Insurance: The Coverage Crunch

Providers are spreading premium hikes far and wide. That could doom some small companies

Randolph L. Marten, who owns and operates 4,000 trailers and tractors in Mondovi, Wis., does most of his business far from New York and Washington. But in the wake of September 11, the chairman of Marten Transport Ltd. is being hit with a 100% insurance hike that will drive his bill for coverage up to 4% of his $260 million sales and take a big bite out of profits next year. "Despite our company's impeccable safety record," fumes Marten, "my insurance rate is doubling."

Millions of businesses, from makers of farm gear to landlords of condos, are facing hefty increases in property and casualty insurance rates since the terrorist attacks. To recoup the $10 billion or so in immediate claims from New York--and perhaps $60 billion more over the long haul--insurers are planning to spread the burden as widely as they can. "Everything is being hammered at the same time," says Fritz Mutter, CEO of Golden Pacific Insurance Services Inc., an insurance broker in Pasadena, Calif., who says he has seen tenfold hikes for coverage such as umbrella policies for businesses since the World Trade Center towers fell. Worse, insurers have stopped writing some types of policies altogether, such as those for apartment building owners who have several buildings close to each other. Initially, airports found their war and terrorism coverage canceled. A few insurers are offering it again, capped at $50 million and costing 8 cents per passenger--$6 million a year for a large airport.

The crisis, far worse than the industry's record $15 billion payout on Hurricane Andrew, could be a big drag on the economy. Pretax earnings for companies in the Standard & Poor's 500-stock index could be slashed as much as 2.5% next year because of higher insurance costs, warns Prudential Securities Inc. That could mean an earnings shortfall of at least $12 billion. With economic growth likely to be modest at best next year, companies will be hard-pressed to pass the costs on to their customers. Indeed, the extra expense could be the last straw for some small and midsize companies, for which insurance premiums make up a larger portion of sales. "It's like a huge additional tax with no returns, which could result in small companies going out of business," says Sung Won Sohn, chief economist at Wells Fargo & Co.

Already, the squeeze is making it tough for some businesses to raise financing. That's because their bankers fret that higher insurance premiums will hurt borrowers, especially small businesses. "We now have to examine whether paying double premiums might affect a company's cash flows," says Gary M. Youmans, executive vice-president at Community National Bank, a small-business lender in Fallbrook, Calif. Real estate companies, especially, are suffering as they lose their terrorism insurance. Brookfield Properties Corp., a major real estate investment trust that owns buildings around the World Trade Center, shook the markets when it announced that its terrorism coverage had been withdrawn when it renewed. As a result, it may now be in technical default of its loan conditions.

To ensure that coverage is available, Washington is creating a safety net for the industry. Legislation, expected to pass by Thanksgiving, would have the Federal government pick up, at least temporarily, 90% of the costs of future terrorist incidents if claims rise above a certain level--$1 billion in a House bill, $10 billion in a Senate version. Treasury Secretary Paul H. O'Neill has argued for such federal "backstops," saying the risk of terrorism is impossible to calculate. Adds House Financial Services Committee Chairman Michael G. Oxley (R-Ohio): "This is not an insurance industry problem or a policyholder problem--it's a national economic problem that demands a national solution. Affordable, available terrorism insurance is necessary for the economy to function effectively."

Insurers are nervous, too, because they don't know for sure that their reinsurers will make good on claims. U.S. regulators have opened an investigation into Lloyd's of London to determine whether it can pay the roughly $8 billion in claims that it faces from the destruction of the World Trade Center. After claiming reinsurance, Lloyd's estimates it has around $1.9 billion in net liabilities and resources of about $27 billion. "We have a 300-year history of paying all valid claims, and nobody should doubt our ability and commitment to ensuring that U.S. policyholders are compensated swiftly and efficiently," says Lloyd's chairman Sax Riley.

NEW ENTRANTS. Even before the attacks, insurers had begun imposing stiff hikes. On average, companies were starting to pay about 18% more this year than last, after enjoying more than a decade of rock-bottom premiums, according to Alice Cornish, an analyst at Prudential Securities. She says commercial insurance premiums in 1999 were lower than in 1984. Insurers started raising rates after stock market returns soured at the same time that they faced a sharp hike in asbestos claims starting last year and fierce losses from Tropical Storm Allison this past summer. Even before September 11, the industry was headed for a $36 billion underwriting loss, Cornish estimates. Now, losses may nearly triple.

Paradoxically, insurers' long-run prospects have brightened. Lloyd's told its 2,850 members in a newsletter that they stand to make money from the higher premiums. There's an "historic opportunity," it says, as some premiums have already gone up 1,400%. In the U.S., Chubb Corp. has admitted that premiums will likely rise over 200% next year. Says CEO Dean R. O'Hare: "This business is back and is headed straight up."

The chance to reap rich rewards is attracting new entrants into the business. Goldman Sachs has teamed up with American International Group Inc. and Chubb to form a reinsurer based in Bermuda with $1 billion of capital. Private equity firms Warburg Pincus and Hellman & Friedman have joined with RenaissanceRe and State Farm Insurance to form a similar company.

But new companies can't form fast enough to push down rates for millions of clients facing increases now. "New insurance companies and the amount of capital raised is relatively small compared to what was lost on September 11," says Robert P. Hartwig, economist at the Insurance Information Institute in New York. Insurers overall expect to raise some $15 billion in the capital markets over the next six months.

If insurers push too hard to raise premiums, they could spur companies to look for new ways of getting coverage. One possibility is catastrophe bonds. Issued by companies, they bear interest, but the wrinkle is that bondholders lose their capital if specified disasters such as earthquakes or hurricanes occur. First introduced in 1996, they failed to take off then because regular insurance was so cheap. Other risk-management mechanisms, such as not-for-profit insurance pools operated by groups of companies or municipalities, might emerge, as they did in Florida after Hurricane Andrew.

Before such innovation can take root, though, stiff cost hikes and cuts in coverage are sure to unsettle the markets further. With some 70% of reinsurance renewals due on Jan. 1, there isn't enough time to nail down alternatives. "The capacity crunch has arrived with a vengeance," says Chubb CEO O'Hare. Managers such as Marten will be paying the price of September 11 for some time to come.

By Pallavi Gogoi in Chicago, with Mike McNamee in Washington

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