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Feeling a little pinched in the wallet, are you, oh, commercial buyers? Taking a big gulp of fresh air before sitting down with your chief financial officers? Don't despair. You're not alone. Just in case you haven't heard by now, there's a massive capacity squeeze under way for those of you looking to insure commercial property sitting in catastrophe-prone areas.

The numbers this year are looking downright ugly, especially in the energy markets. We're talking capacity reductions of at least 25 percent, and that's putting it mildly. Scores of buyers are facing a tightenting of capacity by as much as 50 percent in some places.

In Florida, capacity is drying up faster than Lake Okeechobee, executives have also said. For properties located near the Gulf Coast, of course, coverage capacity is evaporating just as fast.

If you're in the energy sector with offshore oil platforms and undersea pipelines, ouch! Or, to put it more diplomatically: "The biggest challenge is supplying coverage at all, and then at a rate that clients can afford," says John A. Rathmell Jr., president of Houston-based insurance broker Lockton Marine & Energy. "I have never seen anything like this in all my 25 years. It is really a whole new world."

Broker Bruce A. Jefferis, managing director and national practice leader of Aon Natural Resources, is rushing around the Gulf Coast in a desperate search for capacity. "Our toughest challenge is . . . trying to arrange capacity in the Gulf of Mexico," he told Risk & Insurance^® earlier this year. "We have seen a reduction in capacity to less than 10 percent of what it was before the storms last year."

HIGHER RATES

The shortage of capacity in the property-catastrophe segment is going to mean higher rates. Period.

Buyers had better not come crying to their primary carriers because the primary carriers aren't likely to cut their clients any slack. They, too, are on the receiving end of some big hikes, courtesy of the reinsurance industry, which last year suffered its largest catastrophe loss year in history.

Even the rash of new startup reinsurers flooding into Bermuda late last year and pumping $8 billion to $10 billion of fresh reinsurance capital isn't going to provide enough capacity, said V.J. Dowling, managing partner of Dowling & Partners Securities, during an insurance industry roundtable in January.

For some primary carriers, a triple-digit hike isn't out of the question, one ratings analyst believes.

"We've heard that rates could go from 20 percent to 200 percent," says Standard & Poor's credit analyst Polina Chemyak.

Sure, carriers and reinsurers have some wiggle room with commercial rates compared with the more regulated personal lines. But this year, that's hardly saying much. Rates are going up, way up. The question is not whether commercial buyers are going to see an increase, but how much. The only wiggle room anyone's talking about is whether rates have room to go high, higher or highest.

In a report published last December, several Standard & Poor's analysts wrote that "reinsurers are planning to raise their rates for property catastrophe and property per-risk coverage by up to 40 percent in 2006 for insurers with significant storm claims."

Insurers not affected by last year's storms will "most likely experience 10 percent to 15 percent increases for property/catastrophe reinsurance," wrote the authors of the report.

And now, for the statement you've all been waiting to read: "Primary insurers will try to pass through much of the increase to their clients," the authors of the report concluded.

Policyholders in Louisiana are even worse off, even after all they've been through. Louisiana's state-run insurance pool, like many state-run pools, is running a deficit, says Chemyak. One of the easiest ways for any legislature to close the gap is to assess extra fees on carriers, which simply turn around and raise rates on policyholders. Other than workers' compensation and medical malpractice lines, "all policyholders" in Louisiana will be affected, Chemyak says.

In Mississippi, where the attorney general has filed suit to require insurers to cover homeowners for flood damage from hurricanes, "capacity would shrink precipitously," if the state won the case, according to a report last year issued by Fitch Ratings.

REVISING RISK APPETITES

In the wake of last year's brutal storm season, every insurer and reinsurer operating in the United States is reassessing its appetite for risk, according to managers, executives and analysts.

"As a result of Katrina, Rita and Wilma, risk managers will need to rethink their appetite for risk and their management strategies," says broker John J. Bullock, who heads Willis Group's office in Pascagoula, Miss., and represents clients in the hotel and casino industries.

Now, unless you're a commercial buyer for a canned-goods convenience store in a converted missile silo 100 feet under the South Dakota Badlands, chances are carriers and their actuaries are reassessing their appetites for your risk, particularly if you're a commercial purchaser in the energy sector.

If it makes commercial buyers feel any better, perhaps they ought to let off some steam with a good screaming match with their carriers or their brokers. Many reinsurers, along with the modeling vendors, have suffered from shaky loss scenarios.

"What happened is they exceeded their modeled losses," Schreitmueller says. By exceeding their loss estimates, companies are having to adjust to "new and more conservative assumptions" forced on them by investors, reinsurers and ratings agencies. "So what they are doing is putting less of their capacity in harm's way."

And there you have it. If carriers had priced accurately for their risk in the crucial catastrophe-exposed areas of the country, buyers wouldn't be facing increases of 20 percent to 200 percent.

Some managers have said that, as a group, companies are retaining more risk, to the tune of more than $30 billion or $40 billion, which would be more than the loss of the World Trade Center on Sept. 11, 2001. Schreitmueller says the 2005 hurricane season, the largest loss in the history of the industry, has gotten everybody's attention because it is "exceeding numbers that anybody could have imagined a few years ago."

Broker Gary G. Pederson, senior vice president of Beecher Carlson Insurance Services in Denver, who represents clients in the gaming and hospitality sector, says the Gulf Coast storms of 2005 have "challenged insurance premiums, coverages and retentions."

But even with reinsurers increasing rates by 40 percent, these brutal hikes are still not enough to reflect the new loss environment. Standard & Poor's, in its December report, claimed commercial property rates are still "inadequate."

"Given the record hurricane activity over the past few years and our growing concern that the (property/casualty) industry could be in for an extended period of such, current rates do not reflect sufficient loading for risk," the report said.

CYRIL TUOHY is managing editor of Risk & Insurance^®.

April 1, 2006

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