E&S Going Strong
The state of the excess and surplus lines market is strong, as evidenced by the nearly 4,000 attendees, who networked their way through the annual convention of the National Association of Professional Surplus Lines Offices in Atlanta, from Sept. 15 to17.
“There’s a lot of optimism about the market and [the number of attendees] is a testament to the strength and vitality of surplus lines,” said Brady Kelley, executive director of the national organization, which focuses on networking and education for the surplus lines industry.
In fact, A.M. Best reported that surplus lines companies “have been extremely successful when compared with the overall property/casualty (P/C) industry.”
Surplus lines now account for about 13.7 percent of all commercial lines direct premiums written, up from 6.1 percent in 1993, according to a 20-year retrospective on U.S. surplus lines released by A.M. Best in September.
“In 2013, 22 of the top 25 surplus lines groups produced year-over-year growth in premium (as measured by direct premiums written) — a testament to what is likely a contraction in the standard market’s appetite for risk and a broad flow of business back into surplus lines,” according to the report.
“A lot of people are optimistic because the economy is still growing and when the economy is growing, it can make up for a lot of foolish decisions.” — Alan Jay Kaufman, chairman, president and CEO of Burns & Wilcox
But the sector is not without its challenges, specifically overcapacity in the market, according to Alan Jay Kaufman, chairman, president and CEO of Burns & Wilcox, international insurance brokers and underwriting managers.
“The market here is soft,” he said. “I think it’s soft in more areas than people want to talk about. … I would not say ‘doom and gloom.’ A lot of people are optimistic because the economy is still growing and when the economy is growing, it can make up for a lot of foolish decisions.”
E&S underwriting, said Stanley Galanski, president and CEO of The Navigators Group Inc., is “the essence of underwriting. There are no rules. There are no rates. There are no mandatory forms. In E&S, it’s all about your expertise and your judgment.”
To be successful, companies must have underwriters who can bring a “high level of expertise to the risk” and deep relationships with wholesale brokers, he said.
It also requires constant innovation, said Mario Vitale, CEO, Aspen Insurance. “Specialty E&S is tailored for high risk situations. It allows underwriters skilled in these special niches to apply their tools of the trade to help the insured, to help the brokers, with creative risk-based solutions.”
He said Aspen would be releasing some new products in 2015, and noted that there were numerous emerging risks to occupy carriers, including the impact of climate change, nanotechnology, fracking, drones, bitcoin and wearables.
“I believe all of these trends and all of these emerging technologies will bring risks and will bring demands for solutions and underwriter innovations to find them,” he said.
“It’s unbelievable how that [cyber] market is developing so quickly.” — James Drinkwater, president of AmWINS Brokerage
Jeremy Johnson, president and CEO of Lexington Insurance Co., the E&S division of AIG, said in a recent A.M. Best webinar that his organization is designing products to deal with risks from drones, celebrity risk and cyber bullying, and also has “in the pipeline” products to address risks related to Uber and Airbnb.
“If we are not staying ahead of where our customers are going as an industry, we won’t be relevant,” he said.
Bruce Kessler, division president, ACE Westchester, which focuses on the wholesale distribution of excess and surplus lines products, said, “You have to be strategic as an E&S company as to where to grow and where to shrink.”
But, he also noted, the “ease of entry” into the space, which he sees as “healthy and robust.”
“It’s easy for new capacity to come in,” he said, and that has put some pressure on property/catastrophe rates. That softening is “probably the biggest talk of the conference.”
Overcapacity offers one of the industry’s biggest challenges, Kaufman said. “Standard lines companies are aggressively looking to write the gray areas that may at one time have been E&S and now it’s back to standard lines. … You will see companies taking greater risks than they normally have in the past — risks that they don’t understand.”
Jeff Saunders, president of Navigators Specialty, said, “The capital in the industry is looking for a better return than from a Treasury note.”
While the influx of capital has reduced rates — significantly on property and less significantly elsewhere — the company has to compete “no matter what the rate environment is,” he said. That requires E&S insurers to be “agile while rotating in and out of sectors.”
E&S strategies are also increasingly being influenced by predictive modeling, ACE Westchester’s Kessler said. He also noted that he is seeing greater interest in product recall and cyber coverage.
Other experts at the NAPSLO conference agreed that cyber policies were finally taking off.
“It’s unbelievable how that market is developing so quickly,” said James Drinkwater, president of AmWINS Brokerage and one of NAPSLO’s Wholesale Broker directors, during a panel discussion at the conference.
“Companies are getting hit [with cyber attacks] constantly,” Vitale said. “As long as there are more hackers, they will get more sophisticated and we will have to do a better job of staying on top of emerging trends.”
The opportunities in E&S outweigh the challenges, said Peter Clauson, senior vice president, excess casualty, Liberty International Underwriters.
When LIU excess casualty was established in 1999, he said, the E&S business was about a $10 billion market. “Fifteen years later, we are at $37 billion, and there’s a lot of talk that in five years, we could be a $50 billion market.
“That’s a lot of growth and opportunity,” he said.
Top Five Uninsurable Risks
Whether it’s a Sriracha hot sauce maker being threatened with closure by city council or General Motors fighting for its reputation after recalling more cars than it made in the past three years, companies face a world of complex risks.
And some of those risks cannot be transferred via insurance products.
How well are companies protected, for example, when new regulations get passed — such as the EPA’s proposed restrictions on coal burning plants that may drive some in the energy industry out of business, or the current political drumbeat against tax inversion practices?
What insurance covers a company whose rogue employee sells trade secrets to an outside company? How about when a pandemic shuts down operations?
Risk managers identify their organizational exposures as best they can and then work to manage or eliminate those risks. Sometimes, commercial insurance can be used to remove the bulk of that risk, but we’ve isolated five risks which many experts believe are uninsurable in many respects: For the time being anyway.
“For the most part, the insurance industry rises to the occasion and creates products for emerging risks that evolve over time,” said Carol Laufer, executive vice president, ACE Excess Casualty.
“For insureds, the purchase of products such as employment practices and cyber insurance eventually evolves from a discretionary spend to standard insurance coverage,” she said.
For sure there are other challenging risks — such as weak economic conditions or skilled talent shortages — that also are uninsurable, but we have selected those for which risk managers are able to play an effective role in mitigating the risk.
Part of the problem in transferring such risks is the complexity involved in the exposures. Look at tax inversion — where a U.S. company merges with a foreign company to change their tax jurisdiction and lower their tax burden.
Is that a political risk? A regulatory risk? A reputational risk? It could be any one of them, or all three of them.
“I think it’s almost uncountable the ways that a loss could occur where that loss could be tied back to reputational risk or regulatory risk,” said David White, a national actuarial leader at KPMG.
At the same time, calling a risk uninsurable has nuances to it. Coverage for criminal fines and penalties, for example, are truly uninsurable. The law forbids such coverage, said Patrick Donnelly, chief broking officer, Aon Risk Solutions.
But for other types of risks, there may be various products offered by brokers and underwriters to address some, but not all of the specific exposures faced by a company, he said. Such coverage, however, may be rare or expensive, or corporations may find risk transfer to be an ineffective way of hedging the risk.
“I’m very careful about branding something as truly uninsurable,” Donnelly said.
“It’s not black and white.”
General Motors might be the quintessential example of a company undergoing a reputational hit. It recalled nearly 30 million cars, and faces numerous lawsuits and investigations related to a delayed recall of 2.6 million cars — some manufactured more than a decade ago — with a faulty ignition switch that has been linked to 13 deaths and more than 50 accidents.
Video: As this report from the New York Times indicates, automakers have a long history of trying to maintain their reputations in the face of major recalls.
But every day brings another contender for the throne. One day, it’s American Apparel’s founder being suspended, and possibly eventually fired, for alleged sexual misconduct. Another day, it’s a viral video of a Comcast customer service representative who refuses to let a customer cancel his account.
Or it could be yet another cyber theft of customer information or a celebrity spokesman tweeting out an offensive comment.
While there are insurance products that provide coverage for crisis management/public relations costs and product recall expenses, only a limited market exists for loss of income or net profit for reputational harm, said Emily Freeman, global technology and privacy practice specialist at Lockton.
“You need to be able to wrap your arms around the risk and the value of risk before you can insure it,” said Tom Srail, senior vice president, Willis. “What a company name is worth has long been a risk to the industry.”
Freeman said Lockton has been involved in creating customized solutions for large clients that address specific threats of reputational harm. The client and underwriter negotiate the period of indemnity and loss adjustment, she said.
“The perils are not on an ‘all risk’ basis, but rather categories listed that are relevant to the client, such as disgrace of key persons or breach of sensitive data,” Freeman said.
“In my mind,” said KPMG’s White, “you can’t find policies that cover all types of reputational risk from whatever event that occurred.”
When you think of regulatory risk, many risk managers keep an eye on the rules of the Health Information Portability and Accountability Act (HIPAA), the Dodd-Frank Act or a regulatory agency such as the Food & Drug Administration.
But the threat of regulation is immense and often unpredictable. In just one year, 2012, there were 17,763 changes to laws, rules and regulations affecting the banking and financial sectors alone, according to The Network, a training and compliance company.
“From a risk management or risk mitigation perspective, you can’t really predict regulations. You can prepare for them, but you can’t predict them or price them.” — David White, national actuarial leader, KPMG
Plus, risks can emanate from all sectors of government. One recent example is Huy Fong Foods, the manufacturer of Sriracha hot sauce, which was temporarily shut down by a judge following a lawsuit by the city council of Irwindale, Calif., after four families (one of which was related to a city councilman) complained about odors.
Eventually, the city dropped its lawsuit and its declaration that the factory was a “public nuisance,” but it took months for the situation to resolve itself.
“From a risk management or risk mitigation perspective, you can’t really predict regulations. You can prepare for them, but you can’t predict them or price them,” White said. “Regulatory risk is handled through risk mitigation, not risk transfer.”
“Even in the United States,” Srail said, “a government or state can put an industry or a company, if they want to, out of business or severely restrict their ability to operate.”
Certainly, the energy industry has been facing that threat since 2008 when President Obama noted that coal-powered plants can still be built, but at a steep regulatory cost.
“It’s just that it will bankrupt them because they are going to be charged a huge sum for all that greenhouse gas that’s being emitted,” Obama said.
While a final rule has not yet been issued by the Environmental Protection Agency, the president has recently called on it to enact new emissions regulations. The U.S. Chamber of Commerce estimated the regulations will cost the economy about $50 billion annually.
“There are some creative products underwriters have tried over the years … but there is definitely nothing off the shelf or run of the mill,” Srail said of regulatory risk.
“There’s nothing easy to do.”
Trade Secret Risk
“I find trade secrets to be one of the most dangerous areas,” said attorney Rudy Telscher, a partner at Harness Dickey & Pierce, who recently won a patent infringement case at the U.S. Supreme Court.
“There are no boundaries. It’s such a nebulous area.”
It can include anything from a disgruntled employee taking customer lists or R&D information to his next job, a foreign government stealing trade secrets or a hacker burrowing into a computer system to steal a company’s version of its special sauce.
Globalization and the expanded use of supply chain partners increase the potential exposure. Plus, even when a company is able to pursue trade secret litigation, courts consider whether reasonable precautions had been taken to secure the proprietary information.
“The violation,” said Bob Fletcher, president, Intellectual Property Insurance Services Corp., which offers insurance to litigate intellectual property cases, “is not the use [of a trade secret]. The violation is, ‘How did you get the information?’ ”
In any event, said Aon’s Donnelly, “an organization would have a very difficult time obtaining an insurance policy that adequately protects them against the theft or wrongful disclosure of their trade secrets and the potential damage that could do to the company if that trade secret got out.”
More common than industrial espionage, however, are the run-of-the-mill business discussions that revolve around synergies and potential partnerships between enterprises. Often, the nondisclosure agreements (NDAs) covering such discussions are not specific enough to protect the parties, Telscher said.
It is the party receiving the information that is most at risk, he said. If the discussions dissolve, that party may find itself accused of acting upon trade secrets because the NDA did not specify the information that was to be disclosed and held confidential.
“The more information you receive, the greater the risk there will be a lawsuit if you don’t end up doing a deal and you move forward on your own,” Telscher said.
In this era of globalization, companies establish operations all over the world, and the world is not a stable place.
Upheaval — or the increasing threat of it — is prevalent on just about every continent of the globe. Certainly, the possibilities in the Middle East, Eastern Europe, Asia and Latin America are concerning to risk managers.
While political violence and trade credit coverage is available in the majority of cases, companies continue to face uninsurable exposures.
“It’s definitely tricky,” said Mark Garbowski, a shareholder at Anderson Kill.
“Based on the policies I have seen, there will always be some aspects of it that will be fully outside the scope of what can be covered.”
And only “a minority” of companies actually buy the cover, said John Hegeman, AIG senior vice president, specialty lines-political risk.
“I think the principal reason is most risk managers view it as a self-insured business risk,” he said.
“Pretty much anything an insured thinks is really essential to their operations can be covered, but you have to identify it and understand what it is.”
Often, said Richard Maxwell, chief underwriting officer and global head of political risk and trade credit insurance for XL Group, corporations wait too long in the face of deteriorating conditions and insurers will not accept the risk.
“Buy the cover before the barn is on fire,” he said.
Generally, policies cover a host of risks, including government expropriation of an asset, destruction of an asset due to war or political violence, credit default of trade receivables, and when foreign governments block transfer and convertibility of currency.
Some countries, such as Iran, Iraq, Afghanistan and the like, are not insurable, said Jochen Duemler, CEO and head of Euler Hermes Americas Region, which offers risk coverage in nearly 200 countries.
Argentina is a recurring problem, and as for Venezuela, it’s not uninsurable, he said, “but we would say we pretty much have no exposure there and are very, very reluctant” to offer coverage.
Overall, policies exclude losses that occur when currency is devalued, losses that occur as a result of a nuclear incident and non-payment of premium, or any losses to suppliers or partners as a result of political violence, except for trade receivables.
Policies also require insureds to make certain warranties and representations that are included in the insurance contract.
Policy disputes can arise when property is expropriated or licenses are cancelled due to what a foreign government says are reasonable or legally justified regulatory actions, according to an article on political risk coverage by Robert C. Leventhal, an attorney with Foley and Lardner.
Another area of dispute emerges when assets are jeopardized by “creeping expropriations,” such as a series of actions by the government as opposed to a single act, he said.
Many risk managers aren’t too worried about the Ebola pandemic in West Africa that has already killed more than 900 people. And they probably aren’t all that worried — if they even know — about the four cases of pneumonic plague in Colorado that are life-threatening.
But who among them can forget the H1N1 pandemic influenza virus known as the swine flu, that in 2009 killed more than 250,000 people worldwide, including more than 3,600 in North America.
At one point, the U.S. Centers for Disease Control and Prevention estimated that as many as two in five workers might become infected or have to stay home to care for an ill family member.
Video: Researchers at the Massachusetts Institute of Technology studied the role airports play in spreading disease and pandemics, according to this report by Voice of America.
A pandemic flu is something all risk managers should worry about. And there’s no coverage for it.
“A pandemic is a very difficult exposure to insure in any meaningful way. You can do some work around it, but it’s a very, very difficult risk to insure and no one really insures it,” said John McLaughlin, managing director of the higher education practice at Arthur J. Gallagher & Co.
For schools or universities, his specialty, there may be some loss of tuition coverage available, but “it’s not very cost effective.”
For business, supply-chain insurance may offer some protection, but that coverage still has a limited take-up.
Companies may also be able to craft special wording for property or D&O policies, he said.
“You never say never. There’s always some solution that you can work up,” he said.
But, McLaughlin said, a healthier perspective for a risk manager is to analyze how the risk would impact the organization and to devise solutions that are not insurance-related.
A Dreaming Team
Chris Thorn is known as one of the most creative risk managers in the business. After all, his risk management program hit the cover of Risk & Insurance® in March, 2012.
Now the senior manager, payments and risk, for Southwest Airlines is working with Riskonnect, a technology partner that he thinks can take his program to new heights.
“For us, it’s a platform that gives you so many different tools that if you can dream it, you can build it,” said Thorn.
Thorn ditched his legacy risk management information system in 2012 and started working with Riskonnect, initially using the platform solely for liability claims management.
But the system’s “do-it-yourself” accessibility almost immediately caught the eye of Thorn’s colleagues managing safety risk and workers’ compensation.
“They were seeking a software solution at the time and said, ‘Hey, we want to join the party,” Thorn recalls of his friends in safety and workers’ compensation.
“For us, it’s a platform that gives you so many different tools that if you can dream it, you can build it.”
–Chris Thorn, senior manager, payments and risk, Southwest Airlines
What was making Thorn’s colleagues so jealous was the system’s “smart question” process which allows any supervisor in the company to enter a claim, while at the same time freeing those supervisors from being claims adjusters.
The Riskonnect platform asks questions that direct the claim to the appropriate category without the supervisor having to take on the burden of performing that triage.
“They love it because all of the redundant questions are gone,” Thorn said.
The added beauty of the system, Thorn said, is that allows carriers and TPAs to work right alongside the Southwest team in claims files while maintaining rock-solid cyber security.
“This has sped up the process,” Thorn said.
“Any time you can speed up the process, the more success you’re going to have when you make offers to settle claims,” he said.
Since that initial splash in claims management, the Riskonnect platform has gone on to become a rock star at Southwest in a number of other areas. And as Thorn suggests, the possibilities of the system are limited only by the user’s imagination.
With a little creativity and help from Riskonnect as needed, a risk manager can add on system capabilities without having to go on bended knee to his own information technology department.
In the area of insurance policy management, for example, the Riskonnect platform as built by Thorn now holds data on all property values and exposures that can in turn be downloaded for use by underwriters.
Every time Southwest buys a new airplane, the enterprise platform sends out a notice to the airlines insurance broker, who in turn notifies the 16 or 17 carriers that are on the hull program.
Again, in that “anything’s possible” vein, the system has the capability of notifying the carriers, directly, a tool Thorn said he’s flirting with.
“It is capable of doing that,” he said.
“We’re testing out this functionality before we turn on it loose directly to the insurance companies.”
In alignment with the platform’s muscle in documenting, storing and reporting liability and property exposures, the system monitors and reports on insurance carrier financial strength.
If a rating agency downgrades a Southwest program carrier’s financial strength, for example, the system “pings” Thorn and his colleagues.
“Not only will we know about it, but we will also know all programs, present and past that they participated on, what the open reserves are for those policy years and policies,” Thorn said.
“That gives us even more comfort that we have good, solid financial backing of the insurance policies that are protecting us,” Thorn said.
Like many of us, Chris Thorn didn’t set out to work in risk management and insurance. Thorn is a Certified Public Accountant, and it’s that background that allows him to take creative advantage of the Riskonnect platform’s malleability in yet another way.
With the help of the Riskonnect customer service team, Thorn added a function to the platform that allows him to calculate the cost of insurance policies on a monthly basis, enter them into a general ledger and send them over to his colleagues in accounting.
“It’s very robust on handling financial information, date information, or anything with that much granularity,” Thorn said.
The sky is the limit
Thorn and Southwest are only two years into their relationship with Riskonnect and there are a number of places Thorn thinks the platform can take him that have yet to be explored, but certainly will be.
“It’s basically a repository of anything that’s risk-related, it continues to grow,” Thorn said.
“This has sped up the process. Any time you can speed up the process, the more success you’re going to have when you make offers to settle claims.”
–Chris Thorn, senior manager, payments and risk, Southwest Airlines
Not only have Southwest’s safety and workers’ compensation managers joined Thorn in his work with Riskonnect, business continuity has come knocking as well.
Thorn met in July with members of Southwest Airline’s business continuity team, which has a whole host of concerns, ranging from pandemics to cyber-attacks that it needs help in documenting the exposures and resiliency options for.
That Enterprise Risk Management approach will in the future also involve the system’s capability to provide risk alerts, telling Thorn and his team for example, that a hurricane or fast moving wildfire is threatening one of the company’s facilities.
Supply chain resiliency and managing certificates of insurance for foreign vendors are other areas where Thorn and his team plan to put the Riskonnect platform to good use.
“That’s all stuff that’s being worked on by us,” Thorn said.
“They’ve given us the tools, but we’re trying to develop how we’re going to use it,” he said.