Surviving a Tough Market

As premiums double and triple, the comment most often heard is: "Are insurers trying to make up for the soft market years all in one year?"

The answer: no. The reasons:

Under-reserving. Years of under-reserving have put pressure to bolster their reserves, a euphemism for finally admitting and quantifying the sins of the past. Sources of this pressure have been internal and external. Management companies and boards of directors have decided to bite the bullet. There have also been increasing pressures from outside auditors and rating agencies.

Bursting bubble. The combination of investment income and realized capital gains has always more than compensated for underwriting losses. This euphoric bubble burst in 2001. The events of September 11 happened, although only $10 billion or so was recognized by the industry in 2001. Interest rates were at record lows. The stock market cratered.

Bad underwriting scenario. Under-writing results were disastrous. Measured by the combined ratio of losses and operating costs, this was the third worst on record.

Low surplus. The industry's surplus (net worth) fell almost nine percent, to below $300 billion, for the first time in six years.

Overhanging this dismal picture are the following factors:

Reserve deficiencies yet to be recognized could be as high as 15 percent of statutory surplus. The ultimate cost of asbestos and environmental liabilities has not yet been determined.

The full impact of 9/11 is unknown and hangs like the sword of Damocles.

Mold claims (prior to coverage exclusions) could be the next asbestosis.

Unexpected workers compensation claims may require additional reserving.

The Enron situation needs to be sorted out, especially as to whether contentions of fraud can lead to coverage denials.

Statutory reporting requires recognizing realized capital gains or losses. The industry is sitting on $17.7 billion in unrealized capital losses. If multiple premium increases weren't bad enough, coverage is shrinking dramatically. After all, isn't that what insurance is for?

Blanket limits in property insurance have become an anachronism, at least for now. Reasonably adequate loss limits are hard to come by. With insurers imposing separate limits for each property and, in many cases, separate limits for rental income per property, those insured should view this imposition as an opportunity to carefully review replacement cost figures and income worksheets.

As underwriters are once again underwriting, it is incumbent to submit an all-inclusive renewal package. That should include: detailed property listings, including complete Construction Occupation Protection Exposure information; hard copy (i.e., credible) loss experience for the past five years; detailed coverage specifications; and evidence of corrective action in response to previously issued engineering recommendations.

Be warned: inadequate sublimits are the rule rather than the exception now. These policies run the gamut from demolition and increased cost of construction to soft costs in builder's risk policies. There has also been a broadening of the war exclusion to include any possible definition of terrorism, including bioterrorism.

As for liability insurance, there is now an absolute exclusion for toxic mold and mildew; a sharply reduced capacity and high premium increases for umbrella liability; and an unwillingness to offer workers compensation insurance where there is a concentration of employees at one location.

Under Directors & Officers coverage, the "failure to maintain insurance" exclusion has been showing up in more policies. This is especially serious as certain coverages are becoming prohibitively expensive or are not available at any price. Good risk management here would be to memorialize the building's efforts to obtain insurance for its exposures, whether or not they are insurable.

What should you do to cope? Wherever possible, transfer risk to others, such as outside contractors who may be responsible for liability claims. Identify risk and conduct a risk management audit of every aspect of your property, thinking outside the box. Also, quantify your dangers by assigning a dollar range to each risk.

Finally, reduce the risk. Since insurance companies are notoriously inefficient mechanisms through which to pump premium dollars, consider deductibles or self-insured retentions that might take a lot of frequency out of your loss experience with more than a concomitant premium saving. By doing so, you are also demonstrating to a prospective underwriter that you can't expect them to pay for all your losses but that you're willing to absorb them to some degree.

Herbert H. Feldman is president and CEO of Alpha Risk Management, a risk management consulting firm in Great Neck, N.Y.