In the aftermath of the September 11 terrorist attacks, the insurance industry must come to grips with problems that it never imagined. How they will be handled is, at best, difficult to determine. The following are some thoughts from three industry analysts about what may be seen in the next 12 months.
ISSUES IN INSURANCE
By Dr. Robert P. Hartwig, Ph.D.,
Vice President and Chief Economist,
Insurance Information Institute
Many policyholders have seen an increase in the price they paid for auto and homeowners insurance during 2001. For the year, the average cost of insuring both cars and homes rose by six percentage points nationally. Similar increases are projected for 2002. The increases may have taken some policyholders by surprise, given that they came after several years of flat to decreasing prices. While these increases translate into a relatively modest $30 for the average homeowner and $50 per vehicle, many policyholders are understandably concerned about higher insurance costs and have been left wondering why their premiums rose and what they can do to keep costs down in the future.
Why are auto insurance rates rising?
Vehicle owners understand that their personal driving record, the type of vehicle they drive and how much they drive influence the cost of auto insurance. Yet rising medical costs, sharply higher vehicle repair costs, and soaring jury awards in vehicular liability cases are the principal drivers behind higher auto insurance rates today. In several states, fraud and abuse are also pushing up the cost of auto insurance.
Medical costs are an important factor in the cost of auto insurance. Each year there are more than two million car accidents involving injuries. Typical costs for treating an auto insurance victim range from $6,000 - $9,000, but can easily run into tens of thousands of dollars. The cost of auto injury claims is rising by as much as 30% in some states.
The $15 billion - $20 billion in medical claims that auto insurers pay each year are a very significant component of auto insurance costs, and the current upward trend in claims costs is an important cost driver. Higher costs for hospitalization and pharmaceuticals, state regulations permitting a wide range of dubious treatments, and associated legal costs are largely to blame.
Higher repair costs are another significant cost driver. A recent court decision forced many insurers to suspend their use of aftermarket (generic) crash parts in automobile repairs, giving manufacturers of name-brand parts a virtual monopoly in the multi-billion dollar market. The effective prohibition on the use of generic parts--which are of like kind and quality to name brand parts--in the repair of damaged vehicles is a factor that could ultimately add $4 billion - $5 billion to the cost of auto insurance annually. Name brand parts often cost
30% - 70% more than their generic equivalent.
Sharply higher jury awards in vehicular liability cases are putting additional upward pressure on auto insurance rates. The average jury award rose from $175,000 in 1994, to $316,000 in 1999--an increase of 81%. Auto liability issues are much more important than people realize. About 60% of auto premiums paid in 2000--nearly $70 billion--were for liability coverages.
Why is the cost of homeowners insurance increasing?
Homeowners know that the price they pay for insurance depends on factors such as type of construction, age of the home and the quality of local fire protection services. Nevertheless, it is the extraordinary number of catastrophes, the high cost of home repairs and the emergence of mold claims that are pushing homeowners insurance rates upward.
During the 1990s, the frequency and severity of catastrophes began to increase dramatically. During the past 12 years, insurers paid out more than $100 billion in catastrophe-related losses--about $700 million per month--many times more than in previous decades. Catastrophes include well-known events such as Hurricane Andrew and the Northridge earthquake, but also hundreds of smaller occurrences associated with tropical storms, tornadoes, wildfires, hail, ice and snow.
Homeowners rates in many parts of the country continue to rise because of the extraordinary costs associated with paying these claims.
Every homeowner also knows that home repairs don't come cheap. Federal statistics show that the cost of home repairs is rising by more than 7% per year--three times faster than the overall rate of inflation.
Here comes toxic mold
To add to the homeowners problems, mold has recently emerged as the dominant cost driver in some states. Mold is certainly not new--it's been around for hundreds of millions of years--but the sharp rise in mold claims is definitely a 21st-century phenomenon. Multi-million dollar jury awards, sensationalized reporting in the media and profiteering by some individuals have led to an explosion in mold claims and costs.
Many homeowners insurance companies have recently reported an acceleration of home damage claims related to mold contamination and the supposed toxicity of the mold. Claimants demand that insurers pay for expensive rehabilitation of their homes or, in some cases, the entire replacement of their homes. The industry's position is that damage from mold is specifically excluded in standard homeowners policies. Mold damage is covered only if it is the result of a covered peril, such as water damage from a pipe bursting.
There are several remedies for the insurers. Many insurers are now inserting clarifying language into their homeowners policies to make certain that customers and courts understand that mold damage is not covered. Some will raise rates to price for and cover all mold claims, while others will exclude mold, but offer an attachment to the policies that allows insureds to add mold coverage.
Currently, different insurers are proposing different solutions. In Texas, some companies are no longer selling homeowners insurance that covers water damage. The Texas insurance commissioner has proposed adding sub-limits for mold damage to policies, but his proposal does not include a limit on the number of claims a policyholder could submit. Therefore, a policyholder could submit an unlimited number of small mold-related claims under the commissioner's proposal--clearly not a solution.
In Texas, the number of mold claims increased by 581% between the first quarter of 2000 and the second quarter of 2001, while insurer payouts over the same period increased 755%. The runaway costs associated with mold claims are having an adverse effect on the availability and affordability of homeowners insurance in Texas and are now beginning to affect costs in other southwestern states, as well as in California, Colorado and the Carolinas.
THE SEPTEMBER 11 WTC LOSSES
Assessing the impact on the
property/casualty insurance industry
By Kenneth Zuckerberg,
Dresdner Kleinwort Wasserstein
The September 11 terrorist attacks on New York's World Trade Center (WTC) will rank as the largest catastrophe loss ever faced by the property/casualty industry. Industry losses will be unprecedented. Claims costs stemming from the terrorist attacks could total
$40 billion - $50 billion and may go higher. Virtually all major commercial carriers and reinsurers have exposure to commercial property, business interruption, liability and workers compensation claims as a result of the attack.
We believe that commercial and reinsurance prices will continue to firm materially following the WTC loss, as reinsurers re-assess exposures and charge higher rates to primary companies, which in turn, will pass along rate increases to commercial customers. We also think that Lloyd's in general, and the retrocessional market (i.e., the reinsurance market for reinsurance companies) in particular, are now in a very precarious position, both financially and psychologically, and will require higher premiums to cover complex exposures in the future. Capacity will likely exit the business as weak reinsurers either fail or limit their future underwriting appetite, thereby leading to a supply-demand imbalance. While "fresh" capital is already entering the business (and may continue to do so) since September 11, as evidenced by Marsh & McLennan's formation of Axis Specialty, Ltd., a Bermuda-based start-up seeking $1 billion of initial funding, we expect rate firming to continue into at least 2003.
In the period ahead, price increases should accelerate. Prior to the WTC disaster, price increases were running in the 15% - 20% range for commercial insurance and 20% - 25% for reinsurance. Post-WTC, we believe that increases overall are likely to accelerate to the 25% - 35% range. Already, both in London and the United States, terms, conditions and pricing have tightened significantly for aviation liability and hull insurance, anywhere from
200% - 500%, a healthy sign of a hardening market.
We also expect dramatic price increases in the commercial property, property catastrophe reinsurance, workers compensation and political risk business lines. Additionally, directors and officers liability rates could firm, especially if corporations (particularly airlines and security companies) become entangled in future litigation.
How will insurers deal with terrorism in the future?
The terrorist attacks of September 11 will undoubtedly alter how insurance companies evaluate and underwrite risk in the future. Looking forward, it is nearly impossible to determine the magnitude of terrorism risk that may lie ahead, and with what frequency it may occur. Additionally, there is no credible amount of historical loss data to effectively estimate future loss that may result from an increased level of terrorism.
While the insurance industry will be able to fund losses from the destruction of the WTC, the industry's capital base may not be able to withstand repeated future losses. Consequently, many companies are taking measures to protect themselves from future losses.
For example, American International Group, Chubb Corp., and General Re have held discussions with U.S. legislators to request government assistance in covering claims for any future attacks. According to Chubb, it has become increasingly difficult for primary insurers to find reinsurers willing to cover terrorist exposure. Following the Irish Republican Army (IRA) bombings in central London in 1992, the British governments established Pool Re, a government-funded mutual insurer. We believe that a similar pool may eventually be established in the United States, whereby terrorism risk may be distributed across reinsurers, state governments and the federal government.
War exclusionary clause -- to exercise or not?
In the wake of the terrorist attacks on the WTC, much discussion has ensued regarding act-of-war exclusions. Act-of-war clauses, which are often standard in commercial insurance policies, provide an exclusionary measure on damages borne in the event of war. Since President Bush's verbal reference to the attacks as "acts of war," many parties outside of the insurance industry have called into question whether companies will choose to invoke the act-of-war clause in order to avoid paying claims stemming from the WTC attack.
We believe that most P&C insurers are unlikely to invoke act-of-war clauses. In fact, a number of companies have already made public comments reiterating this viewpoint--specifically, ACE Limited, American International Group, Chubb Corp., Hartford Financial Services, St. Paul Companies and XL Capital.
Three principal reasons support not invoking the clause: 1) based on the official terms of the contracts, the act-of-war exclusion does not in fact apply to the terrorist attacks; 2) insurance companies may feel pressure to pay claims in order to ensure future ability to underwrite new business and take part in the upturn in pricing; and 3) insurance companies will feel pressure to follow through with payment obligations as a public good.
OVERVIEW FOR REINSURANCE
"... the possibility of non-natural perils catastrophic losses across many diverse lines is now viewed to have a higher probability of occurrence."
By Sal Zaffino,
Chairman and Chief Executive Officer,
Guy Carpenter & Company, Inc.
The insured losses from the terrorist acts of September 11, categorized by Insurance Services Office as Cat 48, are likely to be the largest in history. Current estimates range from $29 billion - $77 billion, far exceeding the prior highest loss--Hurricane Andrew in 1992, at $19.6 billion in 2000 dollars.
Cat 48 will have a major impact on the income statements of insurers and reinsurers in the coming quarters. Rating agencies and industry insiders agree that the insurance and reinsurance industries currently appear to be adequately capitalized, and most insurers and reinsurers are expected to pay Cat 48 claims, with little threat to their solvency.
The losses of Cat 48, however, have reduced the capital of a number of insurers and reinsurers, leading the rating agencies to downgrade the ratings of some insurance groups and place others on "CreditWatch."
The implications of Cat 48 for lines of reinsurance show a wide variation. Lines such as property catastrophe are likely to experience the most direct impacts, with significant increases in rates and a drastic tightening in terms and conditions.
Cat 48 hit workers compensation insurers hard. As this line is not normally viewed as having major catastrophic exposure, the events of 9/11 came as a major shock to reinsurers; and carriers are re-assessing their positions, particularly for layers above $20 million. For a number of years, accident and health reinsurers had been providing capacity to the workers compensation market, supported by a healthy retrocessional market. The supply of retrocessional cover all but dried up after 9/11, causing a capacity crunch in this line. Our company developed a new reinsurance facility to offer excess of loss cover for this marketplace, and we anticipate that more enterprises will respond to this crucial need.
Other casualty lines, such as surety and professional liability, are more likely to experience indirect impacts, particularly in terms of reduced market capacity. Lines where there was significant excess capacity--reinsurance for traditional life products, for example--are likely to be less impacted.
On the primary level, it can be expected that a terrorism exclusion will be required, particularly for larger commercial properties. Reinsurers are now adding a worldwide all perils terrorism exclusion for reinstatements and can be expected to seek such exclusions at renewals for practically all lines. Any such terrorism exclusions must first overcome anticipated scrutiny from legislators and regulators.
Pricing methodologies used by reinsurers are likely to be reconsidered and revised. Credits for diversification will be reviewed, as the possibility of non-natural perils catastrophic losses across many diverse lines is now viewed to have a higher probability of occurrence. Pricing at the extreme tail of loss distributions is likely to be revised upwards, as Cat 48 revealed that such remote events are more than purely speculative. Underwriting and pricing for major property risks are likely to be subject to more rigorous analysis and, where feasible, will be modeled.
New risk-bearing capital providers are emerging. Transactions valued at more than $13 billion in new capital have been announced. The capital is split among new companies and infusions to existing companies.
The tragic events of September 11 will forever change the world and are profoundly altering the world of insurance and reinsurance. But by working together we can manage our way through this crisis and emerge into a brighter future. *
The thoughts of Hartwig, Zuckerberg and Zaffino were compiled and adapted by Samuel Schiff, a New York-based freelance writer.