Dallas Leadership 100 Interview with Morgan McMillan

Gina Taylor (GT):    A lot of people think of the insurance industry as “recessionproof”.  Is this an accurate description?  What changes have you noticed since the downturn in the economy?

Morgan McMillan (MM):    Well, I’d start by saying that it is not “recessionproof”.  With AIG’s situation, I think we’ve seen how closely intertwined the financial markets are.  Whether you are talking about insurance, mortgages, commercial lending, private equity, or anything else financial, we’ve seen the wake of destruction passing through several areas.  Insurance Included.

Now, minus a few select carriers who were heavily involved in Credit Swaps and/or have had tremendous investment losses, the insurance and financial meltdown has not had a huge immediate effect. Note that I say “immediate”. However, the insurance industry has historically always been relatively slow to react to these types of occurrences.  Insurance Cycles are somewhat predictable and the inflection or transition point happens over months rather than weeks.  Nevertheless, its safe to say that the recent deterioration in the financial markets combined with large losses the industry took in hurricanes Gustave and Ike have triggered a change in insurance market conditions. Pricing will begin rising this year.

Also, you can’t overlook that when a company can’t get financing for a project, or when  retailers are closing their doors, there is simply no reason to purchase insurance.  Carriers and Brokers are both affected by this reduced volume.

GT:    So, it sounds like the financial meltdown has directly affected the insurance markets.

MM:    Insurers work very similarly to banks in that they are required to maintain certain levels of reserves.  When these reserves “dip” due to poor loss ratios or lost revenues on the investment side, it has a direct effect on the amount of capacity that an insurer has to lay out on a risk.  This tightening is very similar to what we’ve seen in other financial markets.  While banks have to reduce the amount they have available to loan, insurers basically reduce the amount of risk that they can take.  Moreover, because their ability to insure is a multiple of their reserves on hand, even the slightest dip in reserves can have a tremendous effect on pricing and capacity.   Ultimately, they have to charge more for taking less risk.

GT:    How has this affected your business and the brokerage community in general?

MM:    Well it has certainly made our jobs much tougher, but it is really a natural occurrence that happens whenever the cycle changes as it is doing today.  It is in these “transitional” times [when the market is going from soft to hard and from hard to soft] where there is the greatest opportunity to differentiate a particular risk and reduce expenses compared to market rates.  I’ve always said the soft market makes every broker look like a genius.  The hard market places a renewed value in underwriting knowledge, structure, due diligence…and it separates a good broker and good underwriter from an average one.

GT:    And I take it that you are not an “average” broker? [laughs]

MM:    [laughs] I guess that came out wrong.  I don’t mean it like that.  I’m just saying that a lot of work goes into getting the best deal in a hard market.  A broker that can provide creative Risk Management strategies and has the right relationships will add a tremendous amount of value to an insured client when their competitors are seeing prices soar.  It’s a lot of work right now, and as a broker, you have to be willing to roll up you sleeves and dig into the losses, the exposures. and everything that goes into pricing risk. Sorry, I hope that makes sense.

GT:    It does.  So, what can a company do to control their costs in times like this?

MM:    You have to almost “blow it up” [the current insurance program] and rethink what you are covering and how you are covering it and why. Insurance carriers are looking to increase their rates, so you have to be open to looking at alternative structures. If you are a mid- or large-size company and have not spent a few hours going through a risk retention analysis internally or with your broker, you need to back up and rethink some things.  I can’t tell you how many times I’ve done a risk review with an owner, CFO, General Counsel or Risk Manager, and we discover that they’ve been overbuying coverage for years.  Now is the time to evaluate what’s important, how much risk you are willing to take, and you have to know where to start.  It’s a process and this is just the starting point.  You have to see that process through.

You know,  no two company’s insurance programs are exactly alike. Each insurance program has its own pressure points, so it is tough to generalize.  Credit is a huge factor today, so companies taking large deductibles of $250k or more will have credit and collateral issues that need to be addressed.  If I have dollars or working capital “locked up” in my insurance program, I’m going to have issues when credit tightens.  It’s not uncommon for large companies to have millions of dollars of cash, Letters of Credit, or trust dollars tied up in a workers comp or liability program in addition to premium.  There are specific things you can do to address this cost and you can be successful at negotiating reductions in collateral.  However, each case is different so you really have to work the process and go through all of the components that make up collateral requirements to effectively address these issues.  I don’t mean to get off onto this one issue, but it amazes me how often I find a large company being misdirected in this particular area…following their broker’s advice and overlooking the key components to the collateral requirements.   You have to do more than simply fly to New York to meet with the insurance carrier’s financial committee.  Carrier relationships are important, but in today’s financial environment, it takes a lot more than that to get them [the insurance carrier] to reduce collateral.

GT:    What process do you do to reduce collateral?

MM:    I was just thinking that you might ask that question [smiles].  I like to think of it as my own process and not something that I want shared with my competitors.  [pause]  The best way I can describe it…  is that it is not just one or two things… it is a combination of many variables that are all somewhat tedious, but can be, need to be addressed.

GT:    Can you give us a hint?

MM:    It's understanding what drives the security and understanding the data you are working with.  There are 10 major areas that need to be scrubbed to reduce collateral costs and I’d say that  90% of large insureds, even the sophisticated ones, are only looking at 2, 3, or 4 of them.  There is a lot to it that would probably take up the rest of our time, if we have not already.  I guess it's similar to the old data mining phrase “garbage in, garbage out”.  The only real exotic difference is perhaps when you begin using some alternative financial structures, captives, trusts, etc. 

Now the guy in the back is waving…I guess I’m supposed to stop.

GT:    No, this is good, we are actually running a little long, but let’s take 3 questions from the audience.

Audience: What do you see happening in the Real Estate sector with regards to insurance?

MM:    This is an area that is close to me, since I have several clients in this sector.  I think real estate companies are looking to drastically cut expenses...Now.  It has to happen.  Meanwhile, developers are burning through cash while waiting for the finance markets to come back to life.  We are doing a lot of Mid-Policy term cancel/rewrite deals to restructure current insurance programs and reduce expenses.  It takes a lot of effort, but it is something that has to be done.  Exposures have changed, they are less in most cases, so the program costs need to react.  Does that answer your question?

Audience: Yes, actually more than I expected.  I never thought of that.

Audience: What do you see to be the future of AIG?

MM: Wow… if I knew the answer to that question, I’d probably be retired and laying on a beach somewhere [laughs].  Seriously, I’m still placing business with AIG.  I feel like their subsidiaries [AIG], the insurance carriers like Lexington and National Union and others are secured.  My understanding is that there is limited credit in the marketplace for other companies to buy some of their most valuable assets which is creating a problem.  However, it is my understanding that their reserves are stable and protected.  I guess my biggest concern would be for AIG to lose its AM Best rating…. Fall below A- or something like that.  With the government’s aid, I don’t see that happening anytime soon.

Again, I don’t have the magic answer for AIG, but I know that there are a lot of individuals and companies counting on them for their insurance protection and they won’t be going away overnight.

Audience: Our company has a very large auto fleet and we’ve been told to expect double digit price increases in the next 12 months.  Does that sound correct to you?

MM: No.  Your question is actually what I really planned on discussing in this short timeframe…in this forum before we got into the other stuff…. Just kidding Gina.  What I’m saying is that it is important NOT to get caught up in the “hard market hype”.  The market may be turning, but that does not mean your expenses will match the average market rate change.  Don’t let the general market drive your program.  First, there is plenty of “Auto” capacity out there [many carriers writing auto coverage].  Do you have a good loss history?

Audience: Yes, we had a large loss a few years ago, but that’s it.

MM: Okay, so that’s positive. If that loss was over 5 years ago,  I would position you as the “cream of the crop” or “cream of the crap” as my partner often says [laughs].   If you are still growing or at least stable, that is also a big plus right now.  So, what I’m saying is that, if your loss history and your growth is trending in a positive manner, why would that not offset what “the market” is doing?  That’s the position you have to take. 

Again, too many large brokers promote the changing of the market…everyone wants to jump on the hard market bandwagon…and you can’t do that.  The goal is to best position your risk no matter what market we are in.  If there is still plenty of capacity, your risk is improving, and the market is getting worse, then a flat renewal is more in line with what to expect…not a double digit increase.

GT: Sorry, but that is all the questions we have time for and we need to move on.  I’d like to thank Morgan for taking time out of his schedule to speak with us today.

MM: You are welcome Gina.  I enjoyed being here.