Turmoil after
terrorism How
last year’s attacks have scrambled an industry
by
John Rubino
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to enlarge
Back
in the 1990s, Chesapeake real estate development and
construction firm Armada/Hoffler didn’t give much
thought to insurance. It didn’t have to, since
the premiums on its workers compensation and liability
policies “actually went down for quite a few years
in a row,” says Mike O’Hara, the company’s
chief financial officer. But when the policies came
up for renewal at the beginning of 2002, O’Hara
discovered just how much times have changed. “The
increases were huge, 40 percent to 50 percent,”
he says.
Believe
it or not, Armada/Hoffler got off easy. Other companies,
especially those in risky fields or with less sterling
safety records, are seeing premiums double or more —
assuming their carriers will insure them at all.
Welcome
to the insurance industry’s version of the Perfect
Storm, where just about everything that can go wrong
has, all at once.
First, there’s the distorted insurance cycle. Look
at the 30 years prior to 1990, says Tom Brown, president
of The Rutherfoord Cos., a large regional insurance
broker. “You’ll see that the markets [for
commercial insurance] would swing pretty religiously
on a three- to four-year cycle,” with carriers
cutting rates to gain business and raising rates when
the cuts weakened earnings. Because the swings were
of relatively short duration, they didn’t cause
much of a stir either way.
But the 1990s were so good for so long that the insurers
— like a lot of other businesses — were lulled
into a false sense of security. They cut rates to chase
new business. As they did, premiums fell to ridiculously
low levels. Between 1992 and 2000 the cost of commercial
insurance fell a whopping 42 percent, from an average
of $8.30 per $1,000 of revenue to just $4.83 per $1,000
of revenue, according to the Insurance Information Institute.
As
a result, in the late 1990s, the industry’s combined
ratio — the cost of writing and paying off insurance
versus the premiums they charged — was 107 percent,
meaning that carriers were losing 7 cents on every dollar
of coverage they extended. That should have set off
alarm bells. But with bonds and stocks returning 10
percent or more a year, investment income more than
made up the difference, allowing the industry to earn
a cumulative $67 billion in 1997 and 1998.
While
the good times were rolling, a series of new risks were
creeping up on American business. Asbestos litigation,
says Brown, “had been going on for years. Problem
is it didn’t stop.” Recently, for instance,
Chubb, a major property/casualty insurer, was forced
to add $625 million to reserves to cover asbestos-related
claims.
Mold
— which affects both structures and the health
of the people living and working inside — recently
came out of left field to become another big insurance
headache. And the efforts of the tobacco industry to
insulate itself from lawsuits have apparently failed,
leading to a string of huge jury awards that culminated
with a $28 billion judgment against Philip Morris in
October. Meanwhile, the stock market’s recent plunge
has turned insurers’ steady investment gains into
big losses. And with all the WorldCom and Tyco debt
still festering in industry portfolios, the bad investment
news may be far from over. Insurance rates, in short,
were going to rise substantially this year and next,
even if nothing serious happened on the claims side.
But
of course something serious did happen — something
incredibly serious. The World Trade Center attack on
Sept. 11, 2001 constituted the biggest insured event
in the history of the world, totaling maybe $50 billion
when all is said and done. “September 11 wasn’t
like when a hurricane hits and you see a lot of property
damage but not loss of life,” says Dorothy J. Dembowski,
a vice president and real estate specialist with insurance
broker Marsh in Virginia Beach. “This was everything
all at once, workers comp, life insurance, business
interruption, accidental death, aviation.”
The effect on insurance industry finances has been catastrophic.
Carriers are required by regulators to hold a surplus
equal to a percentage of the value of policies written.
In 2000, the property/casualty industry’s surplus
was around $300 billion, which means the WTC attacks
sucked 15 percent or more out of the industry’s
capital base in one fell swoop. “Wall Street isn’t
particularly interested in recapitalizing this business,”
notes Bruce Kay, spokesman for Richmond-based specialty
insurer Markel. So rebuilding the industry’s balance
sheet won’t be simply a matter of a few stock offerings.
With a suddenly much lower surplus and no ready source
of new capital, insurers have no choice but to cut back
on business and raise prices dramatically. Barry Flax,
national loss coordinator for Rockville, Md.-based insurance
consultancy Goodman-Gable-Gould/Adjusters International,
tells of an apparel manufacturer client that had a bad
fire at a plant which caused about $1 million in damage.
When it came time to renew its coverage, the premium
jumped from $40,000 to $250,000. “It’s not
the size of the claim, but the fact that it brought
the company onto the radar screen of the carrier,”
says Flax. “The carriers have tightened the reins
on their underwriters.”
They
are, says Flax, looking harder at potential risks and
trying to price in all contingencies. And they’re
dumping businesses that present unpredictable risks.
Among the most vulnerable to lost coverage are costal
properties, due to a rise in the number of Atlantic
storms in the past couple of decades, and lower-rent
apartment complexes, “where you see a lot of fires
and floods,” says Flax. Markel, which frequently
acts as insurer of last resort for companies unable
to get standard coverage, is seeing a rise in the number
of inquiries from restaurants, says spokesman Kay.
But
the problems go far beyond a temporary shortfall in
the insurance industry’s balance sheet. “The
World Trade Center created an exposure that underwriters
had never considered before on the property side, and
obviously didn’t charge for,” says Kay. Now
they’re being forced to assess the new level of
risk that global terrorism represents. The chilling
conclusion: 9/11 could have been a lot worse. As Warren
Buffett, super-investor and chairman of insurance company
Berkshire Hathaway, put it in a November 2001 Washington
Post OpEd piece: “Indeed, had a nuclear device
been available to Osama bin Laden, the loss could have
bankrupted most of the industry, Berkshire very much
included. Given that kind of horrendous, but not impossible,
nuclear scenario, insured losses could have been $1
trillion, an amount that exceeds the net worth of all
property/casualty insurers worldwide.”
Insurers,
as a result, are building terrorism exclusions into
many policies, says Marsh’s Dembowski, exempting
themselves from liability in the case of another attack.
Legislation now working its way to through Congress
will require the federal government to pick up a big
piece of future terrorist attacks, but it won’t
cover everything, leaving insurance companies and/or
their customers with yet another hard-to-quantify risk.
Companies
facing big premium increases and new exclusions are
reacting in a variety of ways. Verona road builder Moore
Brothers, for instance, is part of a group of companies
that pool resources to cover their workers compensation
claims, laying off the excess risk to reinsurance companies
and refunding overpayments to its members. Reinsurance
rates recently quadrupled, says Dennis Miller, Moore
Brothers’ comptroller. “Our group is absorbing
some of that increase,” by holding down member
payments in the short run and paying the reinsurance
increases from the group’s accumulated surplus,
he says. That means lower refunds in the future, of
course. “It’s pay me now or pay me later.”
A
more common way to hold down premiums is to accept a
much higher deductible. “We used to see apartment
complexes that had $5,000-$10,000 deductibles,”
says Flax. “Now we’ll see $100,000-$200,000.
Any loss underneath that amount and they’re going
to eat it.”
Some
bells and whistles in existing policies are also being
sacrificed, says Flax. Blanket coverage is being replaced
with specific — much lower — amounts for each
individual building. And law/ordinance coverage, which
pays for bringing a damaged facility up to new codes,
is in some cases being dropped.
To
counteract the resulting increase in risk, insurance
professionals counsel companies to become more risk
conscious. And, says Brown, “You’d better
be dealing with [a carrier] who can manage those claims,
because they’re coming out of your pocket.”
He recommends policy terms that require the carrier
to consult with the policyholder before settling claims
above a certain amount. As for terrorism coverage, it
may be available on a stand-alone basis, says Dembowski.
She’s currently working with an apartment developer
whose construction loan covenants require terrorism
insurance.
Meanwhile, since insurance is a cost of doing business,
it’s being passed on to customers wherever possible.
At Moore Brothers, rising insurance costs, while painful,
have “no effect on the jobs that we’re willing
to do,” says Miller. “It just goes into the
overhead when we calculate what to bid on a job. It’s
like paying taxes.”
Office
building tenants may see higher rents, especially those
with “triple net” leases, where the cost of
taxes, building maintenance and insurance are passed
through to tenants. In short, the insurance industry’s
problems are society’s problems, and from the looks
of things they’ll be with us for a while.
