Ready to Soar?

John A. Legler and Keith George

Waste service companies and government providers have been in an insurance procurement nirvana for nearly five years. In some markets, it's cheaper to insure a waste collection vehicle than a personal automobile. In fact, policyholders buying property/casualty insurance have enjoyed a prolonged "soft" market since the 1990s - an unprecedented amount of time in the industry's history.

For nearly five consecutive years, policyholders enjoyed a unique bargaining position because of "price war" bidding by insurance carriers. Insurance companies, in many cases, lowered the cost of larger policies for larger businesses to levels where their payouts exceeded the premiums. Many companies that formerly carried varying degrees of retained risk using large deductibles, self-insured retentions, retrospectively rated programs and the like, converted to higher levels of pure risk transfer than had been common throughout the previous decade.

What was heaven to insurance consumers, however, masked the stress that the price-driven market was creating on underwriters. While prices were bottoming out, carriers' loss ratios for the waste industry were climbing at an alarming rate. Carriers who soured on the industry pulled out, but they were quickly replaced by new companies interested in establishing a market position.

Waste service firms would experience adverse losses, but they still could easily buy coverage at "fire-sale" rates without being forced to take steps to manage their adverse accident trends.

Beginning in late 1999, and quickly accelerating in the first months of the new millennium, renewal quotations certainly are catching the attention of risk managers. Increases of 15 percent to 30 percent are being seen, with competitors neither as plentiful nor as willing to underbid just to get the business. The result is a wakeup call for the industry to dust off long dormant safety and loss control techniques.

Rate Increases Come Sudden and Strong Why this sudden market reversal? Essentially, the insurance marketplace follows economic principles of supply and demand. Demand is the need or desire to transfer risk, provide financial assurance to customers, meet regulatory requirements, and protect physical plant or business cash flows. Insurance needs are dictated by federal and state laws and regulations, contractual requirements or through using common business sense. During strong economic times, all businesses demand additional insurance coverage because of increased exposures.

Supply is referred to as capacity. When measuring the risk an insurance carrier can take, capacity represents the spread between the company's liabilities and the amount of free baseline capital (surplus) that it must maintain.

For example, if a company must maintain a surplus to premium ratio of 3-to-1, and has $3 million in unencumbered capital, then it can write up to $9 million in premiums. However, there are other ways that a company can leverage its risks.

An insurance company can cede its losses to another insurance company through reinsurance or aggressively invest its reserve funds for a return greater than the cash flow needed to pay for losses. Thus, the insurance company can multiply its ability to underwrite several times its basic capacity.

The current economy has sustained the longest equity growth market in the nation's history, which has allowed insurance companies to realize a significant return on their invested reserves. This return has been far in excess of prudent expectations made by the actuaries who project cash flows used in basic rate calculations. Simultaneously, medical cost management through health care management organizations, as well as successful legal reform in some states, have helped to keep losses from growing at an expected rate.

The combination of these effects, when multiplied through a growing system of insurers, reinsurers and alternative markets, has created a huge capacity that far exceeded demand in the mid-1990s. The surplus was so large, in fact, that prior to 1999, the industry was able to absorb losses from some of the largest natural disasters in history with nary the blink of a financial eye.

When supply exceeds demand, prices will keep coming down until it reaches equilibrium with demand. In such a market, cash flow to generate more investment return outweighs the need for the premiums charged to adequately cover expected losses.

As in every other leveraged market, when the saturation point is reached, the compounding effect that drove supply upward makes any eventual contraction even more heavily felt.

While the equities markets experienced a downward turn in early 2000, losses underwritten by "fire-sale pricing" matured, meaning the piper had to be paid.

Although loss leaders are fine for building markets, the property/casualty industry as a whole, according to Oldwick, N.J.-based A.M Best Co., has paid out more than 100 percent in combined losses and expenses compared to premiums they've charged for the past 10 out of 11 years. Additionally, during 1999, five property/casualty insurance companies closed.

Mergers and acquisitions among carriers has further reduced the available universe of underwriters, while tapping some of the built-up value in the companies to fund the consolidations. Catastrophe losses produced a record $28 billion in the last reporting year. These combined factors have resulted in a rapidly narrowing gap between the insurers' total capacity and the risk coverage demands of businesses and consumers.

A Shrinking Surplus There clearly has been a trend during the past year toward surplus reduction. But rather than be caught short, underwriters have been shifting away from generating investment cash flow to ensuring long-term operating viability. Something has to give, and that means rate increases.

According to the Council of Insurance Agents and Brokers (CIAB), Washington, D.C., these rate increases are not a short-term phenomenon. Since last year, nearly 65 percent of all property/casualty premiums increased, with more than half of all brokers reporting 10 percent jumps in the past three months. Only the umbrella markets (excess coverage over and above the basic insurance policy, typically for levels of risk above $1 million) seem to be holding the line.

The most essential coverages needed by the waste and recycling industry's operations, the automobile and workers compensation lines, are characterized as "somewhat hard" in the CIAB Commercial Insurance Market Index, with some auto risks seeing "very hard" pricing. In combination, more than two-thirds of the market is experiencing price increases. Medium-sized accounts, which are typical for independent operators and large public entities, are experiencing much more aggressive pricing increases than are very small or large accounts.

Group medical coverages also are showing significant upward pricing pressures, with 90 percent of small accounts, 88 percent of medium-sized accounts and 74 percent of large accounts reporting increases. Approximately one-third are encountering premium bump-ups of more than 10 percent.

Regionally, the Northeast and Midwest are broadly and heavily affected, especially in auto insurance. The West is seeing the largest increases in Workers Compensation. Group Medical premium hikes are being acutely felt in the Northeast, compared to other areas.

In Every Threat an Opportunity According to a recent article in Business Insurance, New York, property/casualty policyholders should expect rate increases of between 10 percent and 40 percent. Additionally, the availability of guaranteed cost programs for larger businesses will be increasingly difficult to find, and premium discounting will be sharply curtailed. The waste industry class of risks has combined ratios significantly of well more than 100 percent, and will be affected in a pronounced way as underwriters attempt to put their books back in balance.

In a firming market, certain sectors, areas of the country or types of operations may be singled-out for heavy premium increases. Some businesses may not be able to find insurance. If parts of an operation either are under-performing or are in a class of operation with identified special hazards, risk managers must consider the effect that these have on the entire underwriting evaluation. In some cases, splitting off those operations into a separate insurable entity may isolate and lessen the premium increase for the entire organization.

In other circumstances, a highly profitable business with an under-performing loss record may find it difficult to place coverage needs. The solution may be to combine the problem area with another part of the organization with a top-notch underwriting history. The blended rate could lower the insurance costs and allow the activity to continue. If the premium increase is significant compared to the problem operation's profitability, then discounting the operation should be considered. A trained and experienced insurance professional should be consulted early and often when evaluating the risk and the various options that need to be considered.

To sway the buyer in the previous soft market, underwriters frequently ignored excessive fleet age, assumptions of liability by contract and overly aggressive valuations of certain equipment types and property as "add-ons" to the coverage. Now, hard market pricing includes having an up-to-date assessment, using depreciation schedules commonly used in the industry, and the company's operating profile, which includes a current program to retire old or obsolete equipment, available up-front for presentation to prospective underwriters.

One important fact, however, provides an opportunity: 80 percent of all losses are generated by 20 percent of the risks. Thus, a risk manager should demonstrate to the underwriters that the company is above average to obtain the best possible quote. Even if a company has a less than sterling loss record, companies can show the voluntary steps taken to correct the causes of those losses, and the resulting performance improvements.

It is important to initiate action long before insurance policy expiration dates, rather than being coerced by an enforcement agency or insurance company. According to Mark West, Loss Control Specialist for the Zurich American Insurance Co., Schaumburg, Ill., many policyholders have ignored safety recommendations made during site visits because in the soft market, this has little impact on pricing.

Back To Basics Cleaning up your act before you buy insurance can affect the premium significantly. Every risk dollar that is avoided or reduced will sink directly to the bottom line.

Consider: * Choosing an insurance broker who is both experienced in working in the industry during hard markets and intimately familiar with your company. This may mean teaming your trusted local agent with a specialty underwriting managing general agency.

* Ensuring that trucks and equipment comply with regulatory and industry safety requirements. Having a company caught up in one of the target enforcement activities, such as the recent "TrashNet" in Pennsylvania, will earn negative points with underwriters.

* Ensuring that employees, especially drivers, have been trained in the basics. Better yet, hold a refresher course prior to discussions with your underwriter.

* Verifying that waste transfer companies to whom you subcontract are running properly maintained equipment, drivers are trained and waste shipment documentation is maintained. If your company is the one performing these services, be prepared to demonstrate this performance to your clients.

* Ensuring that all Occupational Safety and Health Administration (OSHA), Washington, D.C., recommendations made to your organization, especially those needed to abate a violation, are implemented.

* Ensuring that operations that have lower risk are distinguished from those with higher risk. For example, tell your underwriter whether your collection fleet includes both automated and manual trucks.

* Asking for a consultation if the insurance carrier provides loss control services, especially if you are uncertain which actions will produce the best results. Of course, implement the specialists' recommendations where feasible.

* Reinvigorating safety incentive programs that may have been cut back in light of productivity bonuses.

* Consulting industry best management practices, using such documents as the Environmental Industry Associations' "Manual of Recommended Safety Practices."

* Ensuring that your loss runs are current. Present corrective actions taken to handle a serious or catastrophic loss. Be careful when making contractual arrangements that place the company or organization in an indemnity or "hold harmless" situation. Also consult a broker to determine how this may affect premiums, before making a commitment to your customers.

* Having your safety and loss control actions documented so that the underwriter can feel confident that your program is being effectively implemented and managed.