Terrorism Leaves WC Insurers Exposed

|

With the first anniversary of the Sept. 11 terrorist attacksjust around the corner, it is safe to say that the past year hasborne witness to one of the most rapid and radical transformationsin the history of the insurance industry.

|

From Ground Zero, the economic shockwaves from that tragic eventwere transmitted in an instant through many different channels tobusinesses and governments around the world. Insurance was amongthe principle mechanisms by which the death and destruction ofSept. 11 were translated into the cold calculus of dollars andcents.

|

The grim task of assigning values to lives and livelihoods fellsquarely on insurers–workers' compensation carriers in particular.This macabre but necessary accounting exercise produced an estimateof privately-insured workers' comp losses of $1.3-to-$2.0 billionout of an estimated $40 billion in total insured losses (see piechart), exposing the need for a radical overhaul in the wayworkers' comp insurers think about catastrophic loss.

|

For workers' comp carriers and commercial insurers in general,the unprecedented nature and magnitude of the Sept. 11 attack andthe possibility of future attacks forced insurers to make a numberof swift, certain and severe changes in their underwritingpractices to prevent their own possible mass extinction. In mostproperty-casualty lines, terrorism exclusions proliferated, pricesrose, coverage limits fell, and policies were nonrenewed.

|

But as a practical matter, workers' comp is more resistant tochange than most commercial lines.

|

Workers' comp defies a simple fix for a variety of reasons. Theline remains the most highly regulated of all commercial coverages,and has always been offered on a no-fault basis. (Even losses dueto acts of war are not excluded from workers' comp policies.)

|

Changes in terms and conditions that require nothing more than afew weeks notice to the policyholder in most lines could require anact of a states legislature in workers' comp. Rate change requestscan take months even in ordinary times. Moreover, as of thiswriting, no federal backstop for terrorism risks has been put intoplace, and the private reinsurance market has all but dried up.

|

So how are workers' comp insurers protecting themselves againstcatastrophic loss given regulatory resistance to exclusions and bigrate hikes, the lack of a federal terrorism reinsurance backstop,and a severe shortage of reinsurance?

|

Theyre using the only tools left at their disposal–taking theprice increases they can get, increasing their nonrenewal rates,and avoiding the aggregation of risk.

|

The price of workers' comp coverage is rising by 20-to-25percent for most employers. While these increases are significant,they can be justified almost solely on factors unrelated toterrorism, including accelerating medical cost trends (up 11percent in 2001, according to the National Council on CompensationInsurance in Boca Raton, Fla.), the higher cost of reinsurance,guaranty fund assessments, the elimination of unsustainabledeviations and discounts, and depressed investment returns.

|

In short, little of the current increase in price is linked tothe possibility of future terrorist attacks.

|

Nonrenewal of workers' comp policies is an option that insurersare reluctantly forced to pursue. Characteristics that lead torejection by one insurer will often lead to rejection by otherinsurers as well, forcing the employer into the states residualmarket plan.

|

Growth in these plans is rising for the first time in manyyears, in large part due to fear of catastrophic loss. Of course,pushing employers into residual market plans is only a partialsolution to insurers problems, as companies operating in the statesvoluntary market must make up losses in the plan.

|

Perhaps the most intriguing development in workers' comp sinceSept. 11 has been the innovative use of catastrophe modeling.Historically, the possibility of catastrophic workers' comp losseswere all but ignored by insurers. Even if insurers had tried topush the idea of a catastrophe contingency in their rates, the ideawould assuredly have been rejected by regulators based on the lackof actual precedent. But then came Sept. 11.

|

The primary lesson for workers' comp insurers is thataggregation of risk needs to be considered in the underwritingprocess, as it is when property risks are underwritten. At leastthree risk modelers–Risk Management Solutions, Applied InsuranceResearch, and Eqecat–are working on models that will help insurersunderstand their exposure to terrorism risks.

|

Terrorism modeling, unlike modeling for natural disasters, isnot exclusively focused on property losses. Because such modelsalso attempt to estimate the number and severity of injuries anddeaths under a wide variety of attack scenarios, they are of directinterest to workers' comp insurers. Modelers are also looking atscenarios involving nuclear, biological or chemical attacks.

|

Terrorism modeling is far more difficult and complex thanmodeling for natural disasters because it must extend well beyondthe identification and quantification of aggregated risks. Modelingfor terrorism requires the modeler to “think like a terrorist,” soto speak. The modeler has to gain some understanding of how theterrorist mind works.

|

To that end, modelers must gather information fromunconventional sources and apply what is learned in new ways.

|

For example, modelers have studied al Qaeda training manuals, aswell as interviewed counter-terrorism and national securityexperts. Information gleaned from this process can be applied innew game-theoretic models of terrorist behavior. These behavioralaspects of terrorism modeling have no analogy in the modelingnatural disasters.

|

Workers' comp insurers today find themselves in the grips of avise. On the one side, insurer finances are pressured bytraditional pricing factors such as rising medical claim severity,falling investment income, and the glacial pace of rateapproval.

|

But the big squeeze–along with a big boost in uncertainty–iscoming from nontraditional sources, including the threat ofterrorism, the inability to spread or reduce risk efficiently dueto lack of reinsurance or pooling facilities, and unacceptably highlevels of aggregated risk. The inability to exclude terrorism as acovered cause of loss puts workers' comp insurers in a far moredifficult situation than property insurers.

|

When the first anniversary of the Sept. 11 attack passes nextmonth, workers' comp will arguably earn the distinction as the mostexposed of the major “target” commercial lines. Consequently, majorchanges are ahead as workers' comp insurers adapt to the challengesof insuring the well-being of workers in an uncertain world.

|

Robert P. Hartwig is senior vice president and chiefeconomist at the Insurance Information Institute in New York. Hecan be reached at [email protected].


Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, August 19, 2002.Copyright 2002 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.


Want to continue reading?
Become a Free PropertyCasualty360 Digital Reader

  • All PropertyCasualty360.com news coverage, best practices, and in-depth analysis.
  • Educational webcasts, resources from industry leaders, and informative newsletters.
  • Other award-winning websites including BenefitsPRO.com and ThinkAdvisor.com.
NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.