Rearview Mirror Explains EPLI Shifts

Now that the soft market is just a memory and we are confrontedwith the reality of the hard market, many employment practicesliability insurers are reeling from the effects of soft marketpractices for an insurance product that, in retrospect, had beenseverely underpriced and “under” underwritten.

It should come as no surprise that many of these “bargainbasement” insurers have either vanished from the market entirely orare licking their wounds, while feverishly trying to restructuretheir EPLI programs to conform with todays changing market andvoluminous litigation environment.

Many of the financial problems now facing EPLI insurers haveemanated from a significant increase in claims activity, includingan increase in the number of class action suits. Couple that withinadequate pricing, out-of-control defense costs and absurdly lowretentions, and it is easy to comprehend why insurers aretightening their belts.

A lot has changed since EPLI first came on the scene in theearly 1990s.

The original EPLI policies included “coinsurance” provisionsthat required the insured to participate in paying a portion of anyone claim, in addition to a self-insured retention ordeductible.

The reason for coinsurance was quite simple. EPLI insurers hadno actuarial data or claims statistics to support their pricingstructure, so early on the insured would have to pay a specificpercentage of the claim, usually 5-to-25 percent of any one claim.The insurer would pay the remaining portion.

However, this underwriting practice was short-lived,particularly when EPLI was becoming a staple of most insurers. Andas more insurers entered the market, competition forcedcompromise.

Are some insurers toying with the idea again as a means ofcutting claims expenses? Well, that remains to be seen.

EPLI policies also had very large self-insured retentions ordeductibles when they were first introduced. Yet, over the last fewyears, and due in part to the soft market conditions, insurers wereproviding deductibles that, in simple terms, made no sense then,and certainly make no sense now.

It was not uncommon to find a few of the more aggressiveinsurers providing retentions as low as $1,000. This had beenespecially true of program business.

Today, the minimum cost to defend and settle an EPLI claim is$970,000, without considering the effect of any retention. Multiplythis by the number of claims and it is easy to understand themagnitude of the problem and why some carriers are in thepredicament they are now in.

As an EPLI specialist, I am often asked why the deductible is sohigh or whether a lower one can be obtained. What I usually find isthat many agents dont understand that the self-insured retention isused as an underwriting tool, not a pricing mechanism.

Of course, the premium for a policy with a larger SIR ordeductible will be less in premium then that of one with a lowerSIR or deductible. But the price reduction is usually minimal andnot proportional as one might think.

The confusion might be because, for most of EPLIs existence, itwas thought of as a catastrophic coverage, not a frequency one. Nowwe know that EPLI claims can be both catastrophic and frequent.

From an underwriters perspective, there are several factorstaken into consideration during the SIR selection process. Asidefrom past claims history, other factors include the number ofemployees, location(s), and type of risk being insured.

Typically, law firm risks account for the highest density ofclaims in the EPLI market today. Therefore, if you compare amanufacturing risk with the same amount of employees, themanufacturing risk will tend to have a lower retention and bestatistically less likely to have claims then a law firm risk.

Insurers routinely select SIRs that they believe can help lessenthe potential for frequency.

In addition, the financial condition of the insured plays animportant role for two reasons. First, if a company is notfinancially sound, there is an increased probability of a layoff.In addition, a financially-impaired insured may not be capable offunding a large SIR when required.

At present, only a few insurers remain which use a self-insuredretention instead of a deductible. But it is important tounderstand the difference between the two as it applies to an EPLIpolicy.

The primary difference relates to the actual payment of aclaim.

When a self-insured retention is used, the insured isresponsible for all of the costs including defense and indemnity upto the applicable SIR from the time a claim is first tendered tothe insurer.

In addition, the policy will, in many cases, contractuallyrequire the insured to obtain their own defense counsel, since theinsurer is not obligated or does not have a duty to defend theinsured, unlike typical “duty-to-defend” wording more commonlyfound in the majority of EPLI policies today.

In contrast, a policy using a “deductible” instead of an SIR,actually alleviates the insured of any out-of-pocket expenses upfront. The insurer, in essence, pays for all costs until the claimis settled or adjudicated. Then, the insurer will deduct theapplicable amount from the total of the defense costs and indemnitythey pay on the insureds behalf. If, however, the amount of theclaim is within the deductible, it remains the insureds obligationto pay that amount back to the insurer.

In addition, and in most situations, the insurer iscontractually obligated to provide defense counsel and has a “dutyto defend” the insured. In this situation, however, the insureddoes not generally have a say in the selection of defense counsel,since the insurer is controlling the defense.

Each of these options has its benefits and drawbacks. Forexample, SIRs can be beneficial to insureds that can economicallyafford them, since they can control their own defense initially.Those insureds that are less capitalized may not be able toeconomically endure the burden of defending a claim considering thesizable costs associated with EPLI claims nowadays. So a deductiblemay provide a better alternative for an insured in thissituation.

On the other side of the picture, it was not long ago that amultitude of insurers would offer proposals with a variety oflimits. This is not the case any longer.

During the soft market, it was also not unusual for a fewinsurers to offer coverage for “defense costs” outside the limit ofliability. This was, and still is, a beneficial policy feature forinsureds.

The greater majority of EPLI policies available, however,include defense costs as part of the limit of liability. Thissubstantially erodes the overall aggregate limit of the policy.

Consequently, having defense costs in addition to the limit ofliability is a significant benefit for the insured. And consideringthe substantial costs to defend a claim, the additional premium of10 or 20 percent made it a great value when it was available.

Many EPLI insurers have ceased providing this coverage entirelyor are now providing it for a much higher additional premium,usually ranging from 40 percent to 50 percent depending on theparticular exposure.

Over the last couple of years, a handful of insurers withduty-to-defend policy language have allowed select insureds to usetheir own defense counsel with prior consent. However, many ofthese insurers are only now starting to realize that this was notalways such a good idea.

What they found was that the insureds outside defense counseldid not necessarily take into account the best interests of theinsurance company, since they had no allegiance or vested interestto any one insurer. As a result, the insurers have had an extremelydifficult time monitoring claims expenses, which have been accruingat a rapid pace and consuming the SIR or deductible within thefirst 30 days.

Presently, insurers are taking a closer look at theirunderwriting practices and examining overall trends in their claimsexperience. Those who still want to remain in the EPLI market areretooling their approaches to mesh with the present EPLIenvironment. In fact, a few of the more prominent insurers havealready begun to pare down their presence by consolidating theirunderwriting facilities and/or by utilizing the services of selectmanaging general underwriters to administer and underwrite theirEPLI programs.

But is this too little too late? Only time will tell.

Wayne E. Bernstein is a founding member of e-perils.com, awholesale insurance broker solely dedicated to EPLI, D&O,professional malpractice, crime and cyberinsurance for corporateand financial institutions. He may be contacted [email protected].

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, May 20, 2002.Copyright 2002 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.