A year ago, workers' compensation reinsurance was covered but not underwritten. The events of last September changed all that, says Ronald Gift Mullins.

While the terrorist attacks of September 11 left widespread human tragedy and unprecedented insurance losses, they also dramatically and profoundly revolutionized the underwriting, pricing and availability of workers' compensation re/insurance.

Further, with almost all reinsurance contracts now excluding terrorism coverage for workers' compensation, without some back-up mechanism from the federal government any future catastrophes such as an earthquake or terrorist assault could bring many bankruptcies of businesses and primary insurers because of failure to obtain adequate workers' compensation reinsurance. And like dominoes, if too many companies have to fall back on residual market reinsurance pools, state funds or become self-insured and suffer enormous losses, the levies that state guarantee funds put on continuing insurance companies could cause even more collapses.

Workers' compensation is controlled by each state and requires that employers pay for work-related injuries and deaths. The system provides replacement income, medical treatment and vocational rehabilitation for injured workers. The specific benefits provided are defined by state law and are not determined by either the employer or the insurer. The employer pays the entire cost of this insurance.

Contrasting how workers' compensation re/insurance was written prior to September 11 and afterwards unequivocally confirms how extraordinary the transformation has been of this legally mandated insurance line.

Before and after
Prior to September 11, rates for workers' compensation cover were based mainly on type of business or activity and the employer's loss history. The location of a specific plant or building was not considered as a rating factor. Whether employees were scattered in several buildings or concentrated in a single high-rise was not considered relevant.

Up to the World Trade Center (WTC) destruction, nothing of the magnitude resulting from that attack had ever been contemplated by the workers' compensation re/insurance industry. Reinsurance was treated almost as an add-on. With few exceptions, reinsurers did no underwriting of the workers' compensation risks they assumed, depending instead on the primary insurer's collection of statistics and loss data on the risk. There were no exclusions for terrorism or any other kind of man-made catastrophe, except for acts of war, riot and insurrection.

Only the most rudimentary models had been developed to help underwrite the coverage. None approached the sophistication and comprehensiveness of the models devised for property underwriting following Hurricane Andrew in 1992 and which had been very much refined since then. Capacity within the re/insurance industry was perceived to be more than adequate for workers' compensation exposures and, coupled with fierce competition, rates were kept low and policy limitations light. A major market for workers' compensation reinsurance was the life insurance community, which reinsured the carved out accident and death portions of the policies.

Then came September 11. Greg Heidrich of the Alliance of American Insurers (AAI) said that the terrorist attack produced not only the largest catastrophe loss ever for the property/casualty insurance industry, but also, "an unprecedented convergence of coverages with simultaneous, massive losses in the workers' compensation, commercial property, business interruption, liability, life and other lines of insurance, creating a previously unimaginable combination of huge losses from widely divergent lines of insurance; and the spectre that future terrorism losses of even greater magnitude are possible and perhaps even likely."

The WTC toll on workers' compensation writers and reinsurers is estimated at around $3.5bn, but it will take years before the final costs are known. At the end of March 2002, the New York Workers' Compensation Board reported that more than 5,600 workers' compensation claims related to the attack had been filed. Of those, 2,200 involved the death of a worker, which represents four to five years of `normal' annual death claims in the state of New York. About 3,400 were claims for medical care and disability. Almost 2,365 New York claimants were receiving wage replacement benefits from workers' compensation insurance or from self-insured employers.

On top of these figures are the policemen and firefighters affected by the attack, who are covered under city and state programs. People injured or killed in the Pentagon attack are covered by a federal program.

In the aftermath of WTC, reinsuring workers' compensation became a serious business, holding the potential for producing extraordinary losses. Concerns over biological attacks, such as the anthrax attacks that occurred late in 2001, and threats such as a smallpox outbreak, also raised new questions for workers' compensation re/insurance companies. The possibility of having massive claims across multiple lines - property, workers' compensation, business interruption and general liability - brought cold chills to the re/insurance industry. Prior to 1 January 2002, the reinsurance community decided that new and renewal contracts would exclude coverage for acts of terrorism and damages arising from nuclear, biological and chemical exposures

This put primary writers in a painful bind. While they were permitted to exclude terrorism coverage from most lines (except in New York, Texas, Georgia, Florida and California), they had to include terrorism coverage for workers' compensation insurance. As 2001 ended without any agreement on a federal reinsurance plan, and little if any reinsurance protection for terrorist acts available from the private market, many insurance companies began to consider dropping this line of insurance altogether, or writing only a limited, manageable amount. Terrorism coverage was available on a very limited basis, but premiums were sky high.

Rates for workers' compensation, which had been increasing slowly since 2000, started to soar as underwriters began insisting on stricter criteria and demanded increased geographic and ergonomic data before accepting a risk. Employees in factories or on construction sites, once considered the most likely workforce to sustain injuries and therefore losses, now were replaced by "white-collar office workers in large urban areas where a terrorist attack would have the greatest impact," said Nancy Schroeder of the National Association of Independent Insurers.

Paul Japp of Swiss Re Underwriters Agency Inc said that cedants now were providing a lot more information that was focused on employees, their working hours, locations and types of buildings. He said collection of data would become more sophisticated over time, but that it was still difficult to obtain it in some cases.

Hazard groups have become less interesting in the evaluation of workers' compensation exposure, according to Seth Ruff of Swiss Re Underwriters Agency Inc, and more emphasis is being placed on the potential for mega, multi-claimant occurrences, the non-modeled perils. This is the `Armageddon' factor - earthquake, terrorist event, explosion and suchlike - that can send losses into the $100m layer.

With tighter underwriting criteria and a reduction in workers' compensation insurance capacity, early in 2002 ratings agency Standard & Poor's (S&P) reported that since September 11, minimum premium increases were in the 30% to 50% range, but for companies with negative loss experience, hikes of 50% to 75% or even 100% were normal. Don Watson, then of S&P's financial services ratings group, said: "We are seeing insurers pulling back from workers' comp, and I think there will be more of that as they conclude how difficult it is to write. Insurers are thinking, `If government's not going to backstop me and reinsurance is not going to apply to terrorism, I have to limit my exposures.' That's going to drive rates up even more."

According to a survey by the Council of Insurance Agents and Brokers, as of 1 July 2002, commercial insurance rates for mid- and large-sized companies rose, on average, between 20% and 50% over the previous three months. For workers' compensation, rate increases of from 20% to 30% were cited by almost a third of the brokers and agents responding. About 2% said increases of more than 100% had been noted. A significant number of brokers surveyed reported that some insurers had suspended writing new business entirely, while others were rejecting accounts that were not `squeaky clean.'

John Gilbert, the president and CEO of New York-based reinsurance broker Holborn Corp, said the market for the accident and death benefits of workers' compensation dried up at the end of 2000, because the life insurance companies that had been big players in the field began to withdraw. He said one of the main reasons for the life insurers' retreat was the huge losses they suffered from the Unicover debacle in 1999. "Capacity fell from $600m in early 2000 to between $40m and $80m today," he said.

"Prior to 9/11," said Linda Johnson, of reinsurance broker Benfield Blanch, "workers' compensation catastrophe reinsurance was written and priced without a true appreciation for its exposure. The greatest change that has resulted from the attack has been the new participants that have come into the field." She mentioned that new markets - Lloyd's syndicates, Bermuda companies and domestic reinsurers - have developed because workers' compensation rates had risen to attractive levels. "Still," she said, "there is less capacity now than there was at year end 2000". This will keep rates up for some time.

Another significant change post-September 11 has been the rush to develop more appropriate modeling programs to assess and manage re/insurers' exposure to workers' compensation risk. Insurers and reinsurers are gathering more detailed information on workers' compensation exposures, and linking these databases to exposure information for their other lines of business. Risk Management Solutions (RMS), Advanced Insurance Research (AIR) and others have created models that not only attempt to quantify workers' compensation parameters, but also to capture, monitor and manage accumulations of exposures in major urban areas.

Bill Tuttle of RMS, speaking at a seminar on reinsurance sponsored by the Casualty Actuarial Society, noted the changes required in the workers' compensation business. "Workers' comp underwriters have to become more like property underwriters. In addition to the usual data from a customer, they have to consider building construction, occupancy class, proximity of other clients the company insures, and variation of occupancy by time of day or day of week." Sanborn Maps, a publisher of large-scale fire insurance maps of US towns and cities, is developing an electronic program that will identify specific buildings in major urban centres.

A recent report by RMS indicates that workers' compensation losses from a major earthquake could exceed those experienced in the WTC disaster. RMS said a repeat of the 1906 Great San Francisco Earthquake (magnitude 8.3) could cause as many as 78,000 injuries, 5,000 deaths, and over $7bn in workers' compensation losses if it occurred today. Rating agency AM Best has announced it is developing a stress test which will estimate a company's loss exposure to multi-line risks as part of its capital adequacy analysis.

Excluding terrorism
One of the difficulties of excluding terrorism from re/insurance contracts was defining what was meant by `acts of terrorism'. David A Attisani, of the law firm Choate, Hall & Stewart, said, "I am well accustomed to seeing terrorism exclusions in foreign policies, but most reinsurers operating in the US have not had that exclusion - now they do." He cited the terrorism exclusion endorsement published by the London-based Non-Marine Association (NMA) in October 2001, which excludes cover for almost every kind of loss either directly or indirectly caused by any act of terrorism. But the endorsement went further in protecting reinsurers by placing the burden of proving loss on the reinsured: "If the reinsurers allege that the damage to its reinsured is not covered by its reinsurance contract, the burden of proving the contrary is upon the reinsured."

"We don't accept that restriction," said Mr Gilbert of Holborn. "We have negotiated it out of most of our clients' contracts with reinsurers. A few contracts that have that exclusion in place have other limitations and restrictions that lessen the force of it."

"While the NMA exclusion puts the burden on the reinsured to prove that damages are unrelated to terrorism," said Benfield Blanch's Ms Johnson, "there are, however, a number of definitions that do not include that phrase. It has been negotiated out of contracts in many cases. It was put in because of the hardening market and it was probably unnecessary."

As an example of the ingenuity of the re/insurance industry, to spark the interest of non-workers' compensation reinsurers in workers' compensation business, Holborn brokers have turned some workers' compensation policies into a short-tail product. "We have fashioned a reinsurance product that is comparable to property cat," said Mr Gilbert. "By using sunset clauses that limit the timeframe that claims can be made, once that window shuts, the reinsurer can close its books and settle with the cedant without having to deal with long-tail claims." He said a "bunch of policies have been placed."

Looking toward the future, the workers' compensation market should regain a more even keel by the end of 2002, according to Fred Sklow of S&P. "The increases you're seeing now will probably continue through year-end, but probably not at this pace into 2003," he said. "After a while, the competitive element has to come into play. If a government backstop can be implemented in the meantime, this will also likely have a softening effect on prices."

As of early August 2002, the US Senate and the House of Representatives have each passed a bill to establish some sort of federal program to backstop re/insurers if another terrorist attack should hit and leave billions of dollars in claims. A conference committee now must hammer out a compromise bill that then has to be voted on again by the two houses before being sent to the President.

Mr Heidrich of the AAI said passage of the federal reinsurance program would help stabilise the market by making it possible to bear an uninsurable risk. Capacity would come back into the marketplace, he predicted, but, he said, Congress was now very involved with corporate misconduct and fraud, and the federal reinsurance bill had been put on hold.

"It appears insurers were holding their breaths and waiting," NAII's Ms Schroeder said. "I'm not sure the passage of the bill would have an immediate impact on workers' compensation insurance market, but it would lend an overall stability to the line going forward."

"I strongly advocate passage of the federal backstop program. I don't believe the capital to support the exposures is available in the private market," said Ms Johnson, "nor is it appropriate. But, that said, reinsurers are working to provide solutions, and will continue to do so."

By Ronald Gift Mullins
Ronald Gift Mullins is an insurance journalist based in New York City.