARINE UNDERWRITERS

to the

MARINE INSURANCE ASSOCIATION OF SEATTLE

May 14, 2003

SLIDE 1

Thank you for giving me the opportunity to share some thoughts about the terrorism threat, the overall insurance market, the ocean marine insurance environment and the work of the American Institute of Marine Underwriters.

It’s a special privilege to address the Marine Insurance Association of Seattle. Both organizations share the common goal of developing an environment in which marine underwriters can grow and prosper. Underlying that goal is a shared commitment to continuing education and enhancing professionalism.

Inescapably, any discussion about marine insurance and the global insurance marketplace in which we operate must include the impact of September 11 and its far-reaching consequences. And although we are thousands of miles from Ground Zero, there is a sense of immediacy because Seattle and Tacoma are among the most important commercial ports in the nation.

SLIDE 2

With its cargo terminals bordering downtown, Seattle has its own unique security concerns. Fortunately, as The Wall Street Journal reported on April 21, the port authorities here are taking action to improve security with the addition of increased fencing, lighting and security guards. Of course, much remains to be done at ports and other transportation terminals throughout the nation.

SLIDE 3

Earlier this year an independent task force of the Council on Foreign Relations released a special report on terrorism and the nation’s state of preparedness. It concluded that a year after 9/11, America remains dangerously unprepared to prevent and respond to a catastrophic attack on U.S. soil.

SLIDE 4

The task force of national security and intelligence experts, former cabinet members, Senators, Joint Chiefs of Staff and business leaders covered a wide range of security imperatives. But one should stand out for this audience – making trade security a global priority. And the first area of focus is vulnerable seaports.

SLIDE 5

The fact is that 95 percent of all non-North American U.S. trade moves by sea and arrives in 361 ports around the nation. And despite the vital role seaports play in linking America to the world – both economically and militarily – port vulnerability studies are not scheduled to be completed for five more years. The task force observed that over the past few decades, container traffic and energy imports have been increasingly concentrated in just a handful of ports, making them inviting targets.

SLIDE 6

As the West Coast port closures demonstrated last year, the cost to the economy of closing these ports totals about $1 billion per day for the first five days and rises exponentially thereafter.

SLIDE 7

And now more than ever, trade depends on the intermodal container.

There are an estimated 14 million containers worldwide that enter the United States every year. Right now, only four percent receive security checks. And there are no security standards governing the loading or transport of an intermodal container.

If an explosive device was loaded in a container and set off in a port, it would raise concern about the integrity of the 21,000 containers that arrive in U.S. ports every day. “A three to four week closure of U.S. ports would bring the container industry to its knees,” the report said.

As this system becomes grid locked, so would much of global commerce and, I should add, so would worldwide marine insurance.

SLIDE 8

The U.S. is trying to address this issue in a number of ways. AIMU supported the tough provisions of the port and cargo security bill that Congress enacted last November. This measure is part of a strategy that recognizes that the first line of defense against terrorism cannot begin at U.S. ports and borders. The term of art here is “pushing back the border.”

I’d like to briefly review three measures passed or re-prioritized in the post-9/11 world that affect marine insurers.

As the Council on Foreign Relations report correctly noted, the shipping container can serve as an adjunct to terrorism – a means of illicitly transporting people and materials.

For many years, marine insurers have been at the forefront of the effort to improve port security. And we continue to play a significant role in the effort to push back the borders.

SLIDE 9

AIMU vigorously supported the Maritime Transportation Security Act of 2002. The law contains these key provisions:

Planning. The Coast Guard will assess U.S. ports for vulnerability to terrorism, with the results used to implement a comprehensive maritime security plan and specific area plans.
Foreign Ports. Security systems in foreign ports also will be assessed. The legislation provides unilateral authority for the U.S. to deny entry to vessels from ports that do not maintain effective security. The International Maritime Organization (IMO) approved worldwide security standards at its December conference which the U.S. will use to implement this authority. Any inconsistencies between the mandates of the act and IMO’s directives will be reconciled in final regulations to be issued by the U.S. Coast Guard early this summer.
Credentialing. Vessel personnel and workers in designated port areas will be required to have transportation security cards, probably using “smart card” technology, to be issued by the Department of Transportation. Industry groups would like to see a uniform system to be in place internationally in order to pre-empt a hodge-podge of local requirements.
Container Security. The bill provides for a cargo tracking, identification and screening system for containers shipped to and from the U.S. directly or through a foreign port. Performance standards for the physical security of shipping containers, including seals and locks, will be established.

The law also contains provisions for funding maritime security training, expanding the deployment of armed Coast Guard “sea marshals” on high-interest vessels, and equipping vessels with automatic identification systems that will give the government access to information on a ship’s identity, position course and speed.

SLIDE 10

A second security measure gained renewed emphasis after 9/11. Under this law, insurance companies and self-insured employers face potential fines, and even jail time, for failing to screen the names of claimants against a government list of potential terrorists. This list is maintained by the Office of Foreign Asset Investment (OFAC).

The OFAC list, which contains some 5,000 “Specially Designated Nationals and Blocked Persons,” such as foreign agents and front organizations, terrorists and narcotics traffickers, has existed for 24 years. Its use was reinforced by an executive ordered issued by President Bush on September 14, 2001.

Under OFAC, before any financial transaction, including the payment of an insurance claim can be conducted, the name of the customer must be checked against the list. If an insurance claimant is on the list, the claims-payer must notify OFAC. If they don’t and it turns out that they are making a prohibited transaction, they face fines of up to $1 million and up to 12 years in jail. OFAC also has the authority to impose civil penalties.

Among other examples of prohibited insurance transactions listed in a Treasury Department bulletin on OFAC are:

A life insurance policy naming a Cuban resident as beneficiary.
A reinsurance contract for policies underwritten in whole or in part by the Arab Commercial Insurance Company of the Channel Islands, named as a Specially Designated National of Libya.
An aviation policy issued to a non-blocked foreign airline but which names as an additional insured another bank with a Libyan connection.

The bulletin warns that “All U.S. insurance companies and U.S. citizens and permanent resident aliens who are employees, officers or directors of U.S. or foreign insurance companies need to be aware that they may be held accountable for sanctions violations.”

To assist insurers, various software products have been developed to cross-check claimants against the OFAC list. AIMU is working with a vendor to offer a product specifically to enhance the ability of its member marine insurers to comply with the law.

I also want to point out that property/casualty insurers -- for now at least – are temporarily deferred from the enforcement regulations of the Patriot Act of 2001. This measure requires financial services companies to screen and spot money-laundering activities that finance terrorism. The enforcement regulations are still on the Treaty Department’s “pending” agenda, according to AIMU.

SLIDE 11

All property/casualty insurers, including marine insurers, do come under the Terrorism Risk Insurance Act of 2002 or TRIA, better known to us as the terrorism backstop. The measure is meant to increase the ability of businesses to obtain terrorism coverage.

Basically, the law provides for the federal government to share with the commercial insurance industry the risk of loss from future terrorist attacks. Each company has a retention (or deductible) which represents its share of terrorism losses that must be paid prior to any federal payment

The measure requires insurers subject to the act to make terrorism coverage available.

The program covers losses from terrorism which occur within the United States. It does not generally apply to losses which occur outside the U.S. with the exception of those which occur to U.S. citizen-operated air carriers, U.S. flag vessels and foreign flag vessels home-ported in the United States on which U.S. income tax is paid and whose insurance coverage is subject to regulation in the U.S.

TRIA allows exclusions for nuclear, biological and chemical risks. AIMU has prepared suggested exclusion clauses for these risks.

Still, complex implementation issues remain to be resolved by all p/c insurers, in conjunction with the Treasury Department and state regulators. Only time will tell how the law affects the marketplace.

As a result not only of 9/11, but the state of the U.S. economy and the ongoing hard market, it’s hard to recall a time more turbulent than the one the overall property/casualty industry and marine insurers face today.

I’d like to briefly review the financial results and outlook for the property/casualty industry and for marine insurers in particular.

As has been reported many times over, in 2001 U.S. property/casualty insurers reported a worst-ever negative rate of return of 2.7 percent, a combined ratio of 116 percent, the third worst on record and an 8.7 percent drop in industry surplus to below $300 billion. So, it’s not a surprise that 2002 results would show an improvement. Unfortunately, the numbers overall were disappointing, with a return to profitability tarnished by a decline in surplus.

SLIDE 12

According to Insurance Services Office and the National Association of Independent Insurers, the p/c industry combined ratio for 2002 was 107.2 percent.

On the plus side, net underwriting losses were $30.5 billion, down from the record $52.6 billion in 2001.

The receding underwriting losses helped to produce net income after taxes to positive $2.9 billion last year from the negative $7 billion in 2001.

Also encouraging was net written premium growth, which was up 14 percent over 2001, the fastest growth since 1986.

The recovery in net income would have been stronger if not for a 2.8 percent decline in investment income – primarily dividends earned on stocks and interest on bonds -- to $36.7 billion in 2002 from $37.7 billion in 2001.

But the most disappointing development is the continuing decline in the industry’s surplus which dropped $4.4 billion in 2002. And this followed huge declines in 2001 and 2000. As a result, industry surplus at year-end 2002 was $49.1 billion, or nearly 15 percent (14.7 percent) less than surplus at year-end 1999.

Clearly we have a long way to go in digging ourselves out of the hole created, to a certain extent, by a decade long price war, in addition to declining investment returns, mounting losses from natural catastrophes and, of course, 9/11.

SLIDE 13

As the I.I.I. has noted, last year’s one percent return for the the p/c industry was one-half the 2.0 percent return investors received risk free in 2002 from a simple investment in one-year Treasury securities – without any worries about terrorists, hurricanes, mold or trial lawyers.

Unfortunately, there remains a significant percent gap between the industry’s 12 percent cost of capital and its current rate of return.

This gap will not be closed in 2003, especially if financial markets continue to swoon and interest rates remain low.

Keep in mind that a one percent decrease in the investment yield requires a decline in the combined ratio of 2.6 points in order to keep profitability at the same level.

To achieve a target ROE of 12 percent, for example, the industry needs to record a combined ratio of in the area of mid to low 90s.

The I.I.I. observed that “the performance gap is so enormous that any discussion of the end of the current hard market should now be regarded as recklessly premature.”

Fortunately, marine insurance has performed better than the p/c business in recent years. We turned the corner faster than the p/c business as a whole. And, of course, we did not share in the catastrophic losses of 9/11.

SLIDE 14

AIMU reported that for 2002 its members posted a very respectable 92.2 percent – the lowest in six years. That represents a further improvement from the nearly 99 percent combined ratio recorded in 2001. In other words, ocean marine insurers attained that target ROE of 12 percent that the p/c industry as a whole is struggling to reach.

But before we celebrate, here’s a cautionary note. Three years after marine industry recorded the 91.5 percent combined ratio in 1996, the combined soared to more than 108 percent.

There are some signs worth watching closely. Net written premiums for ocean marine insurers in 2002 rose 5.7 percent to nearly $1.3 billion, compared with the 12.3 percent increase between 2001 and 2000. Keep in mind, net written premium for all property and casualty lines grew 14 percent in 2002 – and 16 percent for underwriters of commercial lines.

The sluggish economy in the U.S. and worldwide is likely a contributing factor to the modest increase in premiums experienced by marine underwriters last year. U.S. GDP rose only 2.9 percent last year and is expected to rise only 2.4 percent this year.

But the larger question remains: does this decline in premium growth indicate a turn in the marine market? I think not. Anecdotal information suggests that pricing discipline has not been abandoned.

To a great extent, the ocean marine industry’s performance will follow the results of its two largest lines – cargo and yacht. In 2002, cargo recorded a remarkable combined ratio of 75.4 percent, nine points lower than in 2001.

On the other hand there was some deterioration in the performance of the yacht line, where the combined ratio rose to 97.5 in 2002, up from 93.3 percent in 2001.

The most dramatic deterioration in results was in ocean hull, which recorded a combined ratio of 132 percent in 2002, up from 113 percent in 2001. These are worst numbers since 1998.

At the same time, the most significant improvement occurred in offshore risks which saw a combined ratio of 93.3 percent in 2002, down nearly 60 points from the nearly 153 combined in 2001.

SLIDE 15

But the challenges that confront marine insurers extend beyond those of a highly competitive global marketplace, terrorism and an uncertain world economy. To succeed in a highly competitive industry, marine insurers need a growing body of knowledge and information. Here’s where AIMU comes in.

SLIDE 16

In addition to monitoring significant legislation such as the maritime security bill, AIMU provides direct services in support of its

members. AIMU staff and committees work diligently with a variety of constituencies in classification societies, law enforcement, government and international marine and trade organizations.

AIMU’s Forms and Clauses Committee recently developed an Extended Radioactive Contamination Exclusion Clause and Chemical, Biological, Bio-Chemical and Electromagnetic Exclusion.

AIMU maintains an international intelligence network of correspondents in port cities throughout the world who also arrange surveys of damages to identify the cause and value of losses and help speed claim settlements.

And AIMU’s “Weekly Bulletin” provides the latest information about worldwide marine insurance concerns, including marine insurance law, legislation and publishes technical papers and conducts educational seminars on a variety of subjects, including terrorism, transportation security, P and I underwriting and cargo claims.

AIMU also is offering two new educational programs. The first is an “Introduction to Marine Insurance” course, which provides an essential understanding of the fundamentals of shipping as well as a basic analysis of cargo, hull and marine liability policies.

The other new program, is the “Introduction to Yacht Underwriting, which reviews coverage parts in a policy, underwriting criteria, survey information and the legal environment for this growing line of business.

All this work is done with a common objective in mind – to create an environment in which marine underwriters can grow and prosper.

SLIDE 17

Working in partnership with groups like yours, AIMU is committed to helping develop the unsurpassed skill and professionalism that is the hallmark of the American marine insurance business. Thank you.

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