Need to re-evaluate excess casualty protection as liability losses rise: Marsh

Companies that have not increased excess casualty insurance limits to match litigation cost inflation may be vulnerable to potentially underinsured catastrophic losses, Marsh cautions in a new briefing.

Litigation costs – including jury verdicts for auto liability, product liability, medical malpractice and other casualty exposures – have steadily increased over the last several years, notes a briefing issued late last week by the insurance broking and risk management company.

“As the size of losses has increased, the net effect for companies that have not purchased substantially higher limits has been a reduction in the value of their excess casualty insurance policies,” the briefing states.

Marsh notes, as an example, a company that has purchased the same US$200 million in excess casualty limits since 2004 is less protected from a catastrophic loss today than it was a decade ago. “Adjusting for the aforementioned tort trends, US$200 million in limits purchased in 2004 is worth roughly US$120 million in 2014 dollars,” the briefing states.

Marsh points out that it is only after actual losses or near-misses involving companies themselves or their competitors that companies have reconsidered purchasing additional limits.

There are a number of reasons why companies may continue to purchase the same amount of coverage, including that many organizations “benchmark their excess liability purchases to those of their industry peers — assuming, sometimes incorrectly, that those companies are purchasing adequate limits and have risk and loss profiles identical to theirs,” the briefing notes.

Data compiled by the Insurance Information Institute shows total incurred losses for insurers in all liability lines increased from US$122.4 billion in 2008 to US$133 billion in 2013. These losses are compounded by the defence costs and other expenses that insurers incur to defend their policyholders in the event of litigation, the briefing notes, adding that defence costs increased from US$16.8 billion to US$18.7 billion between 2008 to 2013.

In addition, it has been reported that the most severe losses continue to increase in size.

Still, many companies have not increased their excess limits. An analysis by Marsh Global Analytics indicates that, on average, companies renewing umbrella and excess programs in 2013 Q3 through 2014 Q2 purchased limits of US$48 million, up slightly from US$47 million in the same period three years earlier.

While, on average, companies with revenues of US$1 billion or more increased limits from US$136 million in 2011 to US$151 million in 2014, “this trend has been driven by a relatively small portion of companies,” the briefing notes.

Just 19% of companies renewing in 2013 Q3 through 2014 Q2 purchased higher limits than they had a year earlier, Marsh adds.

Results from a recent study published by Marsh and RIMS – the 2014 Excellence in Risk Management survey – shows that litigation and claims were identified as the second biggest concern for C-suite executives.

The Top 10 risks reported by the C-suite were legal or regulatory shifts; litigation or claims; regulatory compliance; brand/reputation; economic conditions; workforce health and safety; business continuity/crisis management execution; talent availability; competitors; and business disruption.

“In light of this additional scrutiny from the C-suite — and given that excess casualty insurance is still a relatively inexpensive form of contingent capital — risk managers should carefully re-evaluate their excess casualty program limits, with support from analytical tools and risk assessments,” the briefing recommends. “An analytics-based approach to measuring potential exposures can help organizations make more informed decisions about limits and other key program features,” it adds.

Marsh suggests that risk professionals must start the process by seeking the answers to two key questions:

• What is the likelihood that my company will suffer a catastrophic casualty loss that will trigger umbrella and excess coverage over the next 12 months?
• If such a loss occurs, how much will it cost?

An organization can begin to estimate the likelihood of a catastrophic loss by analyzing the number of such losses suffered by industry competitors, and then factoring in the company’s size, business model, risk management programs, and specific exposures, the briefing notes.

To determine the cost of any losses that do occur, a loss distribution analysis will enable a company “to consider a range of potential loss outcomes beyond any range that may be suggested by prior individual losses, and to assign probabilities and financial values for each of these potential outcomes,” the briefing adds.

As well, insureds should consider using a probable maximum loss (PML) approach to quantify the potential cost of the more extreme loss scenarios they could suffer. The analysis can also help an organization determine how large its maximum loss is likely to be.

Marsh suggests that by having a more complete picture – and based on its risk tolerance and other factors – an organization can tailor its insurance policy to protect against these potential losses.