THE BOOK--Playing The Percentages In Baseball

Wednesday, September 10, 2008

Insurance on player contracts

I remember after the last labor agreement, or after 9/11, they were saying that no company was going to insure contracts for more than three years, and you were going to get all these short-term deals.  Of course, nothing of the sort happened.  Now, I’ve got actual details as to how the insuring of contracts works.  This is for the NHL, but I imagine that MLB and the other sports are similar if not identical:

...the NHL’s leaguewide insurance plan will only insure player contracts for seven years...Seeking private insurance to cover a longer deal is prohibitively expensive… program has been in place for about 15 years… The league purchases its disability insurance through the BWD Group, a Long Island, N.Y., insurance broker that also obtains coverage for the NBA, WNBA and Major League Baseball…

Each team pays a premium based on the salaries of its five highest-paid players, but is free to allocate that coverage how it wishes. Typically, a team will extend coverage to as many as seven players, Daly said. Coverage kicks in when a player misses at least 30 games. Beyond that, individual teams are free to pursue additional coverage, but the heavy premiums make it a losing proposition. To insure a player under the league program, it costs about 5 percent of his salary. To insure additional players, it would cost substantially more.

So when David Tanabe suffered a concussion that appears to be career-threatening, the Hurricanes moved in June to buy out the final year of his contract, even though injured players cannot be bought out. Within 10 days, the NHLPA filed a grievance against the team. (No hearing has been scheduled.) Because Tanabe’s contract was not insured and the team disputed his injury status, it was cheaper for the team to pursue a lump sum settlement through the grievance process than pay him his full salary. This season, the Hurricanes will pay almost $1 million for $19 million of coverage through the league program, but even that process isn’t simple. Insurers may balk at something as specific as an individual body part. The Hurricanes were able to insure Justin Williams last season despite a previous injury to his right knee, Rutherford said. They received insurance payments when he missed more than three months with a serious injury to the same knee, but they wouldn’t be able to insure that knee again this season.

This is just such a well-written article, I wish that more mainstream media wrote like this guy.  He also adds this fascinating bit of arbitrage:

Insurance was responsible for one critical piece of salary inflation that led directly to the lockout that wiped out the 2004-05 season. The Boston Bruins started the trend of extravagant bonuses in entry-level contracts with Joe Thornton’s massive deal in 1997. The Bruins insured all of Thornton’s bonuses at a bargain price, as did the San Jose Sharks with No. 2 pick Patrick Marleau. Other teams tried to follow their lead with the bonuses in future years, but the insurance became increasingly expensive after insurance covered all but $230,000 of Marleau’s $2.4 million in bonuses during his second NHL season.  The Hurricanes have insured bonus clauses twice, through different insurance companies—with Arturs Irbe in 1998-99 and Staal in 2003-04. In both cases, the players cashed in on their performance bonuses but the Hurricanes were protected financially.

See, several years ago, these rookies were signed to these great performance bonus clauses that were easy to reach.  I suspect the underwriter must have woefully underpriced those performance bonuses, which seems to have allowed the players to cash in at a far greater rate than the premiums allowed.  If for example the NHL rookies earned some 30MM in “easy” bonus money over a period of a few years, but the teams paid only 5MM in premiums, everyone wins.  Well, except the insurance company.  (All numbers for illustration purposes only.)