Initially this might seem like an odd time to order a fresh shipment of worry pills. After all, the cost of risk rose just 8-to-9 percent during the first quarter of 2004 compared to three or four times that amount just 18 months ago. At least as important as price is the fact that terms and conditions don't appear to be narrowing any further, so there will be fewer new coverage gaps to plug. All is well in the world of risk management or is it?

Every experienced risk manager knows that periods of relative calm are few in number, far between and too often fleeting. More often than not, such interludes mark only temporary victories on issues that still have long-term devastating potential, while at the same time diverting attention from other serious problems that are about to bubble to the surface. The current period of relative tranquility is no exception, and any risk manager who thinks otherwise will soon be shaken awake by cold reality.

This column will discuss a few of the top causes for insomnia among risk managers today, including:

? Obstacles to meaningful tort reform.

? Concerns over ratings and the financial strength of insurers.

? Ongoing problems in workers' compensation.

? The rekindling of terrorism fears sparked by recent world events and the looming expiration of the Terrorism Risk Insurance Act next year.

TORT-ure

The road to tort reform is littered with the wreckage of well-intended legislation. Last year, three bills were added to the scrap heap class-action, asbestos and medical malpractice reform. While all three were expected to be resurrected in 2004, the outlook is not particularly good.

Getting shut out on tort reform over a two-year period is frustrating for risk managers and their insurers after making reform a priority issue, and given that there's little question that the U.S. civil justice system is out of control.

According to Tillinghast-Towers Perrin, tort costs consumed 2.2 percent of gross domestic product a total of $233 billion in 2002. An enormous percentage of these costs are passed along to commercial insurers or financed by corporations through self-insurance arrangements.

In fact, Tillinghast estimates that insured commercial tort costs totaled $87.4 billion in 2002, up a breathtaking 52.8 percent from $57.2 billion just two years earlier.

In a vivid demonstration that self-insurance (including captive arrangements) does not immunize corporations against the infectious problems of the U.S. tort system, Tillinghast also reports that self-insured (and uninsured) tort costs rose sharply from $29.6 billion in 2000 to $42.9 billion in 2002?an increase of 44.9 percent.

Financial Strength

Virtually every insurer has seen its ratings slip one or more notches over the past three years, causing concern throughout the risk management and broker communities, not to mention regulators and investors.

The ratio of downgrades to upgrades across all sectors of the insurance industry reached a 17-year high in 2002, with nearly four downgrades issued for every one upgrade. The flood of downgrades has been accompanied by a surging insolvency rate among property-casualty insurers, which hit 1.33 percent in 2002, up from just 0.23 percent in 1999 and nearly double the 10-year average insolvency rate of 0.72 percent.

Likewise, the number of insurers that became “impaired” that year reached its highest level in nearly a decade, according to A.M. Best. Several ratings agencies maintain a “negative” outlook for the industry despite recent improvements in financial and underwriting performance, citing concerns over the ability to maintain underwriting and pricing discipline, exposure to terrorism risk, tort-related problems such as asbestos, and chronic reserve deficiencies.

Fortunately, the news is not all grim. Insurers recognize that customers having witnessed the failure of once-trusted names like Reliance and Kemper have legitimate concerns over ratings and financial strength.

To that end, insurance CEOs have clearly indicated that they are interested in putting the reserving issue behind them, having recognized nearly $50 billion in adverse loss reserve development over the past three years. Likewise, risk managers should be heartened that the mantra among insurance CEOs these days is underwriting discipline.

Terrorist Threat

Terrorism is more than just a dominant theme in the 2004 presidential campaign or something we watch from afar in places like Spain or Iraq it is also returning as a major concern for Corporate America and its insurers.

Although the Terrorism Risk Insurance Act (TRIA) does not expire until year-end 2005, uncertainty is already creeping back into the marketplace. When insurers begin negotiations on 2005 renewals just a few months from now, any policy with an inception date after Jan. 1 will be necessarily burdened with contract language full of complex contingency provisions in the event TRIA is not reauthorized.

One set of prices, terms and conditions will prevail if TRIA is extended, another if it is not.

Although insurers and other affected industry groups are already pushing hard for reauthorization, extension of TRIA is anything but certain. The U.S. Treasury Department, which is charged with assessing the need for the program's continuation, has until June 2005 to issue a report on the availability and affordability of terrorism coverage under TRIA.

Therefore, risk managers need to be prepared for the worst no reauthorization, lack of adequate (or any) insurance/reinsurance capacity for most terrorism risks, and no demonstrable reduction in the threat from terrorist attack.

Greater uncertainty and confusion in the marketplace will be unavoidable if later this year the prospects for TRIA's reauthorization still appear remote.

Nowhere will the failure to reauthorize TRIA produce greater stress for risk managers than in securing workers' comp protection for America's 131 million workers. Faced with a multitude of multibillion-dollar loss scenarios, no ability to exclude or meaningfully reinsure terrorism risk, and regulators who already think terrorism surcharges are too high, the only option for insurers in many cases will be to walk away from the account.

The Quiet Crisis?

Terrorism is merely the tip of the workers' comp iceberg. It is a line of coverage where most of the troubles run deep beneath the surface. While the casual observer sees a combined ratio improving from 122 in 2001 to an estimated 103 last year, risk managers and insurers recognize that workers' comp is a line in trouble.

Aside from terrorism, workers' comp has one major problem which seems to elude a lasting fix, and from which most of its other problems stem skyrocketing medical costs. Consequently, workers' comp insurers and self-insured employers (including those with large deductible plans) are becoming first and foremost health care insurers.

Given the severe problems of the dysfunctional U.S. health care system generally, this is an ominous development. Worse still is the fact that the trend shows no signs of abating and that the statutory nature of workers' comp gives employers and insurers fewer cost containment options short of a massive legislative reform.

Medical costs as a share of all workers' comp costs stood at 40 percent in 1982, 48 percent in 1992 and 53 percent in 2002, according to the National Council on Compensation Insurance in Boca Raton, Fla.

This means that risk managers and insurers can expect to spend more time worrying about the efficacy of new and expensive diagnostic tests, the rapidly rising cost of prescription drugs, high rates of attorney involvement, often impotent cost containment strategies such as fee schedules and treatment protocols, and adverse claim development. Stemming from these problems are excess utilization and the related issues of fraud and abuse.

All of this is spawning calls for reform in a rising number of states, most notably California. The next big reform battle will be joined in Texas when its legislature convenes in January 2005.

Sleep Tight

Losing sleep is in the job description of every risk manager, and for most burning the midnight oil over the past few years is beginning to pay off. Claim frequency and severity are moderating, and in some cases even declining. Insurer security may also be on the verge of a favorable turn as improved insurer financial performance gives ratings agencies the confidence to bump a few major commercial carriers up a notch or two.

In contrast, there is little confidence to be found anywhere that the U.S. tort system will experience meaningful reform anytime soon, while workers' comp will remain plagued by high medical cost inflation.

Perhaps the most immediate problem faced by many risk managers arises from the threat of terrorism. Since the passage of TRIA, corporations that want terrorism coverage have been able to get it. Within the next few months that will begin to change as insurers plan for the possibility of the federal government abandoning its terrorism reinsurance program.

Robert Hartwig, Ph.D., CPCU, is senior vice president and chief economist at the Insurance Information Institute in New York. He can be reached at [email protected].

For Tort Cost Graph:

Flag: Disorder In The Court

Head: Tort Costs Rising All Around

Caption:

Self-insuring your own risks does not immunize corporate buyers against the infectious problems of the U.S. tort system. Indeed, self-insured (and uninsured) tort costs jumped 44.9 percent over two years to $42.9 billion in 2002.

For Downgrade Graph:

Flag: Security Blanket

Head: How Sound Is Your Insurer?

Caption:

The flood of downgrades has been accompanied by a surging insolvency rate among property-casualty insurers, which hit 1.33 percent in 2002, up from just 0.23 percent in 1999 and nearly double the 10-year average insolvency rate of 0.72 percent.

Quote Box: If neededcan run with authors mug:

“Risk managers need to be prepared for the worst on TRIAno reauthorization, lack of adequate (or any) insurance/reinsurance capacity for most terrorism risks, and no demonstrable reduction in the threat from terrorist attack.

Robert P. Hartwig

Reproduced from National Underwriter Edition, April 16, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.