A Buyer’s Market
Cyber and errors and omissions (E&O) insurance rates will spike in 2016 — some by as much as 150 percent — driven by the growing threat of hacking and data theft, according to the latest market report by Willis.
Overall property and casualty premiums, however, will continue to soften as a result of benign losses and overcapacity, the global insurance broker said in its “2016 Marketplace Realities” report.
In total, Willis expects rates in 2016 to decline in 10 lines, including property, casualty and aviation.
However, cyber and E&O buck that trend, with cyber premiums expected to increase by up to 15 percent in general, and by between 10 percent and 150 percent for point-of-sale retailers and large health care companies.
Smaller organizations with revenues of less than $1 billion face lower increases, said Willis.
“There’s a recognition that because there’s a high frequency of events there will be more demand for coverage as people realize that they are vulnerable to cyber attacks.” — Meyer Shields, managing director, Keefe, Bruyette & Woods
Meyer Shields, managing director at Keefe, Bruyette & Woods Inc. at Stifel Financial Corp., said that cyber rates will continue to climb as a result of the high frequency of breaches.
“There’s a recognition that because there’s a high frequency of events there will be more demand for coverage as people realize that they are vulnerable to cyber attacks,” he said.
With total annual cyber premiums expected to reach $20 billion by 2025, according to industry experts, Willis said that underwriting requirements have continued to rise.
Insurers are also increasing retentions, reducing capacity and exiting certain lines, the broker said.
Excess cyber losses have also caused some markets to stop writing large accounts, while others have ramped up their premiums in upper layers of $75 million plus placements.
Willis said that those sectors at risk from large claims and litigation will continue to see the most upward pressure on rates, such as large technology companies dealing with expanding global privacy laws.
As a result of increasing cyber exposures, Willis said that some carriers have decided to withdraw from the retail, health care and financial institution sectors, as well as E&O programs that include cyber coverage.
Chris Lane, US placement leader at Marsh, said that while rates were decreasing on an aggregate basis, cyber is the exception.
He said “there is a big uptake in coverage by clients, while carriers are driving some rates up as a result of the recent losses experienced, particularly in the retail space.”
As for other lines, he expects “modest to single digit rate decrease across the board.”
“In property, it’s probably a higher single digit decrease and some of the casualty lines might be flat, as are financial lines.”
Soft Market Continues
The continued soft market, meanwhile, has been exacerbated by an increase in consolidation, driven by low interest rates and a benign year for catastrophes, — a trend that is expected to continue in 2016, said the Willis report.
“Marketplace forces have changed the size and shape of the pieces of the risk management puzzle to an extent we have not seen for some time.” — Matt Keeping, chief broking officer, Willis North America
“Marketplace forces have changed the size and shape of the pieces of the risk management puzzle to an extent we have not seen for some time,” said Matt Keeping, chief broking officer for Willis North America.
“The key force driving this change in the market is consolidation.”
“A smaller market with fewer, larger players also opens up the field to newcomers that can focus on smaller, specialized niches in areas of potential growth,” he said.
The report went on to say that while property rates will continue to fall, primary casualty rates for most buyers are declining for the first time in the current soft market.
Premiums for general liability are expected to fall by up to 5 percent and in umbrella/excess by up to 10 percent.
Property rates, on the other hand, should fall by 10 percent to 12.5 percent for non-catastrophe risks and by 12.5 percent to 15 percent for catastrophe risks, said Willis.
Most auto insurance buyers can also expect premium decreases of up to 10 percent, while airline insurance is expected to fall by 15 percent to 20 percent after the industry absorbed the major losses from 2014, according to Willis.
“We continued to hear from our members that this a buyers’ market,” said Ken Crerar, president and CEO, The Council of Insurance Agents & Brokers
The Council of Insurance Agents & Brokers likewise reported that commercial P&C rates continued to decline across all lines by an average of 3.1 percent during the third quarter of 2015. The biggest decrease was in large accounts, which dropped by 4.1 percent.
“We continued to hear from our members that this a buyers’ market,” said The Council’s president and CEO Ken Crerar.
Andrew Colannino, vice president of P/C at A.M. Best, said that the rating outlook for commercial lines in 2016 remained negative.
“There are going to be more downgrades than upgrades for commercial lines and the vast majority of ratings are going to be affirmations,” he said.
“There’s a now widening divide between the strong performers and the underperformers.
“For that second group, there’s going to be an increasing number of reserve charges amongst those carriers – a lot of them haven’t made the proper investments in technology, data and analytics and therefore some are at a competitive disadvantage.”
All For One or One For All
Perhaps the most important decision any risk manager faces when choosing a captive program is whether to select a single-parent or a group captive.
A single-parent captive (SPC) is set up exclusively by an organization to insure against its own risks. The insured owns the captive and is therefore only liable for its own risks.
A group captive, on the other hand, is formed by a group of insureds that band together to share their risks. Each organization is an owner of the captive and thus shares in its profits and losses.
The benefits of a captive from an insurance perspective are obvious — to have greater control over your insurance program and to reduce your insurance costs in the long run.
In its August report, A.M. Best found that captives continued to outperform the commercial sector in most key financial measures.
But before deciding on the right captive, companies must first consider a host of factors including the size of their business, the industry they are in and their risk appetite, and ultimately whether they want to go it alone or be part of a large group, and the advantages and disadvantages each brings.
“The key question you have to ask yourself,” said Dennis Silvia, president of Cedar Consulting, “is whether I can do this on my own or do I need other people to come on board with me?”
The argument in favor of SPCs is a strong one. SPCs have consistently outperformed the commercial insurance market and the overall captive sector over the last few years, according to A.M. Best.
“This focus and discipline on writing coverage where the SPC is only responsible for its parent’s risk, and not mutualizing risks or paying losses for third parties, is another key factor in SPCs outperforming both A.M. Best’s commercial market composite and captive composite,” said the ratings agency.
Such has been the growth of SPCs that between 2010 and 2014, the surplus in U.S.-domiciled SPCs increased by 33 percent, to $9.2 billion, while the amount of dividends paid during that period was a staggering $1.9 billion, said A.M. Best.
An SPC is an attractive option for any company with a highly specialist or unique class of business that doesn’t fit into a group program, or one that doesn’t want to share risk or any of its private financial information with others.
“The type of companies that set up SPCs are typically Fortune 500 multinationals looking to expand their risk management function, who have a loss experience better than the market and/or want access to the reinsurance market,” said David Gibbons, PwC Bermuda’s captive insurance leader.
Advantages of an SPC
One of the key advantages of an SPC is flexibility, with the captive owner in full control of all operational aspects, including lines of coverage and limits, as well as choice of service providers and domicile.
And because there is no risk-sharing, the company has greater control of its risks and doesn’t have to pay someone else’s claims, as in a group situation.
On the flipside, the captive owner is 100 percent responsible for any losses.
“With an SPC you can create your own business plan to define how much risk and the coverage you are going to have, and change that on an annual basis, without the need for agreement with other parties,” said Chad Kunkel, captive services division executive vice president at Artex Risk Solutions.
“And because you are only insuring yourself, you don’t need to worry about any potential losses from sharing with other insureds that may arise in a group situation.”
Another benefit is that any surplus made can then be used to address the client’s immediate needs, such as increasing retentions, insuring new lines of coverage, or reducing future premium requirements.
Added to that, said PwC’s Gibbons, is the faster speed to market of an SPC than a group program because there is only one party making the decisions.
“Group captives, however, need to find other companies with a similar risk appetite and outlook to band together with, to agree on the level of risk they are going to put into the captive, as well as how they are going to share the profits and losses,” he said.
Group captives, on the other hand, appeal more to companies whose premium volumes are not big enough to warrant owning or operating their own SPC.
Similarly, they are likely to suit a company involved in a non-high-risk class of business or that is looking for pre-defined lines of coverage, such as workers’ compensation, general liability and auto liability.
While autonomy is central to SPCs, a key feature of a group captive is the pooling together of resources, enabling smaller to medium-sized companies to join together to share their risks, as well as profits and losses.
“Group captives tend to be formed by medium to small enterprises, like a car dealership, for example, that don’t have the economies of scale or the size of premiums or assets to be a meaningful player in the reinsurance market,” Gibbons said.
“To get that, they need to band together with other entities with similar risks in order to take advantage of the reinsurance market, to achieve lower costs on rates and to build up a big enough portfolio of assets.”
Peter Willitts, vice president of the Bermuda Captive Owners Association, said that because of its structure, it’s key that the guidelines of a group program are established at the outset.
“You have got to make sure that all parties are as committed to risk safety as you are and that they can live up to their financial obligations. Because the last thing you want is somebody to walk out on you after landing you with a big loss,” he said.
“Ultimately, everybody wants cheap insurance and to turn a profit, but at the same time you also need to hold back enough capital for the bad times.”
If you can find the right fit though, Artex’s Kunkel said, joining an established group captive has the advantage of being able to tap into the resources and expertise within that program, which are not necessarily available through an SPC.
“If you fit into the group captive model, long-term I would say it’s the best way to take advantage of the group purchasing, tax deductibility and risk management opportunities that it provides,” he said.
The Case for a Group Captive
Among the most attractive features of a group captive is the ability to spread costs among the various captive owners and thus reduce your own management and administration fees.
“Because all the members are like-minded individuals, everyone is pulling in the same direction — they want to control their losses and to do the right thing from a risk management perspective,” said Nick Hentges, whose company Captive Resources manages 31 group captives worth $1.7 billion in gross written premium.
Added to that, the capital requirements you have to put up are usually lower, Kunkel said.
“Your collateral requirements from an insurance carrier are typically lower in a group captive than they would be on your own because you are part of a group sharing some of that risk,” he said.
“Because all the members are like-minded individuals, everyone is pulling in the same direction — they want to control their losses and to do the right thing from a risk management perspective.” — Nick Hentges, president, Captive Resources
Because of the mass purchasing power of the program, reinsurance and services can also often be obtained at a fraction of the cost of doing so individually.
Group captives also offer ease of entry and a one-stop solution, they are structured to be tax efficient and often only require a nominal fee to join.
In addition, overall claims experience can be predicted with a higher degree of certainty than in an SPC, leading to improved loss forecasting, while there is an increased emphasis on loss control because of the risk-sharing element.
And with adequate capitalization, they allow members to retain higher levels of risk than they would otherwise be able to do on their own.
Disadvantages of groups
One of the biggest challenges of setting up or joining a group program is finding a group of companies with a similar risk appetite because they all have their own agendas, Gibbons said.
Those may include different retention and coverage needs, particularly if they operate in different areas of the country, are of varying sizes and have different ownership structures (publicly owned vs. privately held).
“When you enter into a group captive, you not only have to understand your own loss experience but also that of the other entities in that captive and how you mitigate against such exposure,” Gibbons said.
Sean Rider, managing director at Willis Global Captive Practice, said that in some cases companies don’t feel comfortable sharing other people’s risks.
“The first question I always ask a prospective client is, ‘Do you feel comfortable with taking on other people’s risks?’ ” he said.
“This is because you are entering into an environment where your contribution to the pot is exposed to other people’s activities and their contribution is exposed to yours.”
The distribution of underwriting profits and earnings can also be a bone of contention among members.
Being in a group captive also means it’s harder to change levels of retention and coverage than in an SPC because you have to get agreement from all parties, Kunkel said.
“The main challenges when setting up are data collection, making sure you have the critical mass and being able to take on any claims that may occur on an annual basis,” he said.
Hentges believes the relatively untapped resource of middle market companies means that the possibilities in the group captive space are almost limitless.
“We have about 3,400 clients right now, but we think there are somewhere between 20,000 to 25,000 middle market companies that we can go after, so there’s a tremendous amount of scope for the group concept, regardless of the overall market environment,” he said.
Risks in Three Dimensions
Companies are leaving themselves exposed to a host of costly and unexpected risks if they fail to come to grips with the new challenges presented by 3D printing technology.
Industry experts said that businesses need a fundamental review of their risk management processes and controls to deal with the potential problems caused by this new technology or they could find themselves being sued for copyright infringement or, worse still, having to pay out millions in product liability claims.
3D printing or additive printing, as it is commonly known in the industry, is the process of producing solid three-dimensional objects using a digital blueprint. It works by using a computer to send the design to a printer that then builds the product.
PwC estimates that 67 percent of manufacturers already use 3D printing, while NASA has been testing the technology in its space station for years. It is widely used for creating prototypes in the aviation, automotive and medical industries, and applications range from plane engines and car spare parts to surgical implants and prosthetic limbs.
With the industry expected to grow in value by 25 percent to $17.2 billion by 2020, according to consultancy firm A.T. Kearney, the scope for the technology is almost limitless — as are the potential risks, including counterfeiting and the manufacture of illegal drugs.
“The biggest risk of 3D printing is that you can make anything, anywhere in the world and that presents a host of potential problems,” said Mark Schonfeld, a partner at Burns & Levinson LLP.
“Those problems in the main include product liability, intellectual property, and safety and security issues.”
Supply Chain Risks
Schonfeld said that the biggest difference between 3D printing and traditional manufacturing is the complexity of the supply chain and the number of different parties involved.
“With 3D printing, you have more players than you would have in the traditional manufacturing process, where most of the participants work for the same company,” he said.
“So if something goes wrong with the product, who is liable – is it the designer, the supplier, the manufacturer or even the end user?
“Currently there is no legislation governing 3D printing, so it is often very hard to tell who is responsible.”
Rob Gaus, global product risk group leader at Marsh, said there are three key factors affecting any manufacturing process: “It’s about having a clearer focus on the materials that are being used, the financial strength of your supply chain partners, and the quality assurance program and processes that you have in place,” he said.
“Overarching all of those risks is the product risk management process, which revolves around risk assessment and how they apply in foreseeable use and misuse scenarios.”
Robert Weireter, vice president and senior underwriter at Swiss Re, said that increasing the scale of 3D print manufacturing also creates the problem of ensuring the quality and durability of the end product.
“When you print out something in a small-scale environment, you have a lot of control over the process, and therefore over the quality of the finished product,” he said.
“However, with 3D printing, questions arise when you increase the scale to a commercial level. Can you still ensure the quality of the finished product?”
Another key issue with 3D printing is counterfeiting or the illegal copying of products.
Provided you have the right design or blueprint and a 3D printer, it’s easy to quickly produce, for example, your own iPhone at home.
“It’s very easy if you have your own 3D printer at home to scan a design into your printer, print it out and sell it,” said Cindy Slubowski, vice president and head of manufacturing at Zurich North America.
“We have seen some claims, and the real issue is that the original manufacturer who has the rights to that product now has a counterfeit product out there that it knows nothing about and that can cause serious issues in terms of liability, patent and trademark infringement.”
No one is immune from the intellectual property risks associated with 3D printing, said Tom Srail, technology, media and telecommunications industry group leader at Willis North America.
“Intellectual property is a significant risk not only for the organization making the product but also for the supply chain as a whole and for other companies’ copyrights, trademarks and patents in similar types of products and areas,” he said.
“Even if you’re not producing anything using 3D printing, you can still be exposed to risks in the supply chain with other entities using the technology to counterfeit or copy what you are doing.”
Michael Bruch, head of emerging trends/ESG business services and chief underwriting officer, risk consulting, at Allianz Global Corporate and Specialty SE (AGCS), said that the convergence of manufacturing and digital technology also make unauthorized copying of product designs easier to do in the future.
“Because it will be much harder to track these products, traceability will become an even bigger issue than it was before,” he said.
“It will also bring a whole suite of issues such as piracy and copyright infringement to the fore.”
Therefore, it’s important for companies to do due diligence before manufacturing new products, said Shawn Ram, executive managing director and western regional manager at Crystal & Company.
“When manufacturing or technology companies develop a certain product, they have to do due diligence on patents and discovery on trademarks and copyrights, which is often overlooked because of the time and cost involved,” he said.
Security and Privacy Fears
The shadow of cyber risk also lurks around 3D printing. It’s no stretch to imagine someone hacking into a computer system and fundamentally changing the design of a product.
“You have this whole file sharing component in 3D printing that you don’t have in traditional manufacturing and so that automatically becomes a huge potential security and privacy issue,” said Zurich’s Slubowski.
“We are seeing a lot of 3D printing going into hospitals these days and if someone were to hack into their computer system and modify the design of a key component they produce, such as a heart valve for a patient, then the consequences would be unthinkable.”
Ram said that the lack of a strong regulatory environment in 3D printing also makes it much easier to manufacture a product such as a weapon that can cause harm or damage.
“There are still a lot of gray areas because there are so many different parties involved in the process, so it can be hard to create any meaningful regulations,” he said.
AGCS’s Bruch said that like any new technology, 3D printing will have its teething problems at first, but provided it is closely monitored, risks can be eliminated early in the manufacturing process.
“In terms of cyber risks, risk managers will need to review all of their IT risks in both their office computer systems and production lines and throughout the whole digitalized manufacturing chain from the first idea to the final 3D printed end-product,” he said.
3D printing also opens up the possibility of criminals exploiting the technology for their own gain, said Emily Cummins, managing director of tax and risk management at the National Rifle Association.
“Quite simply, any company that uses credit cards to run its business, which is most, carries a potential threat of being exposed to cyber risk,” she said. She cited a recent case where a criminal gang used a 3D printer to produce an ATM skimmer that was used to steal customers’ details.
“The kind of fraud that can be perpetrated from extracting the information on credit cards includes identity theft and financial theft.”
Risk Management Procedures Lag Behind
All of these risks have opened up companies to a host of potential claims running to millions of dollars, particularly on the product liability side.
Slubowski said the biggest danger to companies is failing to understand their exposures.
“If you don’t understand all of the nuances around 3D printing, then you will probably find yourself with claims that you didn’t anticipate you were going to have,” she said.
“We have seen it in the industry before where small companies get hit with large claims and they go out of business because they can’t come back from the reputational and monetary damage they have suffered.”
Despite companies’ best intentions, many are still lagging behind in terms of their risk management procedures for dealing with the risks of 3D printing, experts said.
Willis’ Srail said that the evolving technology of 3D printing means that companies have to continually adapt their risk management models.
“Some companies are well along the way with that,” he said. “However it’s safe to say that most companies are not ready for everything that is coming.
“It’s something that organizations will need to look at internally, externally and throughout their supply chain, and to undergo an ongoing improvement process by reviewing all of these risks on a continual basis.”
Ram went even further to say that 3D printing is still not even on some risk managers’ radar.
“Our general awareness of the value and opportunity of 3D printing is relatively nascent and so many risk managers aren’t prepared for it,” he said.
However, despite all the risks and possible downsides of 3D printing, Cummins is upbeat about the future.
“As an innovation, 3D printing can be managed either as a sustaining innovation that you can use to improve your business or as a disruptive innovation that overtakes an existing market and puts companies out of business,” she said.
“So those companies that get on board early on with the new technology can use it in a sustaining way to enhance their product and become industry leaders.”