Specialty Insurance Blog

Private Equity Insurance

The insurance market for financial institution D&O has been tightening due to large corporate failures and resulting D&O losses, and this has impacted the market for D&O (directors & officers) and GPL (general partnership liability) insurance coverage for private equity & venture capital groups.  Their unique insurance needs present underwriters with a range of exposures.  A a series of articles from law firm Debevoise & Plimpton highlights both the changing environment and coverage challenges private equity and venture capital firms face.

The articles are found in various editions of the Private Equity Report (see here).  The first article is from the Summer 2009 edition, page 7, and discusses the current insurance renewal challenges (see here).  The second article on page 19 of the Fall 2008 edition discusses insurance issues arising from bankruptcy (see here), and the third article on page 3 of the Summer 2008 edition addresses indemnification agreements and insurance (see here).

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EPL & the Recession

Current high unemployment is increasing employment exposure for small and medium sized businesses, and increasing the need for employment practices liability (EPL) insurance.  EPL insurance covers claims for wrongful hiring and termination, sexual harassment, and discrimination.  Two articles highlight the changing employment environment.  The first article, on page 28 in the October 2009 edition of Rough Notes (see here), notes that one in five small businesses will have an EPL lawsuit this year.  The second article, in National Underwriter (see here), notes:

• EEOC’s filings were up by about 29 percent for 2007 to 2008
• layoffs, restructuring, and discharging of employees are the most likely source of a lawsuit
• Both EPL insurance and strong employment risk management are critical in managing the exposure

EPL insurance is not expensive, and for small and medium sized businesses typically comes packaged with risk management services.  While many insureds do not take advantage of this risk management assistance, it can be extremely valuable at little or no cost, and can prevent significant employment losses.

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AM Best E&S Insurance Review

AM Best has released the 2009 review of the excess & surplus lines (E&S) insurance market (see here, PW protected?), called 2009 Special Report, U.S. Surplus Lines – Market Review.  The annual review is conducted by AM Best from a grant provided by the Derek Hughes/NAPSLO Educational Foundation and has been produced annually for a number of years.  The review notes:

• Market competition has driven both premiums and profitability down
• Surplus lines premium totaled $34.4 billion in 2008, while the entire property/casualty insurance industry premium totaled $493 billion
• The total PC industry DPW declined by 2.63% in 2008, while the total surplus lines industry premium declined by 6.2%
• Overall, the surplus lines industry posted a 2008 combined ratio of 93.6 compared to a 105.1 for the entire PC insurance industry
• The 2008 combined ratios for the top E&S insurance specialists ranged from a low of 47.6 to a high of 116.8
• The two largest E&S writers (groups) are AIG (23.5% market share) and Lloyds (19.7% market share)

Historically, the surplus lines industry results have exceeded the overall PC industry by a significant margin.  For 2008:

The combined ratio of surplus lines over the past five years has annually outperformed the P/C industry by an average of approximately 11 points. The surplus lines industry’s loss and LAE ratio also outperformed the overall industry by an average of 8 points over the past five years.  At year-end 2008, underwriting results for the surplus lines peer composite outperformed the overall P/C industry by a considerable margin, as illustrated by the 11.5 percentage point difference in the combined ratio. This gap closed somewhat in 2008, however, due to the large and frequent weather-related losses on natural catastrophe-exposed business, a great portion of which is covered by surplus lines insurers.

AM Best points out that the surplus lines industry faces challenges in the future, including the soft insurance market and the use of technology, including the application of analytic approaches to underwriting and rating risks.

The study is always well received and extremely informative.  Additional perspectives include National Underwriter articles here and here and a Business Insurance article here.  An explanation of the excess & surplus lines insurance market, the market solution for all types of specialty lines insurance, can be found here and here.

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Insurance Predictions

Dr. Robert P. Hartwig, CPCU, President of the Insurance Information Institute (I.I.I.), provided some insights into the economy and the insurance industry at the recent NAPSLO annual meeting.  See his slides here, and a National Underwriter summary here.  Some interesting observations:

• We are facing a recession and a soft market at the same time, which is not typical and has dramatically reduced demand.
• The economic challenges have changed insurance customer behavior including increased efforts to reduce insurance costs, like shopping, and causing higher claims frequency in lines such as workers comp.
• Business starts normally rise at the end of a recession and drive job creation, but the seizure in the credit markets has prevented an increase in new businesses so far. An upturn in business starts is necessary to drive job creation and commercial insurance growth.
• The impact of the recession is not consistent across the US, with parts of the country doing much better and recovering much faster than others.
• Demand for insurance is down, capacity is strong, and underwriters’ perception of risk is unchanged. This means that, barring an unforeseen external shock, a market turn is not imminent.
• Insurers will likely report flat top line results and improving bottom line results for the 3rd quarter, not deteriorating results as some expect.
• Inflation is a risk a few years in the future (not short term), and will impact insurance costs from rising severity, reserve and rate inadequacy, and the penetration of retention and reinsurance attachment points.
• We can expect deterioration in the tort system over the next few years, possibly resulting in a tort crisis.

In addition, Dr. Hartwig discussed future opportunities and challenges for our industry, including specific sectors of growth and tort challenges.  Mr. Hartwig identified 11 industries for the next 10 years:

Government
Education
Health Care
Energy (Traditional)
Alternative Energy
Agriculture
Natural Resources
Environmental
Technology
Light Manufacturing
Export Oriented Industries

The slides are an excellent source of information (see here).

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Captive Insurance Premium Deductibility

Ensuring that the IRS treats an insurer as an insurer for tax purposes is critically important for captive insurance companies.  This may sound simple, but it can get complicated in certain captive situations.

A captive insurance company must be considered to be an insurer by the IRS for the premiums paid to be deductible.  A summary article on the subject can be found at WebCPA (see here):

The IRS states that for a transaction to be considered insurance, both “risk shifting” and “risk distribution” must be present.

A prior revenue ruling, provided by Active Captive Mangement, disallowed premium deduction with insufficient risk distribution (see here):

Revenue Ruling 2005-40 disallows the premium deduction for a company that is the sole client of an insurance company. According to the IRS, such coverage does not spread risk among more than one policyholder and hence is not a bona fide insurance transaction.

Business Insurance summarizes a new ruling, Revenue Ruling 2009-26, which provides some detail on what structures do provide sufficient risk distribution (see here).

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Insurance Myths

Do you have clients that believe that reporting a claim to their insurer should be avoided if it is not serious?  As we all know, this is just not the case.  This is one of the insurance myths addressed in a series of two articles in Insurance Journal (see here & here).

An auto accident – a fender bender where one party paid cash on the spot to settle the claim – is used as an example of why not reporting a claim is a bad idea.  The author correctly points out that a subsequent, and late, claim for bodily injury might be declined by the insurer based on a failure to report the claim in a timely manner.  While this is a simple and obvious example, we still see this avoidance of claim reporting from commercial insureds from time to time, including professional liability insurance insureds (see a prior post here).

Other myths addressed in the article:

• I don’t have anything, so I don’t need insurance
• He is a 1099 employee, and therefore an independent contractor
• I only need Flood insurance if I am in a flood zone

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Insurance Agents E&O Claim Trigger

We came across an article on insurance agents E&O (errors & omissions, or professional liability) with some misleading information.  The article, which unfortunately is not available on the web, states that receipt of a subpoena is a claim under an insurance agents E&O policy, and therefore should be reported to your E&O insurer.

Unfortunately, the article is misleading.  The receipt of a subpoena by itself does not constitute a claim under most insurance agents E&O policies.  However, you probably should report it under your E&O policy in an abundance of caution, and to have the benefit of expert advice before complying.

Why does a subpoena not necessarily trigger an E&O claim?  All definitions of claim in insurance agents E&O policies are similar (but not the same), so we randomly picked one:

Claim means a demand for monetary damages arising out of a professional service made against the insured...

The key wording is the demand for monetary damages.  A subpoena is not a demand for monetary damages, and would therefore not trigger a claim under this policy.  However, most policies also provide for some mechanism to report an incident which might lead to a claim, and here is one example:

...an event about which an insured obtains knowledge which might result in a claim is reported in writing to us…

What a subpoena might trigger is a realization that there is the potential for a demand for monetary damages at a later date.  But not always.  Here is one real-life example where the subpoena did not trigger a claim:

An insured reported a claim to its insurer.  After its investigation, the insurer denied coverage for the claim for material misrepresentation in the application.  The insured brought a claim against the insurer alleging bad faith, and the insurer subpoenaed the agency which placed the account.  The agency checked their files, and concluded that there was no error on their part and that the file was well documented.  The agency went first to its own counsel to review the matter and obtain advice, and then immediately requested an indemnification from the insurer for any ensuing litigation.  The insurer agreed, and then the agency reported the situation to its own E&O insurer.

The E&O insurer was pleased because there was no demand against its insured, the agency (ie no formal claim), and an indemnification was in place.  And the agency was protected by the indemnification.

Note that each situation is different, and legal counsel is critical in assessing alternative strategies.

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Insurance Competition Remains

Discussions on the potential for a hardening insurance market have pointed to cat property as one area that is leading the way to a tighter insurance market, with increasing pricing.  Following our prior post (see here) on the soft insurance market, Business Insurance noted that the reinsurance market is not hardening as fast as some had predicted (hoped?).  The article (see here) observed that US cat property renewal rates increased approximately 15% at 7/1, but other territories saw more moderate increases.  An insightful comment from AM Best notes:

Those with the technical discipline and market profile to do so are trying to drive up rates, even at the expense of market share. Companies that were weakened by the financial crisis, in terms of capital and ratings, face pressures to make concessions on rates to keep their customers’ loyalty.

It sounds like a hard market is not right around the corner.

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Hard or Soft Market?

As we pointed out in prior posts (see here, & here on D&O), the insurance market continues its competitive ways – no hardening in sight.  Despite deteriorating industry results, the market will not tighten until there is adequate economic incentive (ie pain) for insurers as a group to decline to write business at current prices.  In fact, we still see insurers aggressively pursuing new business and new segments.  Some of the best insurers are showing excellent underwriting results company-wide, and many insurers are satisfied with underwriting results in some of their key lines of business. 

The Mercator Risk Services perspective on the insurance market is well represented in three recent articles.  According to one article (see here), competition is slowing somewhat in the umbrella and excess liability market.

Right now, we’re seeing stability with respect to rate change…A year ago, we were looking at a market that was declining 10- or 12 percent.

And the EPL market continues to be soft (see article here).

While some are expecting a hard market around the corner, the current employment practices liability insurance market is moderately soft… Despite the external factors negatively impacting the EPLI market, significant competition remains. The result is numerous choices, broader coverage and some pricing pressure.

The third article (see here) notes that we are not in a hard market now because the pain was not equally distributed and the pain has not lasted long enough, and concludes:

While the underlying fundamentals of the market point to a continuation of the current soft market conditions, rate decreases have slowed throughout the early part of this year and may result in a "soft landing" where pricing begins to flatten out as the market finds its footing. The exceptions are, as noted, CAT property and D&O. …Short of further shocks to the market, from either catastrophic losses or further weakening of the economy, the general soft market conditions should continue through at least 2010.

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Mortgage Brokers E&O

Because underwriters have expected claims against mortgage brokers from the real estate crisis, the mortgage brokers professional liability (E&O) insurance market has tightened.  While pricing has not changed as dramatically as you would expect, terms have.

Mortgage brokers have been blamed for at least part of the real estate problems, and one claim situation demonstrates why.  What is particularly interesting in this case is the application of the fraud exclusion.  After the insurer denied coverage for the claim, coverage litigation ensued.  On appeal the court held that no professional liability (E&O) coverage was available for the mortgage broker based on the fraud exclusion in the policy.  See here for the appellate court decision.

New Fed Mortgage Corporation, a mortgage originator, sued its insurer, National Union Fire Insurance Company of Pittsburgh, PA, in 2007, alleging that National Union had wrongfully denied it coverage under an errors and omissions ("E & O") policy. On cross motions, the district court granted National Union's motion for summary judgment because it found that New Fed's claim fell within an exclusion in the policy.

New Fed was a mortgage broker, and as such was responsible for providing detailed information to lenders about potential borrowers.  It appears that one of New Fed’s brokers falsified credit reports on mortgage applications provided to lenders, and that if an accurate credit report had been provided the mortgage application would have been denied.  In this case, a contractor New Fed was doing business with suffered losses when the lender required this contractor to repurchase a set of mortgages with false credit reports.  New Fed filed a claim with its insurer, which was denied, and litigation ensued.  The court found:

Whether the policy provides coverage is determined by comparing the allegations of the underlying claim … with the policy provisions...  [The] demand letter alleges that New Fed submitted "fraudulent information" in four mortgage applications. The letter stated: "[T]he credit reports … were altered... [The] allegations place New Fed's conduct squarely within the E & O policy's fraud and dishonesty exclusion, and New Fed is not entitled to indemnification.

From this claim it is clear that fraud exclusions can be applied to deny coverage.  One issue that did not come up in this case is so-called severability provisions.  Generally, severability provisions allow some exclusions, typically fraud and intentional acts exclusions, to apply separately to each insured.  This means that employees and the organization may have coverage for a claim relating to fraud that they did not participate in, and the employee committing the fraud may not.

See other commentary here, here and here.

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