Lessons learned: In the wake of the Sept. 11 catastrophe, insurers need to return to the basics. (Property/Casualty).

After the initial shock of the Sept.11 events slowly gives way to careful analysis of the circumstances and financial consequences of the various property losses, it becomes clear that the insurance industry will have no choice but to change its practices if it wants to survive.

Eager for growth and market share in the unprecedented soft-market conditions during the last decade, the industry abandoned what once were core tenets of insurance and now appears to be paying the price. It, therefore, makes sense for underwriters to review some of the issues, no matter how basic, that were highlighted by the terrorist attacks:

* Terrorism Coverage. It is now apparent that the frequency and, to a much larger degree, the severity of terrorism in the 21st century can no longer be understood. Since all insurance pricing is based on these core principles, it will be impossible to come up with an acceptable pricing and spreading mechanism that would offer investors the reassurance of acceptable returns on their capital and provide insureds with adequate limits. In the face of this, excluding terrorism from industry policies and replacing it with a government-backed instrument similar to Pool Re in the United Kingdom is not an option, but a necessity.

* Risk aggregation. Forced by past catastrophes, many insurers have been doing a fairly good job aggregating liabilities that could coincide during a natural catastrophe, such as an earthquake or a windstorm. But very few insurers thought about aggregating liabilities that might materialize out of a man-made diaster. The development of address-based systems that indicate multiple capacity commitments within the same building or structure are as much needed today as were probabilistic catastrophe-simulation models 10 years ago.

* Probable maximum loss/maximum foreseeable loss. Many insurers will leverage their capacity based on probable maximum loss and maximum foreseeable loss numbers developed by engineers after inspection of insured locations. The terrorist attacks demonstrated that probable maximum loss and maximum foreseeable loss are purely assumptions and not absolutes. Insurers who had relied on probable or maximum loss numbers to determine the share that they could accept on a particular account ended up severely overlined. Using probable maximum loss and maximum foreseeable loss data certainly has a place in the pricing of risk, but they should be avoided to increase available line size beyond reinsurance limits and net capital base.

* Coverages provided with no risk information The insurance industry has historically provided some limits for coverages whose risks were hard to quantify up front, such as newly acquired locations, unnamed locations and certain. contingency coverages within the realm or business interruption--for example, contingent time element, ingress and egress and civil and military authority. These limits were usually very small and, hence, accumulation was little threat to insurers. With the softening of the market, these limits were expanded or abandoned altogether, which created a very large but unknown clash potential. The events surrounding the destruction of the WorldTrade Center have unleashed this huge potential, and indications are that contingency coverages will be a major portion of the overall loss. Going forward, the only answer is risk identification. Unless contingency coverages can be identified and quantified, they should be excluded.

* Valuation/blanket limits. It has been customary in the commercial property arena to accept insured values reported by customers as true and document these values within the policy by an agreed-amount endorsement. Large losses in the past decade that uncovered under-reporting of values have demonstrated that this practice does not work well and, in fact, may lead to complacency with insureds in developing proper valuations. The reintroduction of coinsurance provisions that either have the insured participate in every loss with a set percentage share or indemnify the insured for a loss in the same relationship as reported values compared with actual exposure is guaranteed to put focus in an area that has long been ignored.

* Policy wording. Contrary to capital-market transactions, large-commercial property policies do lack standardized policy language. Instead, every contract is negotiated individually, which is not only expensive but adds the risk that policy forms may lack sufficient clarity. Coverage disagreements and, ultimately, litigation are a likely result if the stakes are high enough. Development of standardized policy forms across the industry is needed in an effort to reduce expenses and loss cost at a time when affordability of coverage will become key.

Klaus Gebhardt, a Best's Review columnist, is senior vice president of Ace Bermuda Insurance Ltd.