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In trying to adapt to a soft market flush with capacity, insurers are covering more risks and creating new and innovative products, Johnson & Higgins says in a new report.

These new products, which include multi-line and multi-year products, along with continued low costs, have slowed the growth of alternative risk financing from the capital markets.

"For most lines, insureds can look forward to even lower prices, higher limits, and more coverage enhancements at negligible added cost," states a report to be released tomorrow by the New York-based broker entitled "1997 Insurance Market Review & Forecast."

"Long-term contracts and the ability to enhance protection for risks that were historically uninsurable" were the most important developments in 1996, Norman Barham, president of J&H, said in an interview. He compared the long-term relationships between buyer and insurer to a marriage, in which both sides win or lose together.

The soft market, however, is not without its risks. "When insurers offer highly attractive terms and conditions, they are making a wager that premiums will cover losses, but competition that drives prices downward can drive them so far that it creates market security problems," the J&H report states. "Concerns about price or reserve adequacy translate directly into concerns about market security and, therefore, claims-paying ability."

"Security will become one of the big concerns in our business" in the long term, Mr. Barham added.

The continued soft market has reduced demand for alternative risk financing from the capital markets, and insurers instead are providing innovative risk financing products.

"Today's alternative market encompasses a broad spectrum of risk financing options, most from very traditional sources," the report states.

Continuing a trend existing since 1978, U.S. property/casualty insurers posted an underwriting loss in 1996, with all profits coming from investment income. In the past two years, the strong stock market has buoyed insurers' profit margins, contributing to record levels of surplus.

Looking at claims, 1996 did not see the catastrophic losses of prior years. However, an increase in the number or severity of catastrophic losses in the future, combined with a downturn in the stock market, could lead to a hard market. Accurate predictions of stock market fluctuations or weather events are equally elusive, the J&H report states.

One sign of an impending hard market, according to the report, will be a reduction in the industry's level of policyholder surplus. A decline in surplus preceded the past three hard markets of 1970, 1975 and 1985. Only 1973's slight drop in surplus failed to lead directly to a hard market.

On the casualty side, the report predicts the soft market will continue through 1997 with greater reductions in prices anticipated for lead umbrella markets than for higher excess layers. Also, Bermuda insurers will be less likely to reduce prices compared with U.S. insurers, despite risking loss of market share.

The report also says Lloyd's of London will play a more prominent role in the future, especially in niche markets, such as professional liability, aviation, marine, oil, gas and petrochemicals, and reinsurance.

In response to buyers' demands and to maintain market share, insurers will offer an increasing array of new risk transfer products. These include multi-year and multi-line policies, the inclusion of non-insurable business risks and sliding deductibles.

"There is no better time than now for insureds to demand the types of risk transfer solutions that meet their needs," the report states. "Carriers are eager to differentiate themselves from the herd and are more ready than ever to consider a client's wish list."

Also, 1996 saw more companies looking at their total cost of risk. "1996 was a year for total cost of risk. Buyers said, 'Let's take a look at what we got,' " in terms of exposures, said Robert Meyers, senior vp and head of J&H's global property practice.

An example of successfully applying the total cost of risk concept to lower costs occurred with workers compensation, said John Deitchman, director and global practice leader for J&H. A few years ago, workers comp rates were sky-high, he said.

"Now it's a money-maker for insurers, and client costs are way down," he said. This was done through a combination of legislative reforms and a determined effort by employers and insurers to lower workers comp costs.

Buyers can apply these efforts to other areas. "If you focus on where the costs are coming from and address them, you can produce some significant results," Mr. Deitchman said.

The report states that workers compensation rates fell during 1996 and will fall in 1997, largely as a result of cost-reduction efforts and competition in the workers comp market.

1996 saw faster-than-predicted rate and coverage term flexibility for directors and officers liability insurance. Because of favorable loss experiences, coverage is plentiful and rates will remain competitive.

As a result of the Private Securities Litigation Reform Act passed in late 1995, the number of federal securities suits has dropped significantly. This drop, however, is offset by increases in state court suits, which could potentially harden the market.

For environmental impairment liability insurance, 1997 should seeexpanded coverage and premiums reduced by 15% to 20%, J&H says. Global programs and multi-year policies also will become more prevalent this year. Increasingly, companies demand that insurance carriers assume greater amounts of risk for environmental liability and clean-up costs. To accomplish this, insurers have created new products to keep their clients. Some of these include coverage for business interruption resulting from a pollution release, an integrated brownfields development product and multi-year programs.

Insurers also have created new products for employment practices liability to keep up with growing demand from employers, J&H says. To meet demand, insurers are expanding capacity and new insurers are entering the market. The report predicts that insurance will continue to grow, eventually reaching the point where "the majority of Fortune 1000 companies will treat employment practices risk management as an integral part of their overall risk management strategy."

One area seeing limited capacity is high level product liability for pharmaceutical companies. In 1995 and 1996 premiums jumped for this coverage, and modest increases are forecast for 1997. Capacity has expanded, easing rate increases, through the introduction of new products called PharmaCat and MedExcess, both designed for limits up to $1 billion in excess of $650 to $750 million (BI, Oct. 21, 1996; Aug. 19, 1996).

The other area of tight capacity and higher premiums is earthquake insurance for California and Japan. Windstorm coverage for Florida facilities also will remain tight.