The Condition of Coverage: A glimpse at how recent insurance industry trends will affect nonprofits and what you can do now to protect your organization.

NONPROFITS, LIKE FOR-PROFIT BUSINESSES, DO NOT EXIST IN AN ECONOMIC vacuum. At some point, trends in one industry will filter through and affect others. This year, that's particularly true of the insurance industry, whose experiences in 2001 will have significant influence on a broad range of other industries in the coming months and years.

Through the early part of 2001, insurance companies were already suffering from increased underwriting losses. Among the factors contributing to this trend were catastrophes, such as Hurricane Andrew, which cost the insurance industry $19.7 billion; the downward movement in the stock market, which led to declining return on investments; and increased medical costs and rising litigation costs, which increased the amount of losses paid by insurance companies.

The insurance industry attempted to correct this trend by introducing rate increases. For good risks--meaning those regarded as low hazard with low-loss ratios--increases were in the neighborhood of 10-15 percent. Rate increases were expected to be higher for risks with higher-loss ratios or those operating in a higher-hazard arena.

Then came the terrorist attacks of September 11, which obviously will have enormous effects on the insurance industry. Already, insurance specialists calculate that the losses from the disasters in New York City and Washington, D.C., will cost the insurance industry more than $50 billion. This estimate may yet rise, as insurance companies often do not know the full-scale cost of any catastrophe until some time after the event. The loss dollars reflect life insurance benefits; workers' compensation claims; business income losses; and claims for destruction of buildings, personal property, vehicles, and more.

Since September 11, the insurance industry has been reassessing underwriting and pricing parameters. Underwriters are reviewing risks and tightening policy terms and conditions. And rates are accelerating at unheard-of percentage increases--in some instances, premiums are doubling.

Changes in your coverage

How will these trends affect insurance purchasing for nonprofit organizations? To begin with, you may find that many of your policies will soon include new exclusions relating to terrorist acts.

The insurance industry has enough capital to cover the insurance losses arising out of the September 11 attacks, but it's possible that another attack of such a scale would devastate the insurance industry. Insurance companies typically purchase their own insurance from reinsurance companies as protection from catastrophes. As a result of September 11, many reinsurance companies are reviewing their reinsurance contracts. A few of these contracts have been renegotiated to include a terrorism exclusion between the insurance company and the reinsurance company. This means that if another terrorist attack occurs, the insurance company will not be able to recover any losses through reinsurance. This could potentially have a detrimental impact on the insurance companies' loss ratios, capital, and return on investment.

In response, the insurance industry is developing terrorism exclusionary wording for its own policies. These exclusions will have to be approved by the insurance departments of the various jurisdictions throughout the United States before they can be attached to insurance policies. Whether terrorism exclusions will proliferate on insurance polices in the future depends on whether the government passes any terrorism insurance legislation. As of late L December 2001, this had not yet happened. If no such legislation is passed, you may expect to eventually see some form of terrorism exclusion on your policies.

Meanwhile, you should be prepared to see some alternations in your policies that go well beyond language regarding future terrorist acts. Nonprofits are likely to encounter changes in several types of coverage, as follows:

Property coverage. You can expect higher premiums for insuring buildings you own, especially buildings of significant value. In order to have sufficient funds to rebuild in case of a catastrophe, make sure you are insured for the full value of the building. In some instances, particularly for buildings of high value, the insurance company may require an appraisal of the property to confirm its worth.

If you own more than one building, you may find that blanket limit programs will not be granted as freely as before. Blanket limit programs allow policyholders to insure multiple buildings under a single policy with a single limit. This single limit could apply to any one loss, so even if a policyholder had a loss involving a building that wasn't insured for its full value, the entire limit of the policy was still available to cover that loss. Now it is more likely you will have to purchase specific insurance on each building, or else have all the buildings appraised before receiving blanket coverage.

Some types of property coverage insure you against losses that might follow a catastrophe. For instance, business income policies cover such problems as loss of earnings or loss of rent, and extra expense coverage provides funds to you to carry on your operations at a temporary location until your regular place of business is repaired. For these types of coverage, you now may have to submit a worksheet to justify the amount of insurance you are requesting.

Insurance companies will also be requiring updated underwriting information. Up until 2001, insurance companies had relaxed their underwriting standards to the point that they often did not request updated information on a building's physical condition. Now the insurance company underwriter will want to know the specifics of the maintenance of the building. For instance, when was the electrical system last updated? When was the roof replaced? Does the building have alarms, and do alarms ring to a central station? Are the fire extinguishers checked annually, and who maintains them? Does the building have sprinklers?

Another question that may arise as a result of the terrorist attacks regards the identity of the other tenants in the building. Insurance company underwriters may now want to know who your neighbors are so that they can determine whether any tenant may be a potential terrorist target.

Casualty coverage. Casualty coverage includes such policy types as general liability, workers' compensation, and automobile coverage, as well as umbrella coverage (a separate policy that "sits on top" of your specific casualty policies and provides additional coverage for all of them). All of these types of policies will be likely to undergo some changes.

Insurance companies may now mandate deductibles for bodily injury or property damage, or both. In the past, insurance companies would typically require these deductibles only for operations that experienced frequent losses. In the future, we may see the bodily injury/property damage deductible standard on a larger number of policies. These deductibles usually range in the neighborhood of $500 to $1,000, but a higher deductible is not out of the question if past losses appear to justify it.

Extensions of coverage may be limited. Previously, insurance companies allowed broad extensions of coverage to the basic general liability policy. One example was the extended cancellation provision; typically, the cancellation provision runs anywhere from 10 to 30 days, and many companies freely extended that to 60 or 90 days. The standard practice in the insurance industry now is to be more conservative in the number of cancellation days.

As might be expected, you should also anticipate higher prices. A recent report from the Council of Insurance Agents and Brokers (reflecting data from November 1, 2000, to November 1, 2001) noted that for general liability coverage, rates in 13 percent of policies increased by 1-10 percent; in 75 percent of policies, rates rose 10-30 percent; and in the remaining 12 percent of policies, rates rose 30-50 percent.

If you subcontract any work, your insurance company underwriter may want to review standard contracts. Underwriters will be looking for indemnification clauses to determine whether you've picked up any additional liabilities.

Obtaining large umbrella policies may also be more difficult than it was in the past. Many insurance professionals now report trouble in finding umbrella coverage for very high limits (typically umbrella limits over $25 million).

Financial coverage. Financial coverage includes crime (such as coverage for employee theft or embezzlement) as well as association professional liability (such as directors' and officers' coverage and employment practices coverage). Pricing for these policies is expected to increase in the region of 10-15 percent. You can anticipate higher deductible costs as well; typically these policies have been written with zero deductibles, but the trend now is for policies to quote a deductible for these lines. The deductible amount will vary depending on the exposure and size of the association.

Multiyear policies will be harder to obtain. Previously, insurance companies were amenable to issuing these policies for more than one year--for instance, for two or three years--and allowing a multiyear discount. Insurance companies now prefer to issue single-year policies so that they may make any adjustments in pricing or coverage more quickly.

Managing your risk

In the face of price increases and greater potential for uncovered losses due to more restrictive policies, what can a non-profit do to mitigate the effects of this situation? One good start is to develop a risk management program. Risk management is a broad topic, of which insurance purchasing is only one part.

Begin by establishing a committee whose task is to develop and oversee a risk management program. Following are some steps that group might pursue:

* Risk identification. This initial stage involves identifying your exposures to loss. If you can imagine something happening to your organization, you should list it.

* Risk analysis. For each of the risks on your list, analyze the probability of that risk occurring. Look at past losses and near misses. Check with other nonprofits for benchmarking purposes.

* Risk control. Decide how to manage your risks and what technique to use to address each one. One possibility is to eliminate a risk altogether by removing any exposure to loss; this is called risk avoidance. Another is to shift the risk to another entity; this is called risk transfer. For risks you must maintain, you can decrease your exposure through risk reduction methods, such as properly training new employees (to reduce the likelihood of accidents) and requiring countersignatures on checks (to reduce the opportunity for embezzlement).

* Risk financing. Consider how to pay for your risk control choices. Are your reserve funds sufficient to pay for anticipated losses?

Once the risk management plan has been created, implemented, and approved, the risk management committee should distribute and explain it to everyone who needs to be involved.

Also, a risk management plan should allow for any changes in operations and exposure. Establish a regular cycle of review to measure compliance with the plan and to update it.

Another valuable tool in handling risk is to have a disaster recovery plan in place. The events of September 11 surely have everyone questioning their complacency--we can no longer be sure that such terrible things are not going to happen to us or to our organizations. Establishing a disaster recovery plan is one concrete step an organization can take to prepare for the unthinkable. Experience has shown that companies seldom are able to take effective action unless planning has been done before an emergency occurs. For instance, if a fire destroyed your building, who will be in the command center? How will you handle communication so that the emergency coordinator and staff are kept informed of a developing situation and are able to implement appropriate procedures? How will employees know when and where they should report to work? An effective disaster recovery plan will also include floor plans, evacuation routes, locations of fire protection equipment, and priorities for recovery and salvage.

A comprehensive risk management plan, together with an effective disaster recovery plan, will go a long way to mitigate rising insurance costs and exposures to loss for any nonprofit organization. Your insurance broker should be able to connect you with firms that can assist you in developing risk management techniques to protect your nonprofit during times of trouble.

Marie A. Subacz, a chartered property casualty underwriter, is a vice president with Thomas Rutherfoord, Inc., Alexandria, Virginia.

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Few association executives have the time or expertise to evaluate the adequacy of their associations' insurance coverages, yet association boards hold the chief staff executive accountable for the effectiveness of the association's insurance coverage. If that thought makes you quake in your shoes, consider conducting an insurance portfolio review. A review helps to ensure that your association's insurance portfolio--including types of coverage--is not only appropriate to your needs, but is also reasonably priced.