E&S Market Continues to Evolve
Risk managers should treat changes in the excess and surplus lines market with caution. Overcapacity is drawing more insurers to seek growth in that market, and they may not necessarily have the specialty underwriting knowledge needed to succeed in the sector.
That would mean a subsequent decision to remove themselves from E&S lines — leaving their insureds in the lurch – or not being able to effectively service accounts or manage claims.
“There are companies writing business in the specialty world that they wouldn’t normally write,” said Alan Jay Kaufman, chairman, president and CEO of Burns & Wilcox.
“On the mergers and acquisitions side, A.M. Best would probably not be surprised if more M&As occurred.” — Robert Raber, senior financial analyst, A.M. Best
“Companies are looking for anything to write because there’s overcapacity,” he said. “Many of the companies do not have the experience, expertise and talent but they are still venturing into this territory.
“Companies are jumping through hoops to write business and the rates keep coming down because of continued overcapacity,” he said.
Some insurers acquire organizations with a nonadmitted platform, while others bring over teams of experienced players in the field, such as when Berkshire Hathaway brought on Peter Eastwood from AIG and a team from Lexington to launch Berkshire Hathaway Specialty Insurance in 2013.
David Blades, senior research analyst, A.M. Best, said that another such event occurred in June 2015 when Argo Group through Colony Specialty expanded the environmental division within its E&S segment by hiring four individuals who had been with Freberg Environmental Insurance.
“On the mergers and acquisitions side, A.M. Best would probably not be surprised if more M&As occurred,” said Robert Raber, senior financial analyst, A.M. Best. “With current market conditions, it’s a challenge for them to grow their business.”
With all of the competition in E&S lines, Kaufman said risk managers may be tempted to look only at price instead of “expertise and where that company will be down the road. The company may have a strong enough rating to offer the product but will they be around to effectively handle the claims and service the insured?”
“I think if I was a risk manager,” said Raber, “I would probably be comfortable with a team that was familiar and had a lot of industry expertise in the business I was looking at. … I would be looking for consistency in the market, a presence in the market.”
“You want a company that has proven they understand that type of business,” said Blades.
“It’s not just underwriting, it’s claims and loss control. You want a company that has proven they understand that type of business, that they have committed to it for a long period of time.”
The interest in the E&S market has been increasing for several years because insurers are finding it challenging to grow organically in the standard lines, Raber said. At the same time, insurers are contending with a soft market and the continuing problem of low investment returns.
Kaufman said the acquisitions were also a way for insurers and brokers to acquire much needed talent.
The most significant new entrants to the E&S market include Kemper Corp., Knight Holdings and Hamilton Insurance.
The most notable M&As in the past year were ACE’s acquisition of Chubb (with the merged company retaining the Chubb name) and XL Catlin.
AIG, which primarily writes E&S through Lexington Insurance Co., remains at the top of the U.S. field, although Lloyd’s of London remains the leading surplus lines market, with 20 percent of the market share, according to A.M. Best.
E&S is also drawing new entrants into market.
The most significant new entrants, though still with minor direct premiums written, according to SNL Financial, include Kemper Corp., whose direct E&S premium in Q3 2015 was $40.5 million; Knight Holdings at $12.2 million; and Hamilton Insurance at $6.5 million.
In comparison, Lexington Insurance Co. wrote $965.9 million in direct E&S premium in the U.S. in the third quarter of 2015, according to SNL Financial.
No Damages for Peanut Explosion
On Aug. 4, 2009, Industrial Fumigant (IFC) dumped about 49,000 Fumitoxin tablets into a single access hatch of a peanut dome owned by Severn Peanut Co. to fumigate the North Carolina building.
A fire broke out on Aug. 10, which smoldered until an Aug. 29 explosion caused extensive structural damage and the loss of nearly 20 million pounds of peanuts.
Travelers Insurance Co. paid Severn $19 million to cover the costs of the peanuts, damage to the peanut dome, lost business income, and remediation and fire suppression costs.
On Jan. 4, 2012, Travelers, Severn and Meherrin Agriculture & Chemical Co. (Severn’s parent company) sued IFC and Rollins Inc. (IFC’s parent company) for breach of contract and negligence.
Severn argued that the Fumitoxin tablets were known to produce a toxic and flammable gas when piled atop each other, and that its agreement with IFC required the company to apply the pesticide “in a manner consistent with instructions.”
The Eastern District of North Carolina court dismissed the case, noting that the $8,604 contract between IFC and Severn specified that the fumigation fee was not “sufficient to warrant IFC assuming any risk of incidental or consequential damages” to Severn’s property or product.
The court also dismissed the negligence claims, finding Severn was “contributorily negligent” in its actions.
On appeal to the U.S. 4th Circuit Court of Appeals, IFC prevailed again. Allocating contractual risks between sophisticated business partners provides business predictability, it ruled. Enforcing such provisions is “far from an outlandish exculpation of responsibility.”
Scorecard: Severn and Travelers will not receive damages to offset the $19 million paid by the insurer.
Takeaway: The manufacturer “chose to bargain away protection for consequential damages” through its contract with the fumigation company.
Excess Coverage Not Triggered
Montello Inc. distributed an oil-drilling mud viscofier containing asbestos between 1966 and 1985, resulting in numerous lawsuits from individuals claiming injury as a result of exposure to asbestos.
The company had primary insurance coverage from The Home Insurance Co. from 1975 to 1984, but the insurer had not paid out any claims for bodily injury by the time it was declared insolvent in 2003.
After Home’s insolvency, Canal Insurance Co., which had issued excess coverage, filed a legal action against Montello seeking a court determination that it had no duty to defend or indemnify the company. Montello responded by filing counterclaims, as well as filing complaints against Continental Casualty Co. and Houston General Insurance Co.
Houston General had also issued excess coverage. Montello alleged Continental had issued an insurance policy as well, but neither Montello nor Continental had a copy of it.
A U.S. District Court dismissed the cases in a series of rulings. On Nov. 27, 2015, the U.S.10th Circuit Court of Appeals agreed with those rulings.
The court noted that Montello’s policy with Canal and Houston General “did not undertake to insure the solvency of Montello’s primary insurer.”
“The Excess Clause is clear: When the underlying insurer’s limits are reduced by payment of loss, Canal’s liability is triggered. The underlying insurer’s inability to pay is not payment of loss.” — U.S. 10th Circuit Court of Appeals
“The Excess Clause is clear: When the underlying insurer’s limits are reduced by payment of loss, Canal’s liability is triggered. The underlying insurer’s inability to pay is not payment of loss,” it ruled, noting that the provisions in Houston General’s policies were similar.
As for the lost policy, it ruled Montello had the burden of establishing its existence. It said the company’s witness at the district court level could not testify as to which umbrella policy was in use or its specific wording. &
Scorecard: The three insurers need not defend or indemnify Montello.
Takeaway: Excess insurers usually have no obligation to drop down to cover a primary insurer’s obligations.
Court: Flood Threat Was Not Direct Physical Loss
In late May 2011, the U.S. Army Corps of Engineers issued warnings of potential flooding of the Missouri River near three properties owned by Infogroup, a data provider in Carter Lake, Iowa.
On June 1, 2011, Infogroup relocated most of its business operations and data center, and decided to set up a new permanent location elsewhere. The Phoenix Insurance Co. advanced $500,000 to the company for anticipated claims under its property and personal business property coverage.
The insurer noted the policy would cover relocation, but not establishment of a new facility.
The company’s parking lot flooded in August; Infogroup and Phoenix disputed whether water caused any physical loss or damage.
Infogroup submitted a claim for $12.2 million, minus a deductible and the $500,000 advance. Phoenix denied the claim under the policy’s Extra Expense coverage because there was no physical damage to the properties.
The U.S. District Court for the Southern District of Iowa ruled on Nov. 30, 2015 that the policy was unambiguous in its requirement that “direct physical loss or damage” was necessary to trigger the Extra Expense clause. It also said that the Preservation of Property clause covered property, not operations, but there was “a genuine issue of material fact” as to what relocation costs were necessary. It rejected the insurance company’s request to dismiss that element of the lawsuit. &
Scorecard: Further legal proceedings are needed to determine how much of the $12.2 million claim is properly due Infogroup.
Takeaway: While the Extra Expense clause required “direct physical” loss or damage, the broader Protection of Property clause required only “loss or damage.”
Searching for Stability in Cyber Space
As headline-grabbing breaches crack systems and tarnish reputations of major retail, healthcare and financial companies, the need for cyber insurance has become increasingly apparent.
Given the constantly changing nature of cyber risk and the market landscape, creating a stable, sustainable cyber insurance business demands a prudent approach, with an eye on the long road.
“We’ve seen carriers jump in and out, wanting to take advantage of a new opportunity, but perhaps underestimating the risk,” said Danielle Librizzi, Senior Vice President, Head of Professional Liability, Berkshire Hathaway Specialty Insurance (BHSI).
“As cyber exposure became more tangible to carriers, in-force coverage was tested and many made radical changes to pricing and availability of coverage. BHSI is committed to entering the cyber market in a thoughtful and sustainable way. We want to be there for our customers as the risks continue to evolve.”
Diverse, Evolving Risks
Cyber exposure – and coverage — have been evolving, posing different risks and underwriting challenges for different industries. The technology, financial services and healthcare industries illustrate the diverse issues that must be considered in order to provide effective, financially sustainable cyber solutions.
The technology sector was the first cyber battleground, and technology E&O forms included some cyber coverage by virtue of the nature of the risk. “There’s inherent cyber coverage for third party liabilities in E&O,” Librizzi said.
While coverage is widely available, tech companies pose challenges to underwriters because of their unique position in the cyber “supply chain.” These companies provide software, hardware and cloud services; virtually every organization in the world is dependent on a tech provider of some stripe. If an insurer is covering both the provider and its clients, the aggregate risk should be monitored closely.
Think of a DOS attack on a cloud provider that prevents all of its clients – which could include anyone from a bank to a retailer or transportation company — from accessing stored customer or corporate data or running cloud-based service apps. That single attack could bring business in multiple industries to a grinding halt, potentially causing business interruption and E&O losses.
The tech industry hasn’t seen a large scale event like this yet, but it isn’t waiting around for one to strike before addressing the underlying risk. Controlling and accounting for the aggregate exposure will mold the direction that coverage development takes.
“Our combined form, introduced in October, 2015, is a comprehensive solution that includes first and third party cyber coverage as well as traditional E&O coverage,” Librizzi said.
However, that approach may not be appropriate for other industries. Financial Institutions, for example, may seek a dedicated cyber only policy which does not include traditional E&O coverage.
While banks typically have strong protocols for network security and privacy, they also have a much greater exposure in massive stores of customer data. Financial Institutions are looking to address liability in the form of class action lawsuits or heavy regulatory investigations and fines emanating from cyber, and may not want to compromise their traditional E&O limits.
“Additionally, given the increased reliance on outsourced providers for technology solutions, we have started to see the introduction of sub-limited coverage for dependent business interruption and payment card industry (PCI) fines and assessments as enhancements to coverage,” Librizzi said. “We might see those sub-limits go to full coverage as competition gets heavier.”
Other industries, which may not be as advanced as financial institutions in addressing cyber threats, have suffered more from a lack of robust cyber coverage that can keep up with increasing exposure.
Healthcare, for example, has seen a surge of cyber attacks since hospitals and other health systems went electronic. To a hacker, healthcare providers represent a warehouse of valuable personal identifiable and protected health information.
Email addresses from healthcare systems typically are white-listed and less likely to get caught in a spam filter, giving hackers incentive to obtain access and gain control of a healthcare provider’s network in order to launch phishing attacks.
After some high-profile breaches in 2015, Human Health Services and the Office for Civil Rights came under scrutiny for not doing enough enforcement of HIPPA. Fines imposed by regulators increased dramatically over the past decade, and seem poised to only get higher.
“They’ll be ramping up enforcement of regulations in 2016, and that’s only a peek of what’s on the horizon,” Librizzi said.
The burgeoning of healthcare’s cyber exposure has challenged the insurance industry to better understand the nature of the risk and how best to secure hospital systems. Coverage for this sector remains the most difficult to write effectively.
BHSI understands the need for different customers to have different solutions. Some customers desire a dedicated cyber policy that does not include traditional E&O coverage. BHSI’s Network Security and Privacy stand-alone policy is designed to address the needs to those customers.
“The cyber exposures and coverages needs of healthcare, financial services and technology are on different timelines and will look very different in the future,” Librizzi said.
Even in more mature markets, the conflation of commercial and personal cyber risk will challenge insurers going forward. Most existing cyber products don’t cover property damage and personal injury; as the risks emerge and the Internet of Things becomes more pervasive, the coverage will have to evolve as well.
“We must always be thinking about what is on the horizon from a risk and coverage perspective – our technology driven society demands it,” Librizzi said.
Anticipating challenges and adapting to each industry’s needs has been a cornerstone of BHSI’s approach to cyber. It’s careful and measured approach has also helped the specialty insurer build an arsenal of experts and ancillary services to help clients better grasp and mitigate their exposure.
“We know the importance of really understanding the risk and communicating it clearly to our customers,” Librizzi said. “We don’t bury our coverage in a pile of definitions, and we provide the expertise to help insureds stay ahead of the next big breach.”
To learn more about BHSI’s professional liability products, visit http://www.bhspecialty.com/.
Berkshire Hathaway Specialty Insurance (www.bhspecialty.com) provides commercial property, casualty, healthcare professional liability, executive and professional lines, surety, travel, programs, medical stop loss and homeowners insurance. The actual and final terms of coverage for all product lines may vary. It underwrites on the paper of Berkshire Hathaway’s National Indemnity group of insurance companies, which hold financial strength ratings of A++ from AM Best and AA+ from Standard & Poor’s. Based in Boston, Berkshire Hathaway Specialty Insurance has offices in Atlanta, Boston, Chicago, Fort Lauderdale, Houston, Los Angeles, New York, San Francisco, San Ramon, Stevens Point, Auckland, Brisbane, Hong Kong, Melbourne, Singapore, Sydney and Toronto. For more information, contact [email protected].
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This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Berkshire Hathaway Specialty Insurance. The editorial staff of Risk & Insurance had no role in its preparation.