Edition: September 2002 - Vol 10 Number 09
Author: Mark Thill
In June, ARC Medical, a Scottdale, GA-based manufacturer of humidifiers, got an unpleasant surprise. When renewing the company’s product liability insurance, ARC’s Office and Accounting Manager Mindy Graham learned that premiums would multiply and coverage limits would decline. Was it because ARC had a poor loss track record? No.
What happened was that ARC fell victim to what those in the insurance business call a “hard market.” In such a market, coverage is hard and sometimes impossible to find. That which is available is expensive.
Virtually everyone – not just medical products suppliers – is feeling today’s hard market. From construction firm owners to homeowners to automobile owners to doctors seeking malpractice insurance, American businesses and consumers are feeling the pinch.
In ARC’s case, its previous insurer – Chicago-based CNA, the nation’s fourth largest commercial lines insurer – exited the product liability business altogether. So, President Hal Norris and Graham were forced to look elsewhere. They did find a company willing to take on ARC, but their premiums quintupled – and that’s minus some umbrella coverage which ARC had had before. Though ARC primarily sells direct, it does sell through distributors for some JIT accounts. But at press time, at least one of those distributors was waffling over whether it would accept the company’s new, reduced coverage.
“We’re certain we’re not the only company who has given them this kind of challenge,” says Graham.
Stock Market’s Role
No doubt the events of Sept. 11, 2001, were punishing for insurers. In fact, Insurance Services Office, a Jersey City, NJ-based company which compiles statistics on the industry, estimates that the ultimate cost of the terrorist attack will be $50 billion, handing U.S. insurers $25 billion in net underwriting losses. But Sept. 11 only exacerbated an already bad situation.
“The insurance industry is a very cyclical industry to begin with,” explains John Liberty, vice president of marketing for Cushman Insurance, Herndon, VA, which writes coverage for medical product liability and other markets. “It goes through hard and soft markets. During a soft market, insurance companies are vying for market share. They’re a lot more liberal in terms of the types of risks they’re willing to write, and their pricing is more competitive.”
Soft markets often coincide with bullish stock markets. Conversely, hard markets coincide with poorly performing markets, as the current one.
“When the insurance companies can get 35 or 40 percent return on investment, all they want are premium dollars,” says Mike Fate, sales executive with Schifman, Remley & Associates, Mission, KS. The agency writes more than $50 million in commercial property and casualty business, a sizable percentage of which is in the medical business.
“They will write border-line risks to get premium dollars. For the past few years, the stock market has been going south. When this happens, the insurance companies can’t make astronomical returns. They have to get back to the basics and do what they were supposed to be doing in the first place – writing and underwriting insurance. When they just wanted premium dollars, they assumed risk they might not have otherwise.
“Then, when the market changes and it’s now a couple of years later, they have different underwriters, who look at the business and ask, ‘What are we doing writing this kind of business?’” So, they make the decision, ‘We won’t participate in this segment.’ They may even start canceling policies by segment.”
The St. Paul Companies, St. Paul, MN, recently made one of those momentous decisions about which Fate speaks. Facing a 2001 underwriting loss of $940 million from its medical malpractice business, the company pulled out of that segment of the business in December 2001. (However, St. Paul remains a provider of medical product liability insurance, though premiums are about 20 percent higher than they were a year or two ago, says Jon Farber, assistant vice president of the company’s technology business unit.)
By no means does this cycle affect the medical industry alone. “It filters down to every segment of the industry, whether it be automobile liability, workmen’s compensation or something else,” says Fate.
Jaxon White, president and CEO of Chantilly, VA-based Medmarc Insurance Group, refers to what has occurred in the recent past as a “hypnotism in an investment market that still made [insurers’] results look great.” In a phenomenon known as cash flow underwriting, the insurer collects cash, puts it in a favorable investment mix, and worries about underwriting profits another time. Medmarc is a mutual insurance company launched in 1979 by the Health Industry Manufacturers Association (now AdvaMed).
But sooner or later, reality hits. In today’s case, it’s a horrific stock market. Insurers’ loss ratios – that is, the amount of outlay for claims against premium dollars collected – get worse and worse. So bad, in fact, that the property/casualty insurance industry recorded its first-ever net loss after taxes in 2001, stemming from underwriting losses and deterioration in investment results, according to ISO. The stats tell the story:
• The insurance industry lost $7.9 billion in 2001, after earning $20.6 billion in 2000.
• The industry's net loss on underwriting after dividends to policyholders ballooned 69.7 percent to a record $53 billion in 2001 from $31.2 billion the year before.
• The industry's statutory combined ratio — a key measure of losses and expenses per dollar of premium — worsened by 5.9 percentage points to 116 percent last year from 110.1 percent in 2000. The combined ratio for 2001 was the third worst on record.
What do insurers do in such a situation? They bail out of some lines and collect more premium dollars while offering less coverage on others. In other words, they play catch-up.
“You will find consistently that any commercial insurance carrier – and this is happening in personal lines too (your auto insurance, for example) – react somewhat after the fact,” says White. “We don’t know our loss experience for a number of years. We can approximate it, but we don’t know it for sure, because claims take a long time [to award]. We now know that our 2000 and 2001 pricing was inadequate to generate a modest profit for the company. We don’t get that back in one year, but over a period of years, by incremental rate increases.”
Being a mutual company, owned by its policyholders, Medmarc strives to keep a balance between investment and premium income, avoiding the highs and lows that other insurers experience, says White. Consequently, while its loss ratio hasn’t been great, it hasn’t been as bad as some commercial insurers. “You won’t find one of our policyholders who got a 100% rate increase,” he says.
But other insurers may try to catch up quicker, hence the 200-500 percent increases that one hears about. And the medical industry is an easy target, given its inherent and, perhaps even more important, perceived risks. There’s another factor at work too – today’s litigious society.
“At the end of the day, product liability losses are more costly than they were five years ago,” says White. “It goes back to our tort system. And this isn’t isolated to medical products. Large, class actions are one of the big issues out there. The cost of the business is high, because the tort system in the United States is very generous – some would say overly generous – on the pain-and-suffering issue. You can compensate someone for medical expenses and lost wages, but when you get into pain and suffering, there’s no limit [as to what can be awarded].”
Can medical products manufacturers and distributors find coverage? If so, where?
“If there is a desperate situation, it’s not surfacing among our underwriters,” says a confident White. “We believe that most manufacturers and distributors of any significant size have access [to product liability insurance] through the retail brokerage network,” continues White. He concedes that some companies may be unable to buy coverage, but “probably because they don’t have a good story to tell, or they’re not convinced they have to pay that much to get coverage.”
Cushman Insurance’s John Liberty says that somewhere between 5 and 10 percent of his company’s medical products clients have had their applications rejected. And some companies – such as those that repair medical equipment – are facing even tougher times.
In such a market, insurers turn to what are called “excess and surplus” carriers. Unlike standard market carriers – which are licensed to do business within a particular state and as such, are subject to state guarantee funds – excess and surplus carriers are not subject to the state guarantee funds. They often offer more flexibility in coverage and pricing decisions, he says.
But there is a caveat. If, for some reason, a standard market carrier is unable to meet its financial obligations (in other words, can’t pay claims), the state guarantee funds step up and do so. But if an excess and surplus carrier cannot pay claims, the insureds are left holding the bag.
“I spend 95% of my day working on insurance matters for medical equipment companies,” says Liberty. “And I know of some competitors who spend that same kind of time doing the same thing. I know they’re all scrambling. But when the capacity to write [policies] simply isn’t there, it’s very frustrating. I’ve been in the insurance industry since 1984, and I can say that the last year has been the most frustrating time in my entire career, because we’re dishing out a lot of bad news to people.”
Adds Mike Fate, “Numbers always help. If you have a number of businesses with millions of dollars of premium offered to an insurance company vs. $50,000, the insurance company has what’s called a spread of risk and can be more flexible. Another factor is that some insurance companies might have more expertise or comfort level [with particular manufacturers] than others. Or maybe they already write a number of manufacturers with similar products.
“Our job is to dig and scratch and find those companies. The problem is, it changes almost daily. What somebody did last week doesn’t mean they’ll do it this week. That’s the chaos. It’s stressful. Underwriters have stacks of files on their desks, and they can only do one at a time.”
What to Expect
“How long will the cycle last?” asks Fate. “That’s the 64 million dollar question. I envision another couple of years. I don’t think rate increases will be as drastic as the first go-around. We’re probably already 18 months to two years in this insurance cycle. People have already had one renewal, and some possibly two. As insurance companies get comfortable with their book of business, the rate increases won’t be as dramatic.”
Adds Liberty, “You can almost guarantee that at some point in time in the future, the pendulum will swing back. Prices may not go down, but they won’t go up meteorically, like they have. And more companies will get back into [the products liability business]. It’ll be much more competitive.
“It’s frustrating to us who are agents in the field,” he continues. “In most other industries, clients can accept and budget for a 5 or 10 percent cost-of-living price increase every year.” But in the insurance industry, clients can see premiums rise exponentially almost overnight, as insurance companies try to make up for consecutive years of losing money, he says. “The insured is the one getting slapped real hard. But if the past is any indication, the pendulum will swing at some point in time.”