Plugging Leaks: Nine Property Risk Management Challenges for 2007

Under-Insurance Due to Building Cost Inflation

Scott Ecker of Atlas Risk sees the cost of building materials continue an upward spiral with no end in sight. It's not just gasoline that is jumping in price. Material costs drive higher rebuilding expense to rebuild and repair damaged property. They raise the odds that repair or replacement costs might exceed the levels of property insurance carried. This could rise up and bite risk managers in the form of coinsurance penalties after losses to under-insured structures. Building cost inflation has ramifications for maintaining adequate insurance-to-value ratios and meeting coinsurance requirements.

Unwittingly under-insuring the organization's property can be job-threatening when, after a loss, upper management demands to know who set the insurance limits before a major storm. Solution: get periodic and realistic updates on building replacement costs, factoring in local inflation patterns in building materials. Undervaluation of buildings is a property risk management issue; replacement costs must be seriously re-evaluated as costs of basic materials soar ever higher.

"Cat" Cover

Another risk manager concern is with accessing quality sources of excess "cat" (catastrophe) capacity. Getting property limits above the primary layer can be problematic. Insurers who previously wrote such coverage may have retrenched in the wake of the 2005 hurricane season, gun-shy about risking more excess limits. To an extent, this is an insurance-market-cycle issue. Unlike 2005, this past year was relatively quiet for hurricanes and natural disasters. That lull is unlikely to continue. Various climate sages and computer models predict freakish weather becoming more the norm than the exception.

Terrorism Risks

Terrorism may not have the top of mind prominence that it had five years ago, but risk managers cannot afford to become complacent. Each risk manager must assess how prepared his or her organization might be for a terrorist attack, or its fallout. Such a threat and risk exists, even if one is not located in downtown Washington D.C. or in an iconic building. For example, how current is your disaster recovery plan? How quickly could your organization bounce back after a loss? How long has it been since you rehearsed your plan or conducted a simulation drill? A disaster recovery plan has no value if it is sitting on a credenza (or in a hard drive), gathering dust.

Deductible Calculation

Coverage structure, i.e. deductible calculation methods, represent another 2007 challenge in property risk management. Are you carrying sufficient deductibles on your property coverages? Does your organization have the balance sheet to shoulder higher deductibles? If so, you may be able to capture meaningful premium savings. Alternatively, are your current deductibles too high? If a loss occurred, would your organization have the financial liquidity to step up and absorb the menu of current retentions? Is your upper management comfortable with the current level of deductibles? Are they aware of current deductible levels? What is upper management's degree of risk tolerance? Is there a structured way to survey C-level executives to assess this periodically, given that one's tolerance for risk can change over time?

Hurricane Risks

Will the 2006 lull in natural disasters continue? Is it an aberration or the calm before the storm? Since no Katrina-like storms hit the American coasts in 2006, many property insurers had strong financial results. They raised prices to compensate for 2005′s hideous loss experience, but no comparable storms hit in 2006. Will this trigger a cycle of competitive cost-cutting among insurers? Many climate experts, however, predict that wacky weather will be an increasingly common feature of our world, in part due to global warming.

Intellectual "Brain Drain"

Some commentators see the broader scope of enterprise risk management and see a vocational "brain drain" as a genuine risk. Michael Keeley, J.D., ARM, vice president of J&K Risk and Insurance Services, Inc., believes the greatest property losses in 2007 will be the intellectual property loss triggered by the number of baby boomers transitioning from the risk and insurance industry into retirement, and a lack of adequately prepared reinforcements. This gap in corporate succession planning will cause the loss of much institutional knowledge, for which many employers have not prepared. The time to get ready is now (if not yesterday) and this calls for succession planning in key roles as a prudent component of enterprise risk management.

Intellectual Property

Intellectual property is another area that needs risk management focus, even if it is not insured. Delving into this can become a part of an enterprise risk management program. Does the organization need to defend its patents or pursue intellectual property claims against those who are infringing on them? Are any competitors misappropriating ways of doing business? Are ex-employees sharing proprietary information with competitors in ways that violate non-compete agreements? Is the organization doing enough to protect and project its brand?

Exploiting Soft Insurance Market Conditions for Price and Coverage Enhancements

One broker reported that he had a package risk with a building valued at $22 million. Four years ago, he recalled, no insurer would offer coverage. Three years ago, the annual property premium was $60,000 (no earthquake cover). Two years ago, the premium was $40,000 (still with no earthquake cover). In late December 2006, however, he bound the 2007 year's policy for $22,000 with earthquake and flood coverage. The earthquake will have a $25,000 deductible; the masonry building is actually in an earthquake zone. The carrier is not a fly-by-night insurer but is rated A+ by A.M. Best.

In his seventeen years in the business, the broker has seen soft markets before but nothing like this. Of course, riding the insurance market cycle is fun in a soft insurance market, but perilous in hard markets. If you take credit for price and premium savings in soft markets, risk managers must shoulder accountability for price jumps when property insurers retrench. Take another spate of hurricanes, one terrorist act, or a major earthquake and there could be a sea change in the property insurance landscape. The same risk managers who seem like Einsteins to upper management during soft markets will appear–through no fault of their own–to be imbeciles when the market turns. And turn it will.

Focus on these nine areas to tune up your property risk management program in 2007!

Kevin Quinley, CPCU is an insurance executive in the Washington D.C. area. He can be reached at kquinley@cox.net or through his web site, www.kevinquinley.com.