This year's business insurance market is all about last year's hurricanes. How will the huge losses from hurricanes Katrina, Rita and Wilma impact property insurance premiums? Will the effects of those losses spill over to other lines of coverage? And what should companies do to ensure appropriate coverage?
The answers to those questions are still unfolding. Advisen Ltd., an insurance information provider with headquarters in New York City, estimates that total worldwide insurance and reinsurance losses related to the three hurricanes will total $57.6 billion, the largest amount for a cumulative catastrophe loss on record. The combined losses from Katrina, Rita and Wilma are more than twice the total losses attributed to other natural disasters in any year on record and one and a half times the losses from the 2001 terrorist attacks in New York City and Washington, D.C.
Before Hurricane Katrina struck, the market had been easing and insurance companies were reporting strong profitability. Many observers expected the market to continue softening into 2006. In the third quarter of last year, companies' renewal premiums were 5 percent lower across all lines of coverage than in the same 2004 quarter, according to the quarterly Risk and Insurance Management Society (RIMS) Benchmark Survey. D&O premiums fell 8.45 percent, property premiums just under 6 percent, general liability 5.2 percent, and workers' compensation 3.75 percent.
"The hurricanes changed the pricing picture," says David Bradford, executive vice president of Advisen, which conducts the benchmark survey. "The only question is: How much?"
One thing is certain: For property insurance, rates are going up, and coverage terms are becoming more restrictive. Some organizations were already starting to see significant rate increases in the fourth quarter of last year. "Companies with energy-related risks saw increases in property coverage of up to 50 percent immediately after Katrina," says Bradford. "Other risk managers are getting hints from underwriters of increases of up to 20 percent, and they don't think that will stop anytime soon."
Bob Howe, director of North American property operations for Marsh Inc., a New York City-based risk and insurance services firm, agrees. "I expect to see fairly significant change in the property insurance marketplace, including tightening on coverage and sharp price increases for catastrophic risks." The outlook is bleaker for exposure to catastrophes. Companies should expect dramatic increases for catastrophic windstorm and earthquake risks, he says, and should look for more flood exclusions and changes to the definition of "flood area."
Capacity also needs to be considered. "Underwriters are becoming more cautious about capacity in coastal and earthquake-prone areas, and that will push up prices," says Howe. He adds that if supply fails to meet demand, "companies with high catastrophic exposure may not be able to get the level of coverage they want or to complete their programs."
Howe believes that many underwriters also will use more conservative modeling techniques for the risks in their portfolios. For example, the techniques many underwriters used for windstorm risks turned out to be inadequate or inaccurate following Katrina, leaving them with higher than expected losses.
All companies will feel the impact of a hardening property insurance market, but businesses with operations in vulnerable locations will suffer more. In high-risk coastal areas, even businesses that did not suffer large losses last year likely will see significant price increases.
Verizon Communications has operations in the areas affected by the hurricanes. Its losses were not as great as those reported by many other companies in these regions. However, Sheila Small, assistant treasurer, risk management and insurance, for the New York City-based company, is not optimistic that Verizon's moderate loss experience will be enough to head off a premium increase. But she's philosophical about the situation, recalling the losses Verizon sustained as a result of the September 11, 2001, terrorist attacks.
"Our property carrier pointed out that even companies that did not have a loss saw a rate increase after 9/11 because those companies took part of our loss," Small says. "And we are in the inverse position today. He pointed out that everyone takes a hit -- and I'm not sure I disagree with him."
On the bright side, the property insurance market is coming off very profitable years in 2004 and, before the hurricanes, 2005, which may help to mitigate both the severity and duration of the harder market for property coverage.
All of these factors are still playing out. "A lot of people are in wait-and-see mode," says David Novak, assistant vice president of San Francisco-based insurance broker Cooper Gay. However, he says, "across the board, underwriters are not offering any reduction in [the cost of] property coverage, no matter what or where the risk." And businesses also face larger deductibles, even in areas that are considered at lower risk of hurricanes and other catastrophic events.
The U.S. insurance market will not be alone in registering price increases. The global insurance industry is vying for the same capital, so as rates increase in the United States, those in other countries likely will follow.
Small has lowered her expectations for the overall insurance market this year. "I don't think we will realize the rate stabilization that we had hoped for," she says. "The good news is that it doesn't seem that the problems in the property market are overflowing into other lines of business." That's a contrast to what happened in the insurance market following 9/11, when every line of coverage was affected.
Steve van Halst, who is director of insurance and claims for Telus Corp., a provider of telecommunications services headquartered in Burnaby, British Columbia, is cautiously optimistic. "I expect the market will remain mixed, with very different issues along specific coverage lines," he says. "I expect ample capacity will continue to be available for major insurance lines, because the market has grown far more efficient in responding to supply and demand imbalances than five years ago," he adds.
The uncertainty in the market is putting even more pressure on finance executives and risk management professionals to understand and manage all of the exposures their business faces and to alert senior management to any significant changes in the cost of coverage. "I'm a firm believer in managing expectations and telling management up front if the company will be affected by changes in the insurance market," asserts Small.
For CFOs and risk management executives, management of exposures might include efforts to influence their insurance rates through mitigation. Telus, for example, has developed major capital projects designed to enhance the reliability of its power systems, upgrade its fire protection systems and increase redundancy in critical systems, according to van Halst.
The company has also initiated a decade-long program of upgrading key network sites to reduce the risk to its operations from an earthquake -- including physical damage and business interruption -- in the Pacific Northwest, even as it increases its network assets and revenue in that region. As a result of that project, the company's property insurers purchase less earthquake reinsurance to cover Telus' risk, so their costs -- and Telus' premiums -- have been declining.
"While the terrible hurricane losses will drive up rates for natural catastrophe reinsurance for our insurers, this is significantly offset by the improvements we have made in reducing risk," notes van Halst. He obtains benchmarking information from insurers to see how the company's loss experience compares with its peers and then shares his findings with underwriters.
Van Halst is also working to improve the information Telus gives its insurance providers. "If data is not available [insurers] must make inherently conservative assumptions to protect their companies," he points out. Telus hires external seismic specialists to provide detailed analyses of the company's key sites so it can quantify earthquake risks and assess the impact of upgrades to its facilities. "It is our responsibility as the client to ensure our insurers understand how we are managing these risks so that insurers can more accurately model their aggregate exposures and optimize their lines and reinsurance, which leads to better program structure and cost for Telus," he adds.
In addition, the company constantly examines risks that emerge as its business and services change to ensure that those exposures are appropriately managed. For example, text messaging on mobile phones was not considered an important feature just a couple of years ago, but now its use is increasing rapidly among consumers, so Telus is taking steps to protect the resulting revenue and to enhance the reliability of these services.
Howe offers another point to consider. "Business continuity planning is as important as ensuring appropriate insurance coverage," he says. "If executives do not have strong business continuity plans that consider issues like supply chain risk and catastrophic exposure, then the insurance program may not be covering what the company really needs."
Companies should model risks from catastrophic events in order to understand the magnitude of those threats. This includes understanding the contingencies that could lead to business interruption, loss of customers and supply chain disruptions. Only with this type of insight can companies take steps to understand what is and is not covered by insurance and to modify their risk management strategy to better mitigate those risks. "This is not just about buying insurance," says Howe. "It is about understanding the risk the company is taking on."
The increasing strength and frequency of hurricanes along the Gulf Coast has prompted some companies to factor climate change into their risk management strategy. "There is a concern that catastrophes like hurricanes have become more common and more powerful and that the game has changed," says Bradford. Events pegged as 100-year occurrences are suddenly happening more frequently.
Telus, for example, considered the impact of climate change on its operations and business continuity after two 100-year floods occurred in its operating area within two years. "Models for natural catastrophes were predicated on the world 30 years ago," says van Halst. "The world has changed since then." He points out the increased incidence of flash floods in North America, as well as the growing strength and frequency of hurricanes and windstorms. Telus does not operate in a hurricane-prone region, but van Halst expects that insurers' and reinsurers' heightened focus on low-probability, high-magnitude earthquakes, floods, ice storms and windstorms will still affect the company's insurance program.
If the intensity and frequency of catastrophic events continue to grow, they may have a major impact on the insurance market and companies' ability to obtain the coverage they need at a reasonable cost. And that could lead companies to turn to alternative sources of risk financing in the capital markets, such as hedge funds, or to retain more risk themselves through captive insurance companies and self-insurance.
Last year's soft insurance market will harden in 2006 as insurers absorb big losses, compliments of Mother Nature.
Building the Underwriter RelationshipAs the property insurance market hardens, companies can blunt the edge of premium increases by building relationships with insurers and strengthening their loss-prevention efforts. CFOs should make a point of developing a working relationship with their organization's underwriters so that all parties can understand one another's needs. A business might want to hold regular meetings with these providers and include senior managers. Underwriters are always looking for more and better data about an enterprise's risks, so it behooves CFOs to explain their organization's exposures and the steps they are taking to manage and mitigate them. Finance executives can provide information about plants and facilities, safety and loss-prevention efforts, and key risk-management initiatives. "Companies will have a positive identity with underwriters if they have a strong story to tell," says Bob Howe, director of North American property operations for Marsh Inc. in New York City. That story should emphasize loss prevention. Sheila Small, assistant treasurer, risk management and insurance, for New York City-based Verizon Communications, relates a tale that underwriters want to hear. She says that following hurricane-related losses several years ago, Verizon changed the layout of its central offices to accommodate storage of its backup generators and batteries on higher floors to prevent service interruptions caused by floods. |