Starting over. (Cover Story).

Industry leaders say this will be a year of dramatic changes in underwriting and pricing policies. Also, a faltering economy, lingering asbestos claims and growing mold claims will continue to present challenges.

Insurance industry leaders have described the events of Sept. 11 as inconceivable, unrealistic and "beyond the limits of most people's thinking." If the industry learned one thing from Sept. 11, it was that it was not well prepared for the terrorist attacks on New York and Washington, D.C. Most segments of the industry were hit hard by the attacks--commercial, workers' compensation, business interruption, aviation, liability, life, health. The effect on the U.S. and global economies was felt immediately. Stocks plummeted, air travel trailed off and job cuts rose to record levels.

Now, some four months after the attacks, industry leaders are predicting dramatic changes in the way insurance companies underwrite and price policies. They say prices will rise, and so will deductibles. And there will be new exclusions and limits for some types of risk. Prices were hardening before Sept. 11, and that trend will continue. With the end of the soft market, underwriting will play a more important role, some industry leaders say. When the industry finally works through all the challenges related to Sept. 11, other pressing issues, like rising mold and lingering asbestos claims, will still be around.

Although most segments of the industry were affected in some way by the attacks, none was hit harder than the Lloyd's market. After Sept. 11, Lloyd's found itself under a microscope as claims mounted and the market faced a squeeze on its liquidity. Gross losses to the market have been estimated at about $9 billion, and Lloyd's put its net liabilities at about $2.8 billion. The market has until the end of March to bring its U.S. trust funds for reinsurance business up to 100% of liabilities related to Sept. 11.

"In terms of Lloyd's, it's hit every segment of the business that we operate in," said Wendy Baker, president and director of Lloyd's America Inc. "It truly was such a clash event for the marketplace, so we've got property, extended business interruption; we'll probably have some liability issues; we've got aviation, comp, personal accident, a little bit of life."

Prices already have risen, Baker said, and Lloyd's will be taking a closer look at underwriting modeling for disasters. One scenario that already has been modeled is two jets crashing in midair over a large city, she said. But the Sept. 11 attacks--in which two hijacked jetliners were flown into the twin towers of the World Trade Center in New York, a third airplane was steered into the Pentagon and fourth crashed in Pennsylvania--was "an unrealistic disaster scenario--well beyond the limits of most people's thinking."

Enough Coverage?

Baker said the attacks will likely force company executives to rethink their risk management. "I don't know how you prepare for something like that," she said, "but I think it does heighten people's interest in trying to improve risk-management techniques in terms of evaluating your insurance coverage to make sure you've bought enough, that you have enough business-interruption cover, for instance."

Jacques Dubois, president and chief executive officer of Swiss Re America Holding Corp., agreed that many businesses will need to re-evaluate their insurance needs now. Many may be underinsured. "For instance, for a lot of small businesses around the World Trade Center, they had liability coverage for themselves if someone walked into their shop and slipped and fell, but they didn't have complete disaster insurance," he said. "They weren't covered if their entire inventory was lost or if their customers couldn't reach them for three or four weeks."

Dubois said rate increases are inevitable, and they will come in different ways. "There will be raw increases in prices for the same exposures, plus changes in terms in the underlying agreement, including larger deductibles or exclusions or sublimits for certain types of risk."

Hugh Warns, an equity analyst with J.P. Morgan Chase & Co., said no one in the insurance industry prior to Sept. 11 could have contemplated the attacks and the losses that resulted. The attacks, he said, alerted many to the global nature of the industry. He said 40% to 50% of the losses from the attacks will go offshore, even though it was all U.S. risk.

Supply and Demand

Warns said prices for some coverage could double, and restrictions will increase. "It's the first time in a long time that you've actually seen the supply of insurance coming down and the demand for insurance is escalating," he said.

Underwriting also is being affected by the attacks. Underwriters are being forced to go back and review their policy forms and rating matrices and determine how best to predict or limit losses, Warns said. "All of a sudden, you had a risk emerge that never in the United States did we ever collect a dollar worth of premium to pay for or ever contemplated from an underwriting standpoint."

Warns said the long-term effects of Sept. 11 will be a renewed focus on underwriting profitability. "What you're going to see is management teams focusing on every decision, and what the new underwriters will be focusing on will be, 'Does adding this piece of business help my portfolio, does it generate a profit as we move forward, and will I generate the type of return I need to on my capital to justify writing the business?' That was a discipline that many of the companies had gotten away from in the past soft market," he said.

Life and Health

Despite the large death toll in the attacks--nearly 4,000 people were Killed--life insurers probably won't see big changes in pricing and underwriting, said John D. DesPrez Ill, executive vice president of U.S. operations, Manulife Financial Corp. "It doesn't really change the mortality profile in any material way," he said. "I don't think anybody is anticipating that these types of acts will become so prevalent that they will affect the mortality profile in the U.S. marketplace. If you look at the total number of deaths nationwide in a year, it's not that material an event."

DesPrez said there will likely be a greater demand for life insurance products as a result of the attacks. And in the long term, businesses will have more sophisticated business-continuity plans to prevent a lengthy shutdown following a disaster. "I think people will now focus on dispersing their operations geographically so that if they lose one facility, they can continue their businesses out of others."

For health insurers, the attacks bring an increased focus on prevention and disaster preparedness, said Jonathan T. Lord, senior vice president and chief clinical strategy and innovations officer for Humana Inc. "The increased emphasis on public health means that there are likely to be public/private sector partnerships that will affect our business," he said.

Lord said the attacks sent a wake-up call to insurers. "The most critical is the visibility of terrorism and the very real potential of biological terrorism, both of which have heightened everybody's awareness to the need to shore up our public health system so we'll be prepared for emergencies," he said. "This has put the spotlight on preventative-care services and how prevention needs to be part of our thinking--not just in terms of the natural epidemiology of disease but also for man-made epidemics and biological disasters."

The captive insurance market also suffered direct losses related to the Sept. 11 attacks. Several captives in Guernsey, Europe's largest and oldest captive domicile, sustained significant losses, said Steve Butterworth, director of insurance for the Guernsey Financial Services Commission. "This has meant that although the captives were sufficiently capitalized and solvent to meet these losses, in order for them to continue with new programs they have had to recapitalize, and several million dollars has been injected in Guernsey captives over the past few months."

Butterworth said there also has been a loss of capacity, and captive insurers, and the industry in general, are concerned about the ability of some reinsurers to meet their obligations.

Other Challenges

Prior to Sept. 11, there were plenty of challenges to keep insurers on their toes. The economy was spiraling downward, the stock market was falling, and asbestos and mold claims were giving insurers conniptions.

The stock market's plummet would have been the most significant event for insurers, had the Sept. 11 attacks never happened, said Butterworth. "Some of these losses have been way beyond the amounts set aside as resilience reserves when assessing the real solvency of insurers," he said. "This will probably lead to a reassessment of the risk-based capital methods of regulation."

Baker of Lloyd's said cyber-liability remains a large exposure that the industry must address. "We're very naked in terms of the ability to have a possible catastrophic virus put in," she said. "I think there's a problem with liability issues, advertising, copyright, patent infringement, all sorts of third-party issues, aside from the first-party damage and downtime, business-interruption losses that you get from a huge virus or a disruption of e-commerce."

Life insurers for years will continue to struggle with changes in the estate tax, which created a lot of uncertainty in the marketplace, said DesPrez of Manulife. Some in Washington, D.C., are calling changes to the estate-tax formula a repeal, he said, while others have a different interpretation. "Now all the advisers have to go back to their clients and explain to them what all this means," he said. "And frankly, the solution is so strange that what they ought to do is not entirely clear."

RELATED ARTICLE: Jonathan T. Lord

Position: Senior vice president and chief clinical strategy and innovations officer

Company: Humana Inc.

Headquarters: Louisville, Ky.

Primary products: Humana offers health benefits coverage for U.S. businesses, Medicare and U.S. military dependents and retirees.

"This has put the spotlight on preventative-care services and how prevention needs to be part of our thinking."

Wendy Baker

Position: President and director

Company: Lloyd's America Inc.

Headquarters: New York

Primary products: Lloyd's writes primary insurance and reinsurance, principally property/casualty, and some life and health business. It writes primary business as an excess-and-surplus lines carrier in the United States and is known for handling unusual and hard-to-place risks.

"I 'think it does heighten people's interest in trying to improve risk-management techniques."

John D. DesPrez III

Position: Executive vice president, U.S. operations

Company: Manulife Financial Corp.

Headquarters: Boston

Primary products: Manulife offers

401(k) plans for small companies,

variable annuities and life insurance.

"I don't think anybody is anticipating that these types of acts will become so prevalent that they will affect the mortality profile in the U.S. marketplace."

Steve Butterworth

Position: Director of insurance

Company: Guernsey Financial Services Commission

Headquarters: Guernsey

Primary services: Regulates insurance operations in Europe's largest and oldest captive domicile.

The terrorist attacks in the United States have meant that "although the captives were sufficiently capitalized and solvent to meet these losses, in order for them to continue with new programs they have had to recapitalize."

Jacques Dubois

Position: President and chief executive officer

Company: Swiss Re America Holding Corp.

Headquarters: New York

Primary products: Swiss Re America specializes in property/casualty and life reinsurance, risk transfer, risk retention financing, and asset management.

"There will be raw increases in prices for the same exposures, plus changes including larger deductibles or exclusions for certain types of risk."

Hugh Warns

Position: Senior insurance industry analyst and vice president

Company: J.P. Morgan Chase & Co.

Headquarters: New York

Primary services: J.P. Morgan Chase & Co. is an investment bank, offering investment management, private banking, treasury and securities services, and retail and middle-market financial services.

"It's the first time in a long time that you've actually seen the supply of insurance coming down and the demand for insurance is escalating."