Taking Cover

Catastrophic explosions at two British Columbia sawmills earlier this year have kick-started safety inspections province-wide and ignited concerns about skyrocketing insurance rates and available capacity in this particular market segment.

“The current situation is horrendous. There’s no other way to describe it,” says Larry Grant, vice president of Hub International’s national forestry practice division. Rates were already spiralling upward in response to the exits of insurers such as ACE, Travelers and Lumbermen’s Underwriting Alliance (LUA) over the last two years, Grant reports.

Speaking generally, he offers an example in which a sawmill paying a 20-cent rate for total coverage two years ago may have seen its rate inflate to 40 cents at about 85% coverage a year ago. This year, the rate has ballooned to 80 cents for roughly 30% to 40% coverage. “So, the rates have gone through the roof and the coverage limits have diminished or decreased significantly,” Grant says.

Recent fires and explosions at two British Columbia sawmills has brought the issue into sharp focus. The first fire happened on Jan. 20 at Babine Lake Forest Products in Burns Lake, and the second on Apr. 23 at Lakeland Mills in Prince George. The incidents left four workers dead.

Within days of the second blast, WorkSafeBC issued a directive that all mills in the province would need to complete a hazard identification, risk assessment and safety review, focusing in particular on combustible dust, dust accumulation and potential ignition sources.

It was a “couple of extraordinary events at a particularly sensitive time that’s allowed things to go way over the top,” Mill & Timber Products Ltd. spokesperson David Gray says of recent events.

In or Out?

Does the current state of affairs serve as a harbinger for insurance companies to enter into or exit from the troubled sawmill marketplace?

Certainly some insurers have taken conditions as a cue to exit the market altogether, the most recent and perhaps most public example being LUA. In an October 2011 letter to policyholders, excerpts of which were published in the Globe and Mail, LUA noted that despite steps taken by Canadian staff over several years — including higher rates, reduced capacity and enhanced attention to loss prevention — efforts “have not garnered the results we had hoped for, or needed, on our overall book of business.” A decision was made to wind down Canadian branch operations “through a smooth and orderly process, throughout the remainder of 2011 and 2012.”

In the letter, LUA noted that the cumulative net loss in Canada — operations had not achieved an underwriting profit in six years — essentially erased positive results achieved south of the border. LUA has nevertheless maintained its A. M. Best rating of B+.

With reduced capacity available, even before the explosions, new players began entering the market, driving up pricing. “This is a simple supply and demand scenario,” says Joe Hawk, senior vice president and strategic account manager of Western Canada for Aon Reed Stenhouse Inc. When a major market that provides significant capacity

exits, “your supply is now reduced. So for insurers coming in, there’s a big demand for their supply and they’re going to charge accordingly,” Hawk says.

But add a number of total loss events to the mix, and “it is going to cause markets that are considering playing in the space to pause and reconsider both their participation and pricing,” Hawk says.

Taking Cover

LUA’s departure left some sawmills scrambling for coverage in an already skittish market. Gray says some Mill & Timber Products operations were not insured by LUA, but rather by a major underwriter of industrial risk. These operations secured a renewal with the unnamed carrier, but the underwriter made it clear it was not entirely comfortable, Gray reports.

Other company mills were with LUA. For these, Mill & Timber Products had been looking at an alternative source of coverage out of London, England when the second fire happened. “That really changed the tenor of the market,” Gray says.

Facing a Sunday midnight deadline in late April, the mill received a last-minute quote that almost tripled the expiring rate. “So we did what I don’t think a lot of people did,” Gray says. “We declined. We went naked deliberately. The mills were not running at that time. We put double security watch on them and we went to another broker.”

The new broker came up with a more risk-based proposal. Once the coverage was made official in London, mill

operations were back up and running a week later. Gray feels sawmill coverage should be taking a more a risk-based approach generally, but thus far, he believes, this has not happened.

Mutually Exclusive?

Players leaving the market have created the space and opportunity for new carriers to enter. “Somebody’s going to look at where the rates are going, and where they are at right now, and no doubt we’ll see somebody stepping in,” Grant predicts.

Hawk says when LUA began reducing capacity in 2010, new markets started taking a look at sawmill risks. They see an opportunity “because they believe now they will be able to get the pricing they need to reflect the risk,” he adds.

Even if a market-based solution does not materialize to fill the vacuum left by exiting carriers, “there’s probably an opportunity now for sawmillers of a certain class to create a mutual or some kind of vehicle that replaces a big chunk of the market,” Gray suggests. “At the low prices, it didn’t make any sense. At the high prices, it does. The race will be: Do the premiums adjust, or do we as sawmillers adjust?”

Grant is not so sure, citing the following scenario. Ten of the best sawmill operations get together and each one pays an average insurance cost of about $1.5 million annually. That produces a total fund in the first year of $15 million. A major loss happens in the $60-million range. “That $15 million really isn’t going to do much,” he says.

If those same 10 operations each contribute $6 million to the kitty to cover the $60-million loss, they would be out $4.5 million on an annual basis — or at least in their first year. “I think asking them to make that commitment would be tough in these times,” Grant says.

“If premiums are too high to support on a mid- to long-term basis or there is a further retraction of insurers from this class, clients would probably look at some form of a buying pool or captive to manage the insurance,” Hawk says.

But these are long-term ventures that require a big commitment from like-minded people. For the first year or two, this type of risk financing structure can be higher than buying insurance in the traditional markets, Hawk says. “I’m not hoping that will happen. I’m hoping things will stablize and normalize.”

Dust up

In a May 14 update on the explosions, WorkSafeBC informed employers of similarities that “may be coincidental, but they certainly cannot be ignored,” said Jeff Dolan, director of investigations for the board. “The ignition sources appear to have been located at the conveyor level where electrical and/or mechanical equipment was in operation in areas contained by walls and equipment,” Dolan said.

Fuel sources, including natural gas, propane and sawdust, “may, depending on their chemical makeup, settle to the lower areas of the mill,” he reported.

Hawk says dust or debris has always been a factor in sawmills. “We see this as something that can be managed and is obviously getting additional attenti
on, which will refocus anyone who may not have been managing this at a high enough level.”

That said, he adds, “insurers are asking for assistance in providing them with the right information that allows them to underwrite both the physical and human element risks.” Physical risks relate to the provision of sprinkler protection, with adequate water supply from a reliable dual fire pump system and good fire hydrant coverage. Human risks relate to, among other things, the inspection, testing and maintenance of fire protection systems; hot work management; debris removal and housekeeping; and preventive maintenance programs for electrical and mechanical.

“If the human element side is not managed well, then a normal loss event could turn into a major event, or even a total loss scenario,” Hawk says.

Through regular auditing and solid risk management, an insured must show “you’re different than the other guy, because right now the insurance markets are having trouble differentiating good operators from the others,” he says. “The insureds that manage risk and can demonstrate that will pay lower rates in any given market.”

Hard Reality

The sawmill segment of the insurance industry is in a “full-blown” hard market right now and hard markets typically follow cycles of 24, 36 and 48 months, Grant says. “Throw in another catastrophic incident, and all bets are off.”

However, he remains hopeful that rates will not only stabilize over the next 12 to 24 months, but they will begin to decrease slightly. “No broker is leveraging volume on rate,” he says. “The only thing they may be able to leverage on is capacity.”

Insurance companies are being very careful about how much capacity they are putting out, Hawk observes. “These are unprecedented losses. I’ve never seen anything like this,” he says.

“I think that if we end up having the balance of the year normalize from a loss perspective, we get some time and distance and the markets get the information and data they need to gain some comfort in this segment, things can start to stablize from a pricing perspective,” Hawk says.