of Sept. 11 and the huge hole in its capital base created by the disaster. Then

again, those are just average increases many companies have complained their

premiums are up 100% to 400%, depending on the line of insurance and the type of

company.

Corporate policyholders aren't buying it the

rationale, that is, for the higher prices. The industry is overreacting, hiking

prices well beyond their actuarially justifiable costs, they argue. Other

companies are perturbed by the industry's reaction to covering future

terrorist risks a fast run for the exits, as they see it and the move by some

insurance brokers to fund the creation of new offshore insurance companies that

will charge their clients astronomically high prices.

What corporations are still buying is the basic

insurance, despite the stunning premium hikes, and accepting the insurance

industry's position that the companies must assume more risk through higher

deductibles while paying much more. Why? Because when

the rain is pouring down all over the place and water is seeping through the

roof, you don't go out and design a fantastic umbrella for the house, says

Nick Goulder, director of alternative risk transfer at insurance broker Willis

in London. You mend the tiles. If

anything, people's willingness to look at alternative risk transfer strategies

is less than it was two years ago.

And after Sept. 11, companies pretty much felt

like drowned rats even if they had enough coverage, which many did not. So

clearly, one can't criticize risk managers for being conservative at a time of

such uncertainty.

Under or Over

But what about the insurance industry? Does its

current under-capitalization really merit currently proposed increases, in

addition to the $10-billion insured-loss guarantee it wants from the U.S.

government for catastrophic terrorism risks?

The answer to that question is a little more

murky. Without a doubt, the industry suffered a major blow Sept. 11, on the

order of $40 billion worth of losses. And it might be asking too much to demand

that the industry be prescient enough to anticipate a disaster of the scope of

Sept. 11

business. Unfortunately, however, the increases being heaped on corporate

policyholders are not all about the tragedy. At least half relate back to some

imprudent business decisions over the last several years specifically setting

premiums too low to cover losses and expecting gains from the unstoppable bull

market for equities and bonds to make up the difference. Even industry

representatives unashamedly admit to that. According to Robert Hartwig, the

chief economist at the Insurance Information Institute in New York, the

insurance industry through the first half of 2001 actually

was paying out $1.11 in losses for every dollar of premium taken in.

In other words, the price for insurance was less

than the losses that insurers expected, akin to a manufacturer of an automobile

charging a price for a car that was less than its costs. You can't run a business like that forever, Hartwig

concludes.

True enough. And well before Al Qaeda supporters

boarded jumbo jets, insurers began jacking up premiums by as much as 20% to make

up losses. Those were the days when insurance didn't look like the flushest

game in town. Now, however, premiums are on the ascent. Insurers suddenly see

more reason to commit additional capital. In the last few weeks, more than a

dozen new insurance and reinsurance companies have been announced by many of the

biggest names in the insurance business, including insurance brokers Marsh and Aon, reinsurers Zurich Re and

Hannover Re and insurers AIG and the French company SCOR. The new companies, if

all materialize, should add $25 billion to the industry capital, according to a

report by Morgan Stanley. Doesn't this $25 billion replace a good chunk of the

$40 billion sucked out by Sept. 11? Moreover, Hartwig says more new companies

will be formed during the first half of 2002. The new capital, however, will not

create overcapitalization (read: it will not result in low prices again at least

for several years), he says.

The Story Changes

But shouldn't it take some pressure off

prices? No, others reply, the new capital is only being invested because of the

higher premiums being charged for insurance and potential profits. For four years the industry has complained that too much

capital flooded the insurance market, says Felix Kloman, a veteran risk

management consultant and editor of the newsletter Risk Management Reports. Then

suddenly there's this major loss of capital (from Sept. 11). Well, what does

the industry do? It throws fresh capital in the market. Wait a second now

there's not enough capital? Does this industry really know what it's doing?

Marsh, for instance, has been sorely criticized for forming a new subsidiary 16

days after the disaster to sell higher-priced insurance to the same corporate

clients it is supposedly in business to represent. Chris Treanor, head of global

broking at Marsh Inc., says MMC Capital, the private equity subsidiary of Marsh

& McLennan Cos., was formed on

behalf of the investors in the funds we manage, rather than for the corporate

insureds it represents through its broking operations. The new subsidiary,

Bermuda-based Axis Specialty Ltd., recognizes

the returns available in the insurance marketplace, Treanor says. If

that's opportunistic, I guess we are. But as Hartwig will tell you: This

is how capitalism works. The rationale is pure business.

Government Bailout

Okay. But should taxpayers be underwriting

capitalism with a federal guarantee to cover future catastrophic terrorism

losses? Is this just a less expensive version of the savings-and-loan bailout

for an industry in less dire need? Consumer advocates, like Robert Hunter,

insurance director for the Consumer Federation of America in Washington, don't

think the industry deserves the protection.

The industry has a long track record of pruning specific coverages from standard

insurance policies after they produce extraordinary losses or raise expectations

of producing large losses, Hunter says, only to create separate stand-alone

insurance products that are very costly. Such was the case with pollution risks,

employment practices liabilities and now terrorist risks. Each of these was once

covered by standard policies only to be jettisoned at the prospect of higher

losses. Asking Congress to bail you

out while you're charging 200% more for your products is absurd, says Hunter. This

is nothing more than opportunistic companies taking advantage of the World Trade

Center tragedy.

Then again, how loudly can corporations protest

since they were the beneficiaries for much of a decade of unrealistically low

insurance rates? It is unlikely that many risk managers were demanding insurers

seek more adequate fees. In the end, insurers may do in their golden goose.

Companies don't have to take this on the chin. They can simply reduce the

amount of insurance they buy to zero if necessary, picking instead from a menu

of alternative risk transfer strategies developed in recent years for such an

insurance crisis.

And to be sure, there are alternatives taking

root much higher self-insured corporate retentions (think deductibles) and corporate-owned captive insurance. These

rather conventional options are said to be proliferating, with at least 650 new

captives expected next year to join the 4,500 currently in operation, according

to Marsh Management Services, a large Bermuda-based captive management firm that

formed 24 new captives in 2001, more than any year in the last 12. Companies are

also undertaking studies of the efficacy of more sophisticated alternatives.

Explains Richard Inserra, assistant treasurer at Praxair Inc., a Danbury,

Conn.-based industrial gases company with $5.1 billion in annual revenues: These

kinds of programs take more time to put in place, but we're looking.