The hard insurance market: how did we get here and what can we do about it?

• Author: Hyman, Allen

Not too long ago, an article in The Chicago Tribune bemoaned the insurance plight of local governments in the Chicago area. (1) Officials from cities, counties, special districts, and airports lamented the fact that they were paying higher premiums for less coverage at a time when their revenues were contracting. The article pointedly described what is known in the insurance industry as a "hard" market--a state of the insurance marketplace characterized by rising premiums, restrictive coverage terms, and unpredictable carrier movement. (2)

Indeed, forces have conspired to create one of the most difficult insurance markets in memory. The current insurance crisis could not have come at a worse time for local governments. With sputtering revenue collections and growing demand for security, health care, and other essential services, public risk management programs are under intense pressure to contain costs and to avoid any additional drain on government resources, in terms of insurance, risk managers and finance officers must walk a fine line between what their jurisdictions really need and what they can afford as they strive to simultaneously contain costs and mitigate their risks. This article provides a historical perspective on the hard insurance market, using lessons from the past to guide local governments through the current crisis.

THE EMERGENCE OF POOLING AND SELF-INSURANCE

Risk management is made up of three major components: loss prevention, loss reduction, and loss financing. Loss prevention in public entities was almost unheard of as late as the 1970s. Most claimants simply did not have a cause of action against public entities, either because of sovereign immunity or a lack of standing to sue local units of government. Insurance was cheap and plentiful, coverage was first dollar, and nobody really had any understanding of what caused claims, let alone what to do to prevent losses.

Three things happened in the 1970s that changed the insurance landscape for public entities. First, a cyclical downturn in the commercial insurance market drove up the price of insurance. For most public entities, this resulted in a doubling of their insurance costs, especially workers' compensation.

Second, a series of U.S. Supreme Court decisions changed the legal relationship between local governments and their citizens. These decisions expanded the definition of a "person" under the U.S. Constitution to include local governments, thus making them liable for injuries caused by the execution of municipal policies or customs. With this one change, lawsuits flooded public entities and forever changed the duty that public entities owed their citizens.

Third, a change in the workers' compensation laws in several states forced public entities to bring their injury programs under the state workers' compensation act. As a result, public entities started crafting their own responses to the new dynamics of the insurance marketplace. Forced by circumstances, local governments created pragmatic solutions. The most notable of these solutions was the public risk pool, which created a means by which public entities could band together and assume many of the duties and responsibilities of an insurance company. In spite of gloomy forecasts by industry experts, public entity pooling grew to replace a substantial portion of the commercial insurance market.

As public entity pools demonstrated their competence in handling workers' compensation insurance, they branched out to other lines of coverage...