P&C the March 2021 issue

Rethinking Heavy Manufacturing Risk

Risk mitigation and adequate pricing are keys to getting capacity back into the market.
By John Smith Posted on February 28, 2021

In January 2020, the U.S. Purchasing Manufacturers Index (PMI), a key economic indicator, had rebounded for the first time in six months and was up to 51.7, only to plummet to 36.1 in April. At that time, U.S. industrial production fell 11.2% as facilities closed due to the pandemic or continued operating with limited staff. The pandemic also led to a slowdown in demand, which caused factory orders to decline by more than 10% in March. Compounding all of this was a 10% drop in employment for the sector and disruption in the supply chain as raw materials became harder to come by, according to Deloitte.

While COVID-19 has certainly disrupted the industry, it is not the only problem facing the heavy manufacturing sector, particularly in the wood niche. For sawmills and pallet operations specifically, the pandemic has only amplified the challenges we were already seeing, including a lack of interest from insurance carriers to take on the risks presented by heavy wood manufacturing businesses.

Today, a sawmill that was once valued at $2 million with $1 million worth of equipment inside, is now valued at $2 million with $10 million worth of equipment inside.

Heavy manufacturing has slowly rebounded from the low numbers of early 2020, but sawmill and pallet operators are not even close to being out of the woods. For the most part, they survived the pandemic shutdowns with minimal long-term damage (as many of them were deemed to be essential businesses), but now they are facing an insurance market where major losses in their industry over the past decade have closed the door on many options they may have had for quality insurance—or any insurance at all. Today, prices are rising sharply, and capacity is difficult to find.

An Empty Pot

These problems result from the fact that, for many years, insurers have failed to collect enough premium from even the best policyholders to cover the amount of loss.

Often for primary manufacturing and the wood industry, when an incident happens, it is catastrophic. Some of the most devastating are fueled by highly combustible wood dust, which can burn an entire facility to the ground.

Not only are these facilities highly flammable due to wood dust and the storage of other combustible materials on-site, today they are also often stocked with costly high-tech equipment. Once solely operated by human labor, these old industries have adopted digital technology and automation. Where once a man would eye the log to determine what lumber would be pulled from it, now lasers scan the log and quickly process it. Today, a sawmill that was once valued at $2 million with $1 million worth of equipment inside, is now valued at $2 million with $10 million worth of equipment inside.

Inexperienced with the wood niche yet perceiving opportunity, some carriers entered the market head first—a move we often see in soft markets. Underwriters saw the rate level availability and the lack of loss frequency and started writing sawmills and pallet operations, cutting rates to woo new business while driving down rates for the competition.

To bring capacity back into the marketplace and ease challenges in securing coverage, representatives from the insurance industry should form a consortium of high-quality, risk management focused insureds and work with them to provide them with tailored loss control solutions that can serve as a guide.

Once the large losses started coming in, the new-to-the-market carriers realized they were in over their heads and the premium paid into the pot was severely lacking to pay the claims resulting from these losses. Consequently, many of these carriers exited the market just as quickly as they came in.

Layered programs have propped up the market, but it is getting increasingly difficult to find a company to write that crucial first layer of coverage. Just two years ago, layered programs were simpler for this line of business with just three or four carriers involved with one insured, but now the market is seeing six to eight carriers or more on one insured. I recently saw a layered program for $50 million with a whopping 15 carriers involved. With multiple parties participating, these policies are often plagued with complications. All parties need to understand whether or not the policies are concurrent and whether or not the coverage ranges are the same, among other things.

With so many carriers exiting the business, it has become increasingly difficult for insureds to find coverage and nearly impossible for a large sawmill looking for coverage in excess of $15 million. My company, Pennsylvania Lumbermens Mutual, has also exited much of this business, first moving away from risks in excess of $25 million and now away from risks in excess of $10 million with exceptions being few and far between.

The facts are that, in the severity business, insurance for the entire class must be priced adequately so that when a loss occurs each carrier has enough premium to pay the loss as well as cover their expenses and generate some sort of profit. Until that happens, we too will sit on the sidelines when it comes to larger sawmills. As a mutual company, founded by lumbermen, this is particularly painful for me, as I feel an obligation to my insureds.

Weighing Solutions

So, what can be done to remedy this predicament?

Some have suggested captives may be a solution. The challenge here is size and scale. Because a captive’s small size could limit its ability to balance a larger number of diverse risks with catastrophic loss potential in its portfolio, it likely would not be able to purchase reinsurance in a cost-effective way. Further, a captive would struggle with other fees and expenses that a larger company, like PLM, could spread across a much wider book of business or with an open distribution model.

The wood business is littered with captives that have tried and failed. Often, after these captives launch, they price fairly in the short term until a loss occurs. Then prices increase, and the best insureds leave the captive. Once that happens, the captive’s results deteriorate.

I believe the solution must entail more adequate rates for this class of business, combined with diligent risk mitigation practices by insureds and risk management services provided by carriers.

Layered programs have propped up the market, but it is getting increasingly difficult to find a company to write that crucial first layer of coverage.

Insurers will have to look carefully at an operation’s safety focus, training and risk management practices, as well as their loss history. Even then, only those operations that can clearly demonstrate a comprehensive and active risk management program that is supported from the top down should be considered for coverage. The solution would also include adequate rate-per-exposure unit (premium). In other words, the higher the value of a location, the higher the rate that will be needed, as these losses tend to be tough to control when they occur and thus routinely become catastrophic in nature.

To bring capacity back into the marketplace and ease challenges in securing coverage, representatives from the insurance industry should form a consortium of high-quality, risk management focused insureds and work with them to provide tailored loss control solutions that can serve as a guide. Those insurance industry representatives then will have to impose realistic rates and premiums to cover future losses, making sure the premium pot is once again full. Insurers can’t focus on the individual risk; they must focus on developing a book of smart risks and charging adequate rates. To make this work, insureds must recognize this issue and the value a good insurer brings to the table and commit to safety and risk management.

A few years ago, a manager took me on a tour of her sawmill. She grabbed wire cutters before we left her office. While we were touring the facility, she noticed a worker with a personal fan operating at his workstation. It was plugged into an extension cord (a fire hazard in a building full of flammable wood dust). She swiftly unplugged the fan, removed the wire cutters from her pocket, and proceeded to cut both ends off the extension cord. She told the employee, “If you need a fan, we’ll get you a properly installed fan.”

These are the insureds we want. It’s about finding the right group of safety-focused insureds, supplying them with risk management services, and offering them a price that will be adequate to sustain the business. This is how we rethink heavy manufacturing risk in the wood niche and likely a best practice that can be applied across all heavy manufacturing business.

John Smith is president and CEO at Pennsylvania Lumbermens Mutual Insurance Company.

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