Specialty Insurance Blog

Attorney Fees

Hopefully we will read the headline: Attorney fees in check, D&O insurance premiums decline!  Wishful thinking, but Milberg Weiss, the embattled (see here, here) securities plaintiff attorney firm, only received one third of the fees it had been seeking in a securities class action lawsuit against Nortel - $37 million rather than the $101 million it had been seeking (see here).  The case settled for more than $1 billion.

Poor Timing?

The Governor of Florida and the Legislature have passed legislation solving, they hope, Florida’s property insurance challenges, but after a mild hurricane season and increasing competition in the insurance market are they buying at the peak?  We won’t know for years whether this bet with (against?) Mother Nature is a good one, and the current politicians will probably not be around to deal with any problems that develop.

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In case you missed it, the new legislation puts the State of Florida in the insurance business by having the state assume a large share of the hurricane risk and by having Citizens compete with private insurers (see here, here, here and here).  The legislation:

• Is expected to result in significantly lower insurance premiums through a rate freeze and rollbacks
• Will allow insurers to purchase catastrophe (cat) insurance from the state fund if savings are passed to consumers
• Allows Citizens to compete with private insurers
• Requires that claims be paid or denied within 90 days
• Prevents insurers from dropping insureds during hurricane season
• Requires excess profits be returned

All this as the market, even the property cat market, gets more competitive:

• Primary and reinsurance incorporations in Bermuda totaled 82 in 2006 – a three year high (see here)
• There is anecdotal evidence that underwriting discipline is waning (see here)

What is the risk for residents?  The state sustains one or more huge cats and significant losses from their entry into the insurance business, and has to go back to taxpayers to foot the bill.  While the specific impact of the new legislation is difficult to assess, a leading analyst had the following comments (see here):

• The legislation … will drive more than $1 billion in premiums from the property-catastrophe reinsurance market—along with a quarter of reinsurers’ profits
• The Florida plan is a “backhanded attempt” at national catastrophe fund legislation
• The aggregate limit covered by the [state cat] fund has soared from $16 billion to $33 billion
• The $10-to-$12 billion property-catastrophe reinsurance marketplace will collectively lose $1.2-to-$1.6 billion in premiums—or perhaps even as much as $2 billion
• The reduced profit impact will be even worse… It is not inconceivable to talk about 25-30 percent of the expected profitability of the worldwide property-cat market that has just been eliminated
• The insurance industry has lost faith in Florida where the political risk of operating has intensified.  It is effectively the Roach Motel - you can get in, but you cannot get out
• Pricing, which would have been under downward pressure absent the Florida law, is now under more intense pressure

A prominent insurance author offers the following comments (see here):

• Florida lawmakers didn't have the political guts to accept reality and truly represent the long-term interests of their constituents

• The scariest part is that Gov. Crist says the new statute is only the first stage of insurance reform in the state

And Fitch sums up the industry sentiment (see here):

Fitch views Florida's proposed legislation as a mechanism to further suppress homeowner's insurance rates in a market where rates continue to be inadequate

All this as property cat rates were set to begin to soften.  (See most recent prior posts here, here and here.)

Certificates & E&O Claims

Insurance certificates of insurance can cause or contribute to insurance agent-broker professional liability (E&O) claims.  More third parties are asking for evidence of insurance, traditionally provided by insurance agents on ACORD forms, in alternative or customized forms and the requests are becoming more complex (see here and here for real-life examples).  Problems with certificates of insurance are impacting agents’ E&O coverage, and the Big I is taking an active role in addressing the issue of certificates of insurance (see here - Some Lenders Refuse to Accept New ACORD Forms).

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According to the IIABA (Big I) E&O claims data certificates of insurance are increasingly involved in E&O claims:

• E&O claims involving certificates – up 28% in 2006
• E&O claims involving certificates – ~5% of all claims

Sources:

• Failure to add or identify additional insureds – 36%
• Misrepresenting coverage on a certificate – 21%

Problems:

• Insurers unwillingness to provide notice of cancellation to certificate holders.
• Unreasonable insurance requirements by contractors, corporations and governmental entities

From time to time we receive requests to add non-affiliated entities as additional insureds to our insured's professional liability policy.  In most cases this is not a good idea, and the clients do not know this. Most professional liability policies have an insured versus insured exclusion, and adding a client as an additional insured defeats the purpose of the policy (see here).  There will likely be no coverage if a claim is made by the client.

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The Big I has published a white paper entitled "Certificates of Insurance: Issues and Answers." (see here and here)  The paper includes some background on certificates of insurance, a description of the issues that can arise, and recommendations on how to address the problems.

Medical Professional Liability Accounts

Insurance agents & brokers that we talk to often ask what types of medical professional liability (medical malpractice) insurance accounts are we seeing and writing – where is the market activity?  Here is a brief summary.

Tough to place physicians.  These accounts are physician accounts that are rejected from the standard market for one reason or another, the most obvious being physicians with claims.  Other examples include:

• Specialty consulting work
• Clinical trials
• Medical file review
• Independent medical examinations

Miscellaneous medical businesses.  New healthcare technologies are driving continual change in the miscellaneous medical business, creating insurance opportunities for both new and existing medical businesses.  Examples include:

• Pharmacies
• Allied medical training institutions
• Testing laboratories
• Ambulatory surgery centers
• Blood/tissue facilities
• Clinical research organizations
• Occupational/physical rehabilitation centers

Medical Spas.  MediSpas, a growing trend in the spa business, integrate medical practices with traditional spa treatments.  MediSpas need specialized medical professional liability coverage because the increased exposure of medical treatments are added to traditional spa exposures.

Marsh Property Facility

Insurance agents & brokers have undoubtedly seen Marsh’s announcement that they are forming MaRI, an in-house facility which will provide additional property catastrophe capacity to their clients (see here).  In case you missed it, MaRi will be a Bermuda-based reinsurer of ACE which:

provides large corporate clients of Marsh with exclusive access to insurance capacity intended to fill gaps that are creating instability and shortfalls in property catastrophe risk coverage

Hurricanes & Models

The hurricanes of 2004 and 2005, and the non-hurricanes of 2006, are continuing to impact the insurance industry in dramatic ways that are critical to insurance agents and brokers, and the impacts seem to be moving from analytic solutions to political solutions.  This is not good news for the insurance industry, and it will be up to insurance agents and brokers to finds solutions for distressed clients.

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A recent paper on the economics of hurricanes and their damage (see here and here) by William Nordhaus has two points that should be of concern to insurance practitioners:

• Greenhouse warming is likely to lead to greater intensity of intense hurricanes
• Damages appear to rise with the eighth power of maximum wind speed

Assuming this paper is correct, the prospects for larger concentrated catastrophe (cat) losses are significant even with no change in frequency, which would indicate a need for greater pricing and reduced exposure in cat-exposed regions.

Politicians are embarking on a political solution to address increased insurance costs.  One approach is focused on challenging the assumptions that the cat models are using - legislators have requested a peak at their inner workings (see here).  The Florida legislature is in special session to find a cost effective solution (see here) which may include shifting more risk from the industry to the state (taxpayors) in return for lower premiums.

The news out of Mississippi (see here), where a federal judge ruled against State Farm in a key wind vs. water case and where the insurer was assessed $2.5 million in punitive damages in addition, is not going to give industry risk takers any comfort.  And it appears to be triggering more scrutiny (see here). 

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Combined, the results are a high level of risk, excellent profits from a cat-less 2006, and politicians wanting action.  For insurance agents and brokers, the result could be more of a crisis for clients as insurers and reinsurers react to the political pressures.  Stay tuned.

Update:  Not all insurance agents & brokers press is positive:  The Palm Beach Post is complaining about higher commissions (see here).

Update 2:  See a good post on the special session by RiskProf (here), and a summary article here.

Management Teams for New Companies

Who do venture capital investors like to back?  A good summary can be found at Union Square Ventures.  Key points:

• Founders and managers are usually the same, but not always
• Top managers must be able to attract new people.
• There must be a high likelihood of a very positive experience - they look for people they will enjoy working with

They divide the types of people they back into three groups:

1. Entrepreneurs they have worked with before
2. Serial entrepreneurs - people who have done it before.
3. First-time entrepreneurs-the riskiest

They will back management teams in all three groups, but the deal criteria are not the same for each group.

Real Estate Professional Liability

Insurance agents and brokers place a wide range of real estate related professional liability insurance, including agents, mortgage brokers, appraisers and property managers, and may be wondering how the downturn in the residential real estate market may be impacting these professionals’ E&O insurance. 

Market volatility can create situations where a buyer or seller suffer a real or perceived financial loss, and may attempt to hold a professional responsible.  Today’s real estate market is characterized by volatility: higher inventories, falling prices and uncertainty.  This has lead to real or perceived loss in value by recent purchasers and current sellers, and may not able to realize the value in their real estate holdings that they expected.  This causes professional liability claims.

The most obvious targets are real estate agents, and one of our underwriter commented:

Claim situations may arise as they blame their real estate agent for their perceived loss compared to market pricing a few years ago. Conversely, it prices rise after a sale, sellers may blame their brokers for negligence in misinterpreting the market.

Mortgage brokers are also a target, and may be exposed from two directions.  The rise in mortgage rates resulted in more real estate owners and buyers utilizing adjustable rate mortgages (ARMs), and declining values may make it more difficult for owners to get out of difficult financial situations caused by ARM adjustments.  The mortgage broker will be exposed to negligence and predatory lending claims when losses occur.  Our underwriter offered the following example:

The year is 2003 and a potential home buyer, Mr. Joe Smith, asks a mortgage broker advice on how to finance his dream home. The broker responds that Joe could indeed purchase that fine house by taking advantage of a wonderful product called an adjustable rate mortgage. The interest rate would be very low. The only caveat is that in 4 years the interest rate would increase to market levels. But so would Joe Smith’s income! Four years later arrives and sadly Mr. Smith’s salary has not increased. His monthly mortgage payment has now skyrocketed along with gasoline prices and credit card debt. Foreclosure looms. The once happy buyer blames the mortgage broker for negligent advice and threatens a lawsuit.

Securities Lawsuits Down

Securities lawsuits, a major driver of the directors & officers (D&O) liability insurance market, are down for the first part of 2006 according to a new, mid-year report released today by the Stanford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research (see here and here).

Conclusions:

• The annualized number of “traditional” securities fraud class actions filed from January through June 2006 decreased 31 percent compared to 2005 levels
• The number of filings in the first half of 2006 is at the lowest level for any six month period since 1996, & on an annualized basis is 36 percent below the 1996-2005 historical average of 194.
• The study also finds a large decline in market capitalization losses related to all securities fraud class action lawsuits filed so far in 2006.  The Disclosure Dollar Loss (DDL) decreased 55 percent on an annualized basis from $100 billion in 2005 to $22 billion ($45 billion on an annualized basis) in the first half of 2006.

The study also looked at the problems with options backdating and concluded:

• Despite the recent wave of public attention surrounding the alleged backdating of options at more than sixty publicly traded companies, the impact of the scandal has not been as large as some might expect.
• Only eight federal class actions had been identified alleging illegal backdating behavior by June 30, 2006.  (Since the close of the report’s sample period, two more issuers have been named in backdating class actions)

Stanford Law School Professor Joseph Grundfest, Director of the Securities Class Action Clearinghouse and former Commissioner of the Securities and Exchange Commission notes several reasons why class action complaints in [options] backdating situations are not more common.

• Many disclosures relating to allegations of backdating are not accompanied by statistically significant stock price declines.
• The alleged options backdating activities occurred so long ago that the statute of limitations defense may be effective.
• In some situations, the uncertainties associated with the application of appropriate accounting principles may cause potential plaintiffs to recognize that they will have difficulty alleging that there was an intention to commit fraud.
• Most of the litigation is being filed in state court through derivative actions because these actions do not, as a practical matter, require significant stock drops as a predicate to filing, and it may be easier to allege a violation of a fiduciary duty in many of these cases than to demonstrate a willful fraud.

Professor Grundfest also noted that “while we lack the data necessary to determine the precise cause of the slowdown, the most intriguing hypothesis is that extensive and expensive corporate efforts to improve governance and accounting have reduced plaintiffs’ ability to allege fraud.” 

Risk management works, as does a strong stock market.

Sidecars

Sidecars, a recent phenomenon, are specialty reinsurance companies designed to provide additional capacity to a specific reinsurance company.  Investors, such as hedge funds, invest in a reinsurance company, the sidecar, to reinsure specific risks for a specific reinsurance company.  Their use has grown significantly since the major catastrophes (cats) of the past few years. 

Investors like sidecars because their capital can be put to work quickly and efficiently, for a very specific set of risks for a specific time frame, often in a tax-advantaged environment.  Reinsurers like sidecars because they have considerable additional capacity for their severity risks, typically cat exposures, without having to go into the retrocessional market.  Credit risk and other market factors are eliminated. Sidecars are typically located in offshore tax havens such as Bermuda.

Additional information on sidecars can be found here:

• CMS Cameron McKenna LLP
• Wikipedia
• Insurance Journal
• Business Insurance (Reg Reqd)