Three Pain Points
From dealing with multi-million dollar claims by private equity funds to assessing the risk profiles of telehealth providers, professional liability (PL) underwriters and practitioners across a broad spectrum of sectors have plenty to ponder.
Ahead of this year’s Professional Liability Underwriting Society’s (PLUS) annual conference in Dallas, we asked a selection of PL experts to outline the key issues in their respective fields.
Cyber Cover: To Buy or Not
Sarah Stephens, partner and head of cyber, technology, and media E&O at broker JLT, is on a panel discussion entitled “When David Fells Goliath — Small Companies’ Role in Large Breaches,” which explores the threat that inferior IT networks of vendors, service providers and other counterparties can pose to larger, seemingly more secure organizations.
According to Stephens, PL practitioners need to be aware of the resource pressure on small vendors, while navigating a “web of interconnectedness” in both the liability and insurance arrangements of the various companies in the technology supply chain.
While large companies’ cyber insurance policies tend to cover them for expenses and third-party liability resulting from another vendor’s error or omission, small tech vendors are often required to buy tech PL liability insurance under their contract with larger vendors.
Stephens said it is important that practitioners help these vendors establish exactly what is and isn’t covered under their own policies, and whether procuring additional cover is necessary — particularly as in some cases, a small vendor may require tech PL cover with limits that far exceed the size of their own business.
“A vendor whose revenues are $5 million may, for example, provide niche services to a larger vendor and be handling the personal data of millions of retail customers,” Stephens said.
“It can be a real challenge for a broker to go to the market on behalf of a company whose revenues are $5 million and requests $20 million professional liability cover, but the exposure is real. This is the cost and reality of doing business if you are a small tech vendor.
“If I were a large company drafting the insurance requirements for my vendors, do I want PL coverage or do I want cyber coverage, or do I need both? And is it acceptable to request PL that includes cyber coverage?” Stephens asked.
“I think more education is needed as you don’t want to be requiring companies to buy cyber policies when they already have that coverage under a tech PL policy. A better understanding of the coverage and how people buy it will drive efficiencies for both large and small vendors.”
A broader industry challenge, Stephens said, is the overlap where third-party cyber liability coverage meets PL. With some doubting underwriters’ pricing sustainability, modelling and claims-paying ability, Stephens noted there has been a flight to quality cyber carriers with enough capital to pay large limit claims without being scared away from the risk or making knee-jerk price hikes.
“From a practitioner’s point of view, my focus is to help insureds choose a market that will be there in five or 10 years and will be relatively consistent rather than reacting unreasonably to inevitable claims in the market,” she said.
According to Stephens, the nature of a company’s business should probably determine whether they choose stand-alone cyber insurance. It makes little sense, she said, for tech/IT companies to buy stand-alone cyber coverage as cyber risk runs through all of their professional risks, while other sectors with long-established PL histories may be advised to buy separate cyber policies — not least for the valuable crisis response services that usually come as standard with this coverage.
Stephens also raised the question of whether simply not having a cyber exclusion in a PL policy (as opposed to affirmative language outlining specific cyber risk triggers) offers assurance of coverage.
“Some companies choose to rely on the breadth of silence in the PL contract; others aren’t comfortable with that uncertainty as they don’t want to have to litigate a claim, so they opt for a separate cyber policy,” she said.
Financial E&O: A Volatile Subprime Legacy
According to lawyer James Skarzynski, principal of Skarzynski Black and president of PLUS, there is also an overlap at the intersection between cyber policies and D&O coverage. Skarzynski focuses primarily on D&O and E&O in the financial sector — a segment experiencing some of the most volatile and expensive PL claims.
“There are still some fairly significant subprime credit losses being litigated and it is taking time for practitioners to sort through all the issues,” he said.
“One issue is the inter-relatedness of multiple claims within large towers of insurance. There could be multiple unrelated claims in several years of the tower, and when you have tower limits of quite easily $100 million, $200 million or more, this becomes a very substantial issue,” Skarzynski said.
These situations are being dealt with on a case-by-case basis, often with the help of mediators.
“The worst outcome is to fail to reach a resolution. It serves no one’s interest to have a dispute linger on, so that factor helps drive the parties to reach resolutions on how to allocate loss.”
But even if all parties agree and it is in their collective best interests to avoid litigation and reach a commercial resolution, negotiation challenges remain.
“Not surprisingly, the carriers at the top of the insurance towers think there should be full exhaustion of the claim from the ground up, while the insurers at the bottom of the tower may argue that if the claim would fully expose the limits of the entire tower, payment of the loss should be made pro rata so the tower shares equally in the loss.”
Even if the carriers at the top of the tower are willing to compromise and agree not to enforce full exhaustion from the ground up, they may insist that carriers in the lower portion pay a much higher proportion of their limits, Skarzynski said.
“These disputes can be very complex to resolve, and I and others in the D&O space have spent many hours in mediations, negotiating over how claims will be allocated as a prelude to mediating the underlying claims themselves, as you can’t resolve the underlying claim until you have agreed how funding will occur,” Skarzynski said.
Another post-crisis issue, he added, is the significant increase in regulatory investigations, with E&O insurers seeing the fees incurred reaching levels comparable to or above those in major 10B-5 securities litigations.
“Many years ago, no one would ever have guessed we would be routinely seeing seven- or eight-figure fees from regulator investigations and proceedings,” Skarzynski said, adding that variances in policy wordings mean that these governmental fees are not always covered under an E&O claim.
Meanwhile, increasing private equity in the corporate landscape has led to insurance around private equity “taking on a life of its own” — often involving large, volatile dollar sums.
“Private equity plaintiffs are often very serious about getting a large dollar recovery and the values can at times be proportionately higher than the recovery on losses to shareholders in a 10B-5 securities case,” Skarzynski said.
Health Care: An Evolving Risk Landscape
“Increasing settlement verdicts, hardening of the market, and a changing model of how health care is delivered through telehealth or retail clinic settings make a busy, swirling bucket for PL underwriters to get their heads around and put the right premium/price on the table,” said Bill McDonough, managing principal and broker for Integro’s national health care practice, who will be on a panel discussing whether the PL industry can keep up with “The Brave New World of Medicine.”
“The delivery of medicine is moving much quicker than how we analyze, underwrite and understand these risks.” — Bill McDonough, managing principal and broker for Integro’s national health care practice
“Whether it’s individual insureds or the lead layer for a large system, there’s a lot of moving parts. Underwriters have to be smarter and rethink how they have been underwriting for past seven or 10 years.”
The primary shift in the U.S. medical landscape is in the delivery of care, which is evolving from “brick and mortar” bedside care to “retail care” available in shopping centers other walk-up venues, and more recently “telehealth” platforms — through which the diagnosis and prescription of treatment is administered by practitioners via phone, computer or other smart technology.
“Now people are receiving care without ever being in front of a provider,” said McDonough.
“It’s a huge issue for PL underwriters. The concerns revolve around whether there are appropriate controls around the delivery of telemedicine care, whether underwriters can accurately measure the risk and understand how the risk differs to the risk they’ve been writing for the last 30 years.”
McDonough said the PL insurance market including brokers, underwriters and consultants needs to let go of its “antiquated mind-set” in order to redefine health care risk profiles, taking into account the new setting in which health practitioners — who in the case of retail and telehealth are primarily nurses rather than physicians — are operating and delivering services.
“The delivery of medicine is moving much quicker than how we analyze, underwrite and understand these risks,” he said.
“In the next three, five or 10 years, there will be a different way not only of delivering care but also in how we define that risk and insure it. As patients increasingly seek quicker, cheaper and more readily accessible health care, I believe a locus of control is being lost.
“Practitioners can operate very independently, and my sense is that offering cheaper and quicker care is going to lead to more risk.”
Yet, McDonough said, telemedicine nurses continue to be covered under the same PL policies that brick-and-mortar practitioners have been insured under for years — either from the PL market or through captives owned by health systems and providers.
“We have to think about the adequacy of coverage with the new risk profile we’re dealing with,” McDonough said.
He added, however, that practitioners are also concerned about the adequacy of coverage — primarily regarding the size of limits they can obtain.
R&I: What was your first job?
My first job during high school was as a salesperson at the department store, Montgomery Ward. After college, my first career job was as a commercial real estate lender at Continental Bank in Chicago, which was then the seventh largest bank in the country.
R&I: How did you come to work in risk management?
In 1997, I became chief risk officer of GE Capital’s railcar leasing business, GE Capital Railcar Services.
A headhunter reached out to me in late 1996. The chief risk officer of GE Capital liked my analytical skills and banking background, and the CEO of the railcar leasing business liked that I had been an entrepreneur investing my own money in real estate transactions. At GE, I learned how to use data and analytics to make better business decisions.
R&I: What is the risk management community doing right?
Risk management has become an integral part of the business processes and strategic planning of companies. In forward-thinking companies like Arch, risk management has a seat at the table.
R&I: What could the risk management community be doing a better job of?
It could better convey to everybody in a company that they all have a role in risk management. There’s an inclination to think risk management is only done by the risk management department, but actually everybody has a role in risk management. Embracing that concept drives an appropriate risk culture and ensures resiliency.
Cyber risk is an emerging risk that gets a lot of attention, but in the mortgage industry, I am concerned that as the housing crisis recedes, the industry may allow some undisciplined practices to slip back in.
R&I: What’s been the biggest change in the risk management and insurance industry since you’ve been in it?
Better analytics and an understanding of the importance of stress-testing your portfolio to make sure your company can withstand extreme events.
R&I: What emerging commercial risk most concerns you?
Cyber risk is an emerging risk that gets a lot of attention, but in the mortgage industry, I am concerned that as the housing crisis recedes, the industry may allow some undisciplined practices to slip back in. A healthy housing market and economy requires that we not let that happen.
R&I: How much business do you do direct versus going through a broker?
We originate all our business directly with our customers who are banks, credit unions and mortgage companies.
R&I: Are you optimistic about the U.S. economy or pessimistic and why?
I am cautiously optimistic since No. 1, the economy has created three million net new jobs over the past 12 months and going forward, another two to three million jobs could be created over the next year. No. 2, consumers have been saving more of their extra pocket money, but spending is likely to pick up with employment growing.
And No. 3, residential construction will likely rise 10 to 15 percent a year over the next few years.
My caution is external shocks like conflicts and an economic slowdown could set things back, at least temporarily. As Warren Buffet once said: “It’s never paid to bet against America. We come through things, but it’s not aways a smooth ride.”
R&I: Who is your mentor and why?
I’ve had teachers who taught me the importance of a good education and managers, particularly at GE, who taught me great leadership skills and to have the courage to stretch myself and try new things.
Also my father, who was legally blind but accomplished many things in his life, taught me to never give up and to find joy in life. Finally, my husband and partner who’s been enormously supportive of me and my careeer.
R&I: What have you accomplished that you are proudest of?
In my 36-year career I have successfully navigated several economic cycles and have been able to mentor many young women, all while achieving a balance between my professional and personal lives.
R&I: How many emails do you get in a day?
More than I would like.
R&I: How many do you answer?
The important ones.
R&I: What’s your favorite book?
“Personal History,” the autobiography of former “Washington Post” publisher Katharine Graham. The book provides a great example of courage and doing things she never thought possible. I had the good fortune of meeting Ben Bradlee, the former editor of the “Washington Post” under her leadership, and he gave me additional insight into the extraordinary person that she was.
R&I: What’s the best restaurant you’ve ever eaten at?
It’s called Rock House on Harbour Island in the Bahamas.
R&I: What is your favorite drink?
Champagne. It’s right for every occasion.
R&I: What is the most interesting place you have ever visited?
My great-grandfather on my father’s side emigrated from Luxembourg in the late 1800s. After my father died a few years ago, I traveled to Luxembourg to meet my father’s second cousin.
He introduced me to my whole extended family and brought me to the town where my great-grandfather was born and to the church where he was baptized. It was very special.
R&I: What is the riskiest activity you ever engaged in?
I once skied with my colleagues down a double Black Diamond slope as only a novice skier — and I survived.
R&I: If the world has a modern hero, who is it and why?
Nelson Mandela. He is an inspiration on the healing power of forgiveness and of strong leadership.
7 Questions to Answer before Choosing a Captive Insurance Domicile
Risk managers: Do your due diligence!
It seems as if every state in America, as well as many offshore locations, believes that they can pass captive legislation and declare, “We are open for business!”
In fact, nearly 40 states and dozens of offshore locations have enabling captive insurance legislation to do just that.
With so many choices how do you decide who is experienced enough to support the myriad of fiscal and regulatory requirements needed to ensure the long term success of your captive insurance company?
“There are certainly a lot of choices,” said Mike Meehan, a consultant with Milliman, an actuarial firm based out of Boston, Massachusetts, “but not all domiciles are created equal.”
Among the crowd, there are several long-standing domiciles that offer the legislative, regulatory and infrastructure support that makes captive ownership not only a successful risk management tool but also an efficient entity to manage and operate.
Selecting a domicile depends on many factors, but answering these seven questions will help focus your selection process on the domiciles that best fit your needs.
1. Is the domicile stable, proven and committed to the industry for the long term?
The more economic impact that the captive industry has on the domicile, the more likely it is that captives will receive ongoing regulatory and legislative support. The insurance industry moves very quickly and a domicile needs to be constantly adapting to stay up to date. How long has the domicile been operating and have they been consistent in their activity over the long term?
The number of active captive licenses, amount of gross premium written in a domicile and the tax revenue and fees collected can indicate how important the industry is to the jurisdiction’s bottom line. The strength of the infrastructure and the number of jobs created by the captive industry are also very relevant to a domicile’s commitment.
“It needs to be a win – win situation between the captives and the jurisdiction because if not, the domicile is often not committed for the long term,” said Dan Kusalia, Partner with Crowe Hortwath LLP focused on insurance company tax.
Vermont, for example, has been licensing captives since 1981 and had 589 active captives at the end of 2015, making it the largest domestic domicile and third largest in the world. Its captive insurance companies wrote over $25 billion in gross written premiums. The Vermont State Legislature actively supports an industry that creates significant tax revenue, jobs and tourist activity.
2. Are the domicile’s captives made up of your peer group?
The demographics of a domicile’s captive companies also indicate how well-suited the location may be for a business in a particular industry sector. Making sure that the jurisdiction has experience in the type and form of captive you are looking to establish is critical.
“Be among your peer group. Look around and ask, ‘Who else is like me?’” said Meehan. “Does the jurisdiction have experience licensing and regulating the lines of coverage for other businesses in your industry sector?”
3. Are the regulators experienced and consistent?
It takes captive-specific expertise and broad experience to be an effective regulator.
A domicile with a stable and long-term, top-tier regulator is able to create a regulatory environment that is consistent and predictable. Simply put, quality regulation and longevity matter a lot.
“If domicile regulators are inexperienced, turnaround time will be slower with more hurdles. More experience means it is much easier operating your business, especially as your captive grows over time,” said Kusalia.
For example, over the past 35 years, only three leaders have helmed Vermont’s captive regulatory team. Current Deputy Commissioner David Provost is one of the longest tenured chief regulators and is a 25-year veteran in the captive insurance industry. That experienced and consistent leadership enables the domicile to not only attract quality companies, but also to provide expert guidance on the formation process and keep the daily operations running smoothly.
4. Are there world-class support services available to help manage your captive?
The quality of advisors and managers available to assist you will have a large impact on the success of your captive as well as the ease of managing the ongoing operations.
“Most companies don’t have the expertise to operate an insurance company when you form a captive, so you need to help build them a team,” Jeffrey Kenneson, a Senior Vice President with R&Q Quest Management Services Limited.
Vermont boasts arguably the most stable and experienced captive infrastructure in the world. Many of the leading captive management companies have their headquarters for their Global, North America and U.S. operations based in Vermont. Experienced options for captive managers, accountants, auditors, actuaries, bankers, lawyers, and investment professionals are abundant in Vermont.
5. Can the domicile both efficiently license and provide on-going support to your captive as it grows to cover new lines of coverage and risks?
Licensing a new captive is just the beginning. Find out how long it takes for the application to get approved and how long it takes for an approval of a plan change of your captive’s operations.
A company’s risks will inevitably change over time. The captive will need to make plan changes which can include adding new lines of business. The speed with which your domicile’s regulatory branch reviews and approves these plan changes can make a critical difference in your captive’s growth and success.
The size of a captive division’s staff plays a big role in its speed and efficiency. Complex feasibility studies and actuarial analyses required for an application can take a lot of expertise and resources. A larger regulatory team will handle those examinations more efficiently. A 35-person staff like Vermont’s, for example, typically licenses a completed application within 30 days and reviews plan changes in a matter of days.
6. What are the real costs to establishing and managing your captive?
It is important to factor in travel costs, the local costs of service providers, operating fees, and examination fees. Some states that do not impose a premium tax make up for it in high exam fees, which captives must be prepared for. Though Vermont does charge a premium tax, its examination fees are considered some of the least expensive options in the marketplace.
It is also important to consider the ease and professionalism of doing business with a domicile in the ongoing operations of your captive insurance company.
“The cost of doing business in a domicile goes far beyond simply the fixed cost required. If you can’t efficiently operate due to slow turn-around time or added obstacles, chances are you have made the wrong choice,” said Kenneson.
7. What is the domicile’s reputation?
Make sure to ask around and see what industry experts with experience in multiple domiciles have to say about the jurisdiction. Make sure the domicile isn’t known for only licensing certain types of captives that don’t fit your profile. Will it matter to your board of directors if your local newspaper decides to print a story announcing your new insurance subsidiary licensed in some far away location?
Are companies leaving the jurisdiction in high numbers and if so, why? Is the domicile actively licensing redomestications — when an existing captive moves from one domicile to another? This type of movement can often be a positive indicator to trends in a domicile. If companies of a particular size or sector are consistently moving to one state, it may indicate that the domicile has expertise particularly suited to that sector.
Redomestications made up 11 of the 33 new captives in Vermont in 2015. This trend is a positive one as it speaks to the strength of Vermont. It reinforces why Vermont is known throughout the world as the ‘Gold Standard’ of domiciles.
Asking the right questions and choosing a domicile that meets your needs both today and for the long term is vital to your overall success. As a risk manager you do not want surprises or headaches because you did not ask the right questions. Do the due diligence today so that you can ensure your peace of mind by choosing the right domicile to meet your needs.
For more information about the State of Vermont’s Captive Insurance, visit their website: VermontCaptive.com.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with the State of Vermont. The editorial staff of Risk & Insurance had no role in its preparation.