MILLIMAN & ROBERTSON, INC.
FORECAST
A Publication by Milliman's Boston Casualty Actuarial and Risk Management Consultants
Volume 3 Issue 3 SUMMER 2000
Page Two


Price Increases, Coverage Changes, and ARF:
Preparing For the Hard Insurance Market
By William L. Granahan, CIC, LIA, CMC

The "hard" market that was the bane of the buyer and the "nirvana" for the insurance industry is back after a long sabbatical! The property and casualty insurance market is unquestionably beginning to increase the pricing of nearly every commercial insurance policy. What is even more disturbing to the buyer is that they are also increasing selected retentions and deductibles, reducing some coverage, and even denying or non-renewing certain classes of risk. The twelve-year soft market cycle has finally driven insurers to force premiums back up to "acceptable" levels.

Some argue that rates and premiums will simply return to reasonable levels, others insist that insurance carriers will try to make up quickly for lost revenues with unfair premium and rate increases.

Generally we are seeing increases in Property premiums of 15% to 20%, General Liability and Umbrella policies of 10% to 20%, and Automobile and Workers' Compensation rates and premiums are rising in nearly every state as well. Medical Malpractice, Employment Practices Insurance and selected Professional Liability "high-risk" areas are increasing even more dramatically. Some carriers are raising premiums across the board, while others are basing their increases on underwriting, class of risk and loss experience.

Added to the premium increases occurring in group healthcare and many other employee benefit programs, the Risk Manager and CFO of the 21st century must prepare for significant increases in insurance costs and to spend more time and resources reviewing, evaluating, negotiating and, perhaps, "self-funding" some operational risks.

The first responsibility is to simply realize that the 12 year "soft" market cycle is over and prepare senior management, particularly your CFO, for a significant increase in insurance costs - not only for the year 2000 but for a number of years to come. In addition to premium increases, the extra funding may have to include higher deductibles and claim expenses if coverage is restricted and/or deductibles are increased.

A second important action item is to meet with your agent/broker and consultant immediately to determine what to anticipate for renewal premium increases and to assess whether that increase is "fair" and consistent with the market. Most carriers already know approximately what they want for premium increases, even if your renewal date is not until the fall or winter. If the proposed increases are exorbitant you may want may decide to proceed with a formal Request for Proposal and Bid Process.

However, the RFP/Bid process requires a minimum of 60 and preferably 90 days to provide the markets with enough time to process and evaluate applications, review underwriting data, inspect properties and complete the underwriting process. Careful and detailed bid specifications for each line of coverage, selection of appropriate insurance carriers and a detailed analysis of the resulting proposals can produce very positive results especially in a hard market.

The third important action item is that you and your insurance consultant carefully evaluate your current insurance program. Remember, in addition to generating lower premiums, the soft market has allowed you to negotiate much broader coverage than is available in a "normal" market. These "extensions of coverage" may have been very beneficial in covering claims and expenses, further reducing your cost of risk by decreasing the actual cost of losses. It is important to know the breadth of your current coverage, what you can reasonably relinquish to save premium, and what you absolutely want to retain when negotiating new or renewal policies.

You may also want to consider the assumption of a higher deductible or retention. This may be important in negotiating renewal premiums, or, in some cases, simply keeping coverage intact. However, taking on substantially higher levels of self-funded retentions is an important corporate financial decision that must be considered in light of the company's financials, as well as its risk tolerance and corporate philosophy.

Alternative Risk Funding Programs

You may also wish to consider Alternative Risk Funding ("ARF") programs. The soft market has allowed even large employers to purchase most of their insurance program very inexpensively and to transfer most of their risk to the insurer. They have not had to utilize Captives, individual self-insurance, group self-insurance, risk retention groups, and large deductibles as often over the last ten to twelve years.

ARF programs can be utilized to hedge against the "historic" cycles of the insurance industry, providing the corporation with level pricing and consistent coverage. ARF programs allow the insured to tailor policy language and coverage to fit the specific operational exposures and, structured properly, this approach can stabilize the cost of risk. Self-funded internal risk and claims management also motivates the corporation to require a more dedicated approach to the identification, evaluation, analysis and mitigation of operational exposures inherent to their specific industry and culture.

Types of ARF Programs

While most ARF programs include a substantial retention level, it is normally only a partial transfer of risk that includes elements of a traditional insurance program and the use of reinsurance. As in a traditional insurance program, the risk above a carefully evaluated retention level is transferred to an insurer, although unlike traditional insurance the retained risk is often not "managed" by the insurer.

What to Consider before Selecting ARF

If ARF appears to be an appropriate option for a corporation, the following issues must be addressed to guarantee the success of this alternative program:

1. Corporate Program Expectations
2. Corporate Commitment to Resource and Management
3. Evaluation of Claims History and Future Loss Trends
4. Ability to Reduce Exposures, Risks, Losses and Overall Claims Costs
5. Adequate Identification of Exposures by Type, Location, Cause, Frequency and Severity
6. Establishment of Reasonable Corporate Retention Levels
7. Ability to Manage and Litigate Claims Effectively
8. Long Term Commitment to Program
9. Debt to Equity Structure and Cash Liquidity
10. Overall Capital Structure

For ARF to be a viable option, the corporation must be financially stable, profitable and willing to allocate the funds necessary to finance the ARF program. Revenues, net worth and access to credit (Bonds, Letters of Credit, and other required securitization methods) must be able to support the ARF program and its losses. Examining the corporate long and short-term objectives and goals, the last three to five year loss ratios and trends, the current premiums and projected increase, the corporate aversion to risk and "affordable" retention levels will determine if ARF is an appropriate option for the corporation.

The Hard Market: Back to Reality

It is the responsibility of every employer in a hard insurance market to take a much more proactive role in the structure and cost assessment of its corporate insurance program. Increasing premiums appear to motivate a great many employers to invest more resources into the identification, management, reduction and transfer of its operational risks.

Anticipating the cost of the hard market and preparing senior management, scrutinizing key coverage bidding out your program, considering higher retentions, and evaluating alternative risk funding methods are important measures. The inattentive risk manager, insurance purchaser and/or CF0 can be quickly thrust into a position in which a "hard market" insurance program not only costs substantially more than is budgeted, but provides far less coverage for claims that occur during the policy period. This could wreak havoc with a company's overall financial goals and strategies.

Authors:
John Herzfeld and Christine Fleming
Wakefield, MA / (800) 558-4847. \

Bill Granahan
Worcester, MA/(508) 798-4787or (800) 558-4847.

Editor: William L. Granahan CIC, LIA, CMC
Assistant Editor: Susan M. Plante

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