Risk takes center stage: the RIMS convention examined how the terrorist attacks and corporate bankruptcies have changed the art of risk management. (Property/Casualty).

Presentations at the annual conference of the Risk and Insurance Management Society in New Orleans in April drove home a vital point: Risk management is more important now--in a time of recovery from history's most expensive terrorist attack, lingering terrorist threats and ongoing corporate scandal--than ever before.

The series of meetings during the conference attended by 10,000 insurance professionals featured risk managers and insurers talking about the importance of identifying and managing risk exposure. They discussed the pressing need for a federal backstop for terrorism reinsurance. They spoke about the ways in which the failure of Enron Corp. and the bankruptcy of Kmart have affected surety insurance. And they speculated on the continuing need for exclusions--both in terrorism coverage after Sept. 11 and in directors-and-officers insurance in the wake of Enron's collapse.

Post 9/11

Insurers and risk managers must join together to manage risk in the post-Sept. 11 era, collecting and modeling more data while exploring new ways to protect assets, said Greg Berg, head of enterprise risk at Hartford Financial Services Group Inc.

That's particularly important, because the United States faces a 100% probability of another devastating terrorist attack in the near future, said James Lee Witt, former director of the Federal Emergency Management Agency, and L. Jerry Bremer, chairman and chief executive officer of Marsh Crisis Consulting Co.

"The Sept. 11 attacks were not a surprise to anyone who seriously studies terrorism," said Bremer, a former U.S. ambassador, who also directed the State Department's Crisis Management Center and chaired the National Commission on Terrorism in 2000.

But many U.S. companies weren't prepared. Of the 400 companies that once resided in the World Trade Center, several won't survive now, "largely because they will be unable to manage this crisis," Bremer said.

Since Sept. 11, "a great deal has changed in America, but a great deal hasn't changed in protecting Americans from terrorism," Witt said. "We have to think and act differently from before."

Insurers are projecting ultimate losses of more than $50 billion from the terrorist attacks, as last year's hardening market has become even harder and rates have soared in some lines, such as commercial property and aviation.

John Shettle, senior manager of Securitas Global, noted the stock market reaction to insurers and reinsurers after Sept. 11. "Clearly, the Bermuda companies came out as the big winners going forward," Shettle said. "They attracted enormous new capital."

Retention and Renewal

In the hardening market, corporate risk managers are struggling to determine how much risk they should retain to cut down on insurance premium costs. That process of determination is complex and often unclear.

"The most important thing is bringing all the data together," said Ben Schull, senior vice president for risk management and consulting with Near North National Group.

Schull, along with fellow speakers Norman Lange, director of risk management for Wolters Kluwer U.S., and Roger Wade, senior manager of actuarial and risk management services with KPMG LLC, emphasized rigorous actuarial review and data analysis to determine risk-retention levels, but they cautioned that many factors might make analysis of the numbers tricky.

"We're not efficient until we've determined the amount of risk we should take," said Lange, who touted a process of analyzing losses by layer. "First, look at the data itself. If you are at higher levels of retention, that implies you have a lot of data."

During the July 1 round of renewals, major accounts are likely to see about a 700% increase in the cost of workers' compensation catastrophe reinsurance, with virtually no terrorism cover and only half the limit purchased the year before, predicted James W. Macdonald, senior vice president and chief underwriting officer for Ace Risk Management Group.

Workers' comp results have been deteriorating for years, and low double-digit rate increases began appearing in this insurance line. Increasing severity has more than offset declining frequency A.M. Best Co. estimated that there was a $5 billion workers' comp reserve deficiency through calendar year 2000.

Commercial Underwriting

Workers' compensation and property are two lines severely disrupted by Sept. 11, prompting Zurich North America to issue new underwriting guidelines in an attempt to manage its risk exposure. "We seem to be pretty competitive in those markets, even though we introduced new guidelines that are pretty restrictive from the customer's point of view," said John Amore, president and chief executive officer of Zurich North America. "There seems to be an acceptance that this is a necessary activity for a company that has to have a strong balance sheet at the end of the day."

Amore said Zurich executives have spent a lot of time explaining to customers the need for price changes and why those changes accelerated after Sept. 11. "We have also gone over their risk profiles and how loss costs have really changed, since they have to maintain a lot of the risk themselves," he said. "Loss cost is not inflation. It doesn't track the inflation rate. Loss costs are far beyond the inflation rate, such as medical costs or repair costs. We explain to them the need to improve their risk profiling and try to assist them in that."

The Greatest Threat to Earnings

Property-related hazards account for most of the top threats cited by
respondents to a study by FM Global. Nearly 200 chief financial
officers, treasurers and risk managers of Fortune 1000 companies in a
variety of industries participated in the study.

                                Percentage of
                                 Respondents

              Natural Disaster       14%
                Fire/Explosion       14%
        Supply Shortage/Strike       14%
      Terrorism/Sabotage/Theft       13%
    Improper Employee Practice       11%
Mechanical/Electrial Breakdown       10%
           Service Distruption       10%
            Pricing Volatility        5%
    Government/Regulatory Risk        3%
     Contamination/Environment        3%
  Personal Accident/Retirement        2%

Source: FM Global Study

Note: Table made from bar graph

RELATED ARTICLE: Economist foresees challenges comparable to 2000.

Insurers and most other businesses are facing a possibly rocky second half of 2002, as uncertainty over terrorism coverage, oil prices and war in the Middle East might give way to worst-case scenarios, an insurance economist said.

David Hale, chief economist for Zurich Financial Services Group, who delivered the keynote address at the closing luncheon of the 40th annual Risk and Insurance Management Society conference, briefed reporters before the luncheon on his views of the insurance industry and related economic issues.

Hale said the lingering issue of how to insure against future terrorist acts has had economic implications far beyond the insurance industry and will continue to do so until solutions, involving government backstop plans, are designed.

The several billion dollars in new capital that has flowed into Bermuda insurance start-ups hasn't had a noticeable impact on tight capacity and rising premiums, said Hale, and it might not, given that the new money will never match what was lost over the past year." All that is happening too quickly," he said of the new Bermuda money. "It will take a while to see what impact is there."

The increasing use of captives and self-insurance probably won't do much to loosen the market either, he said. "There are a lot of experiments going on out there," Hale said. "A lot of companies will turn to captives, but it takes five to 10 years to build up capital in a captive. So there is a flight to alternatives, but that's not the final solution."

Hale said the second half of 2002 could see a convergence of economic problems similar to what occurred in early 2000, when the combination of spending on the Y2K problem, the bursting of the dot-corn bubble and financial collapse in the telecommunications industry heralded the end of the booming economy. This time, commercial stagnation caused by insurance problems might be joined by rising oil prices as conflict in the Middle East continues, and the rising costs of security as businesses spend more on guards and systems that don't contribute to productivity.

Barbara Bowers 

Enron Bankruptcy Slams Surety Market

The surety market has come under a lot of stress over the past year, as declining equity markets and the well-publicized financial failures of companies such as Enron Corp. and Kmart generated unusual losses.

Surety writers will likely face more pain before it gets better, said two executives with Zurich Surety. Bill Cheatham, president of Zurich Surety, and Ted Martinez, vice president of commercial surety for Zurich Surety, told Best's Review during the RIMS conference that they believed their contrarian approach to the surety market would lead to Zurich emerging among the strongest surety writers in the market.

"We're strategically placed to take advantage of this market. We've avoided most of the major problems, which is a unique quality in a surety operation today," said Cheatham. "The issues are pre-Sept. 11. Losses had been building in both frequency and severity prior to Sept. 11, although that adds complexity in terms of reinsurance and capacity."

Enron is a third contributor to the issue, along with Sept. 11 and lack of reinsurance, he said. "Enron probably brought attention to the fact that the surety industry had gone beyond its historical element of underwriting discipline and had probably expanded into areas of revenue which were inconsistent with the basic principles of surety underwriting," said Cheatham. "That's impacted us from the standpoint of available capacity, although Zurich Surety's capacity has not been diminished."

"We have no problem other than large accounts, which require multiple sureties," he added. "In that case, other surety providers may not be available. So, it's reduced the number of companies that have the capacity to serve larger accounts. It has resulted in some rate adjustments, because the cost of doing business has increased."

"In the case of Enron, a lot of the commercial surety bonds were acting in lieu of, or were synonymous with, letters of credit," said Martinez. "So when you have a constriction in the commercial surety-bond market, a lot of these companies are having to go back into the banking sector to provide guarantees, where surety bonds once did that for them. It's just a whole compounded effect."

Two product markets have traditionally been commercial surety and contract surety, said Cheatham. "Historically, when you had one of these market turns, contract surety has always been the loser, and commercial surety has been the element which helped balance the losses," he said. "Unfortunately, this time, when contract surety sustained the severity and frequency of the losses, commercial surety did the identical thing, and even more severe."

Enron represents a loss to the surety industry--depending on legal outcomes--of $2 billion to $3 billion, said Cheatham.

David Pilla

Enron Hurts Already-Faltering D&O Market

Even before energy trader Enron Corp. failed, the market for directors-and-officers insurance was "a complete mess," pummeled by the dot-com implosion, hundreds of securities class actions, a faltering economy and years of soaring loss ratios, said Donald J. Bailey, managing director of risk services for Aon Financial Services Group.

"Volatility existed before Enron--there were many $100 million-plus settlements in the D&O line that had never even existed before," Bailey said. Carriers realized well before Enron succumbed that their products were severely underpriced, he added.

But the collapse of Enron, the biggest business failure in U.S. history, is having a significant impact on D&O policies, as wary underwriters introduce more exclusions and scrutinize everything from the composition of a corporation's board to its insider-trading policies, Bailey said.

The estimated total impact of the Enron failure is more than $6 billion in losses to insurance and financial-services companies, he said.

Government authorities used to pay a lot of lip service but didn't show much teeth in going after company officials, Bailey noted. "That seems to have changed," he said, citing recent published reports that the U.S. Securities and Exchange Commission intends to hold CEOs and other top officers personally responsible in major business failures or questionable activities.

The boardroom has to see the need to structure programs that address that liability, he said. Enron's former Chairman Kenneth L. Lay, former Chief Executive Officer Jeffrey K. Skilling and former Chief Financial Officer Andrew S. Fastow have been named in lawsuits and investigations stemming from the energy-trading firm's collapse.

A federal judge has ruled Enron executives and directors can collect insurance payments to cover legal fees arising from the company's failure.

In preparing for his presentation, Bailey talked with about a dozen underwriters and found that they feel as vulnerable as investors these days. "Mostly what they depended upon, for the last several years, have been financial statements, and if the financial statements are fraudulent, how are they able to assess risks?" he asked.

Underwriters are also very concerned about potential restatement frenzy as firms fire Arthur Andersen, the auditing firm that worked with Enron, and hire new auditors. "What are those new auditors going to do? They're going to clean house," Bailey said. "If you think you've seen a lot of financial restatements in the past few years, wait until you see what's coming forward." These restatements have "underwriters scared to death," he said.

Barbara Bowers