Risk Managers Sing the Hard Market Blues

The Chicago Blues, born in the Mississippi Delta but taking on a new urgency and edge as it made its way north, provides a fitting backdrop for a risk management community meeting at a time of tumult. Ironically, 2003 has been declared the “Year of the Blues”, and no doubt risk managers would agree. Facing perhaps the most difficult market in the last half-century, risk managers meet in Chicago for the Risk and Insurance Management Society (RIMS) Conference filled with anxiety. Not only are current conditions difficult – from rate hikes to new demands for information from underwriters, from scarce capacity to increased scrutiny from boards and senior executives – but the “$64,000 question” now is, how long will it all last?

Answers to that question vary, but there is agreement that the hard market will not end anytime soon. Risk management consultant Karen McWilliam predicts the hard market will last well into 2004, and is optimistic of some softening in 2005. Influencing this are uncertain political conditions in the U.S., not only related to the Middle East situation, but also with an election coming in the fall of 2004.

“There’s an assumption that things are going to smooth out, but I don’t think it’s going to smooth out this year,” says Wayne Hickey, chair of the RIMS Canada Council. He adds that insurance market dynamics will have a lot to do with when competition sets back in and rates soften. “As soon a one insurer opens capacity and changes their thinking, they all will look at it.”

There is also the lingering issue of investment returns, which show no promise of recovery in the near term adds Nowell Seaman, manager of risk management and insurance services for the University of Saskatchewan. However, he adds, “there is certainly an expectation that things should be improving if these price increases are what is required to improve underwriting results. I can’t believe the claims experience has deteriorated as much as premiums have gone up.” He notes that there are some indications of price flattening in the U.S. which could be a positive sign for risk managers to cling to. “It’s very disappointing, having been through a couple years of very turbulent renewals, to have to go through another one.”

But, the U.S. market is predicting one or two more years of hardening at least, explains Chris Mandel, outgoing president of RIMS (who will stay on as chief risk officer in the coming year). With the U.S. on the brink of war with Iraq at the time of this writing, a prolonged war could “tank the economy…it could lead to the double-dip [recession] that everyone is fearing.” U.S. brokers and agents reported continued hardening towards the end of 2002, with most accounts seeing increases above 10% (see chart 1).

More of the same

The year ahead will like bring “more of the same” in terms of price increases, although there are signs of softening in a few specific lines, says Steve Mallory, a managing director with Marsh Canada. Some “quality” risks are enjoying improved terms relative to more difficult risks or lines of business. However, he notes, “in many areas, there doesn’t appear to be an end in sight”.

January renewals were not easy, explains Seaman. “There are a lot of challenges yet in terms of pricing.” Some lines that shot up last year have leveled off to more moderate increases, while others have remained stable, but many continue to rise at double-digit pace. Pricing is difficult despite there being some additional capacity available, says Joe Hardy, director of risk management and insurance for Hudson’s Bay Co. (HBC). His company, like some others, is coming off a multi-year policy and will experience the increases for the first time this year. While HBC had taken higher retentions which have paid off, those companies more reliant on insurance will feel the bite.

Pricing is certainly not the only, or even necessarily the more significant issue facing risk managers. Capacity was significantly depleted after the 9/11 terrorist attacks, and has not rebounded significantly yet. “They [insurers] are not willing to take as much [coverage] on,” says Hickey. He notes that risk managers are having to shop the market for many more companies to make up the limits they previously held. As well, “there’s a price tag attached to things that the underwriters conceded on before”, if they are willing to write this traditionally “throw-in” coverage at all. “Even in situations where companies are writing, they won’t write the same amount…they are either pulling out, or pulling out in part, and won’t write the same capacity,” Hickey says. This leaves risk managers to go out and find someone else to write the coverage, a process that is not only time consuming, but also comes with a price. “When you’re going to with a new company, they know you’re going for reasons other than your health, and they will charge for it.”

Traditionally, new business can expect to see a heftier increase than renewal business. “There’s nothing you can do about it if you’ve got to have the coverage,” Hickey observes. Insurers withdrawing altogether from certain lines has certainly added to the efforts risk managers have to go to fill out a program. “There are a lot of players that are not there anymore [in specific lines],” Seaman comments. “When you have to go out and fill out your programs with new players, there are struggles to get the same level of coverage.” Many risk managers have been “bitten” when their book was transferred to a new insurer, or even to a different underwriting unit within the same company. “They treat you like you’re new business,” he says. This means extra work on producing information for underwriters, as well as possible price hikes. In some ways, he comments, the additional scrutiny being paid by underwriters is almost as shocking as the “sticker shock” of rate increases.

McWilliam notes that even on subscription policies, “many subscribing insurers will not use a manuscript policy. Each wants their own wording and each wording is slightly different.” Different information may be required by each, and different underwriting rules applied. “I’ve seen clients spend a month, two, or even three months just responding to questions. Time is a real killer,” she says. Hardy points out, “in this very tight, tough repositioning of the insurance industry, I find it is just way too slow for submissions”.

Global drivers

Among the lines of business risk managers point to as being particularly troubled, directors’ and officers’ (D&O) was raised time and again as the most notorious culprit (see chart 2). Hardy concedes that D&O was under-priced, “and we’re paying for it now”. He compares the situation to that of products liability in the 1980s, where coverage became a cheap commodity until major companies had massive recalls, such as the Johnson & Johnson recall of Tylenol in 1982 after some bottles were laced with poison. “It was really ugly when the losses came down. It takes this type of loss to drive it home [that the product is under-priced].”

In the U.S., D&O and errors & omissions (E&O) lines are both trouble spots, Mandel reports. “All kinds of carriers are pulling out of those lines.” While Canada has not seen D&O cases on the scale of Enron and Worldcom, certainly there have been domestic shareholder suits (e.g. Bre-X, YBC and Cinar). But this is also an example of how the global insurance industry’s losses are felt worldwide. “This is one of the first times Canadian insurance purchasers have had to accept that we’re dealing with a scarce commodity and it’s a worldwide marketplace,” says McWilliam. She sees further deterioration of the D&O market as one of the top stories of 2003. “Capacity is being deployed very selectively. In addition to very large price increases, underwriters are not necessarily providing all the capacity they’re able to provide.” She has personally seen increases of 75% on “good” books of business with no losses, as well as less coverage being offered. Furthermore, she notes that, while 2002 was the year of property increases following on the heels of 9/11 , the market is now seeing equal hardening in liability lines. Risk managers report that other liability lines, including umbrella and excess are seeing large increases and scarce capacity.

Mallory says D&O is in “deep trouble”. Many of the key players are not Canadian, but even Canadian companies are being swept up in worldwide losses. “It [the increases] are claims driven. Also, it’s a specialized area and not everybody can underwrite it”, he adds with regards to the short supply of carriers and capacity.

Certainly insurers have shown an unwillingness to write specialized lines they do not have an expertise in, with past losses providing incentive not to tread in dangerous waters. Mallory notes that corporate governance is going to be a strong focus for underwriters in setting D&O rates. “Everybody understands the implications of poor corporate governance. Underwriters are questioning their clients’ boards with an intensity we haven’t seen in many years, maybe never.”

Another concern for some risk managers is the lingering issue of terrorism coverage. In the U.S., the implementation of the Terrorism Risk Insurance Act (TRIA) has dominated the first part of 2003, says Mandel. While terrorism cover quotes he received were “reasonable” he has heard horror stories of pricing quotes of between 50%-100% of the property premium. “It’s a question of rate, and ‘do I need the coverage or don’t I?'” Nonetheless, he sees rates in the stand-alone market being dragged down by largely moderate pricing under TRIA.

For Canadian companies, coverage is available, but very expensive, Hardy says. And banks or other lenders are still asking for the coverage in negotiations for letters of credit and other loans. He wonders why, when the U.S. government was convinced there was need for an insurance backstop, Canada has largely abandoned the issue. “Why do we think in Canada that it [terrorism risk] isn’t an issue?” There seems to be an attitude that terrorism “won’t happen here”, he observes. He adds that insurers, through the Insurance Bureau of Canada (IBC) seem to have given up the cause, leaving risk managers as a “lone voice” in calling for government assistance.

Seaman, who will take over as chair of the RIMS Canada Council in March, says he is concerned with the breadth of current exclusions and that there seems to be a resignation to living with the status-quo. Although some complaints have been heard from the U.S. market about its system, this should not necessarily deter Canadian corporations from looking at a solution here. “I’m not particularly comfortable with where things have been left. Is there a way we could maybe do it better? It’s one issue that seems to have fallen through the cracks.”

Steeped in tradition

With all of the turmoil in the insurance industry, last year many were predicting a mass exodus to alternative risk transfer (ART) mechanisms. However, this has not been the case, risk managers say. “The threat of no capacity at all is not as great as it once was,” notes Hickey. “Capacity is out there, but they’re [insurers] going to charge for it. I don’t know that it’s to a point where we’re going to look at a completely different route.”

“In my experience, it takes a period of a few years of hard market for this [ART] to develop,” says Seaman. “While they’ve had a double and triple whammy [of price increases] risk managers have stayed patient.” Mallory notes that even with the rate increases seen so far, prices remain below the peaks of the last 15 years. “People are still generally considering insurance as the most affordable option,” he reports. It is up to brokers to explain the value that insurance continues to represent rather than to exaggerate the state of the market as worse than it really is.

One of the most talked about alternatives has been the captive market, but even this may not be a panacea for risk managers. “Captive growth has been dramatic since 9/11,” says Mandel, “but I wouldn’t say everyone is running away from insurance.” Captives meet very specific needs, and at the end of the day, largely represent self-insurance, he adds.

McWilliam, on the other hand, is seeing serious interest in alternatives as the hard market drags on. “I think 2003 will bring about more alternative risk transfer. I’m certainly seeing clients getting more creative.” There is movement away from considering options to actually getting the ball rolling on them. Companies are also looking at risk control, enterprise risk management and even reassessing how much coverage they need, she adds. They have become more thoughtful and technical in evaluating coverage needs, and while it may cost $20,000 or $30,000 to do a risk study, this can pay off in reducing coverage needed or enticing underwriters to offer more coverage. Mandel agrees that insurance is not the central issue. “You need to find ways to finance risk internally before premiums go out the door.”

Insurer strength

On thing risk managers are taking more seriously is the financial solvency of insurers. While many insurers, including long-term players, have faced ratings downgrades, risk managers have almost been forced to be less picky when seeking out capacity. “The big issue is that some companies’ strategies require them to buy insurance only at a certain [rating] level,” explains Hickey. For example, this may be insurers with a financial strength rating of “A+” at a minimum level. “If you do that, you may not get insurance at all,” he comments. However, as Seaman notes, “we haven’t seen anyone particularly fail yet. It’s difficult to be objective when almost everybody has gone down a notch, but the minute somebody fails, then it will become an issue.”

Risk managers agree that other sources, beyond ratings, must be sought, and other considerations, for example, claims service, play a role. But, as Hardy notes, evaluating insurer financial stability can be a challenge when results are often reported with a year-long lag. McWilliam, like other risk managers, voices the concern that insurers are also unwilling to report who their reinsurers are. While she would not expect to know rates or terms of those relationships, given instability in the international reinsurance market, risk managers need to know that their insurers have solid reinsurance backing to pay out claims. Nonetheless, she says there needs to be greater understanding of ratings, particularly in light of the rapid failure of such companies as U.S.-based Reliance.

Insurer financial results are being watched by all risk managers, who are by-and-large sympathetic to insurers’ need to return to profitable underwriting, but who nonetheless await a signal that rate increases will slow down. After 9/11, boards of directors and senior management easily understood that prices increases were coming their way and why, notes Hickey. “Now, you have to justify it more [so].”

Furthermore, Seaman notes that, as insurers begin to post stronger results for the 2002 financial yearend, this justification becomes even more challenging. “As things return to profitability and you see these kinds of stories [of stronger results], there has to be some rationale…boards read these things and wonder [why rates continue to climb].”