When the going got tough...

The destruction of the World Trade Centre (WTC) was the international community's wake-up call in the battle against global terrorism; it also heralded the arrival of the hardest, most testing market the insurance industry has witnessed for 20 years.

In the past few months commercial insurance premiums have substantially increased, with rates on some lines of business rising by as much as 1,000%. This has been coupled with increased excesses, restrictive wordings and a more cautious approach to underwriting.

The market was already beginning to harden before 11 September owing to years of unsustainably low rates and rising claims costs. However, the 11 September tragedy, the single largest loss the industry had ever suffered, accelerated the process. It also had a more fundamental effect, changing the market's overall perception of risk and its attitude to the calculation of potential losses.

The cost of reinsurance has been a major factor in driving these changes. Recently, reinsurers stopped offering unlimited treaties, thereby requiring insurers to purchase expensive multi-layer programmes to obtain sufficient protection. Capacity problems have caused retrocession rates (the reinsurance for reinsurers) to rocket by as much as 1,000%, impacting on primary reinsurance prices.

There have been major changes in reinsurance treaty coverage, such as an increased use of event limits, exclusions and restrictions on reinstatements. Insurers have been forced to take accept higher net retentions through a greater use of excess of loss programmes, whereby reinsurers are only liable for high level losses. These changes mean insurers have become more cautious in their underwriting.

Insurers are now making a very careful assessment of their exposures on each risk and adjusting their rates accordingly: in markets where rates were significantly eroded over the years, such as employers' liability (EL), substantial increases have occurred; and if the claims experience is poor or the risk exposure high, the increase will be dramatic.

Wordings are coming under close scrutiny, frequently becoming more restrictive, with greater use of exclusions, such as those relating to terrorism, electronic risks and flooding; and the extra `filler' covers previously available in the soft market are no longer granted automatically, limiting cover to core areas.

Insurers are becoming more selective in the risks they are prepared to take; they are concentrating their efforts on a more limited range of target markets and are not afraid to lose business if they cannot obtain their required rates.

New approach
Buyers of insurance are now required to adopt a more sophisticated and proactive approach to the management of their risks. They have to be more creative in their insurance programmes and develop an overall risk management strategy.

Greater emphasis must be placed on loss control in order to reduce claims and thus control premiums. Increased levels of self-insurance and use of captives must also be considered as a way of reducing external costs, with the latter allowing access to some specialist reinsurance markets and their additional capacity. Finally, alternative risk financing solutions are also growing in importance.

The problem of capacity
Following 11 September and the dramatic fall in the stock market there was concern that lack of capacity would become a major problem. In the company market this has generally proved false, save for large commercial property risks; but, at Lloyd's it is becoming a major problem.

Over the past months, dramatic premium increases have started to exhaust syndicates' capacity, forcing many to take out additional reinsurance to enable them to continue writing business. Amlin, for example, has recently signed a £50m deal with each of XL Re and Montpellier Re to boost its capacity for 2002 and 2003; and has stated that it still needs a further £200m capacity for 2003.

Despite this influx of capital, a number of syndicates were forced to stop writing new business temporarily. R J Wallace has stopped writing all new UK business for EL and public liability (PL), and Abacus and The Underwriter suspended writing new business altogether in June. These capacity problems mean brokers are having difficulty placing difficult risks; in some cases liability is impossible to place.

Winners and losers
2001 was difficult for many insurers; in addition to the September 11 losses, there were a number of other major incidents such as the Tamil Tigers' attack on the Air Lanka fleet and the loss of the Petrobras oil rig. Natural catastrophe losses also played a significant role, with major losses from windstorms and floods.

R&SA's profits crashed by 96% to only £16m, accompanied by a combined ratio of 112.6% - an increase from 109.6% in 2000. Lloyd's made a loss of £3.11bn, compared with a loss of £1.2bn in 2000. And Chubb's profits in the fourth quarter of 2001 dropped 83%, following heavy losses from the collapse of Enron.

Nevertheless, there were some winners: Aviva performed well, achieving its combined ratio target of 102% (an improvement on 2000's figure of 109%) and a 41% jump in profits to £2bn. AXA's UK operation managed to improve its combined ratio by 9.5 points to 117.3%.

The published results for the first quarter indicate that insurers seem to be performing better in 2002. Chubb announced premium growth of 35% and a combined ratio of 95.7% (compared with 106.6% in the equivalent quarter of 2001); and Fortis has shown a net operating profit of £535m, up 7% on the same time last year.

The big winners, however, seem to be the reinsurers. Munich Re reported first quarter profits rising to £444m by 174% on last year, achieving a massive drop in its combined ratio from 112.1% to 101.7%; and French giant SCOR revealed that its property and casualty reinsurance has rocketed by 67% in the first three months of the year.

Looking ahead
How long these conditions will last has been a source of much debate. On the basis of current trends, rates will continue to harden where they are not adequate to meet insurers' exposures. Reinsurers are likely to be a major influence. As the chief executive of Munich Re recently commented: "Where prices are not yet risk-adequate, we will press for further adjustments at [2003] treaty renewals."

Rates will also remain high for as long as capacity is an issue, as underwriters maintain the ability to pick and choose risks and dictate prices. Although it is expected that capital will continue to flow into the market during the second half of the year and beyond, it is likely that the capacity problem will continue to worsen, and it will probably be some time before capacity keeps up with demand. N

Sector by sector analysis

Employers' liability (EL)
Many insurers have recoiled from the this line of business and now eschew liability-dominant risks. Premiums have increased by more than 300% on some risks, and a number of London Market players have also started to add deductibles. Liberty, for instance, has introduced an excess of £2,500, while Abacus and The Underwriter have begun to impose £5,000 deductibles on some risks.

These developments are not surprising; insurers have lost a great deal of money in this area due to unrealistic rates in previous years coupled with under-reserving for long-tail liabilities, new types of claim such as stress, and general claims inflation. Nevertheless, businesses are being hit very hard, with some unable to obtain cover, leaving them to fold or trade illegally.

Public liability (PL)
PL accounts have not lost as much money as EL, so rate increases have been less dramatic, starting at around 15% to 25%. However, where the risk is high, such as significant US exposure, then increases can be substantial, perhaps reaching as much as 100%.

Deductibles have also increased, with many insurers doubling their excesses; Lloyd's, however, has been more draconian, with some syndicates increasing excesses tenfold.

Construction
A few years ago this became a very popular area for many insurers, however, the market is becoming more limited.

Lloyd's syndicates such as DJ Marshall and DP Mann, have lost interest in the sector; and composite carriers such as Aviva, Avon and Chubb are choosing their risks carefully and avoiding high-hazard areas, such as roofing and scaffolding.

Higher excesses, lower site limits and site survey requirements are also being employed, and rating increases have been substantial, particularly in relation to liability.

Motor
This sector has seen sustained rate increases over the past five years following the large losses suffered by insurers a few years ago. There are signs that the situation is changing, with the arena becoming more competitive and rates levelling off for some risks.

Attractive claims-free risks can achieve only small increases - less than 10%, level terms or even reductions as insurers battle for the business. However, for those risks with poor loss histories or in high-risk occupations, such as coach and haulage fleets, then substantial increases can be imposed, particularly at Lloyd's where premiums can more than double.

Property
Rating increases in this area have been quite dramatic, particularly for heavy exposures. At the smaller end of the market they tend to start at about 20% for good risks, and for the larger risks rises can be more than 100%. In the case of high-risk property, however, increases may be as much as 500% or more.

Major buyers are also struggling to obtain capacity from either single or multi-line carriers, and insurers are increasingly looking to provide catastrophe-only cover through the use of large deductibles.

Insurers are carefully examining their business interruption wordings and terrorism cover, and have become very cautious in providing cover for flood and storm damage following the large losses of previous years, increasingly turning to risk management initiatives, such as flood awareness campaigns, to reduce future losses.

SME market
The small to medium enterprise (SME) business sector is becoming popular with insurers looking to control costs, given its scope for package policies and the potential for e-trading. AXA is already very keen and Groupama has recently announced its intention to focus on this sector.

A major problems facing SMEs is that in many cases minimum premiums have gone up by as much as 100%. Increased excesses can also be damaging, as many SMEs do not have the financial strength to retain the smaller losses.

But some insurers are taking a pragmatic view. AXA, for example, has said that it will not put on large increases if the risk is claims-free, while Chubb has said that it does not wish to punish companies with unwarranted increases in premiums and deductibles.