This Isn’t Your Grandfather’s Risk; This Is the Risk Revolution

By | December 20, 2004

In insurance parlance “risk” used to be a fairly well defined term. There was a risk the building would burn down or the ship would sink. But things change, and, as the street knows all too well, the concept of risk has metastasized into a virtually limitless array of perils.

Risk management has become a mandatory department in nearly every U.S. enterprise. Eighty percent of U.S. companies now have at least a risk manager, if not a full staff. These functions are expanding because the nature of “risk” is expanding.

“Gotcha’ risk” is the first and still most fertile area. One can imagine an underwriter at Lloyd’s back in the 19th century asking: “What do you mean the ship was carrying gold? We thought its cargo was cotton.” Gotcha! The preposterous verdicts that frequently issue from American courts are another constant source of Gotcha’ risks.

Asbestos is also a good example of the more modern application of the Gotcha’ risk. Perfectly ordinary products liability and workers’ compensation policies, written years ago, suddenly transform themselves into hydra-headed liabilities, stretching into the future. As the companies who made the offending products head en masse towards the bankruptcy courts, the insurers that wrote the policies, or frequently their successors, are increasingly holding the bag for the ongoing losses.

Another good example is medical malpractice. A recent article on Insurance Journal’s Web site (Nov. 1) noted that doctors at several Maryland hospitals, who are fed up with rising medical malpractice insurance costs, are considering doing without the coverage, or “going bare.” While the very image of a gaggle of naked doctors cavorting through the halls of Maryland’s hospitals is enough to frighten anyone, the companies that insure the hospitals have an additional reason to be concerned. They will inevitably be paying the judgments that the naked doctors may incur. Another Gotcha’.

Then there are, for want of a better term, “round robin risks.” These are the kind that feed the litigation food chain. They usually start with a court case and a verdict against the defendant who is represented by an insurance company, who also ultimately pays the judgment. But it doesn’t stop there.

More lawyers, seeing an opportunity, bring more claims and lawsuits and more money is lost. Eventually the insurer has to increase reserves and capital to meet regulatory requirements and remain in business. The ratings are lowered; the stock price slides, and presto, a whole new set of lawsuits is filed against the company because it failed to properly disclose its financial problems, and people lost money on their investments, or their pension plans.

The “spirals,” which used to affect the reinsurance industry fairly frequently, are a related example. Reinsurer “A” assumes a large risk, and in turn reinsures it with reinsurer “B,” who then further reduces his exposure by reinsuring part of it with reinsurer “C,” etc. As blanket treaties pass on most of these risks automatically, they are hard to follow–until a loss claim is made. Then reinsurer “A” may find he has assumed back a large portion of the loss that had supposedly been reinsured.

Closely related to the round robins are “Morton’s Fork Risks.” The expression, Morton’s Fork, relates to a tax collection strategy developed in 1487 by John Morton, Henry VII’s Lord Chancellor. “Morton’s Fork Risks” occur when a company is faced with two equally unpalatable alternatives. A good example is a suit against a policyholder for an auto accident involving a whiplash, or other soft tissue injury. The plaintiff is seeking a large amount of damages–say policy limits–but the claims adjuster thinks he’s faking the extent of the injuries. Do you pay the exorbitant amount, or do you deny the claim and risk paying an even bigger amount when you get sued for bad faith? Morton’s Fork indeed.

Another, more subtle, example involves the cycle. Primary insurers and reinsurers have been almost unanimous in chanting the mantra of making profits on underwriting, observing sound risk management, and rejecting the urge to cut rates to gain or hold on to their market share. Along comes one of your biggest customers, and says he can buy coverage a lot cheaper through someone else. What do you do?

Then there are the world shattering or “900 pound gorilla” risks. One of the most incisive descriptions of these came from Chubb’s Vice Chairman John Degnan at last year’s PLUS conference in Philadelphia, who said simply, “terrorism is an un-underwriteable risk.” An insurance professional of Degnan’s experience knows full well that there are simply some risks the industry can’t handle. Some, like terrorism, can’t be modeled, priced or predicted. Others, like earthquakes, floods and hurricanes, are simply too costly for the industry to bear the entire loss.

Either way they are to a greater or lesser extent, “un-underwriteable.” Losses due to wars, civil disturbances, etc., have long been in this category. Now governmental bodies such as the California Earthquake Authority or National Flood Administration are stepping into other areas as well in order to assure coverage.

Professional liability (E&O) coverage for the big accounting firms is rapidly edging into this category as well. As new regulations, such as Sarbanes-Oxley, require ever more financial disclosure, company directors and officers and their accountants are ever more at risk of having left something out, or of having misstated something. An ever-increasing number of law firms wait breathlessly to pounce on any such errors of omission or commission.

However, this is not really another screed against the trial bar. The U.S. legal system has developed into what it is today over more than 200 years, and it’s not going to change appreciably. Plaintiffs’ lawyers and defense lawyers are an integral part of that system. They’re simply doing what they’ve been trained to do. Boys chase girls; dogs chase cats, and trial lawyers chase insurance companies. As the concept of risk keeps expanding, the street should expect to see even more chasing going on.

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Insurance Journal Magazine December 20, 2004
December 20, 2004
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