Businesses' Insurance Costs Surge,
But They Shouldn't Blame Sept. 11

TULSA, Okla. -- When Bennett Steel Inc., a small construction firm based here, went to renew its insurance coverage shortly after Sept. 11, President Dave Bennett got a shock. The total bill shot up more than $185,000 from a year earlier because of higher premiums for various policies: a 122% increase in umbrella-liability rates, 66% more for liability at job sites, and 51% more for vehicle coverage.

Already dealing with the impact of the economic slowdown, Mr. Bennett increased the number of employees he was planning to lay off, to 15, or 10% of his work force.

Businesses across the country have been forced to make similar adjustments in recent months as they confront rate increases of 100% or more on their insurance premiums. And that threatens to damp job growth at smaller businesses -- which traditionally create most of the nation's new jobs -- and thus possibly slow the economic recovery.

Insurers point to the estimated $50 billion in claims from the Sept. 11 attacks as a big reason for the rate increases. But Mr. Bennett and other business owners strain to see the connection. "It just doesn't make sense that it would hit us like that," Mr. Bennett says.

He's right. The higher premiums many small and midsize businesses hundreds of miles from New York City now face are the legacy of a decade of imprudence among insurers -- a period that combined a relentless price war with aggressive risk-taking. From 1993 to 2000, underwriters slashed rates, sometimes as much as 40%, and fought for customers by loosening terms on all types of business policies -- from directors-and-officers' liability coverage to medical-malpractice packages to workers' compensation insurance. For many businesses, that meant a boost to already-growing profits in a strong economy. (Rates for consumers dropped in the '90s, too, and have been rising lately, but the swings haven't been nearly as pronounced because of closer regulatory scrutiny.)

Insurers eventually reached the limit. By 1999, they were paying out, on average, $1.07 in claims and related expenses for every $1 of premium received on business coverage. During the bull market of the '90s, insurers could sustain these losses on underwriting because the shortfalls were more than offset by investment income the insurers earned on premiums.

Now financial markets have soured, and so have insurers' investment yields. The companies have also been hurt because claims on the cheap policies they wrote in recent years have come in much higher than they originally estimated -- optimistically, in the eyes of some critics. And all this was happening before Sept. 11. Some insurers haven't survived it all. And others are paying a steep price: For the fourth quarter, more than three dozen insurers reported a total of $5.4 billion in charges, mostly related to restructuring or boosting the amount of money set aside to cover claims beyond the impact of Sept. 11.

This mass action is an "industrywide confessional and rush to atone" for the aggressive practices of the '90s, says Alice Schroeder, a property-casualty insurance analyst with Morgan Stanley.

Indeed, risky lines of business that appealed to insurers several years ago now haunt them. For example, Cologne Re, a unit of Warren Buffett's Berkshire Hathaway Inc., took a $225 million charge in 1999 for losses on workers' compensation business it obtained through a complicated premium-sharing system. It involved one insurer after another taking a slice of the insurance pool, then passing a big piece of it along, each successive insurer receiving less premium and more risk. At the time, a Berkshire executive said the practice provided a classic example of an insurer operating "outside its area of expertise."

Selling to Enron

More recently, Chubb Corp. Chairman Dean O'Hare lamented $143 million in losses the insurer suffered on surety bonds it sold to guarantee delivery of natural gas by Enron Corp. "What happened with Enron is that our folks ... didn't know what they were writing," Mr. O'Hare wrote in a December letter to employees to help explain why they would be receiving no year-end bonuses. A Chubb spokesman says the company is disputing whether it is required to pay on some of the bonds it sold to Enron.

Now, the higher cost of insurance in more sober times is adding to pressure on businesses when they least need it. In a recent survey by the National Federation of Independent Business, rising insurance costs tied with taxes as the biggest problem facing small businesses. And these businesses feel the pain more than bigger ones. Among businesses with less than $100 million in annual revenue, about 3% of revenue goes to insurance, according to a study by the Risk and Insurance Management Society, which represents corporate-risk managers. For companies with more than $5 billion in annual revenue, the proportion is a much smaller 0.5% of revenue.

Rising insurance rates pose particular problems for places such as Tulsa. Today, the skyline of this city of nearly 400,000 people is dominated by the Bank of Oklahoma tower, designed by the architect who built the World Trade Center. The city once billed itself as the oil capital of the world, and the area was home to J. Paul Getty and Frank Phillips, founders of what became two of the world's largest energy companies.

Oil has remained a mainstay, but in the past decade, Tulsa shifted part of its economic focus to technology. That meant strong growth in the 1990s. Now, it means layoffs such as the 500 workers Williams Communications Group Inc. has shed since the start of the year amid a glut of fiber-optic capacity. Tulsa's unemployment rate stands at 4.5%, up from 2.8% at the start of 2001, though nearly a full percentage point below the national average.

A Sudden Switch

Among the many local businesses that benefited from low insurance rates in the '90s was Bennett Steel. Mr. Bennett's workers' compensation insurer, American International Group Inc., had been lowering its rates for several years. Then, in 1999, he switched to the Reliance Insurance Co. unit of Reliance Group Holdings Inc. for the coverage. It offered a premium that was $100,000, or 25%, less than his AIG premium.

Mr. Bennett's insurance broker of 15 years, Wally Bryce, of Arthur J. Gallagher & Co., tried to steer Mr. Bennett away from Reliance, arguing that it was weaker financially than other options. "That was the first time in umpteen years of doing business together that he didn't take my advice," Mr. Bryce says.

But Mr. Bennett had plans for the money he saved on insurance. He spent more than $50,000 on new trucks for Bennett Steel.

In 1999, Reliance, which had been as aggressive as the rest in cutting its rates and was now on shaky ground, promised Mr. Bennett a renewal quote but never got back to him. So Mr. Bennett turned to the state-sponsored workers' compensation insurer. He ended up paying premiums 30% higher than the Reliance coverage but still less than what AIG was now offering.

In 2000, the Reliance holding company, long controlled by financier Saul Steinberg, tottered after years of extravagant spending and big dividend payouts. Ratings of the Reliance Insurance unit's financial strength plunged, and Pennsylvania insurance regulators began to exert control over it, eventually announcing in October that they would liquidate its operations. It was part of a small shakeout among less-stable insurers. The same year, Superior National Insurance Co., a workers' compensation specialist, was seized by California regulators, and Pennsylvania regulators last year took control of medical-malpractice specialist Phico Insurance Co.

As weaker insurers fell, stronger ones were freed to raise rates without fear of losing market share. Last fall, Mr. Bryce delivered the news that Mr. Bennett would have to pay much higher rates to Tulsa-based Mid-Continent Insurance Co., which for more than 10 years has been Mr. Bennett's insurer for all coverage except workers' compensation. Mr. Bennett told the broker to show him something better. But only Mid-Continent, a unit of American Financial Group Inc., had submitted a serious bid. Most others simply declined the opportunity.

'Grossly Underpriced'

Mike Coon, a Tulsa-based senior vice president for Mid-Continent who handles Mr. Bennett's account, says part of the rate increase was due to claims Mr. Bennett filed last year. He adds that hefty rate increases aren't uncommon. Some new customers, he says, are being asked to pay more than triple the premiums they paid to their previous insurers. "There are companies who had rate levels that were 15% to 20% of what we would have charged," Mr. Coon says. "A lot of that business was non-renewed because it's been so grossly underpriced."

Mr. Bennett, a weathered 48-year-old Tulsa native with the meaty forearms of a fourth-generation iron worker, started his business in 1980 with four employees, "a bumper jack and a pry bar," he says. Now, it has 135 employees, including his wife and three of his sons, and operates a fleet of 21 cranes -- some valued at more than $1 million -- that erect university buildings, offices and warehouses. Annual revenue is now around $18 million.

The layoffs, the biggest in the company's history, hurt. "If I've got 150 people working for me, it's 600 people," he says, noting that a typical employee has several dependents.

In addition to letting go of 15 people shortly after Thanksgiving, Mr. Bennett cut some of his remaining workers' hours to 30 a week. Business had slowed. A construction contract with American Airlines fell through soon after Sept. 11. And the 32% rise in its insurance rates, Mr. Bennett says, made the cuts all the more necessary -- and deeper.

Throughout Tulsa, businesses public and private are trying to cope with the higher insurance expenses. Brad Frank, president of Tulsa Tube Bending, which bends metal pipes for industrial use, says his rates for property, product-liability and umbrella-liability coverage increased more than 20% when the company renewed Dec. 31. Mr. Frank has tried to absorb the cost increases by preaching efficiency to employees. He says a profit-sharing program at Tulsa Tube will motivate employees to, among other things, pay more attention to workplace safety.

"We were thinking about adding another person," Mr. Frank says. "But that's not part of our plan anymore."

Lloyd Snow, school superintendent for Sand Springs, a small town just outside of Tulsa, got news last July that rates would jump to $280,000 from $160,000. "Schools are seeing increases of 70% to 250%," Mr. Snow says. "It's been phenomenal."

Brent LaGere, chairman and chief executive of National American Insurance Co., which insures most of Oklahoma's school districts, says his company was passing on higher premiums from its reinsurer, a firm that helps insurers spread their risk. Mr. LaGere anticipates his company will need to increase rates further as reinsurers try to recoup losses from Sept. 11 and Enron's collapse.

The rate increases come as the state of Oklahoma is eliminating $194,000 from the roughly $15 million a year it sends to the Sand Springs school district as part of statewide budget cuts. "There will be services to kids that are reduced or lost," Mr. Snow says. Up to 87% of the district's budget goes to salaries of teachers, administrators and support staff, he says, so "increasing costs like insurance means cutting payroll." Sand Springs already has had to delay the purchase of school buses and desktop computers and has canceled an increase in the textbook budget.

Strength in Numbers

Mr. Snow says the rate increases have hit Oklahoma's school systems so hard that school districts are working on a plan to pool their insurance premiums and risks to make insurance more affordable. If that doesn't come together, "we're being told that we're looking at another 50% to 150% increase," Mr. Snow says.

Businesses and institutions that haven't yet paid higher insurance premiums are bracing for them. Valley View Regional Hospital, south of Tulsa in Ada, Okla., has a liability-insurance policy that runs until summer. But in December, Phil Fisher, the hospital's president, received notice that Valley View's insurer, St. Paul Cos., wouldn't be able to renew the hospital's medical-liability coverage.

St. Paul, the nation's largest writer of medical-malpractice insurance, with a 10% market share, decided to shutter its medical business altogether, after losing $940 million on it last year. St. Paul's medical-malpractice problems were emblematic of the impact of the insurance price war of the 1990s. Medical-malpractice insurance was the industry's most profitable line 10 years ago, and so many companies piled into it that they began underpricing their coverage. Then came rising jury verdicts in malpractice suits and higher health-care inflation. A St. Paul spokesman says the company is leaving the business because it doesn't believe it can make the line of business profitable.

Valley View's Mr. Fisher isn't sure who the hospital's insurer will be after its St. Paul policy expires next year, nor how much the insurance will cost. "Everyone is very reluctant to talk about that," he says. "But we need something. We need a marker somewhere along the line."

Write to Christopher Oster at chris.oster@wsj.com¹

Updated April 11, 2002 12:54 p.m. EDT