December 1, 1999 by Lowell Conn
Sports insurance is a specialty-lines oddity. It is unprofitable business marred by rising loss payouts not accurately balanced by the premiums generated. It is a competitive market where premium prices should be two or three times their current rate, insiders agree, but are not, because of eager new entrants. It is an industry with uncertain actuarial science because of the lower number of insureds and a significant disparity between their policies. And it is an industry headed for disaster, market insiders suggest, if these threats are not remedied.
When the Los Angeles Dodgers signed starting pitcher Kevin Brown to a seven-year $105 million dollar contract in 1998, other teams, media and fans cringed at the booming costs associated with sports. Insurers underwriting sport risks — most commonly, injuries to contracted players — also cringed at the news. Sport salaries, always on the rise, create a dilemma for carriers underwriting them.
A career ending injury sustained by superstars in years past did not have the profit & loss impact that an injury to Kevin Brown would have. The Dodgers have taken out an insurance policy paying 75% of Brown’s contract at an estimated premium price of $1 to $3 million. Industry insiders agree the sports insurance market comprises roughly $100 million in annual premiums. In other words, one abnormal twist of Brown’s prized arm this past year could have nullified over 70% of the industry take.
Simply put, contract sports insurance is the most volatile of insurance games. Brokers, insurers and reinsurers agree business returns are tentative at best, and three straight profitable years can be nullified by one catastrophic hit.
“Generally, nobody in this industry makes a penny,” says Ted Dipple, chairman of Boston-based managing general underwriters American Specialty Underwriters (ASU). While other segments are characterized by over-capacity, the sports contract insurance market is under-capitalized because of bad loss experiences of reinsurers who are no longer willing to take the business. “Up until now, primary sports insurers — such as Lloyd’s — have been able to find reinsurers that think the business will be glamourous and profitable. They keep finding bigger fools around, and when those fools are wiped out, there is always someone waiting in the wings to write the business. Because they’ll get a signed Michael Jordan basketball out of it. or can boast about what they do to friends at the country club.
“But the industry is running out of reinsurers who are willing to overlook the bad profitability,” Dipple adds.
For the record, he maintains there is profit to be made from this industry, only insurers must practice restraint. “If you underwrite all of the defensive linemen in the National Football League, you will not make any money. But if you pick and choose a few defensive linemen and throw in some baseball players, certain basketball players, and select who you’ll underwrite, you can create a big enough premium pile to make some sense of the business.”
The problem, Dipple says, is that professional sports offer roughly 3000 athletes worldwide to insure, making difficult any attempts to establish actuarial sciences surrounding reserves, premiums and loss payouts. Common sense is thrown out the window because the sport sector is perceived to be an exciting industry. He adds premium rates should easily be double or triple the current prices.
Dipple tells the story of one not-to-be-named underwriter who had his company underwrite his favourite team — ignoring the unprofitable nature of the business because of the once-a-year fringe benefit of watching a contest from the owner’s box. “We’ve tried to impress upon the market the folly of all of this, but they come back with a justifiable argument that the business develops a few million dollars of premiums and reinsurers are always stepping up to write the business.”
With salaries rising significantly since the early 1990s, it is growing more and more important for professional sports teams to insure their guaranteed contracts. Estimates from the Sports Business News indicate the four major North American professional sports — baseball, hockey, football and basketball — spend $50 million annually on insuring salaries. The National Basketball Association insists that each team insure their top six contracts. The NBA’s insurance policy, a blanket league-wide plan, provides coverage up to 80% of a contract if the player misses more than 41 games. The National Hockey League (NHL) mandates teams insure their top five contracts, according to league sources, the league pools premiums into a self-insured captive with reinsurance backing.
In vogue right now among professional franchises, particularly the NHL, league and insurer sources indicate, is bonus incentive insurance. The product allows teams to sign players to incentive laden contracts — providing bonuses based on statistical and team goals — and insures against these incentives being reached. League sources indicate the Boston Bruins and San Jose Sharks have most enthusiastically embraced these products.
The NHL’s Toronto Maple Leafs maintain they do not utilize bonus incentive insurance, but do, nevertheless, offer players incentives in contracts. The team currently insures only four player contracts, despite paying the league-mandated premiums based on five contracts. They are open to insurance solutions to hedge player and team contingencies, executives say, but are yet to be swayed by many of the current product offerings available.
“You have to manage your business well and if you have an opportunity at a realistic premium rate to save money on the bottom line, you do it. I’m in the business to win games. But my bosses are in the business to make money,” says Bill Watters, Maple Leaf vice president of player personnel.
Ian Clarke, senior vice president of finance & administration at Maple Leaf Sports & Entertainment says the team is always looking at new insurance opportunities. “The insurance industry is being more creative and aggressive in trying to understand our needs. I know of one team that used bonus incentive insurance and they did all right by it. But insurers aren’t stupid and they catch on and maybe begin to increase the deductible or raise premium rates.”
Other NHL officers echoed Clarke’s sentiments. Some also added that premiums for products, like bonus incentive insurance, are too pricey.
Gregg Sutton, director of the international division at Toronto-based William J. Sutton & Co. Ltd., reacts incredulously to suggestions rates are too high. “They think premiums are too much? That’s bad news for them because the rates are going to go higher,” he remarks. William J. Sutton & Co. and ASU are the top sports contract managing general underwriters in North America, and both share the same industry prognostication.
Sutton insists steps forward in underwriting profitability are invariably met by catastrophic setbacks. In recent years, players in the middle of multi-million dollar insured contracts, in all sports, have been forced by injury into retirement, including superstars such as the NHL’s Pat LaFontaine and Cam Neely, the National Football League’s Al Toon and Major League Baseball’s Kirby Puckett. This year alone could be disastrous for football insurers, Sutton maintains, with major potentially career-ending injuries striking many high profile mid-contract athletes.
ASU’s Dipple says one injury-forced NBA player’s retirement cost insurers $21 million. A few years ago, he notes, the Anaheim Angels bus turned over, with the whole team in it. “Eventually, when a big car or air crash happens, you are going to get a catastrophe that is going to cost sports contract insurers north of $50 million and is going to wipe this industry’s slate clean,” he predicts.
Sutton says teams breaking the bank to sign players are practicing fiscal restrai
nt in other areas, which could leave their contracts underinsured and affect their balance sheet — and that of the contract sports insurance sector.
“Because of the reduced capacity in the reinsurance market for this type of specialty business, premium rates will rise and we might see a day soon when baseball teams won’t insure as many players as they currently are,” he says. In the meantime, teams are demanding new types of products to hedge contracts against non-injury related events.
A developing product that could see much utility over the coming years, says Sutton, is the loss of skill insurance product, developed to hedge teams against players signed to long term deals experiencing a noticeable depletion in skill. This product could be particularly popular in the NBA where players are routinely signed to the maximum seven-year contract period. “Teams spend millions of dollars to sign players long term and sometimes these players do not perform down the road as expected. Insurance is allowing teams to hedge that risk.”
Asset value coverage is also being used by teams to hedge against the loss — or contract holdout — of players with direct and tangible affects on team profits. This product, Sutton notes, is only appropriate for players of ultimate superstar capacity — players with Michael Jordan or Wayne Gretzky mystique — where clearly, the player’s absence adversely affects team profit.
Despite these innovations though, Sutton echoes Dipple’s cautionary tone. “Sports insurance is a good industry, but the losses are catching up to us. The premium rates have not sustained losses. The cost of reinsurance for all contract sports specialty lines is going up.”
While the list of eager reinsurers is dwindling, there will be more suitors lining up to take the risk, Sutton adds, but for how long — and how many more will be willing — is anyone’s guess. “Until the business maintains profitability, and premiums reflect the risk, the industry will not attract too many more reinsurers. The business is sexy and glamourous, yes. But not profitable. And in today’s business environment, sex appeal without profit is not enough.”
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