RUNNING FOR COVER
Higher deductibles in return for reduced premiums is one way to avoid crippling payouts...
By Russ Banham and Jasper Moisewitsch

It's been a treacherous season for the bottom line. Among the risks that sting CFOs most is the threat that risk management costs will double. Post September 11, the global insurance industry will be slapped with a US$60 billion pricetag, the highest ever for a single disaster. But while this translates into higher premiums far and wide, the situation is better, for once, for CFOs in Asia than for those in the US or Europe.

In happy contrast to global providers, Asian insurance companies did not have high exposure in the disasters. Not choked by large payouts, they can offer greater leniency on premiums. This is good news for CFOs of small- to medium-sized enterprises, the majority users of local insurers. Multinational companies in Asia - mainly the airlines - haven't been so fortunate and are facing sharp rises in premiums.

But even those companies hardest hit by higher insurance costs are beginning to find ways to ease the pain. Techniques that allow lower premiums in return for greater risk-sharing, long popular in the US, are being introduced into this market by global insurers. And the idea of offsetting higher premiums with higher deductibles (called self-insured retentions, or SIRs) may no longer be a corporate choice.

In fact, the risk-sharing trend was in motion in the US before the September 11 attacks. According to Chris Treanor, head of global brokering at New York-based insurance broker Marsh, deductibles had been doubling and more across the board this year. "Even prior to September 11, if a company had a US$20,000 deductible at its last annual [policy] renewal, chances are it would be US$25,000 this renewal. If it was US$1 million, it was likely to be US$2 million, and so on," says Treanor. He adds that: "If there was no self-insured retention, or [higher] deductible, last time around, there would likely be one this time around." And no doubt, says Stephen Lowe, managing principal of product development at Tillinghast-Towers Perrin, next year "there will be pressure for those deductibles to move up further."

This has taken place in Asia, most notably in Swire Group, owner of Cathay Pacific, the global carrier. Finance director Christopher Raper of Swire Group says he's raising Swire's deductibles on insurable items, which will save on premium outlays and focus management's attention on the cost of risk. He asks: "Is insurance simply just dollar swapping? We pay our premium, and we get it back again in an insurance claim? That doesn't seem particularly efficient and it doesn't promote a good risk management environment." Swire's response has been to promote a culture of risk aversion, in which managers highlight all instances of injury or property damage. This way, Raper can learn how to avoid these kinds of damages before they happen.

Raising the Game

In doing so, Swire has ripped a page from the book of US companies, whose treasurers and CFOs began adjusting to a tighter environment long before September 11. Vinnie Marzano, treasurer of Scholastic, recalls that in the 1990s the New York-based children's publishing and media company was the beneficiary of giveaway insurance prices. Its workers' compensation insurer was so eager to retain the company's business that it waived the usual US$200,000-per-claim deductible and even lowered the premium by 35 percent. "We had a great deal," recalls Marzano.

This past February, however, Marzano had to tell CFO Kevin McEnery that "the good days," as he terms them, were over. Although Scholastic's losses from workers' compensation had not changed as a percentage of payroll, the insurer, New York-based Atlantic Mutual, insisted on a deductible of US$250,000 per claim. It also hiked the price of the policy by 60 to 76 percent, depending on a formula assessing Scholastic's loss experience.

Marzano shopped around for a better deal - to no avail. "To get the same 'no-deductible' policy would have cost an additional US$800,000 a year, quite a bit more than I was willing to spend," he says. "Either we took on more risk through the deductible or we'd pay through the nose."

Marzano's dilemma is symptomatic of the return of the hard insurance environment. During the bull stock market, insurers competed by pricing their products lower while simultaneously absorbing more risk, figuring their investment income would pick up in the shortfall. Robert Hartwig, chief economist at the New York-based Insurance Information Institute, contends insurers went too far, pricing their policies well below expected losses. When the market became a bear market, the investment income to pay losses dissolved. "Record catastrophe losses didn't help either," he says.

Meanwhile, the losses that came in had much higher dollar values than was anticipated. Claim settlement costs for directors' and officers' liability insurance, for example, is up from an average US$7.5 million four years ago to US$14 million today, according to Steven Anderson, managing director of Marsh's FIN-PRO unit. Other tallies include a doubling of general business negligence claim costs from US$759,000 in 1993 to US$1.7 million in 1999, an increase in premises liability (so-called slip-and-fall cases) claim costs from US$324,000 in 1993 to US$457,000 in 1999, and a five-fold increase in product liability claim costs from US$1.4 million to US$7.4 million during the same period.

After the events of September 11, those losses are only going to increase. And what's different about the new claims, says Lowe, is that they cut across multiple lines of insurance, from property and casualty to workers' compensation to life insurance. Moreover, their catastrophic nature will cause first reinsurers and then primary insurers to further evaluate "the limits of insurance they offer" as well as the financial risk they will assume. The result, says Lowe, could be an insurance environment in which "buyers don't have much ability to negotiate."

Yes, SIRs

In the soft market, buyers often used their negotiating power to secure higher SIRs, reasoning that it made more sense to pay low-value risks out of cashflow than to pay an insurer. Several large companies accepted even higher risks.

Take US-based Nova chemicals. When other chemical commodities companies reduced or dissolved their SIRs as insurance prices bottomed out in the mid-1990s, US$3.9 billion-a-year Nova did the opposite, quadrupling its property insurance SIR to US$70 million for claims from fire, explosions and the resultant loss of income. Nova's peer companies were more likely to have SIRs in the US$1 million range. "We felt then and continue to feel that it makes no sense to spend all this money on insurance when we could be spending it instead on loss prevention," says Nova risk manager Brad Silver, who notes that the company hasn't submitted a claim to its insurer for the past decade. "It was a radical decision," he says, "but it has paid off for us over time," he says.

Following a recent merger with TransCanada Pipelines and a subsequent reorganization that spun off its energy business, Nova reduced the SIR on its property insurance program to US$50 million, still very high compared with its peers. However, that deductible, says Silver, will have to be reevaluated during the next renewal cycle, in June 2002, in light of current economic and insurance conditions. SIRs, he says, "are influenced by the financial position of the company, which can change from year to year."

Accepting higher deductibles - whether by choice or not - comes with a downside. "Obviously, you subject your corporation to more earnings instability when you take on more risk," explains Hartwig. "If you take a US$50 million SIR instead of a US$25 million SIR and there's a loss, that will wind up in your quarterly earnings, not an insurer's. If there's no loss, then you've won the gamble," he says.

Scholastic, meanwhile, is taking its SIR on the chin, at least for the time being. "We're just going to pay the US$250,000-per-claim SIR out of cashflow," says Marzano, a strategy that he too says will be reevaluated at the next renewal cycle. Not all is doom and gloom, though. "We get to pay losses now as we go, as opposed to paying the insurer one big chunk of money up front," he says. "If there are no losses, we'll at least get some [investment] float on the money."

Russ Banham is a contributing editor at CFO in the US. Jasper Moisewitch is a freelance writer based in Hong Kong.