Insurers Rethinking Risk in Riskier World

But a big increase in premiums -- and a government bailout -- may actually attract more players into the business.
David KatzNovember 1, 2001

Risk managers pride themselves on their ability to model almost any potential loss to their companies. They can map out, for instance, the potential toll of an earthquake, a jury award, or a rash of carpal-tunnel injuries. They then figure out how to protect against the risk and mitigate the damage from risks that cannot be prevented. But what if a single, devastating event triggers a whole host of losses — losses that come at a company from different angles?

While the disastrous events of September 11 have many CFOs rethinking the concept of enterprise risk, the tragedy has been an absolute eye-opener for executives at insurance companies. The attacks have brought into question the very predictability of risk — a very serious matter to an industry that creates products and generates profits based on the likelihood of future events.

Indeed, the attacks of September 11 have spawned “a whole new paradigm of loss,” says Thomas Motamed, executive vice president and chief operations officer of Chubb Corp. Claims from 9/11 have already reached nearly $8 billion, and estimates of the eventual price tag have reached as high $70 billion. Chubb itself reported on October 30 that its after-tax costs related to the attacks amounted to $420 million, resulting in a third-quarter operating loss of $1.41 per share.

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Previously, insurers “focused on a single peril,” Motamed told a recent gathering of the New York City chapter of the Risk and Insurance Management Society. Now, he says, the industry has learned that “a single event that affects numerous coverages” is quite possible.

In fact, the recent attacks on New York and Washington has insurers taking a hard long look at their product lines. Traditionally, insurance companies have hedged their risk by balancing one product line against another, confident that neither would suffer a big loss at the same time. That’s all changed with 9/11. “The correlations between glass [breakage] and workers’ compensation, for example, have to be rethought,” says Edward Noonan, president and chief executive officer of American Re.

The catastrophe has also enlarged the industry’s notions of what individual insurance lines might actually cover. With so many workers dying on the job when the Twin Towers collapsed, “workers’ comp has now become a catastrophic life insurance policy” that will ultimately pay out hundreds of millions of dollars to survivors, Noonan says.

Further, while reliable estimates of much of the property loss will likely be available in a few months, experts say it might be years before the liability toll can be gauged. “Sometime, we’re going to know who made the latch on the cockpit door on those planes,” Noonan predicts. “We’re going to know the name of that manufacturer.” From there, it’s only a short step to a court finding of negligence and huge product-liability awards.

Renewals Not Renewed

Once the litigation starts, says Noonan, “it will be impossible to stop.” Capping the liability of any one particular industry — as the federal government recently did with the airlines — would undoubtedly send insurers scurrying for other targets to sue. That could set off a vicious cycle of suits and countersuits among underwriters, Noonan claims.

This new uncertainty about uncertainty has sparked real concerns among reinsurers. As much as 60 percent of the insured losses associated with the attacks of September 11 may be borne by reinsurers, with the remainder assumed by primary carriers, estimates Chubb’s Motamed. But reinsurers have only about 20 percent of the capital of primary carriers.

Reacting like “a deer in the headlights,” reinsurers are unlikely to ink any new coverage treaties with insurers before the new year, claims Michael O’Halleran, president and chief operating officer of Aon Corp. In fact, “little is getting done” on renewals of reinsurance contracts that had been slated to expire October 1 and November 1, he reports.

Corporate risk managers are already feeling the effects of reinsurance withdrawals, which have caused some carriers to pull previously completed coverage deals off the table. (See “Losing My Insurance.”)

Available — at a Price

This is not to say that corporate coverage will be scrapped. Customers will just have to pay more for their policies — even policies that bear little apparent connection to terrorism. “I can’t see a single line of business that doesn’t need a rate increase of 20 to 25 percent,” Noonan asserts. “Risk managers should be preparing treasurers and CFOs for rate increases.”

What’s more, substantial hikes in policy premiums are likely to draw more capital into the insurance sector. As much as $10 billion in new capital will flow into the industry in the quest for the newly lucrative business, predicts Aon’s O’Halleran.

Commercial insurance brokers, in fact, are among the big gainers, considering the sudden neediness of their clients for risk management solutions. To be sure, Aon and Marsh, the two top brokers, suffered terrible human loss as a result of the attacks. Marsh & McLennan Cos. (MMC), Marsh’s parent company, lost more than 300 employees at the World Trade Center, while Aon lost about 200. At the same time, the brokers have been alert to the flight of reinsurance capacity from the market.

Last month Aon said it was expanding the underwriting of its spin-off, Combined Specialty Corp., to include reinsurance policies as well as direct P/C insurance. In September, MMC announced it was forming AXIS Specialty Ltd., an insurance and reinsurance company likely to be capitalized at $1 billion.

Outside the insurance-brokerage world, Arch Capital, a Bermuda-based financial services firm, formed a reinsurer that also had about $1 billion invested. Two private-equity firms, Warburg Pincus and Hellman & Friedman, are together plunking down about $750 million for the effort.

Rich Uncle in the Business

Of course, this rush of new risk funding won’t help those on the hook for huge losses from the attacks. For that, there’s the U.S. government.

Under a Senate Banking Committee proposal — a proposal reportedly backed by the Bush Administration — insurers would be on the hook for the first $10 billion a year in terrorism-related damages for two years, with the federal government picking up 90 percent above that amount. Some underwriters gripe that the industry can’t afford a $10 billion hit. Still, the government plan would create predictability. And with predictability, insurers will find it easier to write new business.

In fact, if all goes well, American Re’s Noonan predicts the current chaos may start to resemble a typical shakeout in the insurance business. “Unless,” he warns, “there’s another event.”