As underwriters and other professionals descend on Washington, D.C. for the Professional Liability Underwriting Society annual conference this month, they will share much information and different points of view about the emerging trends and exposures facing the industry today.

Topical discussions about issues as diverse as telemedicine and cyber-liability will draw many PLUS members in at conference luncheons, seminars, and in impromptu debates in lobbies and other places.

Underlying the broad discourse are the unique challenges professional liability insurers, brokers and agents face when assessing risk in today's complex and constantly changing world.

Unlike many other property-casualty lines, the relatively sparse data available, particularly on the more boutique “miscellaneous” professional classes, makes it difficult to accurately assess the profitability of a business and to incorporate insights of real and perceived threats on the horizon.

Can the professional liability community improve its ability to read the tea leaves to determine the impact the events of the day might have on their respective lines of business?

In a soft market, what will it take for industry professionals to react in a meaningful way?

Looking at some past and present issues both within and outside the professional liability realm can perhaps shed some light on the subject.

LEAD TIME HELPS

Many events, both real and theoretical, to which the industry may or may not respond, unfold over a protracted time period with significant lead time for the industry to develop a plausible, appropriate response.

Doomsday predictions of massive worldwide system failures roiling financial markets and disrupting virtually every aspect of business surfaced many years prior to the year 2000.

Insurance companies mobilized their forces to address the Y2K bug, as did many other industries, years before the impact of the event, tackling both their own system problems and the problems faced indirectly via the policies issued to their often vast and varied client base.

In retrospect, some have decried the collective response to Y2K, saying it was overblown. Others have argued that the dire predictions helped to mobilize companies into action, staving off the disaster that never fully materialized.

Not all the exposures faced by the industry are on the scale of Y2K, though, nor do they all get catchy acronyms to provide instant recognition.

Today's subprime crisis, a potentially mammoth exposure impacting many real estate-related professional lines, and certainly directors & officers liability, probably falls short of Y2K in terms of advance notice or predictability of risk. However, one can certainly say the elements or conditions peculiar to a real estate bubble have been measurably evident for some time in housing affordability ratios such as the price-to-income ratio.

“A little froth,” to borrow former Fed Chairman Alan Greenspan's term for the bubble, is what these measures have pointed to for at least a few years.

Of course, connecting the dots between the real estate bubble, the subprime issue and the ultimate effect on professional lines has not been so simple. No one knew if or when the bubble would burst or how badly.

Additionally, if evidence appears in the form of a spike in frequency of claims on a real estate-related professional line, it is quite possible the evidence might erroneously point to the crisis at hand when it is the result of an unrelated phenomenon.

Therefore, a detailed review of individual claims might be necessary before taking action.

REACTIONS CONSTRAINED

So, how does the professional liability community react to events such as the fallout of the subprime crisis, if it is believed that it has begun to or will soon begin to bleed into the numbers?

That depends in part on the regulatory environment in which the market operates. Are the underwriters, brokers and agents working within a single state or multiple states? On admitted paper with filed forms, rules and rates? Does deregulation apply?

Their responses to the coming storm must necessarily take these factors into account.

The surplus lines environment offers the greatest flexibility for response to real and perceived threats. Even with less strident regulation, however, it does not necessarily create a clear path toward adequately addressing emerging exposures.

States do in fact vary in terms of the degree of oversight and level of flexibility available on surplus lines.

Market conditions certainly will dictate what effect an insurer's actions will have. The current soft market that has enveloped most, if not all professional lines, will likely have the most dramatic impact of any single factor on attempts to proactively address impending adversity.

Even some market leaders, who arguably should have the courage to pave the way, are often afraid to act in a hypercompetitive marketplace for fear of loss of market share.

The overriding question mark here is in the leader or leaders' actions and whether or not the marketplace follows.

Further complicating matters in a soft market, companies often arrive on the scene armed with clean balance sheets and what is often termed “na?ve capacity.” But how na?ve is that capacity in truth?

New companies often hire extremely experienced underwriters and actuaries to bring instant credibility to their operations, so calling the capacity na?ve may be a convenient excuse for inaction.

TO ACT OR NOT TO ACT

Now it is fair to say inaction is sometimes a practical approach to the coming storm. After all, storms do eventually blow over. As was the case with Y2K, sometimes the storm fizzles out before it makes landfall.

In the case of the subprime crisis, it is anyone's guess as to whether or not the crisis will last, though. According to a recent survey by cfo.com, investors are divided over whether the current liquidity crunch represents a short-term event or a structural crisis. Fifty-five percent of the 251 institutional investors surveyed see the liquidity crunch as a structural crisis, suggesting the crisis has legs, while 45 percent see it as a short-term event.

Accompanying the tea leaves is the actuarial crystal ball. This often takes the form of inflationary trend analysis by company actuaries.

Of course, trend is a tidy phenomenon in the actuarial world, but not so tidy in the real world. For example, Aon Corporation's 2007 Hospital Professional Liability and Physician Liability Benchmark Analysis, released last month, points to lower frequency and severity of hospital claims. Simply put, costs don't always increase in a straight line.

Tort reform and other state-specific changes in the litigation climate can have a dramatic downward impact on cost that belies the logic of trend analysis.

The conditions conducive to an upward spike in costs of claims adjusting are not a given, just like there is no guarantee that your investments will always generate healthy returns.

Also, when actuarially analyzing company- and line-specific data, the response should probably be tempered by the credibility of the data. But in the absence of alternative data, or competing theories to explain the specific results at hand, the historical data may be deemed to be the most reliable information available.

Externally produced studies and white papers may be available to supplement sparse company data. For example, Harris Interactive Inc. produces a state liability systems ranking study for the U.S. Chamber Institute for Legal Reform, which is readily available on the Internet. Though it is broad in scope and not necessarily the most scientific of studies, it nonetheless provides a good overview of what might be happening now or on the horizon in any given state.

Regrettably, too many carriers focus totally, or primarily, on what the market will bear rather than independently deciding what action to take in the face of a real or perceived threat.

It would be quite tidy if soft markets and hard markets coincided with the shifting sands of risk. Arguably, the bigger picture may point to this being precisely the case, though. On a macro basis, it is the healthier balance sheet of the collective insurance industry that, at least in part, fuels the soft market by bringing in new competition, and the healthier balance sheet is, at least in theory, the result of tectonic shifts in the price-to-risk ratio, which precede the soft market–namely the hard market.

Nonetheless, the conditions that contribute to universal market decay do not always settle quickly to the appropriate resting place for any given line of coverage, so it still comes down to what the underwriter does with the unique blend of external and–if applicable–internal data.

The confluent stream of environmental factors that impact exposure for any given line of professional liability produces a constantly changing landscape for underwriters, brokers and agents to take into account.

There are many details to consider, and credible information is often lacking.

At the end of the day, the soft market is primarily caused, and is often prolonged, by failing to properly set prices, terms and conditions, by ignoring real and developing liability trends, and, in general, by taking a short-term view of the business.

Michael Auerbach is an assistant vice president of professional liability for Liberty International Underwriters in Boston.

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