"Moderating" is the euphemism that brokers and insurers are using to defend premium hikes of 20% and more in most casualty lines. By "moderating," they mean that rates are still increasing, just not as dramatically as the last two renewals. "As a broker, the most important thing we want for our clients is rate stability," Vitale explains. "We want the cost of risk transfer to be predictable for risk managers and the insurers as well, to assure their long-term stability. The days of underwriting a policy at a loss and depending on investment income to pick up the shortfalls are over. Underwriting discipline has returned."

Of course, underwriting discipline is easy when there isn't any investment income worth its salt to tantalize insurers into lowering premiums. Even with upwards-creeping interest rates (insurers invest primarily in bonds and not equities), insurers lack ample financial incentive to underwrite at a loss and compete for market share with low prices–the cash flow underwriting of the late nineties and other earlier insurance cycles. But more than paltry investment income should keep insurance prices on their upward swing. With continuing pressures to fill loss reserves rapidly being depleted by a second wave of asbestos liability lawsuits and a record spate of downgrades of insurers by independent rating agencies, the "moderating" price increases will be in a stage of moderating for some time. "While the rate of increase seems to have peaked, we don't expect premiums to stabilize for at least the next year and one-half," says Karen Horvath, vice president of A.M. Best Co., an Oldwick, N.J.-based rating agency.

Like Dave Hennes, risk manager Janice Chamberlain of Costco Wholesale Corp. is enduring the fallout of a financially unstable insurance market. What's making work even tougher for Chamberlain is that Costco's workers compensation, general liability and commercial auto insurance were covered, up until recently, by Kemper Insurance Cos., an insurer on life support. Stung by losses from the World Trade Center attack and a failed strategy to expand into non-core insurance lines, Kemper has sold off various bits and pieces in the last year to thwart insolvency. Saddled with a "D" rating by A.M. Best–the lowest the rating agency gives out–the Long Grove, Ill.-based carrier is losing market share faster than an insurance sales pitch. "We switched from Kemper to Ace Insurance in the middle of our policy period because we were uncertain over their ability to pay claims," says Chamberlain. "They were very good about returning our premium, which we've redirected to Ace."

Growing Concerns About Solvency

Chamberlain is now anxious about Kemper's ability to pay claims on so-called long tail losses–risks it insured years ago that may produce claims in the future, such as a worker who develops carpal tunnel syndrome from repetitive stress injuries suffered over the course of several years. "We struggle with whether we should try to commute the program–buy back our claims and make some retroactive arrangement with another carrier to take them–or just assume these risks internally," she explains. "For now, we're holding firm."

Chamberlain's experience underscores the growing concern over insurer solvency. A July survey of broker members of the Council of Insurance Agents and Brokers revealed that 71% believe insurer solvency is a greater problem at present than six months ago. Certainly, the failure of large insurers like Reliance Insurance Co., Legion Insurance and Highlands Insurance Group has had a chilling effect. "There is concern definitely on the part of our clients around the country about the financial viability and stability of insurance carriers," says Roger Egan, vice chairman of New York-based insurance broker Marsh Inc.

According to A.M. Best, insurer insolvency rates are at their highest level in the last 10 years. Last year, the industry failure rate was 1.33%, compared with 0.23% in 1999, and an aggregate 10-year industry failure rate of 0.72%. Altogether, 38 insurance companies were put under regulatory supervision or placed into liquidation in 2002. Through June 30, 2003, another 14 companies were put under regulatory supervision or placed into liquidation. What's killing insurance companies? "Many carriers still need to post reserves for asbestos and other liability losses," Egan replies.

The aggregate $90 billion void in loss reserves to cover long-tail asbestos and other liability losses is staggering, though in a nation that is content to live with an enormous federal deficit a deficiency of that size perhaps isn't worth the effort of a raised eyebrow. More than $50 billion of the black hole is attributable to anticipated asbestos and environmental losses. Companies that don't ante up are vulnerable to rating downgrades and, worse, demise. "We have been issuing to our clients more market alerts lately –on the order of two a week, it seems," says Egan. "With all the rating downgrades lately, fewer and fewer insurers meet our minimum guidelines [to provide insurance]."

The under-reserving has resulted in a fusillade of insurer rating downgrades by A.M. Best, Standard & Poor's Corp. and other rating agencies. A.M. Best's Horvath is still adding up the numbers, but says that in the most recent rating cycle that ended June 30, downgrades "are definitely more prevalent and continue to outpace upgrades." Data provided by S&P affirms the trend. Through May 31, the New York-based rating agency issued 30 downgrades and no upgrades. Moreover, the number of commercial- line insurance companies with a "stable outlook" fell from 27 to 21, while the number with "negative outlooks" jumped from 17 to 21. "We're all wondering when the other shoe will fall and where," says Chamberlain.

To reduce the risk of ending up with next year's Kemper, Horvath advises risk managers that they should avoid any carrier with a negative outlook "or one under review for pending capital raising initiatives. The trends in ratings are also important," she says. "Even if a company has a secure rating, if the letter rating is moving downward, that's a signal it's going in the wrong direction. Also, look more deeply into the numbers to find out what makes up surplus–hard capital or soft capital mechanisms, like a loan from a parent. Is this capital being driven by operating earnings or by capital gains, realized or non-realized? A company with persistent adverse loss reserves has issues you must relate to its capital sources. If that source is suspect, it's a big red flag."

As risk managers cautiously weigh the financial stability of their chosen carriers, they must balance it against the cost of the product offered. Not that many bargains can be had in the current market anyway, property insurance notwithstanding. Even with excellent loss experience, Chamberlain says Costco received a 30% rate increase to renew its property policy, insured by FM Global. "We had to increase our risk retentions for earthquake and windstorm exposures and reduce our limits of coverage to get this price," she sighs. Still, the risk manager believes the rate hike was rational given the growth in the number of stores in the Costco chain. "Very clearly, the property market is still in a rate increase mode with premium hikes in the 8% to 12% range, but this is nothing like the last three years," says John F. Graham, senior property executive in the Boston office of insurer American International Group Inc. "Some accounts with good experience can obtain a rate decrease, but obviously this would have to have been pretty terrific experience."

But Willis' Vitale warns that even this slight bit of good news may be fleeting. "We've had the most incredibly long run of no big catastrophes, whether it's aviation, terrorism, windstorm or an earthquake," he says. "The foundation we're in right now is so fragile and shaky that just one big quake could literally push the property market over the top, with a couple of insurers going down the tubes easily. The state of affairs can turn on a dime with one good storm coming up the coast."

As for the casualty market, it's last year's story rewritten. "Primary general liability premium increases have dropped somewhat from where they were a year ago, as has excess casualty," says Shaun Kelly, executive vice president of Lexington Insurance Co., a Boston-based excess and surplus lines insurance carrier. "On the professional liability side, rates are holding stronger, with errors and omissions and employment practices liability still getting significant rate increases. Medical malpractice is a trouble spot, as is everything in health care, from hospitals to nursing homes, given medical inflation. Rates there are through the roof."

What-if Scenarios

But the biggest migraines for risk managers are workers compensation and D&O insurance. Chamberlain says she has been told by her broker to expect Costco's D&O risk retention and premium to rise dramatically come December, when the company is slated to renew its multi-layer D&O policy with Columbia Casualty. Vitale says 50% premium increases for D&O are the norm in the post-Sarbanes-Oxley business environment, with publicly traded companies in the financial sector "experiencing the worst pain." Horvath says employment practices liability and fiduciary liability are in the same boat price-wise as D&O, "since they tend to be tied together."

As for what may lie ahead, many factors–call them "ifs"–can move the market one way or the other. If the insurance industry fails to move Congress with legislation creating a finite payment mechanism for asbestos litigation, that creates additional loss reserve stress and prospects for more rate increases. If the economy improves too fast and interest rates rise, that may entice carriers to compete on price and relax their newfound underwriting discipline. If a storm the size of Hurricane Andrew barrels down on Miami, kiss the property rate relief goodbye. If reinsurers hike the cost of their risk-spreading market at the next round of treaty renewals in October, insurers must bear more risk and raise prices to compensate. And if terrorists strike U.S. soil, causing untold fatalities, today's exorbitant workers compensation costs will seem a bargain by comparison.

Blame all the uncertainty on insurers' underwriting practices in the good old 1990s. "Carriers went too far in their premium decreases," chides Michael Weinstein, director of research at New York-based Conning Research & Consulting. "They lost money and destroyed value at a record rate. In a world where they can't make money on investments, an extra dollar of premium is still better than none."