In the years ahead, liability associated with the Year 2000 computer problem will be the second-most important financial-risk issue for property and casualty insurers after catastrophe risk, A.M. Best analysts predict.

And as falling rates in the property and casualty industry continue to affect all lines, Bermuda's insurers are favoured to capitalise by growing bigger, the analysts state in the January issue of Best Review.

Property and casualty insurers here will be seeking to make more acquisitions in over the next two years.

"Globalisation will continue, favouring offshore insurers with large market capitalisation, strong stock currencies, lower costs of capital and longer-term strategies,'' the analysts state. "We predict large `bolt-on' acquisitions by Bermuda and European insurers over the next two years, broadening their US penetration and taking advantage of modest valuations and market instability.'' The 23-page article, "An Emerging New Landscape'', contains dismal forecasts about the fate of the US property and casualty market over the next few years.

The US market usually makes up the largest segment of risks covered by Bermuda insurers and reinsurers.

Many, such as ACE Ltd., Exel Ltd., RenaissanceRe Holdings Ltd., and PartnerRe Ltd., have also made purchases over the past year that has launched them directly into the US market. ACE is currently negotiating to make a $3 billion purchase of Cigna Corp.'s property and casualty subsidiaries.

The rating agency predicted that up to a third of the 1,100 US property and casualty companies could lose their operating autonomy or withdraw from the market over the next five years.

These will be ripe pickings for Bermuda and European companies during what the analysts characterise as an underwriting cycle in a "permanent down market'', one that has excess supply and weakened demand for traditional insurance products.

It's a market where 90 percent of existing companies compete for about 10 percent of the premium volume. The top ten companies capture 40 percent of the market.

"The industry remains mired in a permanent down market that has resulted in price-cutting in almost all segments,'' the analysts stated. "Declining premium margins and pressure on investment income have started to wreak havoc on the earnings of insurers -- particularly commercial carriers. Top line growth is virtually non-existent, reserve redundancies are dwindling and nature continues to unleash its fury as shown by rising claims frequency.'' In such a market bigger will be better, as companies move toward quality rather than price both in the insurance and reinsurance market.

"The flight to quality movement will take hold in most primary segments, driven by agents and brokers solidifying long-term insurance relationships,'' the analysts stated. "Controlling distribution and leveraging technology are critical to insurers' long-term viability.'' But the biggest possibility for losses for the industry after catastrophe risk is the Year 2000 (Y2K) computer problem. The rating agency estimates 34 property/casualty groups have 75 percent exposure in their lines of business to the Year 2000 bug.

"We consider mass-tort liability associated with the Y2K problem to be the second-most important financial-risk rating issue for property and casualty insurers, following catastrophe risk,'' the analysts stated. "The size of the potential liability, combined with the unpredictability of judicial thinking in this new frontier, has elevated Y2K above core loss reserve deficiency -- which we have estimated to be in the $26 billion range -- as a rating concern.'' The lines most at risk are comprehensive general liability, directors and officers and errors and ommisions liability, product liability, property coverage and business interruption.

About half of the industry's Y2K liability losses will occur in comprehensive general liability coverages, roughly split between legal defence and indemnity costs A.M. Best predicts.

"The primary insurer defences will be lack of fortuity, lack of physical damage or bodily injury, statute of limitations, and use of exclusionary language,'' the analysts stated.

Directors and officers, and error and omission policies will be susceptible to shareholder lawsuits citing mismanagement of Y2K remediation.

"This policy will be defended through exclusionary language, statute of limitations and occurrence date,'' the analysts stated. "We believe losses related to professional liability will constitute 25 percent of Y2K claims and will be heavily weighted toward defence costs.'' Elsewhere the analysts predict that the reinsurance segment of the market will be adversely affected by higher catastrophe losses and competitive pricing.

Insurers that have continued to reduce expenses and become more efficient will survive the turmoil ahead.

"Tomorrow's winners have spent the past years positioning themselves and developing competitive advantages,'' A.M. Best stated. "Their future success now lies in integration, execution and performance. Their success will be validated by favourable operating trends in the future.'' SURIVAL OF THE FITTEST -- A.M. Best's Rreview predicts hard times ahead for insurers -- and more acquisitions by Bermuda companies.

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