The Great Recession: A Risky Proposition?

As the Great Recession grinds on, the impact on both individuals and business continues to spread. All bands of the risk management spectrum–personal and commercial, property and casualty, large and small–are affected. As risk management professionals, it is critical we understand how the current economic situation affects the exposures insurers assume.

Sobering statistics appear in the news every day:

o An unemployment rate over 10 percent.

o Underemployment at 17 percent or higher.

o Business bankruptcy filings up almost 60 percent over the 12-month period ending in March.

o Two million foreclosure filings by midyear 2009.

o More than one million “interest-only” mortgages resetting between now and 2012.

This news can be summed up in one word: R-I-S-K!

Take real estate, for example. Basically, it's a ghost town out there. Soaring foreclosure rates and the closing and consolidation of businesses have led to one of the biggest hazards that properties can face–vacancy. From empty houses in the suburbs to shuttered big-box stores along our highways, vacancy rates are increasing.

When a building is unoccupied and not used for its intended purpose, no one is there to notice leaky roofs or plumbing, maintain trees and landscaping, or detect smoke in the early stages of a fire.

Vacant buildings attract vandals, squatters and other transients who may take up temporary residence and cause further loss or damage. Copper wiring and plumbing can be ripped from the walls and other fixtures stolen for their resale value.

As buildings remain unoccupied, the building envelope can be compromised simply from lack of maintenance. If left unchecked, gutters, shingles or flashing can become loose and be ripped from a building by high winds, damaging neighboring property or causing bodily injury.

A vacant unit in a strip mall–and the adjacent businesses that remain open–may be at risk if fire alarms or other protective devices are rendered inoperable or protective service contracts lapse.

Similar concerns extend to unfinished construction projects started during the boom years but now standing idle. Those projects can easily become a nuisance hazard because they are an attractive place for kids to play. Construction site debris can easily become airborne during a windstorm, damaging the site and neighboring property.

Employment-related risks have also increased. Faced with the prospect of losing their income, some ex-employees will pursue claims–whether legitimate or not–citing unfair discrimination, retaliation, defamation, or other wrongful termination or workplace practice.

It is important that companies have a detailed plan in place when contemplating workforce reductions to ensure compliance with any employee notifications required by statute or regulation and to protect against allegations of wrongful -termination.

Employee sabotage might be carried out in retaliation for layoffs. In today's wired world, it is conceivable that a single line of malicious code, or the striking of a delete key, could be as catastrophic to a business as any structural fire.

Employee theft may also be on the rise as workers are desperate to make ends meet at home. Whether it involves embezzlement of funds or theft of supplies and/or merchandise, employee theft accounts for almost one-half of all retail crime.

Ensuring the company you underwrite puts in place simple procedures such as mandatory vacations, job rotation, closed-circuit monitoring, dual signatures and separation of duties can go a long way toward minimizing the potential for employee theft losses.

As businesses and individuals cut expenses, general maintenance too often takes a hit. Do-it-yourself repairs may be the answer for some, or repairs and maintenance may be neglected altogether. Families may put off new tires or brake pads for the car, or manufacturers may skip scheduled maintenance for machinery and boilers.

But deferring car maintenance can increase the risk of accidents and resulting bodily injury and property damage. Deferring maintenance on machinery and boilers may lead to mechanical breakdowns and increased business interruption.

Even something as simple as canceling a janitorial contract can have negative effects, as slips-and-falls, vermin incidents and other housekeeping hazards increase.

Meanwhile, whether torching a home because of an upside-down loan or abandoning a vehicle because payments can no longer be afforded, insurance claims fraud may be on the rise.

The National Insurance Crime Bureau reports a 20 percent increase in property claim referrals, and 15 percent for liability. Suspicious slips-and-falls are up an astonishing 47 percent.

But fraud also entails providing false or misleading information during the application and underwriting process to avoid policy surcharges or higher rates, especially as firms and families have fewer dollars to spend on insurance premiums.

The economic downturn may force certain skilled workers to take on activities not accounted for when classifying that risk and developing the policy premium. Consider the insured plumber who is also renovating entire bathrooms and kitchens on the side. Or the metal shop that takes on structural iron work. In either case, there is no intent to defraud an insurer but simply an attempt to remain in business.

Exposure bases rooted in variables such as sales or payroll have been shrinking. This could be intentional underreporting to save premium dollars. But to determine the impact on risk, it is important to understand what might be driving numbers down.

Gross sales may be down on a dollar basis, but unit sales may be holding steady because of discounting, 2-for-1 deals, or other promotions. Barter sales are also making a comeback, although such -trans-actions may not necessarily show up in gross receipt figures.

Some employees are being asked to assume multiple tasks. Whether an outside salesperson is also performing clerical work, or an underwriting executive is doubling as the communications “expert,” it is important to understand the functions being performed by individuals within a firm, since dual capacities and associated exposures are becoming more commonplace.

One of the goals of insurance professionals is to collect premium commensurate with exposure. Given the variability of the exposure base in the current economy, premium audits and questionnaires can be used to understand the fluctuations that may occur.

One day–hopefully soon–the “experts” will tell us the recession is over.

However, its effects will linger and affect the risk profiles we need to consider for years to come. Now more than ever, it is important to underwrite carefully and to recognize the potential exposure that each risk represents.

Stephen C. Clarke is assistant vice president of ISO's Commercial Multi-Line Division. Jeff De Turris is assistant vice president of ISO's Personal Lines Division. ISO is based in Jersey City, N.J.