In 1995, when insurance prices were ridiculously low, Union Carbide Corp. decided to take a prudent approach. Knowing that bargains don't last forever, the $5.9 billion chemical company purchased a multiyear, combined- lines property- and- casualty insurance policy that locked in its prices over five years.
Since then, the Danbury, Connecticut-based company has renegotiated the policy annually to add on another year.
A few months ago, however, Union Carbide had to fork over 5 percent more in premiums to extend the policy, despite a perfect claims record. "We didn't hit the insurance markets with any losses," says assistant treasurer Richard Inserra, "yet we still got nailed with a premium increase. Apparently, all ships rise in a rising tide."
And the tide is definitely rising. After a decade and a half of falling premiums, prices are on the upswing. Virtually every insurance product cost more in the last policy-renewal period, with some lines--workers' compensation, product liability, certain types of directors' and officers' liability, and medical malpractice--garnering double-digit increases. In short, the insurance cycle is back.
Anyone with more than 10 years' business experience remembers the cycle well, particularly its last spin in the early 1980s. Companies with excellent loss records were told their liability insurance premiums had doubled, despite good claims histories. Some organizations, such as day-care centers and environmental engineering firms, were given worse news: no insurance at any price. Litigation-weary insurers just stopped selling to them.
While the present hardening market is nowhere near that debacle, it does give pause. That's because during the last 16 years, "insurance has basically fallen from the budgeting radar screen," says Robert P. Hartwig, chief economist at the Insurance Information Institute in New York. "CFOs figured the cost was so budgetable, there was no need to scrutinize it. They reduced their risk-management staffs and basically took their eye off loss prevention."
All eyes are refocusing fast, however. At Union Carbide, for example, CFO John Wulff and his risk managers are preparing the company's "captive" insurance operation--in this case, Bermuda- based Westbridge Insurance Ltd.--to retain more risk if and when it is needed.
"We're going to wield the captive as a recourse if our insurance costs exceed what we believe is prudent," says Wulff. And if prices continue to escalate, enterprise risk management and related integrated risk transfer portfolios are also likely to grow in popularity. In short, says Hartwig, companies are again focusing on managing risk "instead of just transferring it."
How has the market gone from soft to hard so quickly? The change reflects several factors, from litigation trends to a clouding investment climate to irrational competition. Add poor underwriting losses, depleting loss reserves, and higher reinsurance prices, and the market starts to spin, well, harder. So much so, in fact, that a November 2000 survey by the Council of Insurance Agents & Brokers indicated that 97 percent of the respondents reported higher prices across the board, while 54 percent of those stated that, on average, rates increased more than 10 percent.
Other reports paint an equally gloomy picture. Some Lloyd's of London syndicates are reportedly seeking a 25 percent increase in D&O insurance this year, and that's for companies with modest loss records. Dennis Kane, president and CEO of Kemper Casualty, a division of Kemper Insurance Co. that focuses on large-risk Fortune 1,000 companies, says, "It's hard to find any area where we are not seeing at least 10 percent increases," with some accounts, such as those in the technology sector considered vulnerable to shareholder actions, experiencing even greater increases.
Workers' comp is similarly bleak, dogged by premium increases averaging 20 to 30 percent, depending on an employer's location. The situation is so bad in California that the state's Workers' Compensation Insurance Rating Bureau estimates that insurers' reserves to cover losses are short some $4.7 billion. One major workers' comp insurer, Superior National Insurance Group, has failed, and the state itself is recommending at least an 18.4 percent rate increase.
Some insurance lines are even worse. Liability insurance for nursing homes is virtually unavailable, because of a rapid escalation in both the frequency of their claims and their financial severity. Also beleaguered are trucking companies, chemical concerns, and construction firms. Even giveaway "umbrella" insurance policies, which absorb catastrophic losses above a firm's various insurance programs, are closing up. "A year or so ago, underwriters would write umbrellas for next to nothing, just to get the premium on the books," notes Gary Mathieson, CEO of the New York office of insurance broker The Willis Group. "Now they're eliminating certain underlying risks from protection, such as environmental exposures. That, in turn, forces companies into separate, more- expensive, stand-alone programs to cover these risks."
The worst news of all is that the cyclical shift is in first gear. "There are no signs of this slowing down," says Jay Cohen, first vice president and insurance industry analyst at Merrill Lynch in New York. Cohen, in fact, predicts that premium increases will average in the double digits for at least the next policy-renewal period, with Hartwig expecting increases to last a year or two longer.
MAKING CONTINGENCY PLANS
To combat the higher prices, some companies, such as Union Carbide, are making risk contingency plans. Currently, Westbridge absorbs Carbide's property/casualty risks (other than aviation insurance) above an undisclosed deductible, covering up to $10 million in total losses. Over that, Carbide's multiline insurance program has a limit of $200 million. If the insurance markets become excessive, says Inserra, "we may increase our risk retention in the captive." Or, he adds, "we may also decide to have the captive subsidiary retain profits as opposed to paying them out as dividends to the parent, giving it greater financial resources to assume more risk."
Other firms that deactivated their captives are debating whether to reactivate them. "Our members went back into the regular insurance marketplace in 1998 for general liability insurance, due to low prices--much lower than what they were paying to the captive," says Jean Van Tol, president of Resort Hotel Insurance Co., a Burlington, Vermont-based group captive representing 15 hotel holding companies.
"We kept the captive in place, however, just in case the market changed for the worse," she adds. "From what we've been seeing and hearing about price increases, we're mulling reactivating it." The captive previously provided $150,000 in per-loss coverage to members (over individual self-insured retentions between $10,000 and $100,000), above a deductible of $10,000.
Other firms that formed captives in the 1990s are glad they ignored the prevailing wisdom of buying cheap insurance. "We joined a group captive three years ago, set up by our insurance broker, Marsh USA Inc., even though our workers' comp insurer was offering a lower premium for standard coverage," says Larry Countryman, CFO of Wilson Trailer Co., a privately held, 110-year-old manufacturer of semi-truck trailers.
"We'd kept statistics for 10 years indicating that we'd made millions for our insurer, given our low claims history and the investment climate," notes Countryman. "We decided we wanted to keep our premiums instead of giving them to the insurers to invest, in order to invest them on our own." So Sioux City, Iowa-based Wilson Trailer joined Columbus Insurance Ltd., in Grand Cayman. "This was a big decision for a family-owned company," says Countryman. "But now that workers' comp prices are in the stratosphere, we look like geniuses."
While industry pundits proclaim double- digit increases for at least the next two to three years, the question is, Will the insurance market veer as far off course as it did in the last hard market? Few observers seem concerned. "I'd characterize the present hardening market as a customer-friendly-type turn," says Sean Mooney, chief economist at Guy Carpenter & Co., a New Yorkbased reinsurance intermediary.
"Unlike the last hard market, this isn't a balance-sheet turn, where companies are worried about their solvency, net worth, and assets, causing a panic reaction," explains Mooney. "This is more of an income-statement turn: insurers being driven to a large extent by investors, and the stock market saying their returns are hopelessly inadequate."
Responding to the pressure, insurers are simply raising prices where they ought to, says Mooney. "Last time, the industry panicked and took a shotgun approach--raising prices willy-nilly and pulling back coverage, even though some didn't deserve it," he says. "This time, insurers are taking rifle shots, aiming at specific books of business that deserve an increase."
Hartwig concurs. "With new alternative risk strategies abounding, insurers don't want to do what they did in the early 1980s--simply drive business away," he says. "Instead, they're moving prices to a more rational level--a simple correction to compensate for the overshoot in the 1990s. It's not a crisis. Then again, if courts continue to be more generous with their class-action awards, who knows? "
Russ Banham, a contributing editor of CFO, is based in Missoula, Montana.
The average price change of commercial insurance renewals.
|Spring '99||Fall '99||Spring '00||Fall '00|
|Multi- peril Commercial Property||-6.8%||-2.3%||2.6%||8.8%|
Source: Conning & Co.
Behind the Barrage
The commercial insurance market is hardening, as they say in the insurance business. So what's causing the duress?
Blame a variety of factors, from the industry's abysmal return on equity (8.4 percent through the 1990s, compared with 13 percent for the Fortune 500) to the flattening economy. "This year, the legs seem to have fallen out from beneath the stock market," explains Robert P. Hartwig, chief economist at the Insurance Information Institute, in New York. "Meanwhile, higher interest rates are producing capital losses in the bond portfolio. Both are causing insurer investment income to plummet."
Consequently, at a time when the industry's underwriting losses are peaking--up 43.9 percent through the first nine months of 2000, to $21.9 billion--investment income is less of a reliable source to pay off all the losses. "This industry has been paying out $1.09 in losses and expenses for every dollar taken in as premium," contends Hartwig.
Add to the woes the upsurge in insured losses, courtesy of the civil justice system. "The average jury award has soared 93 percent since 1993, to more than $1 million in 1999--far in excess of the 15 percent increase in the Consumer Price Index over the same period," explains Hartwig.
Yet another reason for steeper premiums: those bargain insurance policies of the 1990s. Engaged in a fierce struggle to gain market share, insurers bid down prices, by as much as 20 percent, says Hartwig. "It's payback time." -- R.B.