Risk Management

Property: Factory Seconds

With the price of property insurance going through the roof, some companies come up with creative ways to help hold the line on premiums.
David KatzJanuary 22, 2002

Reality check No. 128:

Take a walk around one of your company’s facilities. Check out the state of the sprinkler systems. Examine the thickness of the walls, the strength of the foundations. Run a few worst-case scenarios through your computer, simulating the effects of a fire, an earthquake, or bomb. Finally, decide how much uninsured property risk your company can handle.

Then, double it.

Welcome to the wonderful world of risk management, post 9/11. With reinsurance backing vanishing after the calamitous events of mid-September, commercial property insurers have raised premiums through the roof. What’s more, brokers are asking corporate clients to do more self-insuring — a whole lot more. Says Bob Howe, a managing director at insurance brokerage Marsh: “Almost all treasurers and CFOs are being faced with having to retain more risk in terms of deductibles.”

They don’t have much choice. With the premiums charged commonly rising 150 percent to 200 percent in recent renewals of property insurance polices, the surest way to keep rates down — without actually foregoing insurance — is to agree to pay higher deductibles. In fact, Howe says many of Marsh’s clients have increased their property insurance deductibles by 50 percent. A number of clients have gone even further — in some cases, boosting property deductibles of $500,000 to $10 million.

Not surprisingly, the rise of the jumbo deductible has some managers taking a long hard look at the risks they’re actually shouldering. Sellers of insurance say in-house evaluations often help a company prevent the kinds of accidents and disasters that tend to produce big losses — things like high-rise fires and plant explosions. At the same time, buyers of insurance say internally generated data can help a company sell itself as a reasonable risk.

And make no mistake, a good sales job is crucial to getting adequate property coverage these days. Indeed, risk managers fresh from recent renewals say it takes a strong marketing effort to get insurers to judge a company on its own merits. They claim property underwriters are no longer interested in tailoring policies to individual customers, and have instead reverted to the hard-market practice of “line underwriting.” In line underwriting, insureds with good loss records are typically charged high premiums just because they happen to be in a high-risk industry.

Carriers have slashed coverage limits across wide industry swaths, including manufacturing, health care, and real estate, says Marsh’s Howe. “It’s a very broad brush that’s painting the market,” the broker adds.

Visions of Vapor Clouds Dance in Their Heads

The broad brush is making for a very bleak picture. To line up any kind of property insurance, companies in high-risk sectors are having to distance themselves from the industries they operate in.

Take the recent case of a corporation that turns feedstock into plastics, adhesives, and sealants. Sounds like a chemical company, right? But Michael Davis, CEO at risk management outsourcer Risk International Services, says otherwise. “We were determined to convince the market they were not a chemical company,” notes Davis, who advised the plastics maker in its pursuit of property insurance. “When underwriters see a chemical company, they think ‘vapor-cloud explosions.’ “

Keen to dispel that notion, Risk International amassed white papers detailing the processing temperatures and pressures for each raw material the company processes. Every plant function was assigned a risk factor on a scale of 1 to 10, with 10 representing the risk posed by an extremely volatile process (such as burning ethylene in a furnace). Zero represented the risk for filtering water.

Davis says the scale enabled him to persuade an insurer that the company’s risks tilted more toward zero than toward 10. The underwriter transferred responsibility for the insured from the carrier’s chemical division to its less stringent general manufacturing unit.

Such tactics might not help companies combat premium hikes in the current renewal season. “It doesn’t matter if you’re good, bad, or indifferent,” Davis conceded in a mid-December interview. “Negotiations are so tight right now.”

Maybe so. But Steve Sachs, a consultant who handles the risk management for shopping-center developer the Rouse Company, thinks tarting up a company’s risk profile is still a good strategy in the current market environment. Sachs notes that he’s using Rouse’s estimates of its own probable maximum loss (PML) from windstorms as bargaining chips in negotiating the company’s February 1 property renewal. (PML is a variously defined estimate of the financial loss that could occur when a destructive storm or earthquake hits a building. It usually assumes most safety measures are working properly.)

“We put in our own information and our own modeling to have high-quality information…to possibly refute [insurers’] projections,” says Sachs, a senior vice president with the Hobbs Group, an insurance brokerage and consulting firm. Sachs claims underwriters are now routinely basing pricing and coverage decisions on such broad categories as a company’s zip code.

To differentiate Rouse’s hurricane exposures in Florida and Louisiana, Sachs has shown underwriters “secondary building characteristics.” This includes things like the quality of roof construction and the presence of protective layers behind exterior walls. By going deeper into the details, “we dropped our probable maximum loss by tens of millions of dollars,” Sachs claims. “That positions us to do somewhat better in terms of [insurance] capacity.”

Sachs is also considering parlaying safety investments into lower deductibles for Rouse. Among the four or five structures he’s considering for renewal, one carrier’s coverage separates windstorm damage from other property insurance. Not long ago, Sachs says, carriers offered windstorm deductibles of 2 percent of a property’s total insured value.

Now, he’s pondering an offer of deductibles that are the higher of either 5 percent of total insured value or the expected maximum loss. (Expected maximum loss is an estimate used by insurers that’s often based on the effects of the most devastating hurricane in 250-year or 500-year periods, assuming breakdowns in safety systems.)

On the surface, that deal doesn’t look so hot. If, for instance, an underwriter calculates an expected maximum loss of $10 million on a $50 million building, the deductible would be too high to justify buying insurance. But if the Columbia, Maryland-based Rouse Company could lower its expected maximum loss to $3 million by spending $300,000 on structural improvements (and amortizing the cost), Sachs says, buying the policy may make sense.

Running for Covers

Risk managers are having to resort to these machinations because of a shrinking insurance capacity touched off by the attacks of September 11. For instance, Industrial Risk Insurers (IRI), a major property-insurance player in the Fortune 3000 market, has slashed the maximum amount of coverage it offers from $1 billion to $10 million. Dan Eudy, president of IRI, says that while the decision to lower its limits was made before 9/11, the attacks “certainly accelerated our move.”

As a result, Rouse, which had all its property insurance with IRI for 10 years, has had to scramble to replace the bulk of its expiring coverage. Three years ago, in the throes of a soft insurance market, the developer was able to ink a $2 billion property insurance program, including windstorm coverage. In fact, IRI once provided the company with limits as high as $5 billion.

Of course, coverage withdrawals are not unheard of in the insurance game. In the late 1980s, in the most extreme market hardening in recent memory, many forms of liability coverage dried up. Generally, such seller’s markets spur growth in the use of captive insurance companies. While the current market hardening may have been too swift for captives to come into play any time soon, Risk International’s Davis thinks they can still help hold down premiums.

Maybe. Davis recently tried to use one his client’s captives to retain a 40 percent premium hike on the company’s quota-share property program quoted before 9/11. (In a quota-share program, several insurers each agree to pay for a percentage of total losses.)

Davis’ strategy was to get the captive to cover about 25 percent of the risk at the originally quoted price. That presumed that the company’s brokers could persuade insurers to stay onboard for the other 75 percent. Rather than raise the rates and reduce coverage on the whole program to accommodate the holdouts, he says the idea was to “have the captive take the line, accept the premium, and buy reinsurance to cover some of its exposure.”

In the end, the captive strategy fell through because the client couldn’t get insurers to sign on for a high enough percentage of the program. “We couldn’t get 50 percent done at that price,” Davis says. The client ended up agreeing to a 110 percent premium hike.

Nevertheless, some consultants believe the captive strategy could still be effective if buyers can convince carriers to cover 70 percent to 80 percent of the risk at the quoted price. Then again, if premiums get too high, corporate risk managers can think the unthinkable: going without property insurance. A company with good banking relationships, for instance, could put together a pre-arranged loan agreement that would go into effect if there’s severe property damage to a factory, using the factory as collateral, says Davis. “You wouldn’t need the loan until you have the loss,” he explains.

Still, buying property insurance has its virtues. Borrowing money won’t protect a company from a hit against earnings the way insurance will. And with a loan, the commitment would be long-term. Says Davis, “You would be paying ‘insurance premiums’ for 20 years in the form of interest payments to the bank.”

The current market for property insurance may be bad for buyers, but it probably won’t take two decades to return to normal.