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.”
A Challenging Environment
The excess and surplus (E&S) lines market is at a critical point in its development, according to industry experts.
The industry has reversed a five-year decline in direct written premiums between 2007 and 2011, with premiums up 7.6 percent during 2014, according to the latest figures from SNL Financial.
The sector has also more than doubled its share of direct written premiums for the property/casualty (P&C) market, from 3.3 percent in 1993 to 6.9 percent in 2013, as well as its share of total commercial lines premiums (13.7 percent), said A.M. Best.
However, with increasing competition from new entrants and more capital than ever flowing into the market, rates — particularly in P&C — are starting to slow. Subsequently, profit margins have been hit.
A.M. Best currently views the surplus lines market as “stable,” but warned that profit margins may shrink in the near term as average rate increases diminish on various lines of coverage.
“Accident year reserve development for surplus lines companies has been slightly more favorable than the overall P&C industry, but the gap has been shrinking as the markets wrestle with excess capacity, low interest rates and capital outlays to enhance operational efficiencies,” said the ratings agency in a recent report. Added to that, the industry faces a constant battle to attract and retain new talent and to keep up with emerging risks and regulations, or risk getting left behind.
All of these issues will be at the top of the agenda when the National Association of Professional Surplus Lines Offices (NAPSLO) meets at its annual convention in San Diego this month, where 4,000 E&S brokers and wholesalers are expected.
“For NAPSLO members and the market in general, it is an extremely challenging environment right now, particularly in property and casualty,” said Scott Culler, regional president at Markel.
“The biggest question on people’s minds is whether the amount of capacity currently available in the market is sustainable.
“Everybody is scrambling just to maintain market share and to stay one step ahead of the competition. So we are constantly having to come up with new and innovative ways to write business in order to remain viable.”
The recent clamor for market share has seen several big players enter the space, most notably Berkshire Hathaway Specialty Insurance (BHSI), and Tokio Marine Holdings, following its acquisition of HCC Insurance Holdings for $7.5 billion.
Other companies such as XL and Catlin have also merged for greater scale and efficiency, and ultimately to increase market share.
BHSI’s Executive Vice President David Bresnahan said that the trend of consolidation would continue as long as there was excess capital available.
“We see evidence that customers are trying to get in front of those trends, and they are beginning to award larger participations to those carriers with a long-term focus and strong balance sheets who can control their own destiny,” he said.
An adverse effect of increased competition, added Culler, has been to squeeze prices further. For rates in a line such as property, he said, “it’s 10 percent off just to start the conversation.”
“Last year, I thought we were at a point where the prices couldn’t go much lower, but every deal is under pressure now — there’s no such thing as a normal renewal.”
Henry Witmer, assistant vice president at A.M. Best, said that competition from the primary market for risks typically covered by E&S has also accentuated market cycles. As a result, insurers need to be prepared to scale up or down their operations and to adjust their prices accordingly.
“As products offered by the E&S insurers gain recognition and are imitated by others, the true innovators within the market need to study, evaluate and develop replacement products in order to stay on the forefront of the market,” he said.
Despite these challenges, Culler said, insurers are increasingly finding ways to differentiate themselves in a competitive market, while brokers are developing specialist niches.
“As the economy starts to recover, more entrepreneurs are entering the market and new cutting-edge ideas and products are being developed all the time, as well as opportunities being created in lines that the traditional market doesn’t want to write,” he said.
James Drinkwater, president of AmWINS brokerage and one of NAPSLO’s wholesale broker directors, is also bullish about the prospects for companies willing to take on such risks.
“As products offered by the E&S insurers gain recognition and are imitated by others, the true innovators within the market need to study, evaluate and develop replacement products in order to stay on the forefront of the market.” — Henry Witmer, assistant vice president, A.M. Best
“Prices are, on average, declining steadily, due to the amount of capital coming into the market and at the same time the market has become very competitive,” he said.
“However, there are still some hard pockets if you are willing to look, such as the New York City construction and transportation sectors.”
Investment in Technology
Going forward, Drinkwater said, companies need to focus more on improving their technology, and the training and development of their staff.
“Everybody will naturally be focused on the rate environment, but I think there are more important factors at play — for example, keeping an eye on what’s happening with regulation and improving the delivery of our product through greater investment in technology and personnel.”
The greater use of technology and analytics has enabled companies to price more accurately, identify new lines of business and, ultimately, to deliver better cost efficiencies to the customer.
It has also spawned a host of new industries such as unmanned aerial vehicles or drones.
“Everything is revolving around technology right now,” said Wyeth Coburn, associate broker at CRC Insurance Services.
“A lot of companies are sitting and waiting to see what happens, particularly with the drone industry, but as soon as the new regulations come in I would expect there to be a big take-up from carriers.”
Culler added that cyber liability has now overtaken energy as the No. 1 risk for the E&S industry following the rise in cyber attacks.
“I think we are just scratching the surface with cyber, trying to understand the exposures companies face because they change almost on a daily basis,” he said.
Drinkwater added: “The cyber marketplace is one that is evolving quickly and with the recent spate of high profile breaches, insureds are steadily realizing that this is an exposure that they must protect themselves against.”
Amid all these new developments, Bryan Salvatore, president of Zurich North America Commercial’s specialty products business unit, warned that it is important for companies not to lose sight of their core value of customer service.
“I prefer to focus on how we can differentiate ourselves in terms of the value proposition that we offer,” he said.
“In that respect, the whole market needs to think about what it can bring to the table.”
That involves a heavier investment in technology to help both the company and the customer better understand their pricing and exposures, he said.
“At the end of the day, we have to remind ourselves that we’re providing an important end solution to the customer for complex and hard to place risks rather than thinking of ourselves simply as a commodity,” he said.
There are also a host of key regulatory hurdles that the market has to overcome in the short- and long-term if it is to maintain its recent growth.
“I think we are just scratching the surface with cyber, trying to understand the exposures companies face because they change almost on a daily basis.” — Scott Culler, regional president, Markel
Brady Kelley, executive director at NAPSLO, said that the main piece of legislation currently impacting the industry is the Terrorism Risk Insurance Program Reauthorization Act 2015 (TRIA), enacted at the start of this year.
TRIA, which was first enacted in 2002 to provide a federal backstop for terrorism claims, was reauthorized at the start of this year and remains in effect until 2020 to cover new policies that run beyond 2014.
Kelley said that the most important part of the bill is the enactment of the National Association of Registered Agents and Brokers Reform Act 2015 (NARAB II), providing a one-stop licensing system for agents and brokers operating in multiple states.
“That will be a tremendous opportunity for us because it will put in place a national set of standards and a new national electronic system for the processing of insurance licenses, meaning that everything is much more consistent and efficient going forward,” said Kelley.
Fight for Talent
“Many of the veterans in our business are starting to retire now and need to put in place a succession plan for the next generation,” he said.
“That means equipping themselves with the best standards and professional talent available and to prepare them so that they are ready to take on those top leadership roles.”
Despite all the challenges it faces, the industry is well placed to capitalize on the new opportunities and risks, such as cyber liability, that the traditional market doesn’t typically extend to.
Markel’s Culler concluded: “I’m bullish about the E&S market — it’s true, there are a lot of new competitors out there, but there’s also a lot of room for growth.”
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.