The first hard market for insurance in almost 15 years has underwriters jittery. Carriers that don't remember past market cycles are slapping higher prices on all renewals. The panic creates new risks for businesses — and new opportunities.

For the first time in nearly 15 years, finance executives have a compelling reason to pay close attention to how much risk their company retains, how much it transfers to insurance carriers and which insurers it uses. The long buyer-friendly, "soft" market in insurance seems to be ending with a vengeance. For those with long memories, it's not yet as bad as the brutally hard market of the late 1980s, when coverage in many lines dried up. But some veterans say the problem today is compounded by the fact that many key people working for insurers and brokers and serving in corporate risk management positions don't remember a hard market and consequently don't know how to behave now that they are in one.

That ignorance is leading to potentially costly mistakes but is also creating cost-saving opportunities for finance executives who know how to take advantage of it.

Effects of a Changing Market

Scott B. Clark, administrative director of the office of risk and benefits management for Miami-Dade County Public Schools in Miami, recently returned from London and a meeting with Lloyd's about his property insurance renewal. The news was not good. "Starting in January, Lloyd's saw huge premium increases and large increases in retention levels when it renewed its reinsurance contracts," he reports. "It's especially bad for areas like South Florida that have a history of natural disasters. I don't know if we'll be able to keep the same program limits, but if we do, it will cost us 25 percent to 30 percent more than last year."

Things are likely to get worse before they get better. Prices today are just back at 1992 to 1993 levels and have a long way to go before they reach the levels of the last hard market or even the point of profitable underwriting for many carriers, notes Mike Chapman, executive vice president of the C.J. McCarthy Insurance Agency in Wilmington, Mass. "It looks like we'll be in this tougher market for a prolonged period," he advises.

However, not every risk manager is feeling Clark's pain. Chris Mandel, assistant vice president for enterprise risk management at USAA, a diversified financial services business in San Antonio, Texas, recently went to the mat with casualty insurers (workers' comp, general liability and auto) and came out a clear winner, getting slightly better coverage at a significantly lower rate by changing carriers and playing up its low loss history. "We saved a bunch of money," he reports.

Now Mandel is preparing to do battle with property insurers. "My market intelligence tells me that almost all of the primary property underwriters are angling for general increases of 20 percent to 40 percent and for the best risks 15 percent to 20 percent," he reports. He plans to fight back by combining the separate programs of two big business units and asking for a 15 percent to 20 percent rate cut. Whether he gets it remains to be seen, but at least he'll go into negotiations with his guns loaded.

He may have a chance. "This is not the marketplace we experienced in 1986, when insurance was not available at any price," insists Paul D. Sanfilippo, senior vice president of Risk Strategies Co. LLC in Boston. "Currently, insurers maintain underutilized capital on their balance sheets."

The experience of Roger L. Andrews, general counsel and director of risk management for E.D. Bullard Co. in Cynthiana, Ky., and immediate past president of the Risk and Insurance Management Society (RIMS), seems to bear out Sanfilippo's cautious optimism. Andrews has heard plenty about the hardening market, but his own renewals have been basically flat, he reports. Bullard, which manufactures hard hats and other safety equipment, even abandoned its self-insured group health plan when a provider pitched a fully insured plan that was less expensive, he notes.

G.E.S. Exposition Services, a trade show services business headquartered in Las Vegas, predicted the price increases and locked in premiums with three-year contracts in 1999, when longer-term lock-ins still were possible, reports Lance Ewing, senior director of insurance, so he has a free ride until 2002 renewals. "We had some good advice from our broker, Willis, and beat the price increase before it hit," he notes. "We have not had to raise our deductibles to offset premium increases, but that's what a lot of my peers at other companies are doing now," he reports.

Ewing thinks the price increases mark the end of the long soft market. "The industry will return to the principles of traditional underwriting. For a long time now, prices have been dictated by the salespeople, based on what they need to compete. In the future, underwriters will dictate prices again, based on probabilities of losses," he predicts.

The Experience Factor

Ewing seems to describe a return to sanity, but some of his peers find the current market wildly irrational. "This is the first hard-market cycle that many of the underwriters and brokers we deal with have ever lived through, and they frankly don't know how to handle it," observes Randy Thurman, director of risk management for Gaylord Entertainment Co., a Nashville business that operates hotels, entertainment and music publishing ventures under the Opryland and Grand Ole Opry labels. "It's scary." Thurman is an insurance veteran who doesn't scare easily. He spent five years as an underwriter, 17 as a broker and the last eight and a half as a risk manager.

Insurers are not just raising prices; they're doing it mindlessly, he charges. "Underwriters have been given an arbitrary number by their management and told to raise prices that much on renewals, regardless of the loss experience of the insured," he complains. "But they're not applying those price increases to new business they write. The result is that my underwriter may require me to pay 20 percent more to renew coverage on loss-free business, but they will write the same coverage for a new customer at less than they are currently charging me."

It didn't take Thurman long to figure out what to do: switch underwriters to get lower prices. "I'd rather not jump from carrier to carrier, but my first obligation is to protect the assets of my company, so I have no choice but to take advantage of that opportunity. To me, it's a sign that the underwriters are running scared. It's making them difficult to deal with."

Nervous Lenders

Jittery underwriters aren't the only ones forcing Thurman to change providers. His bankers are also getting into the act. "Our lenders recently have become concerned about the ratings of our insurers — not just their Best rating but how they're rated by Moody's, Standard & Poor's and Fitch. If their rating is not high enough — or if they don't have a debt rating — they're asking us to change insurers," he reports.

So far, banks have insisted on approving insurers only for property they have accepted as collateral and are not scrutinizing insurers when they make or renew unsecured loans, he adds. "A year or two ago, when the economy and the stock market were riding high and balance sheets were flush, these were not issues our lenders cared about," he observes. Thurman has had to dump carriers he considers perfectly satisfactory because they don't have a bank-pleasing rating.

Line-by-Line Shifts

As expected in the early stages of a hard market, some lines are feeling the pinch sooner than others. Property and casualty insurers have reported negative underwriting results for the past two years and now are putting their business under a microscope, notes Alexandra Littlejohn, managing director for superbroker Marsh Inc. in New York City.

The turning point for industrial and commercial property insurer FM Global came in late 1999. "We were coming off seven or eight years of falling prices and deteriorating underwriting experience," reports Mike Turner, vice president of marketing for the Johnston, R.I., firm. "That trend couldn't continue, so the market started to harden, and rates have been trending up for about 17 months now," he says.

The pain is particularly acute in workers' compensation coverage, where loss ratios have been running around 140 percent (i.e., $140 paid out in claims for each $100 collected in premiums), Littlejohn reports. Now carriers are raising premiums anywhere from 5 percent to 25 percent. Blame it on rising medical costs and growing indemnity claims, she says. The workers' comp problems are particularly bad in California, Virginia and Pennsylvania, but even there underwriters are not yet rushing for the exits.

Also hardening like superglue is the market for automobile insurance for corporate fleets and transportation companies, Littlejohn reports. Once offered as a loss leader, auto coverage now is up 15 percent to 20 percent among companies with good loss experience and 25 percent to 30 percent for companies in the transportation business, she notes. Some carriers are getting out, although most continue to offer coverage at high prices.

Excess liability is another bellwether, with rates up 15 percent to 20 percent, Littlejohn points out, especially for protection from natural catastrophes like earthquakes and wind storms. That's not because losses have been heavy lately, she says. Actually, natural catastrophe damage has been below average for several years, which has led to underpricing, something underwriters are now fixing. "They're cleaning up their books," she observes.

The market for directors and officers liability (D&O) has turned as well, with renewal rates for public companies already up 10 percent to 20 percent and headed for 20 percent to 30 percent by the end of the year, reports Steve Anderson, another Marsh managing director. Private companies will pay a lot less, and the reason is not hard to find: They don't have shareholders who will sue them. Half the claims and 80 percent of the dollars paid out by D&O carriers now go to settle shareholder class-action suits, Anderson explains. Some insureds are shopping for lower prices, which they may find because there is plenty of capacity still in the market, but most are reluctant to risk opening a gap in coverage by switching carriers, he says.

Employment practices liability is holding up better, with premiums up just 5 percent to 10 percent. The larger a company's work force, the more it can expect premiums to rise, Anderson reports. Large employers also can expect to be pressed to increase their retention. Except for workplace violence, broad coverage still is available for most exposures (e.g., wrongful discharge, discrimination, sexual harassment), he notes.

The Bigger Picture

What can finance executives do about this unfriendly market? They can't protect themselves with long-term contracts any longer, says Littlejohn, but they can sharpen their pencils and take a fresh look at how much risk to retain and how much to transfer. For several years, retaining a lot of risk hasn't made economic sense. With coverage so cheap and plentiful, finance managers simply transferred risk and moved on to other decisions. Now it pays to consider the alternatives and use more self-insurance and higher deductibles, she notes.

Bullard's Andrews says that if he runs into price increases, he will retain more risk and go shopping. "We're in the ninth year with our current carrier. If they raise rates significantly, we will market our program more broadly and look at other carriers," he says. Higher retentions and aggressive shopping "got us through the last hard market, back in the mid-80s, pretty well," he observes.

Higher prices and signs of shrinking availability will reawaken long-dormant interest in risk retention strategies like insurance captives, Thurman predicts. "It takes a fairly long lead time to get a captive up and running, so we aren't seeing much of that yet, but if the policies coming up for renewal in the next six months confirm the price increases we saw in the last six months, I think you'll see a lot of self-insurance and captive insurance arrangements start to come back," he says. Although Bullard is not large enough to charter its own captive, Andrews says he will look closely at joining a risk pool.

Risk managers also need to start collecting good information for contract negotiations, Chapman says. "A hard market requires good information. A lot of risk managers haven't been asked for a loss control report in the past three or four years, but they will be asked for one now," he observes.

The tightening market is a good opportunity for companies to adopt a sophisticated approach to risk management that is rooted in financial analysis and loss modeling, Sanfilippo argues. "Underwriters base insurance products on a static view of a client's risk. Traditional underwriting approaches do not capture the full spectrum of a company's risk profile," he insists.

But the most constructive response, G.E.S. Exposition Services' Ewing says, might be to "turn up the heat on management to push harder to reduce risks and prevent losses. In a soft market, you tend to get complacent; your losses are covered and insurance is cheap. But claims are expensive in a hard market, so it's time to put more of a push into preventing losses and avoiding claims."

New Business Patterns Create New Risks

Complicating the normal, albeit rather extended, insurance cycle are fundamental changes in how business is conducted and therefore in the risks that finance executives must manage, notes Mike Turner, vice president of marketing at FM Global, an industrial and commercial property insurer in Johnston, R.I. "It's called 'contingent liability,' " he explains. "You see it in arrangements like outsourcing, which have greatly increased the extent to which you rely on outside partners instead of internal staff, and the extent to which other companies rely on your performance.

"You also see it in reliance on computer networks and the Internet, where a hacker attack or an accidental crash could disrupt your ability to receive orders. And you see it in mass customization, where you have huge quantities of a critical material (like semiconductors) made to your specifications by a single supplier. If that supplier goes down, you can have a sudden, huge loss of production. That risk can only partly be transferred to an insurer. You can recover some lost revenue but not lost market share," he says. "It is making life more complicated for risk managers and finance executives."