Rearview Mirror Explains EPLI Shifts

Now that the soft market is just a memory and we are confronted with the reality of the hard market, many employment practices liability insurers are reeling from the effects of soft market practices for an insurance product that, in retrospect, had been severely underpriced and “under” underwritten.

It should come as no surprise that many of these “bargain basement” insurers have either vanished from the market entirely or are licking their wounds, while feverishly trying to restructure their EPLI programs to conform with todays changing market and voluminous litigation environment.

Many of the financial problems now facing EPLI insurers have emanated from a significant increase in claims activity, including an increase in the number of class action suits. Couple that with inadequate pricing, out-of-control defense costs and absurdly low retentions, and it is easy to comprehend why insurers are tightening their belts.

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

The original EPLI policies included “coinsurance” provisions that required the insured to participate in paying a portion of any one claim, in addition to a self-insured retention or deductible.

The reason for coinsurance was quite simple. EPLI insurers had no actuarial data or claims statistics to support their pricing structure, so early on the insured would have to pay a specific percentage 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. And as more insurers entered the market, competition forced compromise.

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

EPLI policies also had very large self-insured retentions or deductibles when they were first introduced. Yet, over the last few years, and due in part to the soft market conditions, insurers were providing 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 aggressive insurers providing retentions as low as $1,000. This had been especially 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. Multiply this by the number of claims and it is easy to understand the magnitude of the problem and why some carriers are in the predicament they are now in.

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

Of course, the premium for a policy with a larger SIR or deductible will be less in premium then that of one with a lower SIR or deductible. But the price reduction is usually minimal and not proportional as one might think.

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

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

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

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

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

At present, only a few insurers remain which use a self-insured retention instead of a deductible. But it is important to understand the difference between the two as it applies to an EPLI policy.

The primary difference relates to the actual payment of a claim.

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

In addition, the policy will, in many cases, contractually require the insured to obtain their own defense counsel, since the insurer is not obligated or does not have a duty to defend the insured, unlike typical “duty-to-defend” wording more commonly found 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 up front. The insurer, in essence, pays for all costs until the claim is settled or adjudicated. Then, the insurer will deduct the applicable amount from the total of the defense costs and indemnity they pay on the insureds behalf. If, however, the amount of the claim is within the deductible, it remains the insureds obligation to pay that amount back to the insurer.

In addition, and in most situations, the insurer is contractually obligated to provide defense counsel and has a “duty to defend” the insured. In this situation, however, the insured does 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. For example, SIRs can be beneficial to insureds that can economically afford them, since they can control their own defense initially. Those insureds that are less capitalized may not be able to economically endure the burden of defending a claim considering the sizable costs associated with EPLI claims nowadays. So a deductible may provide a better alternative for an insured in this situation.

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

During the soft market, it was also not unusual for a few insurers to offer coverage for “defense costs” outside the limit of liability. This was, and still is, a beneficial policy feature for insureds.

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

Consequently, having defense costs in addition to the limit of liability is a significant benefit for the insured. And considering the substantial costs to defend a claim, the additional premium of 10 or 20 percent made it a great value when it was available.

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

Over the last couple of years, a handful of insurers with duty-to-defend policy language have allowed select insureds to use their own defense counsel with prior consent. However, many of these insurers are only now starting to realize that this was not always such a good idea.

What they found was that the insureds outside defense counsel did not necessarily take into account the best interests of the insurance company, since they had no allegiance or vested interest to any one insurer. As a result, the insurers have had an extremely difficult time monitoring claims expenses, which have been accruing at a rapid pace and consuming the SIR or deductible within the first 30 days.

Presently, insurers are taking a closer look at their underwriting practices and examining overall trends in their claims experience. Those who still want to remain in the EPLI market are retooling their approaches to mesh with the present EPLI environment. In fact, a few of the more prominent insurers have already begun to pare down their presence by consolidating their underwriting facilities and/or by utilizing the services of select managing general underwriters to administer and underwrite their EPLI programs.

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

Wayne E. Bernstein is a founding member of e-perils.com, a wholesale insurance broker solely dedicated to EPLI, D&O, professional malpractice, crime and cyberinsurance for corporate and financial institutions. He may be contacted at wayneb@eperils.com.

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

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Rearview Mirror Explains EPLI Shifts

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