Specialty Insurance Blog

Signing Insurance Applications

Virtually all specialty insurance applications, such as Professional liability (including D&O and EPL) insurance applications, are designed to be signed by the insured because the information in an application is a representation about the risk and the information is material to the underwriter.  Every once in a while we come across a situation where an agent or broker has signed an application as the insured.  This is surprising because this is completely inappropriate - it is neither legal nor ethical.

We have all been subject to the pressures of binding coverage at the last minute, and this is the opportune time for a costly error in judgment.  There are many reasons for communications breakdowns, and unfortunately the pressure is usually on the agent or broker.  Whether an impending effective date or binder expiration date, underwriters will often not finalize an order without specific information, such as a completed and signed application.  If the insured has been difficult to pin down, it is easy to take care of the problem with a signature.  Unfortunately, we have seen the most wily clients put pressure on their insurance reps to resolve the situation themselves, with the result that the agent or broker signs the app.  This can prove very costly for the agent. 

In a recent situation a producer could not reach the client, and the insurer would not extend the binder date without the signed and dated application.  The agent signed the app without instructions from the client, and, you guessed it, a claim ensued shortly thereafter.  The insurer discovered that a series of prior claims that had not been disclosed on the application, but the insured pointed out that he had not made any false representations since he did not sign the application.  While the case is still pending, the agent has both an insurance agents E&O claim and regulatory issues to deal with.

A recent Amercian Agent & Broker article (see here) points out the importance of proper application documentation, and notes two cases relating to this issue. 

Agents and brokers should attempt, as a matter of self-preservation, to have each insured sign the application or authorize the agent or broker—in writing—to sign the application on the insured’s behalf, with a statement by the proposed insured that the application has been reviewed and the facts stated in the application are true and correct.

Good advice.

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A New Life/Health Broker on the Way

A group of private equity firms are forming a new life and health insurance broker.  According to a press release (see here and here), the broker, called Insphere Insurance Solutions, will be formed by The Blackstone Group, Goldman Sachs and Credit Suisse.  The plan:

This new company expects to be the nation’s largest independent career agent distribution group offering life, health, long-term care and retirement products for small businesses and the middle-income market. Long-time insurance industry executive Phillip J. Hildebrand has been named as chief executive officer for the new company. Insphere Insurance Solutions will be exclusively focused on the under-served small business and the middle income market, said Hildebrand. This market has been largely ignored by major insurance carriers and agents who have migrated to serve more affluent consumers. This has resulted in a scarcity of distribution in this market.

Insphere Insurance Solutions expects to be the largest independent career agent insurance distribution group in America, with a force of 3,500 agents and offices in over 40 states expected when the company commences services in 2010.

Why start small!

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Buffett Shareholder Letter

Berkshire Hathaway is well known in our industry as the owner of insurance standouts National Indemnity, General Reinsurance, GEICO and USLI (our favorite).  Berkshire's 1Q 2009 earnings were down, but the Chairman was cautiously optimistic about Berkshire's insurance opportunities (see here & here). 

After Berkshire's worst year ever, Warren Buffett, well known investor and Chairman of Berkshire Hathaway, published his highly anticipated annual shareholder letter (see here), and it is worth taking a closer look at a number of interesting and valuable observations on the insurance industry contained in the letter.  Here are a few:

Our insurance operation, the core business of Berkshire, is an economic powerhouse.  Price is what you pay; value is what you get.

GEICO grows because it saves money for motorists......drivers look for the lowest-cost insurance consistent with first-class service.  Efficiency is the key to low cost...Americans are focused on saving money as never before

A promise is no better than the person or institution making it.  That’s where General Re excels: It is the only reinsurer that is backed by an AAA corporation. Ben Franklin once said, “It’s difficult for an empty sack to stand upright.” That’s no worry for General Re clients.

Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of geeks bearing formulas.

We commented on the challenges of effectively using modeling in the insurance business in a prior post on The Black Swan (see here).  And The D&O Diary points out (see here) that the annual shareholders letter omits any mention of the criminal trial that arose concerning reinsurance arrangements between Berkshire sub General Re and AIG (see here & here).

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Employment Practices & Risk Management

Risk management has a very significant impact on employment practices liability loss experience, and will impact employment practices liability insurance (EPL) premiums.  One of the best risk management practices is the proper maintenance of personnel records.

Personnel records provide some of the key documentation necessary in defending employment claims, and in many states employees have the right to review part or all of their own personnel file.

Troutman Sanders has an excellent summary on some of the key points for best practices in maintaining personnel files (see here).  Note that state laws regarding disclosure of personnel files, and other employment requirements, are not consistent, and local counsel should provide the last word on personnel records and other employment practices risk management.

Key points:

• Maintaining performance records deserves a special mention, because they are often critical to an employer’s ability to get a lawsuit dismissed or win at trial.
• Watch out for information that identifies an employee as a member of a protected class…keep this information separate to help defend against any suggestion that a manager considered the demographic information in making a personnel decision.
• To ensure that you are fully complying with these [ADA/HIPAA] laws, keep all medical-related documents in a separate file.
• Investigation records should be kept in a separate file.

Employers committed to risk management, who utilize best employment practices, will reduce wasteful and unnecessary employment litigation, and keep their EPL premiums at a lower level.

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The Power of the Internet – & Insurance?

The internet has opened up new frontiers for highly specialized groups as well as the masses, but has its true power had any significant impact on the insurance business? 

Many so called experts predicted the demise of insurance agents through disintermediation by the internet.  What they did not understand was the valuable role insurance agents play in a transaction, and disintermediation has not occured.  But new internet changes could still impact the way we conduct business, and one such change is beginning to gain some traction.

All of us are familiar with the big names in internet change:  YouTube, Wikipedia, Google, Facebook, Amazon,…  These and other innovative internet applications have provided new ways for individuals and businesses to communicate and process information.

One fascinating trend, although not new, that is just starting to get some real traction is using the internet to harness the distributed knowledge of individuals to create collective information.  Where the power of individuals working collaboratively is more powerful than any single organization is able to build on its own.

The most obvious example is Wikipedia, a web based encyclopedia written collaboratively by volunteers from all around the world.  Created in 2001, Wikipedia has 65 million visitors monthly, more than 75,000 active contributors working on more than 13,000,000 articles in more than 260 languages.  This massive compendium could not have been created without the contributions of many different experts.

A second example is specialized, called CellarTracker, which allows an individual to maintain an online inventory of their own wines.  What is unique about CellarTracker is that there is one underlying database which is created through the sharing of information between members.  For example, if you want to enter a particular bottle into your inventory, you first see if someone else has already entered that particular wine.  If so, you choose it and add the wine to your inventory.  Each member has their own set of information based on their own wine collection, but the combination of this information creates a huge database.  The database structure facilitates sharing comments and notes, and adding external data such as pricing.  Started in 2004, 81,000 members have added their 12.8 million bottles of 626,000 different wines from more than 51,000 producers.

A third example is much more narrowly focused, really in the Long Tail, and is a Google Earth project on North Korea called North Korea Uncovered (see here, and articles here & here).  The site began with an individual began gathering information on North Korea from pictures and first hand accounts and mapping them.

Spying on North Korea would seem to be a job for intelligence services, but one PhD student at George Mason University has exposed many of the secrets of the insular regime from his home computer. Piecing together clues from news reports, photos, and eyewitnesses, Curtis Melvin and colleagues have annotated Google Earth's map of North Korea with hundreds of labels, documenting everything from mass graves to a waterslide. "It's democratized intelligence," he tells the Wall Street Journal.

So where is the insurance business?  The internet in particular, and technology in general, have been integrated into our daily business processes.  But are there any examples of similar collaborative approaches – combining the collective knowledge of the many – in the insurance business?  Are there any ideas or early stage organizations?  Please let us know.

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OB/GYN Liability

Medical malpractice insurance for OB/GYNs is a very difficult healthcare segment to underwrite.  Not surprising, the insurance market for this class is very thin.  Some of the highest severity claims occur in this segment – for obvious reasons.  An excellent discussion of why, with statistics and data, was presented in an article from Willis Healthcare Practice (see here, & here for the article).  There is not much for us to add.  This article is well written.

 

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Black Swan Theory in Insurance

Black swan theory was bound to show up in the insurance industry, but so far there has been limited discussion.  Do you know what a black swan is?  Black swans are important in assessing future insurance losses, but are they adequately represented in the models? 

The term originates from a book called The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb (also see here, or see Recent Books on the left of this blog).  Wikipedia provides a good definition (see here):

a large-impact, hard-to-predict, and rare event beyond the realm of normal expectations

The book was written from the perspective of investing (Taleb was a hedge fund manager), but the concepts are particularly important for the insurance industry.  A central thesis of his book is that models are defective and lead to incorrect conclusions because black swan events are not contained in the data and are therefore assigned a probability of zero outcome – obviously incorrect. 

While there has been quite a bit of discussion of insurance modeling, there has been little discussion of black swan events and the ability of predictive models to adequately assess severe catastrophes for insurance purposes (see here and here for two such articles). 

However, two articles came to our attention recently.  The first (see here) is a response to some comments made by Taleb in an interview (see here).  Taleb notes:

My idea in The Black Swan is to make people think of the unknown and of the potency of the unknown, particularly a certain class of events that you can’t imagine but can cost you a lot: rare but high-impact events.

The author makes an excellent pitch for combining predictive modeling techniques with outcomes not envisioned in historical data, and makes 4 suggestions for planners (see here).

In the second (Risk & Insurance commentary, see here) the author is concerned that the black swan theory may result in less risk management and assumes that because black swan events occur we should or will not consider past history. 

I fear they may increase paralysis in risk management and further promote inaction.

But black swan theory is telling us that modeling, which relies on historical data, is only part of the story.  In fact, the future will be a combination of prior history, reflected in historical data, and new events, which can and at some point will lead to more volatility – sometimes better, sometimes worse.

The important point is that black swan events are not contained in historical data, and therefore traditional predictive models cannot provide complete picture of the future.  The second piece is equally important:  these events can be so large that they will dwarf other outcomes if they occur, although the probability of occurrence is extremely small.

Unfortunately, we have seen a number of these black swan events in the insurance business in the last few years, 9/11 and Katrina being two such examples.  Maybe a more flexible approach to modeling and a focus on risk management could be beneficial to the insurance industry.

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Coastal Risk Management

Insurance exposures within coastal communities are rising from climate change and development.  Increasing populations and property values, higher sea levels and more violent weather are all working to threaten insured property and challenge property insurers.  The insurance industry response has been focused on financing the aggregation of coastal exposure in a manner that does not risk insurer solvency.  Most of the political response has been focused on affordable insurance options, and one such result, which nobody in the insurance industry believes is effective or reasonable, is Citizens in Florida (see here & here).

Very little attention has been paid to risk management and the impact a risk management approach can have on adverse outcomes.  Both pre-loss and post-loss risk management tactics are critical components of successfully financing risk, yet there is little will within the industry or political segments to promote risk management.

A recent paper by The Heinz Center and Ceres has brought a group of diverse organizations (sponsors) together to generally agree on an approach to address the coastal threat that includes a heavy emphasis on risk management (see here, and here for the entire report).  Some key points:

Over half the U.S. population lives in coastal counties and almost half of the nation’s gross domestic product – $4.5 trillion – is generated in those counties and in adjacent ocean waters.  Further, insured property values along the Gulf and Atlantic coasts have been roughly doubling every decade.

Wharton has demonstrated that homeowners in Florida could reduce losses from a severe hurricane by 61 percent, resulting in $51 billion in savings, simply by building to strong construction codes. Putting this in perspective, the same cost reductions applied to Katrina damages would have reduced the $41.1 billion worth of insured property losses to about $16.1 billion. Similarly, the National Institute of Building Sciences showed that every dollar spent on mitigation saves society about four dollars on recovery costs. Despite this evidence, nearly all U.S. coastal cities and towns lack adequate land use requirements and building code standards to realize these savings.

Five hundred commercial clients of the insurer, FM Global, experienced approximately 85 percent less damage from Hurricane Katrina as similarly situated properties. This significant reduction in the amount of damage was directly attributable to hurricane loss prevention and preparedness measures taken by these policyholders. The return on investment is striking – a $2.5 million investment in loss prevention resulted in $500 million in avoided losses.

While risk management will not eliminate the exposure, it can go a long way towards making the cost of insurance reasonable.

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Mark to Market Accounting

You may have heard about mark to market accounting, also known as fair value accounting, but did you know that this accounting theory has contributed to the economic crisis and can lead to professional liability insurance losses?  Unfortunately, this particular accounting technicality, FAS 157, may have contributed - some say caused - the credit crisis, and may lead to more litigation.  These claims are starting to make the rounds in professional commentary and on blog posts.

Mark to market, or fair value, accounting is the new standard for GAAP accounting contained in FAS 157.  I have put some links on this subject below.  An excellent article from Duane Morris (see here) outlines some of the issues relating to causes and potential litigation from the application of FAS 157.  Additional articles are available here, here, here and here.

FAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Fair value accounting sounds great in theory, but it creates some very significant and real problems in reality.  FAS 157 requires asset values on balance sheets be adjusted to reflect the current market values.  For example, a bank is required to write down a loan on an asset where the value of the asset has fallen below the loan amount regardless of whether the loan is performing.  In times like these, when asset value are falling, FAS 157 requires massive write downs on loan portfolios even if they are performing.  These write-downs create a real loss of GAAP capital, and can impair the financial strength of the institution with the technically impaired assets.

Take another example.  A venture capital firm invests in a new technology company that is expected to take a number of years to get to profitability (ie it is burning cash as it develops the technology).  The VC firm must make a market-based estimate each year, and sometimes more frequently, of the market value of its investment.  Typically, the market value of early stage companies would be zero (0), even though the investment might be performing exactly as expected.  [Note that this example assumes no interim rounds with outside investors that would set a market price.]  So the VC firm must, according to FAS 157, write the value down to zero (0) early in the process.  That might be okay for the VC firm if everyone understands what is going on, but it does not reflect long-term economic reality.

Now, some are anticipating that the fair value, or mark to market, valuation approach will add volatility to reporting company financial statements, and that this will lead to increased litigation against directors and officers, accountants and other professionals.  Obviously, increased litigation will drive up the costs of professional liability insurance.

If significant restatement activity results from increased levels of scrutiny, legal implications can be anticipated, as history has shown during other periods of financial results restatement activity. This could result in additional litigation through shareholder lawsuits.

It is too soon to tell whether the increased litigation, and increased professional liability insurance pricing, are coming.  But the controversy around FAS 157 continues.

Info & Articles on FAS 157:

FAS 157
Private Equity Guidelines
PE Blog Post – Fair Valuation
VC Valuation Committees
VC Perspective on 157
General Commentary on 157
General Commentary on 157
General Commentary on 157
VC Perspective on 157
Tuck School Valuation Survey
Tuck School Valuation Article

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Specialty Lines & Technology

The internet is having a profound impact on how society interacts and how business is conducted, and this extends to the insurance business.  Companies like GEICO and Progressive operate online as well as in person – the client chooses.  Has the use of technology impacted the specialty lines insurance segment as well?

A recent article in Insurance Journal highlights some of the challenges, and the perceived lack of progress, in the specialty lines market (see here).  Our perspective – different – is noted below.  The article is a summary of an interview with Jeff Ward, a director of London Market reform technology specialists TriSystems.  Key points in the article:

• the wholesale market is miles behind the retail market...they haven't even come close to the level the retailers have.
• In most cases - other than certain specialty lines - a potential wholesale buyer gets only limited information.
• The London market basically doesn't do business electronically
• It [electronic transactions] may not work for complex risk[s]...They will probably always require face to face negotiations, but there's a great deal that can be done electronically. Much of the actual work is not so complex that computers can't handle it.
• For wholesale business, a true global electronic market is probably many years away. Retail will get there first.

This characterization of the specialty lines market is only partially correct, and not because the specialty lines market has failed to adopt technology.  The specialty lines market (see here) is composed of insurance accounts that do not neatly fit into the rigid underwriting boxes of the standard markets due to more risky exposures, unique operating characteristics or adverse loss experience. 

The key is the underwriting approach in the specialty lines business - art, not science.  It is all about risk assessment.  Different underwriters will look at the same account differently, and will want to review different information.  And because the exposures presented can vary substantially, underwriter requests for information are not always consistent.  Additionally, the terms that are provided are not consistent between accounts or between underwriters, and are often negotiated.  This makes it difficult to neatly define the information needed by underwriters for large parts of the specialty lines business.

The article points out that some complex risks may require face to face negotiation.  Maybe, maybe not.  But today many complex risks are negotiated by specialty brokers, like Mercator Risk, and specialty underwriters without face to face meetings.  How?

Specialty lines brokers and underwriters are actually heavy users of technology.  The primary method of communication today, and of exchanging exposure and quote information, is email, and many specialty lines organizations (including Mercator) are completely paperless.  Negotiation of complex risks takes place every day via email and phone.

Most specialty lines rating and quote systems today are electronic, at least in some form.  They differ substantially from their standard market peers in that they allow for significant customization of rating and terms by underwriters.

While most of the business written in the specialty lines business is customized, there are significant segments that are handled completely electronically, online, by end to end underwriting and rating systems.  Mercator, through its MercatorPro division, provides online quoting for its retail insurance broker clients on its website for some lines of business.  The challenge for the specialty lines business is that some percentage of the business gets rejected from these systems due to the exposure variations or coverage adjustments inherent in specialty lines business.  Specialty lines brokers like Mercator have built in processes to efficiently handle this rejected business to ensure that, in most cases, the specialty lines applicant receives terms.

Bottom line, the nature of the specialty lines business is the driver of the differences in the use of technology, not a failure to adopt technology.  The use of technology in specialty lines is significant and continues to grow, but how technology is used will not exactly match the commodity-like approaches of the standard lines businesses.

Readers should note that this subject is very complex, the specialty lines business large and equally complex, and that this short commentary does not do the subject justice.

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