Playing with fire

Liability is a word that has caused UK insurers a great deal of heartache in recent years as losses have mounted and reserves have had to be increased in the face of continuing adverse claims and mounting uncertainties. Across a plethora of classes, including directors' and officers', employers' liability and public liability, UK insurers have lost millions and have seen their balance sheets ravaged as their exposure to liability risks has cost them dearly.

And it is not as if the problem has gone away. Only last month, Lloyd's insurer SVB Holdings saw its share price plunge by 25% as it announced a further provision of £103m to cover the run-off of its US reinsurance liability business, which it closed in 2001 after sustaining severe losses, mostly as a result of exposure to D&O risks. At least SVB continues to trade, whereas for other insurers the liability problem has proved terminal.

Just look at London Market insurer and liability specialist The Underwriter, which was placed into solvent run-off in 2003 after discussions with the Financial Services Authority over its capital raising proved unsuccessful.

Prior to that, EL specialist Chester Street Insurance Holdings, formerly Iron Trades Holdings, was forced into insolvency in January 2001 as a result of escalating payouts.

These examples are only in the UK. Overseas, the problem is even greater - the high-profile troubles of Swiss reinsurer Converium are a prime example.

Spun off from Zurich Financial Services in 2001, the company is now seeking a $420m (£235m) emergency rights issue and has faced several ratings downgrades - again mainly as result of exposure to long-tail liabilities.

The dangers of the liability market

It would appear that the liability market is simply too dangerous for the insurance industry, faced with the appalling combination of long-tail exposures, rising claims and an increasingly litigious environment that seeks to find companies liable for an ever greater number of actions.

And this is the prognosis that is reached by many in the market. According to one senior London Market figure - a specialist in the area of liability - the class is simply no longer available as an option.

"I think it is very difficult for any insurer that carries risk to manage long-term exposures these days," he says. "Not only do you have the growth in the compensation culture but, more importantly - and the fundamental reason, really - is that new risks are emerging all the time. So, by the time the risk becomes apparent you already have exposure to it. An example of this is asbestos, where experts predict that claims will go through the roof from 2005 to 2020. It is a difficult position to be in."

Such a catalogue of woe might suggest that this is an area in which the future does not look great, though this is far from the reality. The truth is that liability insurance is a form of cover that is increasingly needed by the corporate sector. The sector itself is concerned about ensuring that it is adequately protected in the face of an increasingly litigious client base and, faced with such demand, prices for cover can be very good indeed. According to Lloyd's, demand for such specialist cover is actually expected to rise significantly this year and next, following a survey of brokers, which showed that 85% expected a significant increase in demand for professional liability insurance in the period.

The fact of the matter is that UK insurers and brokers continue to write significant swathes of liability business. One of the main drivers has been the potential returns to be made across a range of classes. Although the market was stung with severely depressed rates in the late 1990s, in recent years rates have hardened substantially across a number of classes, and continue to do so in some areas.

According to Datamonitor's latest UK commercial liability report, rate rises in the professional indemnity market were 25%-30% in 2003 as underwriters attempted to compensate for years of capacity shortage, claims inflation, weak investment income, poor underwriting performance and increases in reinsurance costs. Furthermore, according to Datamonitor, the D&O market is also experiencing hard market conditions to compensate for the terrible period of 1995-2000, with an ever-greater emphasis on corporate governance spurring a better rating environment.

It is not only in the PI and D&O sectors that better rates have been coming through recently. According to the British Chamber of Commerce, around three-quarters of UK employers saw an increase in their EL premiums over the last year. Of those reporting an increase, one-third said their premiums went up between 20% and 50%, according to the survey of 600 companies.

Thus, despite the inherent dangers of liability business, it is an area that promises considerable rewards for the prudent underwriter. One of the main ways of attempting to ensure that a business is not overburdened by long-tail exposures and a high degree of liability-related claims is simply to limit the amount of such business written. And this is precisely what has happened in the UK market in recent years among insurers. Thus, the number of insurers writing EL is now pared down, while for other liability classes some of the big names in the market have been very cautious in recent years.

Careful management, stable market

According to Tony Holt, director of underwriting at Amlin, one of the largest quoted Lloyd's insurers, the business has been very careful in managing its liability book over the past few years, with a present portfolio around the £50m mark. If this had been maintained at the 2000 level, it would today equate to some £120m. As he explains, the reason behind this was simple: "The liability market in London got seriously stung between 1997 and 2000, so the risk exposure coming into London diminished considerably after that period."

Holt says that the UK liability market is currently stable, with price rises having come to a halt, though Amlin is still experiencing price rises for long-tail liability business in the US, where it writes nursing-homes insurance, contractors insurance and medical malpractice. Responding to the suggestion that such lines have been the bane of other Lloyd's insurers in the past, he says that the company's policy is not to have such classes constitute more than 15% of the overall book, and that Amlin is careful to limit much of its US business, where most of the policies are written on a claims-made basis.

The difference between the traditional losses-occurring policies - which, by law, EL in the UK has to be - and the claims-made policy turns out to be a crucial part of the liability debate. Naturally, the attraction for the client of the losses-occurring model, where they can claim years after the policy was written, is huge and was never a serious problem for underwriters. However, with the advent of asbestos claims in the 1980s and the continuing growth in long-tail claims since then, this liability policy model has proved to be an extremely dangerous one for the industry.

Some players are still confident that long-tail policies can still be written, however. Craig Bennett leads the UK business at David Constable's Syndicate 386, one of the limit syndicates and one of the oldest liability specialists at Lloyd's, having started writing EL business in 1974. Nowadays it underwrites a variety of product lines, including product liability and PI on a primary and excess-of-loss basis.

"Our book has not changed that much," says Bennett. "We have been around for 30 years and we tend to avoid attritional risks." He says the Syndicate is currently looking at launching a new product, 386 Cares, which is focused on the EL market and will seek to provide advice and rewards for those policyholders who maintain appropriate standards and adhere to sound principles of risk management, as well as looking to promote a philosophy of rehabilitation.

"That is something we are looking at because EL is such a difficult class in which to make money. I read something the other day that said that, over the past 20 years, there have been only one or two classes in which insurers have made a profit."

He is nonetheless optimistic over the sector's future but thinks that changes need to be made: "I think long-tail liability is still a viable option, but one area to which we are trying to move is claims-made policies for EL disease claims. The problem is that there are a number of composites that have written (losses-occurring) policies over the years so, if we moved to claims made, there would be more competition but they would still have their historic exposure."

Other insurers are also reasonably relaxed about liability risks, despite the damage they have caused to the industry. Ray Cox, UK director of underwriting at Royal & SunAlliance, points out that, in the UK: "Liability can only attach for a risk you are aware of; it can only arise at the point at which you have knowledge." However, he adds, this does not mean that the industry can afford to be complacent as it needs to ensure that its knowledge base is constantly up to date and that it cannot be accused of not knowing from where the new liabilities might come. As such, RSA has a specialist technical team within its survey unit, charged with ensuring that it is scanning the environment to see if there are new risks that come along that could cause the company a problem.

New concerns and areas of liability

Cox says that new areas of liability currently on the radar screen are the threat posed by the science of nanotechnology; the danger caused by electro-magnetic fields; and the possible side effects of new chemicals.

For Norwich Union, according to a spokeswoman, whether or not asbestos - in forms other than mesothelioma - will continue to be a threat in the coming years is also one of its major concerns.

Of course, it is not only insurers that are interested in the future growth of liability and spotting where the new markets are likely to be.

Grahame Chilton, chief executive of broker Benfield, says that the company is very keen to build up its strengths on the liability side, particularly in Europe, and has demonstrated its commitment through the recruitment of new teams from rival brokers in recent months. "We have been getting good growth by selling more products into the casualty areas," he adds, stressing that D&O and medical malpractice are two core areas for the broker.

According to Chilton, broking more liability lines in Europe makes sense at the moment as the Continent moves evermore towards a US-style litigious environment. As he speculates: "I think there will be pick-up in the need for casualty insurance."

And therein lies the dilemma. For in the very litigious system that is creating the demand for liability products comes the potential for very serious and ever-greater compensation claims. Thus, despite the trauma of recent horrendous losses for the industry, there seems to be an increasing demand for new liability products. But insurers and brokers know from bitter experience that they are playing with fire.