Commercial Insurance: Strategies for Renewal

Commercial Insurance: Strategies for Renewal

FEI Research Foundation

Issue Alert

September 2002

Commercial Insurance Strategies for Renewal

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Purpose To analyze current commercial insurance market conditions and provide strategies for renewing commercial insurance policies.

Introduction Even before September 11, 2001, the commercial insurance market had begun to “harden,” with coverage becoming more expensive and more difficult to obtain. The situation became even more troublesome for companies seeking coverage as the events of 9/11/01 focused attention on the importance of business continuity and disaster planning, and as the Enron situation increased corporate interest in insurance protection. In the year since, there has been anecdotal evidence of commercial insurance price increases and coverage decreases as policies come up for renewal. To get a better sense of the extent of the difficulties that corporate customers 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 two years ago, meaning that coverage was readily available at very competitive prices. During this 15-year soft market, insurers were generally profitable, not because of underwriting revenues—it’s been decades since that was the case—but because they were able to invest the premiums at significant gains. The investment returns offset the underwriting losses and, in fact, produced a profit. Insurers continually cut premiums to gain market share, and supply continually exceeded demand. Toward the end of 1999, into early 2000, as stock market conditions deteriorated, investment returns were no longer sufficient to offset underwriting losses. In early 2000, the insurance market began to harden as insurers raised premiums and cut supply. In a hard market, more careful underwriting is conducted, loss control requirements increase and inexperienced insurance professionals face new demands. Although the insurance market is historically cyclical, 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 of insurance. Current estimates of the commercially insured loss are The FEI Research Foundation approximately $50 billion. If government spending, a form of insurance itself, is included, the total loss will be many multiples of that.

There were also significant human losses within the industry: approximately 20% of the victims at the World Trade Center were insurance industry employees, most serving large corporate accounts. These victims included many of the top property underwriters in the country, who were together in a client meeting. Additionally, the survivors faced the daunting task of trying to overcome their own personal trauma while picking up the pieces left behind by those who did not survive. Beyond the human side of this tragic loss, the industry also faced a series of problems that increased the chaos: the loss of documents, shutdown of offices, temporary communication failures of both telephone and computer lines, and multiple relocations of underwriting, claims, and brokerage offices. New York City’s downtown financial district is the historic center of the insurance industry in the United States. As such, this attack took a considerable toll on our industry. While the firms affected have largely regrouped, some service issues related to the human toll remain. Jack: Not unexpectedly, the insurance market was in disarray for the first few months following 9/11/01. It is somewhat more settled now. Insurers took their losses on last year’s income 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 in premiums. 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 those insurers that either wrote off 9/11/01 losses in 2001 or suffered minimally. Insurers that have new capacity to offer can charge premium prices for it. As a result, these insurers can underwrite 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 those accounts that need it, such as landmark properties and utilities. In general, businesses that need large amounts of insurance for high catastrophe exposure are having the greatest difficulty 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 liability coverage more difficult to secure. Margaret: All industries have been affected to some degree. The hardest hit industries include those with large property and business interruption risks, those that have large concentrations of employees in a single location, those that face international travel exposures, and any business that might be noted as a terrorist target, such as, large financial 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, large technology companies or entertainment organizations may face greater difficulties because they have greater concentrations of employees at one facility, and may be viewed as likely terrorist targets. Kidnap and ransom coverage has also become more difficult 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 2

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availability of reinsurance. Because risk is shared with another insurer, reinsurance treaties may exclude certain lines or classes of business, or can be priced prohibitively. The intent of reinsurance is to spread large losses over many insurers, relieving the primary insurer of the full financial burden of any single loss. This mechanism worked well for the 9/11/01 attack. The result was that losses were spread across the market. The 9/11/01 losses now affect 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 the long term. Much like the advent of pollution exclusions in the early 1980s, terrorism will probably 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, standalone pollution policies became available. Initially, this coverage was underwritten on a very strict basis and subject to exclusions. Over the past 20 years, coverage has become broader and more affordable, but continues to be underwritten separately. Other environmental exposures, such as lead paint and mold, have followed this same exclusion, lack of availability, limited availability, and stand-alone coverage cycle. We are now seeing 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 that adequately reserved for 9/11/01 losses in 2001 should be fine. We believe that insurers generally were adequately reserved. Some aspects of this loss, such as actual business interruption 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 face downgrades.

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 accounts tend 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 that these estimates are for coverage where the insured organization has not had high claims activity. For organizations that have had high claims activity, rates have increased more than 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 ANY rate increase. Premiums increased with a company’s growth, but rarely by rate. The FEI Research Foundation

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Occasionally, we saw price firming by specific lines of coverage. For example, following Hurricane 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 compensation premiums. A regular annual rate increase was unheard of, and would simply send clients shopping for a better deal. Insurers that initiated rate increases of 5% to 20% in early 2000, were often faced with the prospect of losing a renewal. However, those clients that stayed and accepted minimal rate 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 than what we’ve seen recently. Some classes of business, such as contracting and transportation, faced severe lack of availability. The major difference in comparing the two hard cycles is that this current cycle seems to have legs, whereas the 1985-1986 cycle was short-lived.

Have any of your clients found it difficult to obtain insurance? If so, why? Jack: Yes, insurers have faced constraints in their reinsurance treaties and available reinsurance capacity. They are underwriting more carefully and are limiting the capacity that they will offer to difficult risks. Those clients that have ignored loss prevention a d v i c e , h a v e experienced large or frequent claims, or fall in to those specific categories that we have already mentioned, have faced the greatest difficulty. The larger exposures, where high limits of catastrophic coverage are required, are more likely to be layered among several insurers. Capacity is available in

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Case Study: Mid-Sized Manufacturing Company While tumultuous, this market is navigable, and proper planning and communication can make the difference. For example, a midsize manufacturing company had ignored for years several critical loss control and fire safety recommendations made by their insurer. Traditionally, the plant manager would review these insurer recommendations and incorporate them in his capital expense recommendations to the executive committee. For one reason or another, the executive committee rarely approved these capital expense recommendations. Finance made the insurance buying decisions, and was unaware of the relation that these unbudgeted, and unapproved, improvements, had to the insurance program. Years went by, with few of these recommendations implemented. Hobbs suggested a roundtable meeting with finance, plant management and engineering. Jointly, they devised a strategy for immediate implementation of some of the less costly recommendations and a 12-month plan for budgeting and completion of all critical items. Additionally, the committee reviewed the existing program and determined that their current deductible could be increased. The company took risk in other areas with greater self-funded retention and felt that they could do the same with their property insurance program. Hobbs and the committee then met with several insurers to present their improvement plan and discuss higher deductible options. The response from the insurers was favorable, and a program was put together within the client’s budget.

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the market, but at an increased price. There are ways to offset market conditions. While difficulty exists, it can be overcome or mitigated. Both large and small organizations have faced difficulties in obtaining coverage. We know of several multinational companies that have drastically increased their self-insured retentions, and in some cases, chosen to completely self-insure certain exposures. We also know of small companies, with difficult exposures—such as hazardous product manufacturers that have been priced out of the insurance market. They too could choose to self insure. However, if faced with significant claims, they might be forced to file for bankruptcy.

What strategies do you recommend for coping with this insurance market? Can you 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 do not think about their insurance program renewal until a month or two before expiration. This leaves inadequate time to properly accumulate all of the important data that underwriters will want to review. Move back the start-date for renewal planning, but move the final decision date to the 11th hour. Keep in mind that underwriters are both backlogged and hesitant to release proposals in this constantly changing environment.

•

Begin renewal information preparation at least six months in advance. Reviewing your insurance schedule for adequacy of coverage is a good start. Additionally, projecting your 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 claims should say so. Unrealistic reserves should be brought down. Incorrect information should be corrected. A new insurer, unfamiliar with your company, will rely on this data to judge your company. Claims experience speaks to financial stability, safety, compliance, and offers an underwriter insight into how your program should be structured. Misinformation can have serious adverse effects.

•

Resolve outstanding loss control recommendations. Has your insurer recommended changes to your sales contract language, your employee work environment, or your fire suppression system? Insurers recommend a variety of business practices to help corporations 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 current budget or those that create hurdles for your sales force. Work with your broker to develop compromises. If you ignore loss control recommendations, your coverage will go away.

•

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

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•

Understand your risk. We strongly recommend forming an internal risk management committee. At a minimum, this committee should include representation from Finance, Risk Management, Legal, Operations, Human Resources, and your broker. This committee should address corporate exposure to risk, the firm’s current insurance program, currently uninsured risks, willingness to take greater risk, and alternative risk financing solutions, such as self-insurance, captive insurance companies, and large deductibles.

•

Companies with full-time risk managers and those where risk management falls within the confines of finance or legal need to address these risk issues in a holistic manner. Risk management is interdependent with every aspect of an organization. Imminent changes and long-range business plans require risk consideration and integration.

Jack: A company will want to work with a good insurance broker and advisor. The manner in which your company is represented to the market is critical. Today’s market dictates that underwriters view your company in the most positive light. You have not mentioned Directors and Officers Liability Insurance. What strategies do you recommend for renewing D&O insurance? Margaret: D&O insurance presents an entirely different set of issues and circumstances. While D&O was not the most affected coverage by 9/11/01, its price and availability has been affected by the Enron collapse and other corporate governance issues. In fact, there are many issues that surround D&O insurance, and they had begun to surface long before Enron. Perhaps we could discuss D&O in another Issue Alert.

Some of our members have asked about captive insurance companies. Is this a viable alternative? Jack: A captive insurance company is an insurance company that is owned and controlled by its insured. Captive insurance companies can be excellent financing tools for matters having to do with risk. Their application is greatly varied and should not be viewed in the short term, regardless of how pressing the current problem is. If the commitment to funding risks in this way exists, and if loss-reserving discipline can be maintained, a captive can achieve risk-financing efficiency for almost any large organization. About Hobbs Group, LLC John F. Jennings is Senior Vice President of Hobbs Group, LLC. Hobbs Group, LLC, is headquartered in Atlanta, Georgia, and has 21 offices located throughout the United States. With twenty-four years of experience, Jack oversees Hobbs Group’s Morristown, NJ, office, which provides advanced financial solutions, risk management services, and insurance programs to large organizations and emerging businesses. Margaret R. Barbuty is a Vice President of Hobbs Group, LLC. Her responsibilities consist of new business development, marketing, client service, and insurer relations. Margaret’s twenty plus years of experience in the insurance industry include involvement in many facets of risk management, program design and implementation for national and regional accounts.

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Report authored by William M. Sinnett The FEI Research Foundation Copyright © 2002 by Financial Executives Research Foundation, Inc. All rights reserved. No part of this publication may be reproduced in any form or by any means without written permission from the publisher. Financial Executives Research Foundation, Inc. is an affiliate of Financial Executives International. The purpose of the Foundation is to sponsor research and publish informative material in the field of business management, with particular emphasis on the practice of financial management and its evolving role in the management of business.

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