Financial Executives Research Foundation Commercial Insurance- Strategies for Renewal 2002

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Commercial Insurance:Strategies for Renewal

FEI Research Foundation


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The FEI Research Foundation

Commercial Insurance Strategies for Renewal

PurposeTo analyze current commercial insurance market conditionsand provide strategies for renewing commercial insurancepolicies.

IntroductionEven before September 11, 2001, the commercial insurance market hadbegun to “harden,” with coverage becoming more expensive and moredifficult to obtain. The situation became even more troublesome forcompanies seeking coverage as the events of 9/11/01 focused attention onthe importance of business continuity and disaster planning, and as the Enronsituation increased corporate interest in insurance protection.

In the year since, there has been anecdotal evidence of commercialinsurance price increases and coverage decreases as policies come up forrenewal. To get a better sense of the extent of the difficulties that corporatecustomers may be encountering, we spoke with John F. (Jack) Jennings,Senior Vice President of Hobbs Group, LLC, and his colleague Margaret R.Barbuty, Vice President, Marketing.

For historical perspective, can you describe what was happening in the

commercial insurance market prior to 9/11/01?Jack : Commercial Insurance was a soft market from 1986 until about twoyears ago, meaning that coverage was readily available at very competitiveprices. During this 15-year soft market, insurers were generally profitable, notbecause of underwriting revenues—it’s been decades since that was thecase—but because they were able to invest the premiums at significant gains.The investment returns offset the underwriting losses and, in fact, produced aprofit. Insurers continually cut premiums to gain market share, and supplycontinually exceeded demand.

Toward the end of 1999, into early 2000, as stock market conditions

deteriorated, investment returns were no longer sufficient to offset underwritinglosses. In early 2000, the insurance market began to harden as insurers raisedpremiums and cut supply. In a hard market, more careful underwriting isconducted, loss control requirements increase and inexperienced insuranceprofessionals face new demands. Although the insurance market is historicallycyclical, no one can predict how long the current conditions will last.

What effect did 9/11/01 have on the commercial insurance market?

Margaret : The terrorist attacks were the most significant event in the history ofinsurance. Current estimates of the commercially insured loss areapproximately $50 billion. If government spending, a form of insurance itself, isincluded, the total loss will be many multiples of that.

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Issue Alert September 2002


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There were also significant human losses within the industry: approximately 20% of thevictims at the World Trade Center were insurance industry employees, most serving largecorporate accounts. These victims included many of the top property underwriters in thecountry, who were together in a client meeting. Additionally, the survivors faced thedaunting task of trying to overcome their own personal trauma while picking up the piecesleft behind by those who did not survive.

Beyond the human side of this tragic loss, the industry also faced a series of problems thatincreased the chaos: the loss of documents, shutdown of offices, temporarycommunication failures of both telephone and computer lines, and multiple relocations ofunderwriting, claims, and brokerage offices. New York City’s downtown financial district isthe historic center of the insurance industry in the United States. As such, this attack took aconsiderable toll on our industry. While the firms affected have largely regrouped, someservice issues related to the human toll remain.

Jack : Not unexpectedly, the insurance market was in disarray for the first few monthsfollowing 9/11/01. It is somewhat more settled now. Insurers took their losses on last year’sincome statements, and now some even expect a banner year in 2002.

Not all insurers were hurt by 9/11/01, and all insurers have enjoyed the upswing inpremiums. Market capacity, which is capital infused to secure limits of insurance afforded,has increased, but often at a high price to the insured.

For certain insurers, profits should exceed expectations. This category includes thoseinsurers that either wrote off 9/11/01 losses in 2001 or suffered minimally. Insurers that havenew capacity to offer can charge premium prices for it. As a result, these insurers canunderwrite more stringently.

Can you give us some specific examples of the effects of 9/11/01?

Jack : Specific effects of 9/11/01 include a dearth of terrorism coverage, at least for thoseaccounts that need it, such as landmark properties and utilities. In general, businesses thatneed large amounts of insurance for high catastrophe exposure are having the greatestdifficulty and are paying the most to obtain or renew insurance. Airports, arenas, utilities,large retail centers are among the types of accounts finding property, terrorism and liabilitycoverage more difficult to secure.

Margaret : All industries have been affected to some degree. The hardest hit industriesinclude those with large property and business interruption risks, those that have largeconcentrations of employees in a single location, those that face international travelexposures, and any business that might be noted as a terrorist target, such as, largefinancial institutions, refineries and utilities, news organizations, and large real estate

organizations.

Jack : For employee-related coverage, such as Workers’ Compensation and Disability,companies with large corporate centers are more adversely affected. For example, largetechnology companies or entertainment organizations may face greater difficultiesbecause they have greater concentrations of employees at one facility, and may beviewed as likely terrorist targets. Kidnap and ransom coverage has also become moredifficult to procure, especially for businesses with employees that travel in high-risk areas.

While some capacity has increased, most insurers have faced a reduction in the

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availability of reinsurance. Because risk is shared with another insurer, reinsurance treatiesmay exclude certain lines or classes of business, or can be priced prohibitively. The intentof reinsurance is to spread large losses over many insurers, relieving the primary insurer ofthe full financial burden of any single loss. This mechanism worked well for the 9/11/01attack. The result was that losses were spread across the market. The 9/11/01 losses nowaffect the pricing, capacity, and coverage terms available in the reinsurance market.

The long-term impact on pricing and coverage availability is impossible to predict.However, it is likely that terrorism coverage will be excluded in reinsurance treaties for thelong term. Much like the advent of pollution exclusions in the early 1980s, terrorism willprobably become a stand-alone coverage line, on a permanent basis.

Pollution was once covered under General Liability contracts. Following several large,unforeseeable claims, insurers eliminated this coverage entirely. Shortly thereafter, stand-alone pollution policies became available. Initially, this coverage was underwritten on avery strict basis and subject to exclusions. Over the past 20 years, coverage has becomebroader and more affordable, but continues to be underwritten separately. Otherenvironmental exposures, such as lead paint and mold, have followed this same exclusion,lack of availability, limited availability, and stand-alone coverage cycle. We are nowseeing this cycle play out for terrorism coverage.

How have the ratings of insurance companies been affected?

Jack : By and large, AM Best ratings have not changed significantly. Insurers thatadequately reserved for 9/11/01 losses in 2001 should be fine. We believe that insurersgenerally were adequately reserved. Some aspects of this loss, such as actual businessinterruption and occupational disease claims may have a longer development period.

Reinsurers may face multiple hits because of cumulative positions on multiple insurers’policies. Also, they may face multiple positions on different insurance lines. Insurers that

did not adequately reserve, or who have problems in reinsurance recoveries, could facedowngrades.

Which insurance lines have been hit hardest by 9/11/01?

Jack : We have seen Real & Personal Property, Business Income, Workers’ Compensation,Travel Accident, and Terrorism lines all hit hard.

What is the range of price increases you have seen recently?

Margaret : Rates have increased anywhere from 20% to 300%. Middle market accountstend to fall into the lower end of this range. Certain policies within large organizations’programs tend to rise towards the upper end of that range. However, I would add thatthese estimates are for coverage where the insured organization has not had high claimsactivity. For organizations that have had high claims activity, rates have increased morethan this 20% to 300%, to compensate the insurer.

How do these increases compare to more typical annual increases?

Margaret : In the 10 years preceding 2000, it was unusual for a good risk to experience ANYrate increase. Premiums increased with a company’s growth, but rarely by rate.

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Occasionally, we saw price firming by specific lines of coverage. For example, followingHurricane Andrew, Florida windstorm coverage became less available and more costly.Also, companies with poor loss experience were penalized by increased premiums.Employers with bad safety records were often hard hit by workers compensationpremiums. A regular annual rate increase was unheard of, and would simply send clientsshopping for a better deal.

Insurers that initiated rate increases of 5% to 20% in early 2000, were often faced with theprospect of losing a renewal. However, those clients that stayed and accepted minimalrate increases have not faced the dramatic bumps that some insureds have seen.

When was the last time the industry saw increases of this magnitude?

Margaret : The 1985-1986 price increases were as dramatic and in some cases more thanwhat we’ve seen recently. Some classes of business, such as contracting andtransportation, faced severe lack of availability. The major difference in comparing thetwo hard cycles is that this current cycle seems to have legs, whereas the 1985-1986cycle was short-lived.

Have any of yourclients found it difficultto obtain insurance? Ifso, why?

Jack : Yes, insurers havefaced constraints in theirreinsurance treaties andavailable reinsurancecapacity. They areu n d e r w r i t i n g m o r ecarefully and are limitingthe capacity that they willoffer to difficult risks.Those clients that haveignored loss preventiona d v i c e , h a v eexperienced large orfrequent claims, or fall int o t h o s e s p e c i f i ccategories that we havealready mentioned, havefaced the greatestdifficulty.

The larger exposures,where high limits ofcatastrophic coverageare required, are morelikely to be layeredamong several insurers.Capacity is available in

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Case Study: Mid-Sized Manufacturing Company

While tumultuous, this market is navigable, and properplanning and communication can make the difference.

For example, a midsize manufacturing company had ignoredfor years several critical loss control and fire safetyrecommendations made by their insurer. Traditionally, theplant manager would review these insurer recommendationsand incorporate them in his capital expenserecommendations to the executive committee. For onereason or another, the executive committee rarely approvedthese capital expense recommendations. Finance made theinsurance buying decisions, and was unaware of the relationthat these unbudgeted, and unapproved, improvements,had to the insurance program. Years went by, with few ofthese recommendations implemented.

Hobbs suggested a roundtable meeting with finance, plantmanagement and engineering. Jointly, they devised astrategy for immediate implementation of some of the lesscostly recommendations and a 12-month plan for budgetingand completion of all critical items. Additionally, thecommittee reviewed the existing program and determinedthat their current deductible could be increased. Thecompany took risk in other areas with greater self-fundedretention and felt that they could do the same with theirproperty insurance program. Hobbs and the committee thenmet with several insurers to present their improvement planand discuss higher deductible options. The response from theinsurers was favorable, and a program was put togetherwithin the client’s budget.


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the market, but at an increased price. There are ways to offset market conditions. Whiledifficulty exists, it can be overcome or mitigated.

Both large and small organizations have faced difficulties in obtaining coverage. Weknow of several multinational companies that have drastically increased their self-insuredretentions, and in some cases, chosen to completely self-insure certain exposures. We alsoknow of small companies, with difficult exposures—such as hazardous productmanufacturers that have been priced out of the insurance market. They too could chooseto self insure. However, if faced with significant claims, they might be forced to file forbankruptcy.

What strategies do you recommend for coping with this insurance market? Canyou give us some suggestions for ways to offset market conditions?

Margaret : Here are some of the suggestions that we make to our clients:

• Change your planning calendar . Many businesses without full-time risk managers donot think about their insurance program renewal until a month or two beforeexpiration. This leaves inadequate time to properly accumulate all of the importantdata that underwriters will want to review. Move back the start-date for renewalplanning, but move the final decision date to the 11 th hour. Keep in mind thatunderwriters are both backlogged and hesitant to release proposals in this constantlychanging environment.

• Begin renewal information preparation at least six months in advance . Reviewing yourinsurance schedule for adequacy of coverage is a good start. Additionally, projectingyour sales and payrolls, as well as your plans for expansion of locations and products,will set the foundation for a quality renewal proposal request.

• With the assistance of your broker and carrier, clean up you claims history loss runs .Obtain copies of your prior five years of claims history. Review the data. Closed claimsshould say so. Unrealistic reserves should be brought down. Incorrect informationshould be corrected. A new insurer, unfamiliar with your company, will rely on this datato judge your company. Claims experience speaks to financial stability, safety,compliance, and offers an underwriter insight into how your program should bestructured. Misinformation can have serious adverse effects.

• Resolve outstanding loss control recommendations . Has your insurer recommendedchanges to your sales contract language, your employee work environment, or yourfire suppression system? Insurers recommend a variety of business practices to helpcorporations control their losses. Feasible recommendations should be complied with.Will a minor change to contract language reduce your exposure to a professional

liability claim? Will better workstations reduce expensive ergonomic related losses?Alternatives should be considered for recommendations that are not in the currentbudget or those that create hurdles for your sales force. Work with your broker todevelop compromises. If you ignore loss control recommendations, your coverage willgo away.

• Rethink the information that is included in your underwriting submission . Are thepositive aspects of your company’s quality control, safety management, and businessplan being emphasized? Are you factually addressing your risk?

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Report authored by William M. SinnettThe FEI Research Foundation

Copyright © 2002 by Financial Executives Research Foundation, Inc.

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Financial Executives Research Foundation Commercial Insurance- Strategies for Renewal 2002

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