Transparency will reportedly bring fundamental changes in how the industry operates, resulting in more open communication between the client, the broker and the underwriter.
A change in the dynamics of the business also brings a change in expense ratios and companies’ competitiveness in the marketplace and many companies are thinking about shrinking or already have begun to shrink their books of business, insurance executives told the recent PLUS D&O Liability & Insurance Issues Symposium in New York City.
Looking at industry capacity, Bruce Hayes, executive vice president, Executive Assurance, Zurich North America Specialties, noted that as a result of all the issues that have arisen during the last 12 months, including the size and scope of settlements, there is a need for additional capacity that “needs to be structured in fashions that are different than we historically think about them,” he said.
“There isn’t too much capacity in the marketplace,” said Gregg Flood, executive vice president and chief operating officer, National Union Fire Insurance Company. “How it is deployed that’s a concern. If you look at the settlements that are coming through today compared to the insurance programs that were purchased by Fortune 1000 companies, there’s a gross disproportion of insurance loss being assumed by the defendant company. That points to a huge lack of capacity for the large risk,” he said. “The market caps of these companies are so large today, the damages are so unprecedented and historical, it screams for more capacity in these larger risks. For the smaller risks, the market is saturated, more competitive, more than fair.”
Laura Banez Lopes, senior vice president, Financial Insurance Solutions, AXIS Financial Insurance Solutions, noted that over the last six months, insurers have started using capacity more frequently, “but not sure if it is used wisely.”
She noted that from an insolvency perspective, a lot can happen in a very short period of time with a carrier. “It’s important to understand the capital base of your insurance company so that your policyholder has time to make changes in case things head south. There’s a lot of uncertainty there. As a broker, client or as a carrier, you don’t want to be put in that situation.”
“The solvency issue is a big one,” said Flood. “I’ve always told clients: this is the most sensible way to push the solvency and behavior issue. Take a look at the long-term debt ratings to the bonds. Bond debt ratings show the credit sensitivity of the whole organization and that’s critical.
“Claims take years to settle, so you have to anticipate the behavior of the insurance carrier,” Flood said. “The contract is the starting point. What you have to look at is the insurers’ dependency on reinsurance. If you’re heavily reinsurance-dependent, you have to have an understanding of what that carrier’s reinsurance response is going to look like.”
Hayes noted that one of the biggest testimonies to the D&O carrier is the huge risk-based capital analysis every year. “The extent that senior management of major P&C companies are prepared to commit substantial capital to the D&O operations speaks volumes about the kind of immediate profitability opportunities and long-term strategic opportunities. It’s a critical question to ask what part of that debt is a part you retain yourself or what part of that debt is retained by another part of your company.”
Anthony Giacco, senior vice president, XL Professional Insurance, noted that there have been tremendous pressures on excess pricing in the last 12 months. “If you’re a primary first excess, you need to keep within a certain range for pricing. People are trying to push back on that. Some are trying to push back proactively to pick up coverage or take out coverage.”
Looking at recent events regarding contingent fees and the impact on the industry, Giacco noted that there will be fundamental changes in how the industry operates. “Transparency will bring about more open communication between the client, broker and underwriter,” he said.
James Bronner, chief underwriting officer, Chubb Specialty Insurance, agreed that it would have a dramatic impact on the marketplace. “I don’t think the carrier behavior will change dramatically, but I think many dynamics of the market will change. It will certainly be more of a playing field, particularly with new business. Obviously, disclosure and transparency from the standpoint of compensation are going to be evolving over time.”
Flood noted, “Things are going to change. It’s going to open up new technology and bidding processes. Clients are now going to be completely informed. When dynamics change, expense ratios have to change. You can’t spend the kind of money you used to have.”
“It is a watershed event that’s just begun,” added Hayes. “Transparency will go well beyond the broker side; underwriters will be faced with similar issues.”
A finite number of brokers and carriers have reportedly sworn off contingents. What complications does that create in the marketplace?
According to Bronner, disclosure around those compensation agreements is going to change. “You’re going to have significant influence from various state insurance departments, probably a model for compensation disclosure,” he said. “To a large degree it will be out of our control. The fashion, disclosure, and transparency will be dictated to us.”
“When you look at D&O, you should negotiate the commission based on how complex and time-consuming the transaction was,” said Flood.
Looking at the D&O market and instances like WorldCom and Enron, Bronner noted that from a director’s point of view, it’s a disturbing trend that will probably keep happening. “From the recent ruling it doesn’t indicate that they won’t pay out of their pocket. These are two of the most egregious situations.”
“This is a complicated piece that hits just about every spectrum of the financial industry,” said Hayes. “It’s a catastrophic concept for us to be thinking about as there isn’t enough insurance to actually solve this problem,” he said. “Given some of the corporate governance going on, to see those kinds of events happen with the scope of multiple party influence, I think it will become more remote, given the fact that there’s a much higher level of diligence being brought to bear and ratifying of financial statements. You see many companies come back to square one to reconfigure accounting issues and problems they need to address.”
“The trend is not a good one for the future,” said Giacco. “There is a financial impact on a whole variety of constituents. It seems to be the intent of institutions to set behavioral patterns to change. This is what they’re striving for.”
Insurance executives also looked at whether there had been a positive impact to the Sarbanes-Oxley Act, what came out of it that hadn’t been anticipated, and whether the provisions had created a more risk-free corporate America.
Hayes noted that public accountants really focus on this issue now. “This type of disclosure may be a good thing for us. Now, if it’s associated with a stock drop, then we’d be changing the whole dynamics of how we look at SOX. The investment community looks at a SOX non-compliance as a means to sell the stock offering; an event trigger.”
“The whistleblower provision of SOX has generated a lot more claims activity,” said Flood. “The key is the more you make these rules complex, the more you’re going to end up with mistakes. There were 414 restatements this past year 2004. That’s a lot of mistakes.”
The panel was moderated by Don Bailey, head of Financial Services, Willis Worldwide.
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