RISKVUE ARCHIVE | RISK BITES

Watch For The Weakest Link In Your Insurance Chain

By Robert J. Hennessey

The economic impact of the September 11 terrorist attacks on the insurance industry is unprecedented. Current claims estimates from the attacks vary from $30 billion to $70 billion — with most analysts putting the figure between $50 and $55 billion. Even the lower end of that range would be twice the losses from Hurricane Andrew in 1992, which to date is the largest insured loss for a single event.

What do losses of this magnitude mean for the insurance industry? Profound concern. The markets for business insurance already are seeing substantial changes, including higher rates of as much as 20% to 25%; and stricter underwriting, including the elimination of terrorist coverage.

One critical part of the insurance market is reinsurance. In an early post-attack overview of reinsurance, Morgan Stanley warned of insolvencies. With the announcement of the liquidation of Carolina Reinsurance Limited, Morgan Stanley’s prediction seems to be coming true.

When Morgan Stanley made the prediction, it clearly stated that blue chip reinsurers, such as General Re/Berkshire Re and Munich Re, would weather the storm—but less well capitalized reinsurers were the ones to watch. As evidenced by Carolina Re’s losses, which are estimated between $2.3 billion and $3 billion, less well capitalized reinsurers had huge losses from September 11.

The fate of reinsurers should be the subject of substantial concern to business policyholders. That is because reinsurers commit themselves contractually to reimburse primary insurance companies for losses they have assumed on behalf of their policyholders. In return, the reinsurers receive part of the premiums paid by policyholders. In many instances large portions of the insurance risk is assumed by the reinsurers.

For example, in the last large liquidation in the State of Minnesota, the primary insurer had policies of insurance up to $10 million, but retained only $250,000 of the coverage risk. The remaining amounts were subject to elaborate reinsurance contracts that involved more than 130 different reinsurers.

The commitments reinsurers make to primary insurers are only as good as the solvency of those reinsurers. When reinsurers become insolvent, the financial health of the primary insurer also might become questionable because its obligations to policyholders remain. Obviously, such a situation can lead to insolvency of a primary insurer. If the failure of a reinsurer results in the failure of a primary insurer, the effect on the policyholder’s covered claim could be disastrous.

The payment of claims from an insolvent insurance company is an assessment-based system in which all of the companies that do business in the state fund the payments up to the maximum provided by law. Although the system is called the “guaranty fund system,” it does not mean that all claims are covered. The amount of the coverage varies throughout the United States ranging from $100,000 to $500,000 per claim.

In addition, many states have net worth provisions that might disqualify businesses from making a claim under the system. A review of the myriad of state guaranty fund laws makes it clear that this system does not provide sufficient insurance protection for most businesses.

Consequently, those buying business insurance coverage must pay close attention to the financial strength of the reinsurance companies that stand behind the primary insurer. Risk managers must ask questions they probably have not asked in the past, such as who are all the reinsurers for the primary insured firms and are they all solvent? The best method of inquiry is through your broker. He or she can consult the various rating services that analyze reinsurance companies and determine whether the reinsurers are A, B and C companies, among other types of ratings.

If the reinsurance solvency is questionable, get backup or replacement coverage. Failing that, shift insurance policies to primary insurers that are financially strong and that have reinsurers that are just as strong. No weak links in the chain. 

ABOUT THE AUTHOR

Robert J. Hennessey is a partner at the Minneapolis law firm of Lindquist & Vennum. For more than 20 years, he has been counsel for state-appointed liquidators in insurance matters. He was counsel for the special deputy liquidator of Excalibur Insurance Co., the last major liquidation of a casualty insurance company in Minnesota. His e-mail address is rhennessey@lindquist.com.

riskVue | The webzine for risk management professionals
February 2002