Buyers Take Big Risks By Going Bare To Cut Costs

Corporate America is feeling the heat these days and is deciding to go bare. Buying less insurance–and in some cases no insurance at all–and betting the corporate farm that nothing bad will happen seems to be how risk managers at many U.S. corporations are dealing with the higher cost of insurance.

While buying less of anything is usually considered to be a rational economic response to higher prices, the strategy of buying less insurance–or going bare altogether–will almost certainly lead to more businesses being burned by a wide variety of existing and emergent perils.

The fact of the matter is that the six million businesses in the United States operate in an environment that is more uncertain and more hostile than ever–and the threats against them seem to multiply by the day. Terrorists want to destroy their property, employees claim harassment and discrimination with ever greater frequency, angry shareholders sue every time the companys stock swoons, and trial lawyers file dubious but expensive-to-defend suits by the dozen.

Despite the obvious threats, there is compelling evidence that Corporate America is willing to play Russian roulette with shareholder money. By cutting back on the limits of property and liability coverage they purchase, many U.S. businesses appear willing to jeopardize their long-term survival in exchange for short-term profit.

With the threats against them greater than ever, skimping on insurance hardly seems like a long-term winning strategy. Its not. But the annual temptation to save a few dollars at renewal time is all the more irresistible in the face of sharply higher insurance costs and the current economic slowdown.

Consider whats happening in the liability arena. There is no doubt that the threat of expensive and even ruinous lawsuits to corporations, large and small, is greater than ever. Today, one in five jury awards are for $1 million and above, compared to one in 14 in 1994, while nearly one in 10 businesses experienced a liability loss of $5 million or more over the past five years.

According to Jury Verdict Research in Horsham, Pa., the average jury award in business negligence cases rose about 20 percent per year through much of the 1990s, while the average jury award in a product liability case skyrocketed 410 percent, from $1.44 million in 1993 to $7.36 million in 1999 (the latest year for which data are available).

Paradoxically, a recent study by New York-based Marsh revealed that the average total liability limits purchased by businesses actually fell by 3 percent in 2001, from $105 million in 2000 to $101.8 million last year, after increasing steadily for years.

Why, then, are the average limits of coverage purchased falling? There are only three possible explanations:

Businesses believe they have too much liability coverage and are cutting back. This explanation is unlikely given the fact that litigiousness and liability losses appear to be on the rise.

Businesses feel that they are unlikely to be sued. This explanation is nothing other than the common “it wont happen to me” syndrome that afflicts many insureds, frequently to their own detriment or destruction. Moreover, in liability cases defense costs alone resulting from merely being named in a suit can be very expensive.

Businesses are cutting back on liability purchases to save money. With liability coverages, including general liability, umbrella, and directors and officers coverage renewing with increases of 30 percent or more, economizing on liability is a fast and convenient way to save money–especially given that the recession has pinched revenues and profits at many companies.

According to Marsh, it is small to mid-size businesses that are purchasing less coverage. Firms with revenues of less than $200 million decreased limits purchased by 4 percent, while firms with revenues ranging from $201 million to $400 million reduced the limits they carry by 13 percent. These are precisely the firms most susceptible to ruinous loss from even a single lawsuit.

The very largest of U.S. corporations, on the other hand, understand only too well todays legal environment and recognize the need for even more liability insurance protection. Businesses with revenues over $10 billion increased their liability insurance limits by 11.2 percent last year, despite rising prices.

Businesses (and homeowners) have a long tradition of skimping on insurance, often with disastrous results. Two recent property disasters illustrate this point.

Tropical Storm Floyd, which devastated Texas last June, resulted in economic losses of $5 billion, but insured losses of only $2.5 billion. Likewise, economic losses from Hurricane Floyd, which swept up the East Coast of the United States in 1999, exceeded $7 billion, although insured losses totaled just $2 billion.

Both events were unusual in that while they were windstorms in name, the bulk of the damage was from severe flooding. Flood is excluded in virtually all residential insurance policies and in most commercial forms covering property at fixed locations, yet much of the uninsured loss could have been avoided through the purchase of flood insurance through the National Flood Insurance Program, and special commercial flood coverages (such as is provided through difference-in-conditions insurance).

Insurers are accustomed to viewing many of the products they offer as absolute necessities. They might be dismayed to find that their customers, on the other hand, view insurance as just another input to the production process–something that can be cut back if the price rises too much.

Corporate America now appears to be willing to play another round of Russian roulette, this time with terrorism. Although insurers have not always been willing or able to offer terrorism coverage in the amounts their insureds require, there are many businesses that have been offered adequate limits of protection but decided to forego some or all of the coverage available.

Some businesses cite cost, some their belief that they are unlikely to become victims of a terrorist attack–and most think the government will come to their rescue in the event that such an attack does occur.

Pennywise-but-pound-foolish risk management decisions are an unavoidable consequence of the hard insurance market. This is hardly surprising given that corporate decision-making is closely aligned with the economic interests of management.

While insurers and brokers can warn clients about the hazards of underinsurance, posting better quarterly earnings results produces immediate financial benefits for management (through higher stock prices, bonuses, etc.), even if it means eviscerating a responsible and comprehensive risk management program that has served the company well for years.

Short-sighted risk management decisions should not be rewarded or encouraged, yet as long as shareholders are kept in the dark about such decisions and boards of directors remain complacent, the probability of corporate collapse from a wide variety of property and liability catastrophes for many U.S. companies will rise.

Robert Hartwig, Ph.D., is senior vice president and chief economist at the Insurance Information Institute in New York. He can be reached at bobh@iii.org.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, February 18, 2002. Copyright 2002 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.

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Buyers Take Big Risks By Going Bare To Cut Costs

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