The market has changed significantly. Business as usual won’t suffice. Doing a thorough and professional job for your clients and your carriers is the best way to protect all parties and sets your agency apart as a professional and ethical entity. Ken Buehler examines the added strains that current market conditions have placed on agencies.
Moving from a soft to a hard market can make placing business and arranging reasonable pricing very challenging for an agency.
A hard market brings a heightened awareness of a number of factors. Many of the changes won’t manifest themselves immediately, but when a loss occurs later and isn't paid or is paid at a fraction of what the client expected, the client and their attorney will look to the agency to fund the loss, knowing that the agent normally has E&O coverage.
Investment losses, underwriting losses, and a general loss of underwriting capacity are the roots of the problem. Reinsurers have experienced the same losses that primary companies have and must charge more for less coverage (or for more restrictive coverage). Of course, the primary companies must react accordingly.
Agents must take the initiative in a number of areas to protect themselves and their clients:
- Coverage reductions and restrictions
- Financial vulnerability of companies
- Occurrence vs. claims made policies
- Agency relationships with carriers
- Standard markets vs. surplus lines markets
- Communication levels with clients and companies
In a hard market, agents spend more time renewing business. Many agents say that they have less time to go through the additional safeguards needed in a hard market.
Considering the time an agency would have to spend on an E&O claim, time spent on additional safeguards might be a good investment. With an E&O claim, no one wins. The agency loses a good client, who tells other people about the experience — some of whom might also be clients.
In addition, the agency has to pay the E&O policy deductible and spend time defending itself. And what if they find that they have inadequate coverage? They might also have their E&O policy non-renewed, and in a hard market might have a hard time finding coverage or pricing as their expiration approaches.
Sadly, about the only ones who benefit are the attorneys. Agencies must take the 'due diligence' process in their client relationships to a higher level.
Let’s look at three areas in detail, together with the problems inherent in each.
- Carrier solvency issues, including financial impairment and the resulting limitation and vulnerability
- Standard vs. Excess and Surplus Lines Markets
- Expiring vs. Renewal Coverage
CARRIER SOLVENCY
Carrier solvency issues are a major problem. We’ve gone through a long period of soft market conditions, with little attention paid to the fact that insurance is an underwriting business, not an investment business. In the haste to write business to generate cash flow, the industry forgot about the underwriting risk process.
This isn’t to say that the insurance business shouldn’t participate in investment income, but risk underwriting remains the primary reason for a company’s existence.
Good underwriting practices should produce revenue and resources that maximize investment returns over the long term. You can say that underwriting is No. 1 and investment is No 2; the focus is always on No. 1, which makes participation in No. 2 possible. However, increasing loss ratios are an obvious sign that proper attention isn’t being paid to underwriting.
Too many insurance company executives are fast to blame their underwriting woes on natural and man-made catastrophes, social values, changing environmental conditions and requirements (asbestos, pollution and mold), unfavorable legislation, a hostile legal environment, and so forth The fact is that these situations have been around for many years.
Although these issues have had an impact, irresponsible pricing, underwriting laxity, and unbridled competition with the inevitable increasing loss ratios have had an even worse effect. Unfortunately, many companies opted to use 'cookie-cutter' underwriting so that they could reduce expenses. In some cases, this drove off experienced and competent underwriters.
Even reinsurers joined the parade for a short period. Fortunately, they forced a 'back to basics' attitude on the rest of us when they started to lose substantial amounts of money and realized how under-reserved the industry was.
Many try to blame 9/11 on all of our woes, but things were bad before then, and a healthy, profitable industry would’ve easily absorbed this catastrophe, even though the process would’ve been difficult.
The shift in emphasis from underwriting to investment has changed the industry. The result: Many companies are financially vulnerable and some are impaired.
They’ve lost enormous amounts of money on both underwriting and investments. The Independent Agency System and direct writers haven’t helped matters. We sell price and the broadest coverage possible. We’ve programmed our clients in this way for years, when we should’ve been selling our services and abilities at a fair price. We’ve also suffered a spiral of reduced commissions and bonuses due to the carriers’ inability to make underwriting profits.
It’s not enough for agencies to monitor solvency issues. The new due diligence involves documenting files and making special efforts to keep clients aware. Agency management must also be sure that all producers and staff members are aware, and that they follow agency directives to the letter in their communications with clients. Create written guidelines and procedures and make compliance an employment performance requirement.
With all of the information readily available about carriers, you’ll have trouble claiming that you were unaware of any carrier’s problems. The solution is to have an ongoing monitoring program.
Although a carrier might be OK currently, you must be aware of any negative changes that they might undergo. Further exacerbating this problem is the vulnerability of reinsurers. Ask your primary carriers about their reinsurers and monitor their Best ratings.
Also keep in mind that clients aren’t the only source of an E&O claim. Carriers can allege that you’ve made an error. Insurance companies often accept claims and start an investigation with a reservation of rights when they don’t feel they should be involved.
If a company loses a case due to a jury decision, they might allege that the agency didn’t carry out its responsibility, forcing the company to pay a claim or judgment for which the agency was responsible.
Make sure you dot the Is and cross the Ts when completing applications and making representations to your insurance companies. Present the risk in the best light possible, but also thoroughly. Submit a narrative about the risk characteristics. Eliminate any surprises and document the file to the best of your ability. If you’ve done your job properly, it’ll be difficult for a plaintiff to build a case against you.
STANDARD VS. EXCESS AND SURPLUS LINES MARKETS
Keep in mind that the farther removed from the direct standard company you are, the more due diligence you’ll need to perform. In a standard agency/company relationship, the agent has underwriting guidelines, rules, and other documents in their hands. The agent communicates with the underwriter directly. In an E&S market, the agent talks to an E&S broker, who might talk to another broker or at the very least to an E&S underwriter.
Documenting information becomes much more important in this scenario. Take special initiatives to present the risk in its entirety to the E&S broker. The best way to do this is to do a complete submission.
EXPIRING VS. RENEWAL COVERAGE
In the past, when you changed carriers you were generally going to a market that was comparable to the one before it. If the carrier remained the same, the coverage was basically unchanged. It might have been even broader, given the competitive nature of the market.
The rules have changed. With the reduction in capacity and more restrictive and limited reinsurance, it’s not prudent to assume that things will remain the same, especially if you move from a standard market to an E&S market. Premiums on almost every risk are increasing and coverage is narrowing.
These conditions require a heightened level of reviews, coverage summaries, documentation, and communication — with clients and with companies. A casual policy review with your client isn’t enough. Make sure that the client understands and acknowledges everything and document your file accordingly. An easy way to do this is to confirm the review and discussion in writing. Write a letter to the client that outlines what you discussed. Include a statement that if you don’t hear from the client, you’ll assume that they’ve read and understood this discussion.
There might be times when you’re unable to replace coverage, but you’re aware of other markets that you believe can duplicate the expiring coverage. It might be prudent to make the client aware of this fact and let them make their own business decision — even if this might cost you the account.
Don’t assume that the E&S broker has done their homework about the solvency of the markets they’re using. If there’s ever a solvency issue, the agency client will look to the agent. Few agency clients have any contact with the E&S broker or even know that there is one.
Also, don’t make assumptions about premium levels or the importance of coverage to the client. If the expiring premium is $15,000 and the renewal premium is $25,000, tell the client and be prepared to explain why. Obviously, you’ll want to check other markets to be sure the increase is in line, but if you can’t improve the situation, tell the client, and let them make a business decision.
Likewise, don’t decide for a client that a premium is too high for the requested coverage — let the client make the decision and document your files accordingly. We’ve seen a number of E&O cases in which the agent thought that they had such a strong relationship and such intimate knowledge about the client’s business that they knew what the client would or wouldn’t do and decided on their behalf.
I’ve mentioned the need for a thorough explanation of Best Ratings (or other rating organizations). Make sure that the client knows the difference between a 'secure' and a 'vulnerable' carrier. Together with this process, check the company’s rating history. A company that has a Best secure rating of B+ might’ve had a B++ the previous year and an A or A- prior to that. The client needs to know when a company is heading in the wrong direction.
Likewise, a Best rated 'vulnerable' B rated company that has moved from a 'not Rated' to a B- to a B could be on the upswing. If the company’s profitability, leverage, and liquidity ratios meet or exceed the ratios published in Best’s Key Rating Guide, then the company might be fine to use, as long as you explain it to the client and document your files.
Be careful when using a 'B' rated carrier. Some E&O carriers have an endorsement or provision in their policy excluding coverage from an insurer rated lower than 'B+' (most don’t enforce the exclusion if the rating was downgraded after the E&O policy took effect).
Give your client all of the information, let them make an informed business decision, and then confirm this decision with them in writing.
On the E&S side, when you get a proposal from the broker, review the limitations and exclusions carefully. Be sure you understand them so that you can go through them with the client.
For example, if you were writing a risk that served alcohol and the Liquor Liability and General Liability had total exclusions on assault and battery, be sure you explain this to the insured. It’s best to have the E&S broker provide a copy of the exclusion endorsement so that you can go over it with the insured. We’ve seen a number of E&O cases in which the agent (according to the client) assumed the client had read the proposal and never brought up the exclusion. Of course the client specifically remembered telling the agent that they needed the coverage and the file wasn’t documented.
There are a number of initiatives that you might take to protect yourself and your client in this process. Take extra precautions and be aware that you have a very real exposure that might impair your ability to operate.
The market has changed significantly. Business as usual won’t suffice. Communicate your agency policy to all agency staff and make compliance with the policy a condition of employment.
Although this might seem harsh, doing a professional job for your clients and your carriers is the best way to protect all parties and sets your agency apart as a professional and ethical entity.