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The professional liability market may be significantly affected by the increase in frequency and severity of hurricanes, causing greater rating agency scrutiny and changes to evaluation models.
“The three recent hurricanes — Katrina, Rita and Wilma — will result in losses of $70 billion to $90 billion pre tax, $50 billion to $60 billion after tax,” said V.J. Dowling of Dowling & Partners during a panel discussion at a recent Professional Liability Underwriting Society meeting.
Dowling noted that rating agencies were supportive of mono-lines in the 1980s and early 1990s, but after 9/11, everything changed.
“As a result, rating agencies changed the models favoring less diverse platforms,” he said. “After Hurricane Katrina, the rating agencies are shifting to a preference for multi-lines.”
Dowling warned professional liability underwriters to think about what rating agencies will do once they are done with short-tail companies. “The end result will be that you’ll need more capital than you do now to write the same lines,” he said, adding, “There needs to be more capital than the risk insurers are exposed to, requiring more of a cushion. Diversification is back. Just look at the capital being raised; Bermuda is where all the action is, as there is a shortfall of overall capacity.”
Robert Deutsch of CNA, who moderated the PLUS panel, said he believed that rating agencies have become more aggressive in their actions. “Not only were rating services quick to downgrade carriers after Katrina, but they are using harsh and frank language in their press releases,” he said. “I do think that some of them have good reason, as they have been burned by companies in the past.”
Recalibration of models
Recalibration of rating agency models will be the most significant issue coming into play, according to Peter Porrino of Ernst & Young LLP. “How is that going to change behavior? The question is, does an insurer become a more broad-based carrier, and what does that mean for the business?”
Porrino noted that there are reinsurance issues to consider, including $170 billion in corporate bonds held by insurance companies. “There are different perspectives as to how collectible the $170 billion is and what the effect is on the pricing environment. It’s hard to get a handle on this as there can be differing opinions on what percentage companies will get down the road,” he said.
“Disputes only happen when there’s an amount presented for payment. How much of the case will go into dispute is unclear. Most companies are optimistic that there will be a few disputes or insolvencies, although there will be a significant number in run-off, but not a significant insurance event.”
According to Andrew Newman of Corwill and Co., the ability to pay is manifest.
“Its credit worthiness is lower today than any other time,” he said. “The willingness to pay is clearly an issue. There are run-off companies that allow this, and I can see that becoming an area of difficulty.”
Dealing with run-offs
Newman noted that dealing with run-off managers isn’t easy. He sought a higher degree of scrutiny and mentioned putting language into a reinsurance contract that requires a change in control in claims handling assigned to a third party manager.
“It will force the company to post collateral so the issue doesn’t perpetuate itself going forward,” he said. “There are a number of things that have emerged in dealing with run-off managers. The value for run-off companies is investment income. In this marketplace, I’m not altogether sure we’ll get reinsurers to agree.”
Dowling mentioned the use of a special termination clause. “The whole issue you’re alluding to, investment bankers will find their way around that. We’ve been a proponent of this, but if you set up a system, it has to be done quickly.”
Looking at finites, Deutsch questioned whether they are truly dead or whether there were appropriate uses for it.
“In my role, I go through a lot of audit committee meetings,” Porrino said. “You can’t go to a meeting without someone saying, ‘you’re not buying that finite stuff, are you?’ If you’re management, you don’t want to be answering in the affirmative. I won’t say finite is dead, but the appetite has been dramatically reduced for three to five years. And how it goes in the future depends on the market. It wasn’t the finite product that was the problem; it was that there was fraud.”
Broker compensation
Deutsch weighed the issue of brokers’ compensation and contingent commissions.
“The big brokers disavowed them; the smaller brokers continue them,” he said. “Has transparency been a positive or a negative issue for the insurance industry, and how do the big brokers compete when small brokers still accept this?”
According to Newman, the winners in the issue are insurance companies that see big reductions in acquisitions costs.
“In the long term, this is fundamentally a really good thing for the insurance industry,” Porrino said. “There was always too much power in the hands of a few brokers.”
“As an industry you’re better off,” Dowling added, noting that the power and the take of the premium dollar have been reversed. “It has caused a trend that is lowering the distribution costs.”
Looking at specialty lines, Deutsch said that there had been tremendous reform at the state level regarding medical malpractice, although nothing had occurred at the federal level. He asked whether the panelists saw a trend continuing and how that affected underwriting.
“Our clients expect and support tort reform as a tactic against tort reform erosion,” Newman said. “Texas did an outstanding job of constitutional change. The plaintiffs bar would try to erode it. It took 10 years for all the challenges to abate.” Newman said he expected the trend to continue at a state level.
But Washington is another matter. “At the federal level, our clients suggest there won’t be any meaningful tort reform in this Administration. There are bigger issues; there’s less of an availability crisis. I can’t see this as a federal priority.”