The current state of the management liability market

We reviewed 18 products for this report, which we believe represent the core of the market. In most cases, we examined actual policy forms and endorsements provided by the carriers. Of course, the insurance policies govern the coverage provided, and the carriers are not responsible for our interpretation of their policies or survey responses. Readers should understand that the following information applies to the carriers' standard products, and that it may be possible to negotiate different terms.

Following passage of the federal Terrorism Risk Insurance Act, all carriers reviewed in this report started offering terrorism coverage in their management liability policies. As this was written, however, it was unclear whether TRIA would be renewed after it expires at the end of this year and, if so, in what form. If TRIA is not renewed in substantially its current form, carriers may not be able to continue terrorism coverage in these policies.

State of the market

Rates: Rates for management liability products continue to soften. The softening seems to be driven primarily by:
oA large number of carriers interested in (indeed, enthusiastic about) the market opportunities.
oA general softening of commercial P&C rates.
oIncreased demand by insureds (and their brokers) for lower rates.

Participating insurers report that rates for private-company management liability insurance, like most forms of commercial insurance, are flat to decreasing, but that decreases are relatively moderate. Having said that, we think there is more rate competition than carriers admit. From our own client experience and anecdotal information from several brokers, rates appear to be dropping more for attractive clients. As in the EPLI market, there is a fair amount of competition, as carriers seek market share. For the right insured and the right carrier, rates could be significantly lower than they were last year.

There is a clear pattern to rate changes, with carriers in this survey generally planning slight rate decreases, unless more is needed to retain a good account. Almost all carriers report that difficult classes or troubled insureds will see rates flat or increasing-not surprisingly. No carrier reported that they plan a rate increase. Carriers estimate that their competitors will approach the market similarly, with rates decreasing 5% to 10%.

Retentions: The retentions or deductibles that carriers offer do not appear to be changing, primarily to protect market share but also because insurers seem to believe they are at appropriate levels. None of the carriers report that they plan to increase retentions, except for marginal accounts, with some small increase mandated. Two carriers said they planned to decrease retentions by about 10%.

Last year, some carriers said they planned to increase EPLI retentions, but did not actually do so, except for "difficult" risks. We do not see any indication that insurers plan to increase EPLI retentions this year.

Claims: We did not solicit information about claims experience because of the large number of coverages in management liability policies. Anecdotally, we understand that the product is reasonably profitable. EPLI portions are not so profitable, but the line in general seems to be. The amount of competition still evident for these products certainly indicates that the carriers find them attractive. For example, several carriers report loss ratios of 45% to 55%, or less. Carriers that have offered the product the longest generally have the highest loss ratios, reflecting the maturing of their books of business. Much of the claims pressure is on the EPL line.

Target markets: Carriers focus this product on small and midsize companies. Most insurers define their targets as companies with fewer than 2,000 employees or $500 million in assets. We find both of these to be guidelines, not absolutes. The real bar to management liability coverage appears to be any plans to go public. The D&O risk for pre-IPO companies is far greater than for those that expect to stay private. For those carriers willing to write pre-IPO businesses, agents should check for coverage restrictions, such as SEC exclusions. Some carriers also decline to write management liability insurance for technology companies, which is understandable given their volatility.

Deductibles: Management liability polices offer a variety of deductible options. Here are three that are widely used:

oAn annual aggregate for each coverage. Consequently a blowout loss in one coverage, like EPLI, will not erode the limit for another, like D&O.
oA combined annual aggregate for all coverages. Here, a blowout loss in one line will erode the limits for other coverages. This is dangerous, since insurance brokers and risk managers do not find it much fun to inform the directors that their coverage has evaporated because of a big EPL claim.
oA combined multiyear aggregate for all coverages. Here again, a blowout loss in one line will erode the limits for the other coverages. In these multiyear policies, the chance for eroded limits also is greater, because claims can accumulate over the policy term.

Insurers often offer a premium discount to insureds who opt for something other than annual per-coverage aggregates. Those stated by the companies we surveyed included 15% and 25%. At many other companies, the discount varies or is negotiable. To counter the risk of inadequate aggregate limits, most carriers offer reinstatement-of-limits options via endorsement. Use of such an endorsement often is negotiable. The reinstatement may not be for the full original limits.

Limits: Since limits often correlate with the scope of an insured's operations, we asked carriers participating in the survey to specify the limits that insureds of different sizes typically buy. The results are summarized below. The answers should not be used as an indication of sufficient limits. To us, it is evident than many smaller employers do not buy enough coverage.

oInsureds with $500 million in annual sales: Typically $5 million to $10 million.
oInsureds with $100 million in annual sales: Typically, $3 million to $5 million.
oInsureds with $25 million to $50 million in annual sales: Typically $1 million to $3 million.
oInsureds with $10 million in annual sales: Typically $1 million to $ 2 million.

Terrorism insurance: We asked carriers about the wording in their standard (unmodified) policy form. TRIA has had its impact, prompting all carriers to offer coverage to their U. S. insureds. Typically, there is little additional premium charged. Of course, management liability policies exclude bodily injury and property damage, and so it is difficult to envision a covered terrorism-related claim. However, an underwriter might be concerned if an insured was either a cultural or business icon that might be a target (unlikely for this product, since by definition most insureds are not large companies), or was not attentive to its disaster recovery exposures (much more likely).

Coverage enhancements: Some states prohibit coverage for punitive damages or intentional acts. Most carriers offer separate coverage to fill in such potential gaps, either via most-favorable-venue wording or with an offshore wraparound in a jurisdiction like Bermuda. Coverage for outside directorship liability is included or available in most forms, as long as the outside service is on the board of a nonprofit organization.

Policy type and definition of insured: All policies reviewed can be written on a duty-to-defend form, but the majority offer the insured the option of an indemnity form as well. Interestingly, all carriers offering this option require the insured to select the duty-to-defend or indemnify choice when purchasing the policy. One exception was AIG, which allows the choice to be made at the time of a claim, giving the insured more flexibility.

The definition of insured varies from policy to policy, and from coverage to coverage. The most significant differences show up in the EPL line, where most policies do not automatically include coverage for independent contractors, leased employees or part-time employees. A number of carriers extend coverage to leased and contract employees if they are indemnifiable like employees. Policies also may differ in regard to coverage provided for newly acquired organizations and subsidiaries.

So-called "Side A" issues have become critical for publicly traded companies, following the well-publicized coverage problems of directors and officers at Enron, WorldCom, Adelphia, etc. Private company directors and officers probably are not as concerned about the risk that corporate bankruptcy will limit their coverage, or that policy rescission will eliminate it altogether. While a few carriers have, or are creating, D&O policies for individuals in response to the aforementioned exposures, most report that they have seen little demand for individual (Side A) products in the private-company management liability market. Several report they are willing to provide their policy with Side A coverage for D&O exposures only, but that they have seen little demand.

All carriers offer entity coverage. Most include it automatically, while a few make it an option.

Claims reporting requirements and ERPs: Most carriers require the named insured to report a claim "as soon as practicable," which seems reasonable. Some restrict the period to 60 or 90 days.

All carriers offer an extended reporting period, but its length and cost differ. All offer at least a one-year ERP, and four carriers in our survey offer ERPs of three years or longer. Several insurers said the length and cost of an ERP is negotiable, which can be dangerous for insureds. They should make sure that any such negotiation takes place before their carriers lose interest in their business.

It's also important to know whether the ERP is one-way or two-way (bilateral). A one-way ERP is available to an insured only if the carrier cancels or refuses to renew the policy. A two-way ERP (which 15 carriers in our survey explicitly said they offer) provides extended coverage even if the insured, rather than the insurer, decides to end the relationship.

Selection of counsel: We have been vocal in our criticism of carriers that do not allow insureds a voice in the selection of counsel. We believe the relationship between counsel and client is a vital one, characterized by as much trust as the bond between patient and doctor. While it is desirable for insureds to have input on the selection of counsel for EPLI claims, it is even more important to the comfort and security of directors faced with a D&O suit, since they can be held personally responsible for damages. At the same time, we agree with carriers that unqualified legal representation cannot be allowed, and that control over fees is necessary in lines like D&O and EPLI.

We are pleased to report that, while most carriers continue to control the selection of counsel, almost all are flexible in allowing the insured to select or approve counsel. If the insured requests specific counsel approval at the right time (during proposal negotiations), the carrier is likely to approve the insured's choice.

Some carriers offer the insured a choice of an indemnity policy, which allows the insured full control over selection of counsel. While some dispute our attraction to indemnity policies (since they may not defend uncovered allegations), we still think control over counsel is of enough value to make indemnity policies worth consideration.

Consent to settle: Carriers understandably are still reluctant to allow insureds much control over settlement, since D&O and EPL suits often involve a good deal of emotion. Both employer and employee are often willing to continue their fight in court long after it makes economic sense to settle. Carriers are reluctant to fund such battles, of course.

The so-called "hammer clause" allows a carrier to limit its claim payment to no more than the amount it could have settled for, plus defense costs. This protects the carrier against a "litigate at any cost" insured, while protecting the employer against a "settle it, who cares about the precedent" carrier.

The hammer clause causes both insured and insurer some unhappiness, which has led to the introduction of so-called "soft" hammer clauses, in which carrier and insured share costs above the claim-settlement figure. These clauses were originally offered by Royal, and many carriers now make them a feature of their products.

A few policies still allow the carrier to settle without the insured's consent, which is dangerous to an employer. In practice, if the insured has a good reason to continue the defense, most carriers will not enforce a hammer clause.

Preset allocation of costs: Allocation is an issue that comes up when a claim makes multiple allegations, some of which may be covered by a policy while others may be excluded. Few carriers are willing to agree in advance that defense costs will be allocated on a fixed basis; i.e., that defense costs for uncovered allegations (if any) will be x% of the total defense costs of a claim. In regard to allocation, carriers offer various options, including no preset allocation, allocation for defense costs only, allocation of defense costs and indemnity (securities claims only), and allocation of defense costs and indemnity (all claims).

Prior acts coverage: Prior acts coverage is a valuable protection that used to be difficult to obtain. Underwriters were reluctant to offer it, anticipating that only those organizations that needed the coverage would buy it. This ignored the reality that all employers confront the management liability exposure and that even the best-managed risks need the coverage.

As carriers competed for business, though, they were forced to offer prior acts protection, since management liability insurance is written on a claims-made basis. As they became more comfortable with this risk, carriers began offering the coverage even to new insureds.

Summary

The private-company management liability insurance market is a big one, served by a combination of large insurers like AIG and Chubb and a number of smaller ones, too numerous to mention. Some of these smaller carriers clearly have their sights set on growth, as they make meaningful product improvements.

In monoline EPLI coverage, we see rate competition heating up for smaller employers. We suspect it will extend to the management liability market as well.

Some insurers are attempting to gain market share by reducing rates. We hope this does not lead to a downward pricing spiral, to the detriment of both carriers and their insureds. At the same time, there are many private employers who, because of good management and execution, are unlikely to have a claim, making them attractive targets for premium reductions. Separating such risks from the less attractive ones will be a key underwriting challenge.

This article was derived from the August 2005 issue of The Betterley Report, which is published six times a year by Betterley Risk Consultants. The complete report, which contains charts showing the responses of individual insurers, can be purchased for $65. Annual subscriptions are available for $347. For more information, contact Richard Betterley, CMC, at (877) 422-3366 or at rbetterley@betterley.com.