Prognosis on Risk Management and Insurance

The tragic events of September 11 were a defining moment for the insurance industry. The risks may be the same as before, but the perception of risk has changed, and its potential to impact business and the global economy has been heightened. Suddenly, senior management is interested in its company’s risk management activities to ensure that shareholders’ assets and revenue are protected. Insurance brokers and their clients must work together closely to prepare clear and realistic placement strategies and to manage their expectations about underwriting. Despite some early dire predictions by the news media, all industry analysts believe the insurance industry is financially sound and able to meet the demands that have been placed on it.

Before September 11, the insurance market had already tightened considerably for property, liability, automobile, and workers’ compensation coverage. Years of price cutting were directly related to the high rates of return the insurance companies were earning on their investments. With the significant downturn in the economy, insurance pricing had been rising for the past 24 months. The price cutting ground to a halt as a result of a reduction in investment income over those same years and an industry loss record that had been unacceptably poor. In addition, considerable consolidation within the industry left fewer insurers to compete. Nevertheless, the scale of the September 11 disaster and the lessons that it will teach the insurance industry will generate many changes in the industry.

The estimated $50–65 billion that the industry will eventually pay out in claims has undoubtedly made September 11 the most costly disaster in property and casualty insurance history. The insurance costs will be almost double the costs of Hurricane Andrew, the North Ridge earthquake, and the Oklahoma City bombing combined.

Howard Kunreuther, Wharton professor of decision sciences, summarizes all of the opinions and statements of industry executives, academics, and government officials when he says that “This is going to change the way the insurance industry does business.”

Some changes will be immediate; the impact of others may take years to be felt. One likely immediate consequence is an increase in renewal pricing, regardless of the line of converge or loss history on any particular account. Increases due to the World Trade Center payouts will probably be specifically tailored to the type of insurance offered; property and casualty and workers’ compensation are likely to be more affected than other lines.

The federal government is currently considering various proposals for the government to become involved in maintaining insurance coverage for terrorism, just as the government provides for flood insurance and catastrophic (greater than $200 million) losses from a nuclear accident. Congress, the White House, industry associations, and company executives met to discuss how to avoid having a terrorism exclusion added to policies when property reinsurance treaties are renewed. Without financial backing for terrorism coverage from the federal government, reinsurers will not offer this coverage. The Bush administration has voiced support for one proposal that has some industry support, and the prospects look good for an agreement to be reached.

The property area was already experiencing increases of 15–30% with the leading underwriters, and this changed dramatically as a result of September 11 and the availability (or lack) of treaty reinsurance capacity in January 2002. The current question is whether some of the primary property carriers will even buy reinsurance at the rates quoted, and of course, very little terrorism capacity is being offered to these primary carriers. A further problem is that state regulators are only now beginning to approve terrorism exclusions, thus the market has held back property capacity, because it does not want to pick up terrorism as part of an “all-risk” program.

In 2002, fewer players will have the capacity to provide a stable property insurance market. In addition to terrorism coverage, which will not be available in large amounts without government intervention, there will be a major contraction in coverage for coastal windstorm, earthquake, and flood areas.

In addition to the dramatic rate increases already experienced and anticipated for the next 12 to 18 months, carriers are beginning to pare back on coverages, especially for exposures that cannot be readily identified or priced. After expanding coverage for the past 8 to 10 years, carriers are now reversing themselves.

Some good news: By the end of 2001, more than $15 billion in new capital was announced, and $25 billion is anticipated by the end of 2002. Of course, this is only a partial replacement of the $50–70 billion lost by the industry on September 11.

Looking at the casualty market, which is basically workers’ compensation, general liability, and automobile liability, again there has been a further hardening of rates, a return to stronger underwriting standards, and a tightening of market capacity since September 11. In the workers’ compensation sector, carriers are looking at catastrophic exposures very carefully. These include locations where there are more than 250 employees. Reinsurance for catastrophe workers’ compensation claims has been drastically reduced, and life insurance reinsurers are exiting the market.

The capacity for liability coverages once again seems to be contracting, and this will affect the umbrella and excess liability areas. The lower limits for primary coverage will be increasingly self-funded, as buyers will prefer to hold risk rather than trade dollars with insurance companies.

In the casualty area there is a major “flight to quality,” partially as a result of recent downgrades of some major carriers by rating agencies since September 11. The hope is that insureds will seek only financially strong carriers who are able to price the premiums within their own house, rather than depending on a costly reinsurer.

The events of September 11 will probably not have a major impact on specialty coverage, including directors and officers (D&O), professional liability, errors and omissions (E&O), and employment practices. But we do believe that D&O, professional liability, and employment practices policies will see unexpected increases in premiums for a variety of reasons unrelated to September 11. These lines of insurance have been underpriced in the past and there is a hardening market, as well as reductions in capacity, in all areas.

The directors and officers (D&O) liability area is affected by the economic uncertainty of the times, a lack of reinsurance support, an increase in claims activity, and mounting insurer losses. September 11 affected the D&O market, as insurers need additional premiums to help pay losses, and the D&O market is just not able to support its own reserves. The forecast is for less capacity, as well as increasing retentions and premiums. Expect an annual renewal increase of 25–50% in this area. Terms will change to the point where insureds will once again be participants in every loss, as they were when D&O first began.

It is also expected that in 2002 D&O insurers will use nonrenewals to better position the carrier to impose coverage restrictions, eliminate entity coverage in favor of pre-agreed allocation (as in prior forms), eliminate retention waivers for successful defense of claims (only available in recent years), eliminate total severability, possibly remove punitive and exemplary damages coverage (in certain states), change coverage with regard to new subsidiaries, change the discovery and reporting periods, and use more restrictive wordings.

In all areas, companies will underwrite risks in more detail, requiring insureds to provide more detailed information about each risk. Underwriters will also weigh new factors when assessing risk, such as the concentration of locations and of employees.

In the United States, terrorism had not been a condition of business. As they contemplate the risk of terrorism, many insureds may want to review their insurance coverage. The following are items to consider:

• Travel and accident policies should be reviewed to make sure they contain no terrorism exclusion.
  
• Ocean/marine policies should also be reviewed to make certain there is no war or terrorism exclusion. If there is, consider buying back the exclusion for an additional premium.
  
• Accidental death and dismemberment policies may be added to insurance programs to provide an additional or optional benefit to employees. This coverage provides additional life insurance protection for the accidental death of employees. An average employee may be able to obtain more than $200,000 of coverage for a premium of as little as $300 per year.

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