Expertise from A-Z: Casualty - Into the unknown

It goes without saying the long-term stability of a provider, regardless of line of business, requires risk premium calculation and collection to cover all expected future costs – including the unknowns.

The uncertain future amount of these costs is a given in the industry. But this ambiguity is somewhat magnified for liability lines due to the long-tail nature of this business, and brokers need to be mindful of this when giving advice.

Challenging market
To cover this ambiguity, insurers need sufficient security and decent investment returns. In the enduring low interest environment, returns have remained low. Couple this with claims inflation, and achieving year-on-year profitability in the liability market remains challenging.

In 2014, the UK’s total liability insurance market reached £5.6bn, an 8.4% rise on the prior year and helped by an improving economic environment. However, it is a difficult market with the Association of British Insurers stating underwriting losses of £527m up against significant downward pressure on rates, which show no sign of abating. Overcapacity in both the underwriting and broker space has adversely affected margins nationally and regionally. Further, claims costs and inflation are a very real concern for the industry and as such, brokers and insurers face a testing environment.

Known unknowns
What is meant by claims inflation? Put simply, the amount claims increase in terms of both number – frequency – and cost – severity – represented as an annual percentage.

To help manage the risks of the modern liability environment, prudent insurance provision and broker-to-client advice requires an accurate understanding of current market issues and likely emerging trends. Claims inflation though is not a directly observed or measurable figure. Levels depend on the category of claim, specific class of liability and possible exacerbation through excess of loss layers. It, therefore, plays a significant role for an insurer’s market approach and profitability, with obvious impacts on brokers and clients.

Calculating future claims inflation costs uses historical claims data. However, this method does not stack up if claims inflation deviates from what has been before. In today’s global world of societal and technological change, it is questionable as to how insightful and accurate the past can be, potentially leaving the insured in a vulnerable position in the future if the provider does not have the capital backing.

Over the past decade, the market has seen significant growth in both the number of liability claims received and average payment made. The increase in frequency may be attributed to better and fairer access to justice, thanks to civil justice reforms.

But it it is also influenced by the growth in claim management companies and a value shift towards a ‘blame’ culture. Severity has been impacted by the increasing amount spent on legal costs – which can contribute as much as half of the total claim payment – as well as the annual inflationary increases. This is at its most pronounced level for personal injury claims, where, according to the Institute of Actuaries, annual inflation can run at up to 10% per annum for non-life changing injury, and up to 25% for life changing injury.

This inflation has a major influence on reserving for claims with large losses. The following are examples of claims that have a variety of features, providing food-for-thought when advising clients of suitable limits.

First to a restaurant where an employee fell through a window while moving a piece of equipment. The fall caused significant and life changing injuries to the mid-twenties manager who was an up-and-coming talent within the restaurant business. Owing to the bright future, severity of injuries and the young age of the injured individual, the reserve for the employer’s liability case hit the millions.

Another claim involved a fight between two pupils, which saw one receive a head injury after falling to the ground. The damage was serious enough to require the boy to need full-term care. Reserving escalated in this instance, not only due to the very young age of the injured but also because the real extent of the loss will not be realised until the boy is old enough to enter the employment market.

Finally, to a property owner’s case. A passenger lift failed and collapsed in a communal building causing fatal injuries to a high-earning professional with family dependents. Unfortunately, this occurred in full view of the customers and staff of the building. As a result, the reserve picks up potential mental anguish and post-traumatic stress claims of those in the vicinity, on top of the allowance for high earnings and dependency.

Market trends
The increasing frequency and severity is reflected by market data. According to the Compensation Recovery Unit, the number of employer’s liability-related personal injury claims has increased nearly 250% since 2011. In the market, this rise is predominantly because of disease-related claims.

Noise induced hearing loss claims are a key driver in this area with Allianz alone seeing a 250% increase in claims since 2010 and volumes hitting a new high in the first quarter of 2015. This, and the movement of other more difficult and expensive claims from the portal, is leading to a lengthening of the underwriting year, again increasing length of claims settlement.

Furthermore, periodic payment orders have become more prevalent in the UK since 2008. Replacing the certainty of a lump sum with a smaller lump sum and the uncertainty of an annually payable amount to the claimant for the rest of their life, PPO liabilities remain on an insurer’s balance sheets for decades. The potential to change claims costs is significant.

Positive outlook but future challenges
These developments fall against a fairly stable macroeconomic backdrop, providing some relief from the upward claim cost pressures. Gross domestic product growth stood at 2.2% in 2015 on the back of 2.9% in 2014. This is good news for an industry looking to support expanding workforces, additional employment and greater turnover. This economic strength, coupled with increasing health and safety awareness and implementation reducing the number of workplace injuries, is positive for liability books.

The liability environment is subject to significant changes year-on-year. The long-tail nature and historic claims give only ambiguity when trying to determine what is, and what will be, the impact of latency conditions. NIHL developments, continuing asbestos-related exposures, ever-changing legal liability and potential future exposures such as mental health, stress and chronic pain, all pose future challenges for brokers and insurers.

Brokers need to be aware of these developments. Working with clients to best understand their specific existing and future vulnerabilities can help to ensure the right insurance programmes are in place and that they’re fit for purpose now and in years to come. Advice must be mindful of the changing landscape. Ultimately, insureds need to be aware of how and why appropriate cover and limits of today’s claims does not mean appropriate cover for claims at next year’s costs, or at costs in 30 years’ time. This insightful advice will not only help fund future potential claims for the insured but also help reduce the errors and omissions risk for the broker.

For the insured, adequate limit scoping combined with broker support should be supported by prudent underwriting. In a market where longevity of a provider is king, financial stability backed up by adequate capital and proactive risk insight is the best mitigation.

Stuart Toal,
Casualty account manager, Allianz