Suddenly, there is chaos. After a dozen years of
falling insurance premiums, companies are now paying an average 30% to 40% more
for insurance than they did last year. Insurers contend the increases are
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justified, given the industry's poor economic performance prior to the events
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.
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