Casualty Actuarial Society2002 Spring Meeting
C18: Umbrella Liability
Russ Buckley, FCAS, MAAA - American Re-Insurance Company
Tom Ghezzi, FCAS, MAAA - Tillinghast-Towers Perrin
Dave Westberg - Towers Perrin Reinsurance
May 20, 2002 San Diego, CA
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This session will focus on recent significant developments in the umbrella market
Recent experience
Difficult exposures
Current state of the market Provider perspective Buyer perspective
Professional liability
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Russ Buckley, FCAS, MAAA
Started his career at Aetna Life & Casualty Transferred to American Re-Insurance in 1989 Experience includes
pricing almost all lines of P/C reinsurance 10 years with Munich American Risk-Partners
Works with Fortune 1000 risks, government entities, insurance pools, reciprocals, and other organizations which retain significant insurance risk
Currently responsible for American Re’s Direct Facultative Division $1 billion of 2002 written premium $500 million of commercial and personal
umbrella Licensed soccer referee
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Dave Westberg
Consultant in Towers Perrin Reinsurance’s Consultative Placement Division
20 years of experience Risk financing consultant with Watson Wyatt Treaty reinsurance broker with BEP Underwriter with CIGNA, Allstate, Royal
Expertise in Design and implementation of alternative risk
financing strategies Self-insurance and reinsurance Captives Professional liability exposures
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Tom Ghezzi, FCAS, MAAA Consulting actuary with Tillinghast since 1984
Areas of expertise include Loss reserving and pricing for all types of
insurance entities Strategic analyses
Line of business expertise in Medical malpractice E&O Products liability Personal lines
Past president of CANE
Proceedings paper on federal income taxes
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We have split up this presentation as follows
Topic Presenter Slides
State of the Market Russ 7 -27
Difficult exposures Tom 28-40D&O, Fiduciary Liability, E&O Dave 41-69
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Umbrella coverage characteristics
Umbrella policy is excess of underlying coverage Underlying policies generally include
automobile liability, general liability and employers liability
Can include other liability exposures
Underlying limits generally $1 million per occurrence or higher Trend toward $2 million aggregate
Forms include Follow form excess - generally larger risks Standard umbrella - generally smaller risks
Leading writers AIG, Chubb, Kemper, Royal, Zurich
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News Headlines – Part 1News Headlines – Part 1
Summer of 2001 – CNA posts a $1.47 billion loss for the first half of the year, which the insurer said reflected reserve strengthening, an IT restructuring charge, and realized losses associated with certain subsidiary operations.
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News Headlines – Part 2News Headlines – Part 2
October 22, 2001 – SAFECO announces a $240 million charge for strengthening of reserves in the third quarter. Included in this amount is $90 million for recent developments to prior-year claims for construction-defect claims.
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News Headlines – Part 3News Headlines – Part 3
November, 2001 – Berkshire Hathaway 3rd quarter report on General Re
“Underreserving occurred principally in the casualty treaty, commercial umbrella and casualty individual risk reinsurance lines, and primarily for accident years from 1998 through 2000.”
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““National” Umbrella CarriersNational” Umbrella CarriersEstimated Loss Ratios by Accident YearEstimated Loss Ratios by Accident Year
0%
25%
50%
75%
100%
125%
150%
175%
200%
225%
250%
1997 1998 1999 2000 2001 2002
Accident Year
Lo
ss R
ati
o
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““Regional” Umbrella CarriersRegional” Umbrella CarriersEstimated Loss Ratios by Accident YearEstimated Loss Ratios by Accident Year
0%
20%
40%
60%
80%
100%
1997 1998 1999 2000 2001 2002
Accident Year
Loss
Rat
ios
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News Headline – Part 5News Headline – Part 5
June 14, 1999 – Business Insurance
Commercial rate cuts slowing, predict that buyers will see rates leveling off rather than increasing, according to a Conning & Co. study.
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News Headline – Part 6News Headline – Part 6
July 5, 1999 – Business Insurance
Reinsurance rate-cutting less prevalent, reinsurers are pushing for modest increases, while retrocessional reinsurance rates are rising sharply.
“There is a bottoming, and I think we have gotten there” says one reinsurance executive
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Commercial Lines – Pricing Trends
Representative commercial lines pricing trends
1997 1998 1999 2000 2001 2002 Q1
-5.1% -3.7% 1.8% 9.9% 14.3% 17.9%
Courtesy of the Travelers website
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Commercial Umbrella – Pricing TrendsCommercial Umbrella – Pricing Trends
Information provided by Conning and Co.
22.4%9.9%0.8%-3.5%
2002200120001999
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News Headline – Part 7News Headline – Part 7
Business Insurance – April 22, 2002
CIAB sees rate increases across all lines for the first quarter of 2002, with the increases in the range of 10% to 30% for all commercial lines.
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News Headline – Part 8News Headline – Part 8
Business Insurance – April 22, 2002 - Commercial Umbrella information
Rate Increases % RespondentsLess than 10% 10%10% to 30% 29%30% to 50% 32%50% to 100% 18%Greater than 100% 11%
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““National” Umbrella CarriersNational” Umbrella CarriersEstimated Loss Ratios by Accident YearEstimated Loss Ratios by Accident Year
0%
25%
50%
75%
100%
125%
150%
175%
200%
225%
250%
1997 1998 1999 2000 2001 2002
Accident Year
Lo
ss R
ati
o
-5.1%
-3.7%
1.8%
9.9%
14.3% 17.9%
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Commercial Auto Loss TrendsCommercial Auto Loss Trends
Between 1993 and 1999, the average settlement for commercial auto liability claims has increased over 200% during that time period.
- this will have a disproportionate impact on umbrella insurers and reinsurers, as the leveraged impact of trend drives more losses into the higher layers.
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Limits and Attachment PointsLimits and Attachment Points
Changes in attachment points vary by market and type of risk
The amount of limits available from carriers is greatly reduced from two years ago
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Terms and ConditionsTerms and Conditions
Terrorism
Mold
Sexual Misconduct
Construction Defect
Incidental Professional Liability
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Reinsurance Support
Reinsurers are reducing limits across the board
Some major carriers are having problems putting together umbrella treaties, or are doing so with smaller limits
Increased pressure on guidelines for restrictions on classes, minimum premium levels and minimum attachment points
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Several high profile developments have hit umbrella coverage especially hard and pose significant challenges
These events/exposures affect underlying policies and expose the umbrella coverage Terrorism Construction defect claims Toxic mold
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September 11 terrorist attacks caused virtual elimination of coverage for terrorist acts
After September 11, availability of coverage for terrorist events was almost non-existent Some improvement lately High rates and narrow terms
Umbrella policies follow terms/exclusions of underlying coverage
Federal legislation Possible federal backstop
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Construction defect claims have had a significant impact on primary general liability and umbrella coverages
Claimants include Homeowners Associations Class actions
Defendants/Insureds Developers General contractors
Additional insureds Subcontractors Design professionals
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Construction defect loss exposure was increased significantly by the Montrose decision in California
Montrose Chemical Corporation of Califoria v. Admiral Insurance Company, 10 Cal. 4th 645 (1995) Montrose applied the continuous injury trigger
to third party claims
“Manifestation” vs “Continuous Injury Trigger” Manifestation triggers policy in effect at the
time the damage appears Continuous injury - triggers all policies in effect
during the time the damage begins to occur and the time it ceases
This trigger increases the number of policies exposed, creating all sorts of unusual difficulties
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A secondary issue in Montrose was “loss-in-progress” or “known loss” rule
This rule provides that a loss that is already known to an insured at the time a policy coverage starts cannot be covered by that policy Only contingent or unknown events can be
insured
The Court found that since Montrose was not certain of its legal liability, the loss was contingent
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Impact of Montrose on construction defect claims
Which construction defects are “continuous” or “progressively deteriorating?” Defective wiring Faulty foundations Water leakage Dry rot
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The industry’s response
Montrose endorsement routinely added to liability coverages, and therefore to umbrella policies Incorporates known loss doctrine into the
CGL policy language Loss intended to be covered only by the
policy during which it first became known
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Actuarial and claim handling issues related to evaluating construction defect exposure
There are significant differences in exposure among different insured types General contractors the highest severity, but
relatively lower frequency Subcontractors and “artisans” lower severity,
but potentially very high frequency Data should be available by insured type
Definition of accident year is difficult Report year data should be used
Allocated loss adjustment expenses can be significant Time on risk
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A more recent development relates to
Stachybotrys chartarum
AKA … TOXIC MOLD
There are over 100,000 known species of mold
Stachybotrys chartarum is considered to pose the greatest risk May cause physical reactions in some
individuals
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There have been large losses incurred because of toxic mold claims
Several recent multi-million dollar cases Texas homeowner - $32 million award (Ballard) California homeowner - $18.5 million award Florida courthouse - $60 million North Carolina motel owner - $6.7 million New York community college employee filed
suit for $65 million
Insurers incurring large losses One insurer reported mold-related claims during
Q1 2002 jumped to $119m, up from just $7m the year before.
Texas homeowners premium indications up 40%
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Coverage issues - homeowners
Homeowners forms are emerging that can include a variety of mold related clauses or endorsements Absolute exclusion Coverage if a direct result of leaking
plumbing, heating, or other system or domestic appliance
Coverage only is resulting from a covered peril
Some states may not allow the exclusions
There are internal limits
Mitigation required
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Coverage issues - CGL
Current form excludes losses related to “pollutants” Mold may not be considered a pollutant
Endorsements limit coverage Similar to homeowners
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Typical toxic mold claims
Potential damages Investigation and
testing costs Containment and
remediation expenses Abatement and
mitigation Loss of use Relocation expenses Diminution expenses Bodily injury Loss of earnings Emotional distress
Potential defendants Property owners and
managers Architects and
engineers Developers Contractors
Construction HVAC
Construction materials manufacturers
Testers, remediators, etc.
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The session description includes Professional Liability
Not usually part of umbrella coverage Errors & omission exclusions for all except
innocuous risk
However, professional liability coverages are coming under increasing pressures Similar market conditions as faced by
umbrella coverages Restrictions in capacity Significant price increases Coverage restrictions
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Market update for several significant Professional Liability exposures
We will look at
Directors and Officers (D&O) Fiduciary Liability Actuarial E&O
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Trends in current D&O market place
2002 D&O renewals should expect:
Substantial premium increases
Restrictions in capacity
Attachment point increases
Possible restriction of coverage
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D & O price increases and coverage availability varies by type of risk
“Standard” business rates increasing 50-100%
“Non-standard” such as aviation, financial institutions, technology, public health care, etc. up to 300% increase
No multi-year agreements or automatic extensions
Underwriters requiring more detailed exposure information
Underwriters concerned about financial restatements and m&a activity
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Possible D&O coverage restrictions include
Security claims co-insurance
Warranties
Pending & prior litigation exclusions
Deletion of retention waivers
Automatic subsidiary coverage reduced
Maintenance of insurance clauses
Reduced discovery periods with higher premiums
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Class action trends show...
Federal Securities Fraud Class Action Litigation
164202
163
231188
110
178236
205 211
487
0
100
200
300
400
500
600
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
# S
uit
s F
iled
Pe
r Y
ea
r
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SEC pursuit of financial fraud has intensified
“Accounting fraud” has become a major factor in many recent cases with extremely large D&O losses
100 brought in 2000 alone
260 investigations currently in progress
Due to Enron, it is likely that this number will increase
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Financial fraud (continued)
40 investigations target the largest 500 corporations in the US (8%)
233 financial restatements in 2000 (twice that in 1997)
Major SEC investigations include Enron, ConAgra Foods, Boeing, Cendant,
Xerox, Oxford Health, Comp USA, Rite Aid, Sunbeam
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Along with frequency, the size of D&O settlements has increased dramatically in recent years
Prior to a couple of years ago Difficult to identify any settlement or
judgment for more than $100 million for the “typical” D&O suit Even the most difficult to defend cases cost
less than $100 million
Since mid-1999, severity has increased dramatically More than a dozen settlements or verdicts
over $100 million One-third of these over $200 million
Securities class action suits most problematic
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D & O Market Trends (continued)
The result of all this is that,
“D & O insurance purchasers in 2001 faced the largest premium increases since the hard D&O market of the mid-1980’s”
These trends will continue and likely intensify through 2002.
D&O & Ficuciary Information sources: Aon March 2002 Executive Liability Market Update & Tilllinghast-Towers Perrin 2001 Directors & Officers Liability Survey
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Fiduciary Liability Market Trends
Enron claim a watershed event
This claim is not likely in isolation but illustrative of more to come
The fiduciary suits against Enron are over losses in the company-stock portion of their 401(k) plans
The suits allege the plan trustees breached their fiduciary duties by continuing to offer company stock, even after they became aware of serious business problems that would hurt the stock price
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Fiduciary liability claim trends
Not just post-Enron claims environment
Examples Airline pilot retirement plan alleging under-
funding of $1,000,000,000 Financial services firm - alleged improper use
of employee retirement funds- $26,000,000 Health care company - alleged improper use
of health care plan funds - $3,000,000 Consumer goods co-alleged improper
investment management involving company stock - $100,000,000
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Issues to consider with respect to fiduciary liability
Employee benefit plan asset size (aggregated for all plans)
The number of employee benefit plan participants
Method and form of corporate matching or funding of asset bearing employee benefit plans such as pension plans, 401(K) plans, ESOP’s, etc.
Percentage and amount of plan assets invested in corporate stock. What is the maximum What is the maximum exposure to the plan related to a market exposure to the plan related to a market capitalization drop in the common stock?capitalization drop in the common stock?;
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Investments in company stock under greater scrutiny
Given recent developments like Enron
Focus that regulators and the plaintiff’s bar now have on employee benefit plans in general and, specifically, with respect to 401 (K) and ESOP
investments in company stock,
the duties of the plan fiduciaries and trustees responsible for safeguarding those plans will be under increasing scrutiny and may point toward increased litigation.
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Actuarial Liability - We saved the best for last!
Actuarial liability is traditionally classed as part of miscellaneous E&O
Lately, we have been distinguishing ourselves by emerging with our own unique risk profile
Liability claims against actuaries have been on the rise, but the most dramatic change over the past five years has been in severity
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Considerations with actuarial liability
Is actuarial science perfect? Some (mostly lawyers) seem to think it
should be
High standard of expectation applied to inexact science of predicting the future
Occasionally mistakes are made and real damages are sustained. These need to be compensated for, however…...
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Recently the rules of the game seem to be changing
For the most part actuarial E&O needed to result in real, objective damage or loss to sustain a claim
Inappropriate actuarial appraisal price leads to wrong sale price in mergers or acquisitions
Inadequate loss reserves lead to inappropriate growth or lack of funds to pay claims.
Incorrect assumptions lead to under-funding of pension or benefit plan
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Changing Rules (continued)
Recent damage theories put forward have tried to change the standard
Something went wrong, so everyone involved (or somebody with “deep pockets”) has to pay
The basis for some of these claims would not have been sustained ten years ago
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A real life example provides some insights
Public service pension fund
Contribution calculation assumption error which in isolation causes lower funding than the correct assumption would have indicated
Years pass, interest rate variations from original assumptions more than offset any potential shortfall due to the error
Pension fund in surplus position
What’s the problem? ...
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The plaintiff’s damage theory was
If contributions had been calculated correctly years ago,
Pension fund would be in an even greater surplus position
Damages to be based on difference between current surplus and what it could have been.
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There are varying levels of exposure by type of work product
Pension and other benefit consulting
Reserving and rate making
Heightened exposure with mergers & acquisitions and work for companies facing financial
difficulties
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Is it a crisis?
Actuarial E&O is an emerging class of risk
E&O premiums have been in the 1% of revenue range for actuarial firms
Accountants E&O premiums in double digit territory
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What can be done about it? Loss prevention & mitigation
Consistent application of professional standards
Clear written contractual engagements
Rigorous application of peer review guidelines
New risk management initiatives such as…..
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Contractual limits of liability in client engagements
Most major consulting actuarial firms are committed to implementing or are considering this approach
Limit of liability is linked to the fee associated with the work performed
Contractual limitations of liability are not likely “iron clad” but they should be effective tools for managing expectations in many instances
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We are still in the woods
It will take some time for limits of liability to be in place on all business
There is a lot of potential liability from work already completed
Plaintiff lawyers are as bright and busy as ever
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As actuaries, you must be aware of the:
Nature of the work
Expectations of market place
Appropriate loss prevention and mitigation measures