How well are you managing your loss exposures involving market conditions?

This article will offer guidelines on your agency’s management of market exposures in hard and soft markets alike.

During a soft market, carriers are far more flexible and willing to grant enhancements that aren’t available in a hard market. Knowing what gaps can occur and making sure the client understands them can help avoid or reduce the impact of an E&O claim and help make your client an agency advocate.

There are fewer exposures when you go from a hard market to a soft market than when going from a soft market to a hard one. When the market hardens, standard carriers become more selective about what business they write and under what terms. Excess & Surplus Lines (E&S) carriers increase their writings considerably.

When you need to move a standard policy into an E&S market, you must consider a number of due diligence areas, such as:

• Policy coverage and definitions
• Restrictive endorsements
• Occurrence vs. claims-made forms
• Admitted vs. Non-Admitted carriers
• Solvency/guaranty fund protection
• Relationship with a contracted carrier vs. the E&S broker or carrier

Even if an E&S market uses a standard form, it might be an older version than the one your client currently has and/or be more restrictive than the one it’s replacing. You could also run into a situation in which a coverage enhancement included on the old form must be added to the new one at an additional premium.

You might find that the new policy’s definitions section isn’t as inclusive as the old one or that there’s been a change as to whether it’s an occurrence or a claims-made form. Even if you move the coverage from one standard carrier to another, the old carrier might have coverage enhancements that the new carrier doesn’t include.

This all boils down to the fact that your agency needs to exercise a greater degree of due diligence to avoid or reduce the impact of an E&O claim. Taking the right steps will also serve the client more effectively and strengthen your carrier relationships.

In that light, we’ll discuss three broad topics — solvency, regulatory issues, and policy coverage — focusing on background information, exposures, and agency risk management techniques.

SOLVENCY

Although solvency is a concern in hard or soft markets alike, the problem worsens with increased E&S use in a hard market. E&S market insolvency is no higher than for standard companies. In most cases, agents who use E&S markets are “once removed” from the kind of contracted company relationship it has with standard carriers. If the E&S market is e approved but not admitted to do business in the agent’s state, the problem becomes still more serious.

Also, in most states an E&S market carrier has as much regulatory oversight as an admitted and licensed carrier and that has met the financial deposit requirements. Finally, the State Guaranty Fund protection probably won’t extend to the insured if the carrier becomes insolvent.

To start with, most E&S brokers do a good job of advising agencies about companies’ Best ratings. In many states, specific requirements and procedures apply when using an E&S market. Because your agency’s due diligence requires making sure that the client understands the risk, it’s necessary to understand Best’s or other rating organizations.

RATINGS

A.M. Best, established in 1899, has a huge database. It’s considered the leader and the standard for the industry. There are other rating organizations, most of which are also outstanding sources of information. Some of these firms specialize in certain areas.

As a general rule, avoid carriers that A.M. Best rates as “vulnerable,” although sometimes there’s no other market available. Best rates carriers with a “B” or below and those with a financial performance rating (assigned to small or new companies that provide the required financial information) of FPR 4 as vulnerable. Your E&O policy might also have an insolvency exclusion. At the least, you should take specific steps to explain and document the client’s risk.

Best also has a number of “Not Rated” categories for such reasons as insufficient data and operating experience. Take such a rating as a warning either to not use the market or to be particularly careful in advising the client.

Here are some specific E&O risk management techniques your agency might use: 

• Establish an ongoing Best’s (or other rating organization) rating review program. Make it a regular duty of your producers and staff to check the ratings.
• Review your agency’s current E&O policy and every renewal, as well as any policy provisions, if you shop your renewal with other E&O markets. If there’s an insolvency exclusion, ask your E&O carrier if it can be deleted based on your written policies and procedures for monitoring activity. If not, the carrier might have a broadening endorsement that reduces the impact of an insolvency, based on special circumstances.
• Develop, install, and enforce a policy of not using carriers with “vulnerable” ratings. If special circumstances force you to use a vulnerable carrier, outline and communicate the specific actions and requirements that must be followed to use the carrier.
• Have a written procedure requiring that a carrier’s rating be checked and recorded before using it. If the rating has been downgraded, even with a “secure” rated company or when Best notes that a company is “under review,” require agency management approval before using the carrier. Make following agency procedures a criterion of staff and producer performance evaluation. Since most agencies do a monthly production and financial review; it should be easy to add an automation report that monitors the ratings check.

Carriers “under review” or rated “vulnerable” by A.M. Best might not be a risk, but they bear scrutiny. Advise your client accordingly and document your actions. Too many agencies do nothing because they take the attitude that the client is aware of the risk. Then, if the worst happens, they have an E&O issue that’s difficult to defend.

Rating information is available daily, weekly, monthly, and annually through the rating organizations, their publications, trade magazines, newspapers, and the Internet, so there’s no reason for not keeping up with rating changes and developments.

REGULATORY ISSUES

Regulatory issues involve state insurance regulatory agencies and the roles they play.

The issue of whether a state or federal agency will regulate the industry is still up in the air; although the states will probably continue to regulate, this might change. Possible areas of change include licensing standardization among the states, the possibility of a single federal agent’s license, resident/nonresident agent status, electronic signatures, and electronic commerce in general.

What’s certain is that there will be change. The potential impact of combining financial services, insurance, and electronic commerce is just emerging. The time frame for change is compressed, and an enormous amount of information will be available instantly.

Most states tax premiums to raise the money for regulatory activity, but the regulatory agency gets so little of this revenue that it can’t afford the actuaries, auditors, technicians, and other specialized staff to oversee admitted companies properly. Most states do a commendable job with their limited resources.

Your agency can’t just pass off its due-diligence responsibility to the regulatory agency. Your clients view you as their primary information source and expect you to inform them of developments that might affect them. Communication with clients is more important than ever amid the company mergers, acquisitions, and realignments, and the expected regulatory changes.

For example, although the causes of an insolvency might evolve over time, it could be triggered by a sudden event — such as a catastrophe loss, an unexpected revenue reduction, or a market downturn that reduces investment income — without which there might not be an insolvency at all.

It’s crucial to pay attention to your market performance!

POLICY COVERAGE

Policy coverage involves two broad areas: 

• Policy forms, coverage, definitions, and endorsements
• Occurrence/claims made, coverage triggers, retroactive date, and extended reporting periods

We’ve mentioned the differences between E&S and standard markets; but you might also have problems going from one standard carrier to another.

Although many carriers use ISO or AAIS coverage parts and forms, a number of carriers use their own filed forms. Also, a carrier might use an ISO form and then file its own endorsements. Definitions might be more specific on some forms than on others. Coverage enhancement endorsements might differ from one carrier to another. Even if the client renews with the expiring carrier, the carrier might have filed a renewal coverage that’s only slightly more restrictive to most insureds, but happens to affect your client significantly.

In all these cases, it’s essential to review renewal policies and forms, and new business policies when changing carriers. When writing a new client, compare their current carrier’s policies with your replacements — a good practice whether the market is hard or soft.

Pay careful attention to the edition dates of the forms, definitions, and endorsements, as well as to the forms. It’s crucial to confirm any differences, positive or negative, with the client for their benefit, as well as to avoid or minimize an E&O claim. Remember the old saying: An ounce of prevention is worth a pound of cure.

Occurrence/claims made, triggers, retroactive dates, and extended reporting considerations are other problem areas, primarily in Liability and Umbrella/Excess Liability policies. You must understand these areas to prevent coverage gaps and to be able to explain them to the client, who then can make an informed decision.

In general, when a policy that has been on an occurrence basis continuously is renewed on an occurrence basis, a problem is unlikely. However, changing from one basis to the other can cause coverage gaps if you don’t understand and inform the client of the circumstances. You should also consider coordinating a General Liability policy with an Umbrella/Excess Liability policy.

You need to be able to explain these terms to your clients: 

• Policy Trigger: This determines when a specific Liability policy covers a claim.
• Occurrence Trigger: The loss is covered if the event causing the loss occurs during the policy period, no matter when the loss is reported.
• Claims-Made Trigger: The loss must be reported during the period the policy is in effect.
• Retroactive Date: This is usually the inception date of the policy, but it can be a specified date prior to inception or not specified at all (also called “prior acts” or “full prior acts” coverage).
• Extended Reporting Periods: This is usually called “tail” coverage because once it’s added, the policy will cover claims submitted after the policy expires. Normally, the policy is designed to cover claims reported within five years, as long as the occurrence is reported to the insurer within 60 days of the end of the policy term.

CONCLUSION

We’ve only covered the tip of the iceberg in soft market/hard market E&O exposures.

Taking initiatives to reduce these exposures will benefit your agency, while demonstrating your professionalism and your concerns to your clients.