Q3 2020 - Financial Lines Market update

The early days of March are only a few months behind us but, to this commentator at least, already seem a halcyon memory of pre-pandemic calm. Three and a half months of lockdown has caused us all to re-assess the way we work and, hopefully to a less profound extent, live.

Quite apart from the human tragedy, the social and economic costs of the pandemic are only starting to become apparent. By their nature, insurance and reinsurance are right at the heart of events – though there is no calm in the eye of this storm. In March, when we wrote of the market that “the rate of change continues to accelerate, making it very difficult to predict market conditions” there was no foreknowledge of how startling that acceleration would be nor of the extent of change. COVID-19 hit the insurance market very hard, with its direct impact being likened to 9/11 or the combined effects of Hurricanes Katrina, Rita and Wilma. Lloyd’s has suggested that COVID-19 could be the market’s largest ever single loss event estimating a potential of USD 107 billion in claims. Lloyd’s expects its own share to be up to USD 4.5 billion. In addition, Lloyd’s estimate that “the industry will also experience falls in investment portfolios of an estimated USD96bn, bringing the total projected loss to the insurance industry to USD203bn”¹.

Beyond its direct effect, the pandemic has acted as a catalyst, hastening and intensifying change in an already hardening market. The market cycle was coming to the end of the soft phase of the past decade and COVID-19 has changed an orderly retreat from risk into headlong flight. In this respect, the pandemic has had a similar effect on the insurance market as did 9/11, as a catalyst that forces a measured realignment into something far less coherent or consistent. The immediate impact on capital has been compounded by fears over the economic future, in both the short and medium terms. These fears have led to a significant contraction of risk appetite for almost all insurers. This is further complicated by the variance of different underwriter’s responses, both in focus and severity. There are few insurers actively seeking new business at the current time, with most looking to reduce capital deployed on existing business written. At the start of Q3, 2020, we are already seeing some carriers withdrawing from new business in certain lines.

In the specialised Financial Institutions area, a market already hardening in premium terms has reassessed its risk appetite and pricing. This is being caused by both an unprofitable past and a deeply uncertain future. We have seen insurers take different routes, from reducing their capacity across certain lines and across specific programmes right through to exiting complete sectors (either by geography, industry or by product line), but all insurers have reacted in some way in the face of the crisis.

Pricing has further increased since the lockdown began. There is little unity amongst Insurers, with a remarkable diversity in individual responses to any given renewal, let alone across a book of business. We list below the different manifestations of the hardening market, but probably the most profound change has been in market capacity.

• Significant contractions in capacity and risk appetite across all lines. Whereas this was more marked for certain coverage types or certain industries or geographies, it is now the case across the board.
• Increased selection on an individual risk basis in specific areas, including:
  • D&O
    • US and Australian listed companies
    • Any non-US company with any ADR exposure (see commentary in our Q1 market update re Toshiba)
    • Pharmaceutical and Life Science companies
    • Companies involved in either the travel or entertainment industries
  • Professional Indemnity
    • US-exposed General Insurance companies – particular concern over the handling of COVID-19 related claims
    • Life Insurers mis-selling issues (see commentary in our Q1 market update)

• Scrutiny of excess rates on large limit programmes, with specific focus on historic increased limit factors (“ILFs”) on excess layers. There is a growing awareness that intense competition in past years for excess D&O has depressed rates to an uneconomic level. Combined with “social inflation” in general and some large individual losses in particular, this has meant rate increases up to tenfold in some cases.
• Capacity monitoring by underwriters, with significant shrinkage in the overall amounts that carriers will put at risk across any programme and, in some instances, carriers looking at their exposure to an individual client across their financial lines (and sometimes broader) offering.
• Increased scrutiny of coverage terms and conditions, with a number of soft market “standards” under threat.
• Increased overview of underwriting decisions within carriers and limitation of individual authority, to the extent that in some large insurers an underwriter has become almost an internal broker, having to persuade their management to allow them to write the piece of business. This means that markets are generally less accommodating, with an uptick in subjectivities and information requirements and overall decision making significantly slower.

  To summarise, all these indicate a fundamental change in Financial Lines underwriters’ attitude. Underwriters are now prepared to “walk away” from risks that, in their opinion, do not fit their risk appetite or, if they do, fail to attract adequate premium rate. Much depends on the broker’s understanding of the underlying risk factors and of the complex market dynamics involved in any placement today. Only then can they effectively differentiate their client in this fickle and still-evolving market.

  Overall, this has slowed the renewal process. Whilst all insurers have been able to manage renewals remotely, there has been a significant increase in the time required to achieve certainty, whether on coverage, terms or the suitability of information provided. Although some of this can be put down to the pressure of remote working or to the volume of business, we find that the most significant delay is down to the need for almost every underwriting decision to be subject to internal sign off. Information requirements are more demanding and, generally, response time and flexibility is impaired.

  As a final note, we should share the unwelcome observation that market conditions have not bottomed out, indeed it seems clear that things will get worse before they get better. The rate of change is accelerating and is likely to continue to do so as more carriers hit their annual premium caps. There is a mood of fear in the market – this, and the resulting inconsistencies, seem set to continue for the immediate future.

  Market Concerns

  Business Interruption Cover

  Around the world, following the governmental-enforced shutdown of certain businesses, there has been a spike in claims for business interruption coverage. In many cases insurers have already denied these claims, citing a wide range of grounds for such denial. Unsurprisingly, this has led to a backlash against insurers with calls for government intervention, either to enforce payment or to step in as “insurer of last resort”, policyholder suits against insurers, and regulatory intervention. The two territories examined below, being the UK and the USA have demonstrated very different approaches to the problem, each reacting in a way that might be considered typical of its own legal / regulatory climate.

  In the US, we are seeing a growing number of lawsuits against insurers alleging bad faith in their denial of coronavirus related Business Interruption claims. The impact on the Professional Liability policies of the insurers themselves (and any intermediaries) is as yet unknown, and much will hinge on the specific language in each contract, but the extraordinary nature of the coronavirus outbreak and the number and quantum of these claims have huge potential in financial terms.

  In the UK a large number of businesses have made claims for losses under business interruption policies. There are widespread concerns about insurers’ response to many of these and the basis on which they are making decisions to refuse these claims. As a consequence, in May 2020, the FCA announced in a statement its intention to “obtain court declarations as part of a test case, aimed at resolving the contractual uncertainty around the validity of many BI claims”. The test case in the High Court of England and Wales, involving eight defendants, is due to take place over 8 days, on 20-23 July and 27-30 July. In the FCA’s words “The test case is not intended to encompass all possible disputes, but to resolve some key contractual uncertainties and ‘causation’ issues to provide clarity for policyholders and insurers.”².

  ¹https://www.lloyds.com/news-and-risk-insight/press-releases/2020/05/covid19-will-see-historic-losses-across-the-global-insurance-industry

  ²https://www.fca.org.uk/firms/business-interruption-insurance#revisions