NAKED CAME THE INSURANCE BUYER Going bare is the term for getting along without property and casualty coverage. In a litigious world it's a chilly, unwelcome experience for corporations. But a sudden sellers' market has made commercial insurance a hard-to-get, expensive-when-you-can item.
By Carol J. Loomis RESEARCH ASSOCIATE Cynthia Hutton

(FORTUNE Magazine) – INSURANCE COMPANIES have more than one way of refusing your business, says Norman S. Wintemute, who buys coverage for BankAmerica: ''They can simply say no. Or they can quote you a fantastically lousy price.'' BankAmerica has met both kinds of rejection in the last few months and so have hundreds of other corporations. With a suddenness that has astounded and horrified corporate buyers, the market for commercial property and casualty insurance has turned wicked. Premiums have risen broadly and, for some types of coverage, are up enormously -- by 300%, 500%, even 1,000%. The availability of insurance, nevertheless, has sharply contracted. Many corporations do not have as much coverage as they would like, and for some kinds of potential losses have none at all. In insurance parlance that leaves them ''going bare,'' and most seem appalled at the exposure. In the past the insurance industry, that spreader of risk, has been the fallback in most corporate disasters. Union Carbide, for example, is believed to have $200 million of coverage for the tragedy at Bhopal, India -- an amount of uncertain adequacy but balm nonetheless. Bhopal, however, qualifies as ''sudden and accidental pollution,'' a type of coverage now extraordinarily difficult to buy. The probability of a large corporate loss that is not covered by insurance, or only covered meagerly, thus increases daily -- as does corporate dread of the event. ( The dread is particularly great because most corporations have grown in recent years to want more insurance, not less. Asbestosis, toxic waste, the general litigiousness of society, the tendency of judges and juries to reinterpret the legal doctrines of negligence and fault -- all these have driven home the need for bountiful insurance protection. And now it's in scarce supply. Rivers of tears for the buyers are not totally justified. The property and casualty business is relentlessly cyclical, and for five years before the market turned last year, corporate customers enjoyed a hotly competitive, ever-softening market. Originally, insurers cut prices to haul in premium dollars they could invest at the high interest rates that prevailed; ultimately, they scrambled for premiums to cover the claims rolling in from the bad business they had underwritten. In that leg of the cycle, prices for commercial insurance fell in some cases by 50% or more. The corporate folk who buy insurance -- called risk managers -- knew prices were absurdly low. But few argued for a return to sanity, naturally, and some abandoned their traditional suppliers to shop for the cheapest prices around. They are now riding a ricochet. A threefold rate increase sounds punitive; but if the base rate is one-third what it was at the last peak -- and such cases exist -- the rise is no more than restorative. WRETCHED RESULTS for the insurance industry in 1984 -- around $3.5 billion of pretax operating losses -- produced the ricochet (see chart). Reinsurers, who assume some of the risks that primary insurers underwrite, finally forced the end to the soft market. Throughout the year the reinsurers jacked up premiums and retreated from some lines of business, putting pressure on primary insurers to follow suit. Then, on December 3, came Bhopal, rocking the market just as insurers, reinsurers, brokers, and customers were negotiating renewals for the great number of commercial policies and reinsurance treaties that expire on January 1. Using a metaphor that is unintentionally ghoulish, one broker says Bhopal ''put the last nail in the coffin'' and ''scared the living wits out of reinsurers.'' A tight, tough sellers' market promptly materialized and has worsened since. The most tangible part of the problem is the increase in premium rates, which is wrecking corporate budgets approved last fall. The risk manager of a major financial services company says his expenditures in 1984 for insurance -- 65 & different packages of it -- were about $8 million. For 1985, anticipating some tightening in the market and wanting if anything to overestimate the bill, he budgeted $10 million. ''Today,'' he says, ''it's looking like $24 million or more. We're writing the numbers on plastic now, with crayon, so they'll erase easily.'' For their money, companies are getting substantially less coverage, at both the top and the bottom, than they got in 1984. At the bottom, businesses are taking higher ''retentions'' -- deductibles, so to speak. At the top, where the slice is thicker, businesses have lost the high dollar limits they prize as protection against catastrophes. Why, given the law of supply and demand, aren't the high limits available at a price? Maybe they are. Perhaps the buyers just haven't yet begun talking prices that would bring the supply out. But another explanation is the so-called capacity problem, a creature of insurance regulation. Trying to make sure that policyholders' claims can be paid off, state insurance departments judge the soundness of insurers on easily measurable criteria. One, called the risk ratio, relates net premiums written (new and renewal premiums minus those passed on to reinsurers) to an insurer's surplus, roughly equivalent to net worth. The rule says that the premiums-to-surplus ratio should not be more than 3 to 1. The ratio puts a crazy kind of ceiling on insurers during a tight market. They usually enter such a period with surplus depleted, driven down by losses. Were they to choose the most obvious means of getting well -- the pursuit of every premium dollar possible -- they would soon have a risk ratio unacceptable to the regulators. Consequently, the insurers plead ''capacity constraints'' to their customers and do not write all the business they can get. They also turn conservative in their choice of what types of risks they will insure. Says Robert Clements, president of the insurance brokerage firm of Marsh & McLennan Inc., ''When you have a great contraction in the market, the industry first leaves the area of unpredictable risk.'' The exodus is speediest from ''excess'' coverage that companies seek atop their primary insurance policies. An example is earthquake insurance, on which insurers have done an abrupt about-face. In the soft market, a company could secure $300 million or $400 million of excess quake coverage with ease. It could also get the excess, says broker Daniel Batonick of Johnson & Higgins, almost as a freebie, tossed in with other kinds of property coverage. The probability of a U.S. earthquake cannot be much greater this year than last. Yet today $100 million of excess coverage is about the most a buyer can pull together. ''Even with a blank check, we may not be able to get more than that,'' says Helen Terry, risk manager of Equitable Life, a big owner of California real estate. Terry figures the insurers, focusing on the immensity of their exposure, ''finally began to notice how much at risk they are.'' High limits are also vanishing from the liability policies that cover such professionals as doctors, lawyers, accountants, engineers, and architects -- prime targets of litigants these days. Accounting firms, for example, have proved exceedingly vulnerable to suits charging that they wrongfully gave clean opinions to clients later revealed to be dishonest or financially in deep trouble. Since 1980 the biggest accounting firm, Arthur Andersen & Co., has alone paid out $137 million in judgments and out-of-court settlements and faces many other suits. In what could be a monster case for Alexander Grant & Co., one of its partners is caught up in the litigation involving ESM Government Securities, a Florida dealer charged with defrauding customers. Lloyd's of London writes most of the accountants' liability insurance and has grown highly nervous about the profession's exposure. Taking steps to reduce its own, Lloyd's just renegotiated policies with a number of Big Eight accounting firms, lowering their limits by about 35%. Accountants won't say what the new maximum is, but a reasonable guess is $125 million or so. U.S. money center banks also insure with Lloyd's, long the principal provider of the fidelity bonds the banks need as protection against robberies, embezzlements, and other crimes. The lead underwriter in this business is Lloyd's Merrett group, which manages several syndicates of investors. Hit lately by heavy losses (most arising from the dishonesty of bank employees), Merrett first considered withdrawing from the business, but instead imposed higher deductibles on the banks. A couple of years ago deductibles of $2 million or less were common. The norm now is $10 million and Merrett is pushing for $25 million -- what Marsh & McLennan broker Walter S. Tomenson Jr. calls ''Merrett's comfort level.'' The banks have run into bigger problems in the excess market. At the moment, $150 million of coverage is about the maximum available to a money center bank and limits that big are an endangered species. Financial institutions of all kinds were shocked in March by a sudden announcement from Fireman's Fund, a subsidiary of American Express, that it was canceling all fidelity policies written for financial institutions and would write no more. Fireman's Fund had been a major player in the excess market, able to write a $50-million layer of coverage for a single buyer. But losses on the business had been large and in its announcement Fireman's Fund said it saw neither vigilant screening of risks nor pricing as a solution -- so goodbye. The rejection of pricing as a cure suggests the company may have also felt hobbled by its premiums-to-surplus ratio, which at year-end 1984 was nearly 3 to 1, against the industry's average of only 2 to 1. Companies needing pollution coverage find themselves in the ultimate sellers' market. Growing apprehensive in the early 1970s about pollution liability, the insurance industry divided coverage into two kinds. Coverage for sudden and accidental pollution was included in the general liability policies that businesses buy; it is meant to take in a Bhopal, as well as such occurrences as the spillage of toxic chemicals from an overturned truck, the accidental discharge of harmful effluents into a stream, or an explosion in a manufacturing plant. The second kind of coverage, known as environmental impairment liability, is written under a separate policy and is intended to cover gradual pollution, such as the seepage of buried toxic wastes into underground water supplies. Under Environmental Protection Agency rules, companies handling toxic waste must have both environmental impairment and sudden and accidental insurance, or the financial strength to handle the claims on their own. But the insurance industry considers environmental impairment risks unmeasurable and therefore uninsurable. You cannot make insurance companies commit suicide, and today almost none are writing environmental impairment policies. At the annual convention of risk managers in April -- held, appropriately, in the city of funereal blues, New Orleans -- one speaker, broker Robert M. Grella of Alexander & Alexander, named the three suppliers remaining in the market: American International Group; St. Paul Fire & Marine; and Pollution Liability Insurance Association, a consortium. None, Grella said, could offer a buyer more than $10 million of coverage. A speaker from St. Paul Fire & Marine, Kenneth F. Goldstein, contributed further qualifiers, among them his yen to contain risks by doing business only with relatively small companies. Said he: ''We're not looking for FORTUNE 1,000 accounts.'' In the other part of the environmental market, meanwhile, the courts have been redefining sudden and accidental pollution to include the gradual variety. Robin A. G. Jackson, a director of Lloyd's Merrett Syndicates, describes the courts as having ''driven a horse and cart through the sudden and accidental wording,'' making it ''foolhardy'' to continue to provide that coverage. Agreeing, the U.S. industry is scheduled to move in January to a standard general liability policy that will specifically exclude most forms of pollution coverage. Many insurers have already stopped writing sudden and accidental. It can be had, says Grella of Alexander & Alexander, but not easily. THE PROSPECT of going bare in this danger-laden area frightens many corporate executives, among them Gerald A. White, chief financial officer of Air Products & Chemicals of Allentown, Pennsylvania. White counts himself lucky to have renewed his general liability policy last September, before the crunch. He's covered for sudden and accidental, but he worries that the coverage might not be renewable next fall, when many forecasters expect an even tighter market than now. ''What we have here,'' says White, ''is a major, major problem for industry. It's not just chemical companies, it's everybody.'' In April, Air Products sold $100 million of bonds in an offering managed by Goldman Sachs and Shearson Lehman Brothers. As they must, the underwriters went through the ''due diligence'' process with White, digging for information that might have to be disclosed to investors. Considering the major problem that insurance has become for corporations, did the underwriters quiz White about Air Products' coverage? ''No,'' he answers, recognizing the irony, ''they never mentioned insurance.'' Risk managers are searching madly today for solutions to the problems of high premiums, high deductibles, low limits, and making-the-boss-und erstand- why-all-this-is-happening. For some companies, one approach to the deductibles could be to relax and regard them as logical. They are a limited form of self- insurance (the industry's euphemism for no insurance), and many companies can easily handle the added risk. In the eyes of some buyers high deductibles are perfectly affordable but unfortunately apt to cause lurches in earnings. That's because accounting rules do not allow companies to gradually build reserves for anticipated insurance losses by making periodic charges to earnings. Instead, the companies must wait until the losses come along and only then charge off the costs. The rules do not promote smoothness in earnings, as premiums paid to an insurer do. In the last tight market, in the mid-1970s, captive insurance companies were the rage among corporations seeking to self-insure. But the Internal Revenue Service has since pared the tax advantages of captives, and some have also been economic disasters for their parents. Certain companies, however, still find special reasons to set up captives, and BankAmerica has just done so. Forced recently to take a $95-million write-off on overvalued mortgage securities for which it was trustee (FORTUNE, April 1), the company sued several of its own officers for gross negligence and also filed claims against the two insurers carrying its directors' and officers' insurance. One, First State, had earlier given notice that it was canceling BankAmerica's policy; it's one of many insurers cutting back on this type of coverage (FORTUNE, March 18). The other, Employers of Wausau, maintained that the policy did not cover the bank's action against its officers and canceled when the claim was filed. BankAmerica sued both insurers. Meanwhile its director of risk management, Wintemute, began searching widely for replacement coverage. But Wintemute ran into those two types of rejection: no and, from one insurer, an out-of-sight price. This presented a thorny problem: under the laws of Delaware (where it is incorporated) BankAmerica cannot reimburse its officers and directors if they are held liable for damages in suits brought on behalf of the company. They must be covered by an outside insurer. BankAmerica has created one, so to speak: a captive, based in the Cayman Islands. Wintemute says the captive will deal with the parent at arm's length and will thus be sufficiently independent to meet Delaware's requirements. But some bankers and insurance executives say it's all legal hogwash, since BankAmerica assets will be behind the captive. BankAmerica's directors and officers no doubt devoutly hope that this exotic solution can survive challenge. Otherwise, they are going bare -- a far chillier experience for a flesh-and-blood businessman than a corporation. Focusing on more conventional alternatives than BankAmerica has available, % many corporations are now intently studying the possibility of banding together to form captives. The scheme has worked in the past for certain industries denied coverage: Nuclear Electric Insurance Ltd. insures nuclear power plants against damage. Oil Insurance Ltd. (known as OIL, naturally) insures offshore drilling rigs. Today, the New York clearinghouse banks are considering the formation of a captive. Then there's ALAS and ALAC, midwifed by Marsh & McLennan, a whiz at acronyms. ALAS (Attorneys' Liability Assurance Society) was incorporated some years ago by law firms based outside New York City. ALAC (Accountants' Liability Assurance Corp.), just being formed, will provide coverage for medium-size accounting firms. MARSH & McLennan is now working to form ACE (American Casualty Excess Insurance Co.), by far its most ambitious undertaking. As visualized by Clements, the broker's president, ACE would be a $100-million or bigger stock corporation capitalized by insurers and their corporate customers. The company would specialize in excess insurance and would sell only to its owners (who might also cash in later through a public sale of the company). Clements thinks innovations such as ACE are essential if business is to get the coverage it needs: ''The loss of high limits of coverage is not going to be acceptable to corporations.'' The problem for any industry captive born out of dire need is that it is a refuge for parties that cannot get insurance elsewhere. That makes it a victim of ''adverse selection,'' in which it attracts more than its share of inferior risks; this can drive away prospective members. If you are a New York clearinghouse bank, do you really want to insure other high-wire acts just like your own? In a chaotic market like today's, all the questions are hard -- but answers will develop. Prices will surely rise further. Supply will surely increase. Outsiders will come in to add their capital; the industry will expand its own, partly through profits to be made in this market, partly through securities offerings that insurers are already scurrying to make. The imbalances in this market may, nevertheless, take time to correct, if only because buyers may have to be hauled kicking and screaming toward the prices necessary to clear a market grown paranoid about risk.