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September 2012 Bermuda Re/insurance
falling asleep at the switch”. However, while regulators might have been accused of applying a light touch prior to the crisis, “what you are seeing now is the pendulum of regulation swinging way back the other way—with a lot of regulation, much of it very complex”.
Just how firms will be affected by a number of these regulatory measures remains unclear, creating additional uncertainty. Irvine highlighted Dodd-Frank as a case in point, with little guidance on its likely final implications, although the same can be said of a number of other measures such as Solvency II and Basel III, which continue to be constructed at the behest of governments. This uncertainty is likely to create mis-steps by those firms responding to such developments, with an evident knock-on effect for re/insurers. Irvine said that while companies might think they are conforming to regulation, reinterpretation of, and changes to, new measures could leave them “liable or in breach of regulation”. He said that the industry needs to watch such developments closely so that re/insurers and clients are “up to speed as regards potential threats”.
Gray concurred, arguing that “good underwriters need to be intensely curious. They need to have an up-to-date view on what is going on in the world, both politically and legally, and a way of understanding the implications”. He added that insurers’ long-term relationships with clients would help them navigate some of these challenges, with close cooperation enabling both parties to acquire a “consistent view of what the real levers of risk might be”.
One eye on the horizon
While the financial crisis has created significant and ongoing implications for professional liability clients and re/insurers, many of the concerns haven’t gone away, with the economic downturn presenting the sector with a further set of unique challenges. Irvine
A changing dynamic
Whereas in the past reinsurers in the professional liability space took an overarching position in the market, nowadays they are applying a more focused approach to their relationships with primary insurers, said Gray. Previously reinsurers would “support as many practitioners as they could in order to even things out and get a market performance”. Now they are increasingly applying “an approach that supports specific underwriters—those that have a strong underwriting philosophy, a good track record of profitability and who structure reinsurance deals in a way that is consistently fair to reinsurers and helps them control aggregates”. A close relationship brings with it greater understanding of an insurer’s liabilities, said Gray, enabling reinsurers to avoid the prospect of holding “five or six different spots on the same loss tower. By supporting fewer insurers, reinsurers have a mechanism for controlling the level of exposures they might have to any one loss”.
Such a close approach ties in well with the idea that reinsurers appreciate predictability in their insurance partners, said Gray. “If they adhere to a strategy that can be described, then reinsurers tend to stay with a known quantity.” At the same time, the increasing interconnectivity of business encourages close interaction between cedant and reinsurer. “Reinsurers understand that insurers have relationships with a number of large clients that are beneficial to everybody and through close contact reinsurers can participate and benefit from these long-term relationships.” Personal interaction, as always, is key.
indicated that for D&O the biggest challenges were directly linked with economic conditions—“the low interest rate environment, the faltering economy, the exposure to a double-dip”—all of which are creating a challenging business environment and increasing the chances of business failures. This will in turn raise the prospect of “further D&O suits directed by shareholders against management”.
A further challenge has been the US government’s “constant search
for additional sources of revenue”, said Gray, with international firms— and their international profits—finding themselves increasingly in the firing line. Again, firms find themselves treading a fine line between regulatory compliance and retaining international profits, and there are significant liabilities associated with Washington’s aggressive approach to US tax jurisdiction.
Finally, companies and re/insurers are having to factor in the
increasing size and complexity of business and the deals that are being done, said Irvine. For professional firms on the E&O side, “if things go wrong, it is either more costly to defend or more expensive to resolve than ever before”. Those that were involved in the 2008–2009 denouement have spent hundreds of millions of dollars defending themselves, Irvine said, and these costs are only likely to rise still further. Despite such concerns however, the pitfalls presented by the constant evolution of business is exactly what professional liability coverage insures against, said Gray. As he summed up: “the job of the underwriter isn’t to eliminate all risk, it is to understand the risks that are coming through and price for them accordingly”. The financial crisis certainly created a few of those, and in many cases they continue to rumble on, but events at least served to highlight the benefits of D&O and E&O to those firms exposed to the fallout.
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