Corporate finance in job london

As just about every CEO in America demands departmental cutbacks to survive this recession, the nation's risk managers, whose job it is to purchase insurance are handing in bigger budgets -as much as twice that of last year. They are bedeviled by an out-of-control commercial insurance market. Just look at the Meadowlands Sports Complex in East Rutherford, N.J., the stadium in which the New York Giants and Jets football teams play. The complex, which seats close to 70,000, recently reported that its liability premium had tripled to $2.4 million from $700,000.

September 11 and, to a lesser degree, Enron's bankruptcy have caused premiums m many lines -particularly workers' compensation, directors' and officers' liability property, fidelity aviation and surety-to skyrocket. Along with the higher prices is the insurers' requirement that corporate buyers retain more risk on their balance sheets, with deductibles in many lines now double what they were in 2000. Add it up and companies are paying a much higher premium for a lot Less coverage.

These problems pale when compared to the most disturbing news from the commercial market: the industry's refusal to provide coverage to absorb future terrorist incidents.

"The possibility of financial loss is so huge and so unpredictable that there is no tolerable premium level insurers could charge that could sustain the magnitude of risk," explains Mike McGavick, chairman and CEO of $7.1 billion SAFECO Insurance Co. in Seattle.

The estimated $40 billion in loss produced by September's tragic events-which could end up being much more - is a catastrophe that insurers and reinsurers are only beginning to pay out. The disaster caused the industry's single largest loss, with the second-largest, Hurricane Andrew, an $18 billion loss by comparison. In terms of the property destroyed and the thousands of lives lost, September 11 is also history's first workers' compensation catastrophe. According to the Insurance Information Institute, U.S. insured catastrophe losses for 2001 will set a record of $24 billion, compared with $4.3 billion in 2000. Second-highest losses were in 1992, with $22.9 billion.

So companies are handing off the pain. "For insurers to maintain even a modest level of profitability, additional increases of 20 to 30 percent in the premiums were needed in many lines," explains Joe Plumed, chairman and CEO of Willis Group Holdings Ltd., a New York-based insurance brokerage with a market capitalization of $3.4 billion. In some cases increases were double or triple what they were. Airlines and firms with aircraft are paying much higher premiums, as are companies with high-profile office buildings, large employee concentrations in one location and operations in big cities.

Prelude to a fall

But even before the attacks ripped a hole in the industry's capital base, property and casualty insurers were hiking premiums an average of 15 to 30 percent. The culprit was not Osama bin Laden, but the falling stock and bond markets, on which insurers depend to compensate for poor underwriting results. The robust investment returns in the 1990s had permitted insurers to charge less for their products than the losses those products would produce. In 2000, for example, the industry paid out $1.11 in losses for every dollar of premium taken, with the shortfall made up by the substantial investment returns. But when the stock and bond markets faltered in 2001, premiums had to rise.

Companies that renewed their policies on Jan. 1 were the first to get the bad news--that the current environment differs dramatically from the one in the past decade. The l990s' fiercely competitive market was one of history's longest, a consequence of severe overcapitalization. To effectively deploy that capital for shareholders, publicly traded insurers cut prices and deductibles, the latter to zero in some lines like workers' compensation. As the decade wore on, says McGavick, "it was clear the prices being charged were inadequate to meet claim costs."

More frequent and severe claims attributed to higher medical costs, and soaring jury awards, coupled with deteriorating investment income, compelled insurers to raise prices in late-2000.

The expensive market is now guiding many companies to forego conventional insurance. Penn Tank Lines Inc., a $55 million Malvern, Pa.-based petroleum transportation company, is buying liability protection through Fleet Solutions Ltd., a Bermuda-based captive insurance association. "We've joined with others in our industry that have excellent risk management controls to basically insure each other for general liability, automobile liability and workers' compensation," says John A. McSherry, Penn Tank Lines president and CEO. He estimates that his company will save 20 percent this year compared to what he previously paid for traditional coverage.

Some companies are battling higher premiums by retaining more risk internally. Told by its broker that the cost of its commercial automobile insurance would double when the policy renews in February, New York book publisher Scholastic Corp., with $2 billion in revenues, is mulling much larger deductibles, admits Vincent Marzano, vice president and treasurer. By transferring less risk to an insurance company, the cost is reduced, similar to taking a higher deductible on a car insurance policy

Retaining more risk is cost-effective only if stringent attention is paid to managing it. NOVA Chemicals Corp., for example, quadrupled its property deductible to $70 million for claims from fire, explosions and resultant loss of income in 1994, when its peer companies were more likely to have deductibles in the $1 million range. "We believed that it didn't make any sense to buy what was expensive insurance given our strong management of risks and effective loss-prevention efforts," says Brad Silver, risk manager at the $4 billion Pittsburgh-based chemical company. That decision has saved the company roughly $25 million over the intervening years, Silver says. Following a recent merger with Trans-Canada Pipelines and a reorganization in which it spun off its energy business, NOVA has reduced the deductible on its property program to $50 million.

Now, CEOs are especially concerned about the paucity of insurance available to cover terrorism. Within weeks of September 11, the industry flied with state regulators to exclude terrorism as a covered exposure in standard property and casualty policies. Only workers' compensation policies continue to cover terrorism in full.

The action was fueled by reinsurers--large financial institutions that absorb layers of risk from insurance companies for a premium. "The magnitude of loss now is far greater than anyone ever contemplated and the frequency of loss is completely unknowable. Thus, our policy, at present, is to exclude terrorism coverage," says Andreas Beerli, CEO of the Americas division of Zurich-based reinsurer Swiss Re Group. Unable to spread terrorism exposures through reinsurance, an insurer would have to bear the risk on its own balance sheet--too dicey for many to consider. "Terrorism for us became an uninsurable risk for the same reason that war is excluded," says SAFECO's McGavick.

There is some insurance available, although the amount of coverage is paltry. Companies basically have two options: negotiating a new property policy at renewal that includes a separate "endorsement" covering terrorism or buying a separate terrorism policy altogether.

The first option presents no more than $5 million worth of coverage. The second option--a separate terrorism policy--offers greater coverage, as much as $150 million per terrorist incident, but it's expensive. "We've seen rates ranging from 2 to 10 percent [of the values covered]," says John T. Sinnott, chairman and CEO of New York-based Marsh Inc., the flagship of Marsh & McLennan Cos., the world's largest insurance brokerage.

Three groups offer the standalone policy: American International Group, Berkshire Hathaway and Lloyd's of London. But brokers find it difficult to combine the limits of financial protection available in each policy to afford wider protection, common with other insurance lines. "Each facility defines 'terrorism' differently and offers different coverage elements," Sinnott explains. "It's hard for us as a broker to stack the limits to provide more than $150 million in coverage for clients."

For a company facing a multi-billion-dollar exposure, such as the owner of a Manhattan skyscraper, $150 million in insurance is a pittance that may not be worth the cost. Many companies, in fact, are passing. "We're likely to go 'bare'--without insurance," says the risk manager of a large utility. "There's just not enough insurance available to cover the financial severity."