“To truly differentiate on the basis of service in the face of pure price competition requires a much deeper understanding of what customers really want. Our service models will have to change,” he said.

Very few industries have survived this challenge of differentiation, he said. “I'm not saying that the insurance [industry] will be the McDonalds of the next 10 years. On the other hand, there is significant risk that the bulk of insurance–particularly in personal lines–could end up like the fast food industry,” he warned.

During the question-and-answer session, Mr. Kelly suggested that selective underwriting and risk-based price differentiation would be emphasized more if insurers did not have the ability to share data through organizations like the Insurance Services Office.

Responding to a question about underwriting and pricing discipline–and the availability of data to allow for such discipline–he said: “We would be a much better industry if we couldn't share data.”

“There is plenty of data. We just don't do a good enough job of using it,” he said, adding that companies the size of Liberty Mutual should not need to lean on ISO as a “crutch.”

Asked about the potential for insurers to grow through consolidation rather than price competition in the near future, Mr. Kelly said that excess capital will likely fuel acquisitions over the next few years.

In addition, he suggested that federal lawmakers could force consolidations of small insurers. To support his theory, he cited the debate over the trigger of federal terrorism coverage, noting that when smaller companies argued for a trigger as low as $50 million, federal lawmakers on both sides of the aisle asked, “Why is a company in business if it can't support a $50 million terror event?”

He said the lawmakers concluded that such insurers shouldn't be in business, predicting that these companies “will be squeezed out of business [and] forced to consolidate.”

Beginning his address, Mr. Kelly delivered his thoughts on the risks of terrorism and hurricanes, outlining Liberty Mutual's positions in support of a federal government role in terrorism insurance–but not natural catastrophes. “It is easy to differentiate [them] both philosophically and actuarially,” he said, emphasizing that he adamantly opposes a national catastrophe fund proposed by Allstate (see page 8).

Although he admitted he had concerns about inviting the federal government into any area of the p-c insurance business, terrorism losses “can be far greater than private capital can take on,” he said.

Still, he noted that when federal insurance programs exist, political pressures by consumers and business groups often lead to under-pricing and moral hazard. He cited the history of the federal flood insurance program–which is underfunded by $20 billion–as a case in point, adding that there is overbuilding in flood-prone areas, in part because of this federal safety net.

While Mr. Kelly advocates greater pricing freedom in catastrophe-prone areas instead of federal government assistance, he recognizes the problems. “There are very few people outside the industry who ultimately do not believe in a price-controlled insurance market,” he said, later adding that a benign hurricane season has caused outsiders to raise accusations that the industry “cried wolf” over potential risks.

Such accusations are akin to finding someone playing Russian roulette who pulls the trigger and lives, then saying they incurred no risk, Mr. Kelly said. “If he plays long enough, it's going to eventually go off.”

He noted that while homeowners prefer incremental price increases over the long term to periods of low prices followed by price shocks, the industry “didn't do it right.”

“In the last 12 years in Florida, had the average homeowners premium actually doubled, the cost of hurricane damage would have been pretty well covered,” he asserted, adding that while home values in Florida jumped over 177 percent in the last decade, premiums rose only 84 percent.

“In the end, insurance should be risk-based. Those who deliberately take on greater risk should pay more than those with less [risk],” he said, adding that “over time, the probability of risk becomes more predictable.”