GREGORY CASE, PRESIDENT AND CEO, AON CORP.
Case comes to Aon following 17 years of service at McKinsey & Co., where he last headed up the international management consulting firm's financial services practice. Previously, he was responsible for the firm's global insurance practice. Prior to joining McKinsey, Case was with the investment banking firm of Piper Jaffray & Hopwood and the Federal Reserve Bank of Kansas City. He brings worldwide experience to Aon, having worked extensively in Continental Europe and the U.K. as well as North America.

T&RM: The most significant unexpected disaster we have had to face, without much benefit from previous experience, was probably the terrorist attacks on the World Trade Center and the Pentagon on Sept. 11, 2001. Is the insurance industry any more prepared in the area of terrorism? What will happen when the Terrorism Risk Insurance Act (TRIA) sunsets at the end of next year?

Gregory Case, president and CEO of Aon Corp.: There seems to be this notion in Congress that terrorism risk is an insurance industry problem, and insurers will get their arms around it and resolve it. We take a different view that this is fundamentally a client risk problem. Insurance companies will not be fully prepared to underwrite this sort of risk. With respect to TRIA, and we are a strong proponent of the legislation, we have real concerns about how clients will transfer this risk after the 2007 policy renewal cycle if the law is not extended. We are concerned that a private market solution has not emerged, and consequently we are battling for our clients in Washington to have TRIA extended.

Brian Storms, chairman and CEO of Marsh Inc.: The standard insurance market for terrorism, while slightly more robust, is still pretty inadequate to handle the risk. I've been talking and working with regulators looking to develop concepts for a longer-term solution. There are impediments, however. I can't say I see a significant amount of energy going into trying to come up with stand-alone (insurance and reinsurance) alternatives to TRIA, for example. Reinsurers right now don't see a market opportunity. That doesn't mean we will stop trying. I am still hopeful there may be capital market solutions.

Joseph Plumeri, chairman and CEO of Willis Group Holdings: The insurance industry is more prepared to deal with the risk of terrorism than when TRIA was first passed. A combination of exposure monitoring and the use of models to help determine potential severity have assisted the industry in providing a limited market for conventional terrorism risks. Nevertheless, there are shortages of capacity in target zones like Manhattan, Washington, San Francisco and Chicago, as well as for target risks like landmark buildings, bridges and sports stadiums. The risk of nuclear terrorism is everyone's nightmare. A scenario often cited is that of a "dirty bomb"–a conventional weapon containing radiological material that could devastate a major urban area and cause significant loss of life. Insurers are responsible to their shareholders and policyholders to use their capital in a responsible way. While the commercial insurance industry is better prepared today than when TRIA was passed, its assets are still insufficient to fund the type of risk from nuclear terrorism. There just is not enough money. TRIA was a good short-term measure, but we need a permanent solution to what is a permanent problem.

T&RM: Although it has been several weeks since there has been any evidence that human-to-human transmission of avian flu is even possible, the threat of pandemic is still real. How prepared are the majority of U.S. companies, and is there something they should be doing?

Plumeri: While avian flu has not yet mutated to be easily spread from one human to another, if it does–and in the insurance industry we have to consider that it could and plan accordingly–it could have dire consequences for a world with over triple the population that existed during the last influenza epidemic in 1918. Under some scenarios, the consequences of a pandemic, in human and financial terms, could easily dwarf those of any other natural disaster. Since commerce is more global and international travel is the rule of the day, the risk of easier and faster transmission of the virus is much higher than in 1918. A global pandemic flu outbreak would impact employees, vendors, customers, product availability, costs, revenues, markets and market shares. Virtually every aspect of corporate life could take a hit. Businesses dependent on the global economy and complex supply chains, as well as those with a significant international customer base, may be the most vulnerable to loss. Supply chain management is about dependency, and with dependency comes vulnerability.

Companies that have adopted just-in-time manufacturing and single-source supplying could be especially vulnerable. To mitigate the exposures, companies should consider broadening the number of their vendors and suppliers. With respect to employees, companies can proactively take measures to ease the impact of a pandemic, such as educating them about the nature and risk of contagious diseases, offering or encouraging immunizations, reducing their travel, facilitating work-from-home programs and limiting face-to-face meetings. In terms of the preparedness of our clients, it varies. Most large clients are evaluating potential contingency plans and some have progressed to written documentation. Given the limitations of risk transfer for pandemic through insurance, risk mitigation is crucial.

Case: There is an undercurrent of will, which has led to a very clear call to action on the part of many clients, but across our global corporates there is a high degree of variability as far as preparedness for avian flu. We are working with clients to identify the risks they are facing, such as human capital risks and risks to their global supply chain and business interruption exposures. This is where we are spending a significant amount of time. But, it is one thing to have a call to action across an industry and another for a company to mobilize and take action to protect itself. You need facts to mobilize a leadership team, and we see ourselves in the position of providing these facts, where we can.

Storms: We are working with our clients in 100 countries to prepare. Unlike other disasters like climate-related catastrophes, avian flu is a catastrophe with no significant warning. It is still speculative right now in terms of the potential of this virus, and it is very hard for insurers to come to grips with it. But everyone I talk to is paying attention to it, and the insurance industry recognizes the catastrophic potential. There are no specific solutions from a traditional risk transfer standpoint at this juncture. The standard market has been slow to evolve a viable product. Hedge funds and private equity funds are talking about it, however, and we are working closely with them to discuss alternative products.

T&RM: On a less cataclysmic scale, how prepared is the industry for the next hurricane season, and what is the state of the property casualty market?

Case: Last year, the insurance industry came through the worst loss ever recorded for a natural disaster, an aggregate loss almost three times the size of 9/11 and Hurricane Andrew, respectively. Nevertheless, the balance sheets of the industry to underwrite catastrophic risk are still quite strong. Our view is that the industry has adequate capacity at present, and will strengthen itself with new capital, ideas and innovation going forward. For example, we are pulling in reinsurance markets we have not worked with before in other parts of the world that have an appetite for property catastrophe risks in the U.S., on a client-by-client basis. A lot depends on what happens during the current hurricane season. If we have a repeat of last year, it will put significant pressure on property catastrophe reinsurers, many of whom have just come in with new capital and may not be as financially strong or diversified. Even with this additional capacity at present, the property market for catastrophes is much tighter.

Plumeri: Overall, the U.S. property/casualty insurance industry is in solid shape. Capacity today is greater than it was at the end of 2004, the expected combined ratio for 2006 is less than 100, and investment income is up. While certain portions of the property marketplace are softening, the market for natural catastrophes is altogether different, and is tightening extremely fast, both in the primary and reinsurance marketplaces. Commercial insurers have moved decisively to impose larger deductibles, and they have taken several other measures to put themselves in a better position, such as non-renewing certain catastrophe-exposed insureds and cutting back their capacity commitments to cat-prone areas. There is sharply reduced capacity for cat-exposed business, with much lower limits, much higher deductibles for insureds and dramatically higher premiums.

Storms: It would be an understatement to say the property catastrophe market is extremely difficult. We are drawing on years of experience from our broad, global footprint to try to access markets and help clients navigate this risk. While we're personally involved in mediating between clients and markets, it is a tough time to be in renewals. If 2006 turns out to be another bad year for property catastrophe losses, there will be even greater market dislocation going forward. If we see a mild season, we may see some capital inflow to improve the situation, but new catastrophe software models and rating agency decisions regarding catastrophic risks borne by insurers will make this more difficult. The rating agencies have changed how they evaluate catastrophe exposures, forcing insurers to take a more conservative approach to underwriting. We are doing everything we can with risk managers and senior people at our clients to start the renewal process early. It is critical for insurers to know their risk and convince underwriters of the quality of this risk.

T&RM: Are any new risk transfer products on the shelf or in the pipeline to absorb losses from the magnitude of catastrophic exposures posed by nuclear terrorism or pandemic? Are any alternative risk transfer products expected?

Storms: While underwriters can forecast hurricanes, they can't forecast the next terrorist incident or a nuclear attack. Consequently, there are both insurable and uninsurable disaster risks. Where there is no insurance, we're at work trying to develop alternative risk transfer vehicles, and assisting clients in reducing and preparing for these risks. While you can't forecast a nuclear attack, you can ask, "What if one occurred and what are we doing today to plan for this and mitigate it?" The business for us today is as much about managing and mitigating these risks as it is transferring them. Our role, which historically has been called a "broker," is evolving from solely transactions to transactions and advice. We've got to be in a position from an intellectual standpoint and capacity standpoint to help companies work through these issues. We have been heavily involved working with regulators and talking with carriers and clients to develop concepts for long-term solutions to catastrophic risks, which is important for buyers and for the economic health of the country. Frankly, I don't see an immediate solution on the issue.

Plumeri: When it comes to risk transfer products, whether from the traditional insurance marketplace or from capital providers, there are specific underlying principles to keep in mind. The risk has to be reliably identifiable and quantifiable for material amounts of capital to be committed, and the spread of risk has to be broad enough that the premium inflow is reasonably expected to cover claims, expenses and an acceptable return on capital. With that in mind, terrorism risk does not readily lend itself to multi-dimensional modeling for frequency and severity, and that's the chief impediment to shaping risk transfer mechanisms, including alternative market solutions such as catastrophe bond facilities. For potential pandemic diseases, the first step–modeling–has been taken by Risk Management Solutions, which has developed a model addressing probabilistic loss assessments, investment strategies and business continuity planning. Corporate implosion is a different matter, as it is usually specific to a single insured or industry, and therefore may be uncorrelated with movements in the general economy or other statistically significant risk factors. Still, there are ways to deal with this risk, such as planning for adverse publicity, and financing through contingent capital or debt to address the need for cash or equity. Looking at all these risks across the board, I have called for a single, federal approach to disaster insurance issues. Addressing losses from these catastrophic events is not an insurance issue and it is not a political issue–it is a matter of national economic security. Since the industry does not have enough capital and the federal government has not yet acted in this direction, our nation is not prepared for a worst-case scenario.

Case: As the risk adviser, our obligation is to bring new ideas and perspectives to the table. While lots of folks talk about alternative risk transfer, we are the only broker to have done nine deals over the course of the last few years–capital market solutions like catastrophe bonds. We believe we've got to continue to innovate on behalf of our clients to find options and ideas to relieve or mitigate risk. We would expect to work with the primary markets to do that and continue to work with the capital markets in developing alternative risk transfer products. For example, we are working on creating a business interruption option that would be invaluable against these sets of risks. We're doing this essentially on a client-by-client basis, as opposed to one broad-based solution, assisting them to address the kinds of catastrophic events that may or will occur but haven't occurred before. We are changing the paradigms in terms of how to attack them.