The rate rises in D&O and PI cover over the past couple of years have helped insurers to recover some previous losses, but the threat of a price war could be damaging warns Jeremy Brazil
The professional indemnity (PI) and directors' & officers' (D&O) classes saw significant rate increases during 2002 and 2003. Rates started to improve in the latter part of 2001 but were given momentum, as was the case in almost all classes, by the World Trade Center attack in 2001.
Was this being opportunistic? Well, in part, yes. But the over-riding factor was a backdrop of very poor results in these classes that began to manifest during 2001. The market in these classes began to significantly soften in 1998 with prices reducing, terms and conditions being relaxed and many long-term placements tying in insurers for two or three years at what was the bottom of the cycle.
The softening cycle was sufficient to result in such classes being unprofitable. This was compounded by the financial failures in corporate America, such as Enron, Worldcom and the dot com companies.
This was not confined to the US. Many other parts of the world, such as Asia and South America, have suffered economic and financial failure that has resulted in claims under D&O policies and claims against professional advisers such as auditors and accountants
So Lloyd's for the period 1998 to 2001 saw loss ratios well in excess of 100%, with 1998 to 2000 running at over 170%. This will affect both the insurance and reinsurance sectors. If insurers are experiencing such severe loss ratios then their reinsurers are very likely seeing loss ratios that are multiples of this.
Consequently rate increases seen during the past two years are a long overdue correction and may help mitigate the significant losses of the years 1997 to 2001. The rate increases will not extinguish insurers' deficit from this period, but this correction should bring both stability and certainty to both buyers and sellers.
The cost of PI is often an insured's second largest expense after salaries and benefits, and consequently large variances in cost from one year to the next are difficult to plan for.
The capacity for PI and D&O shrunk dramatically post 11 September 2001 and so, in part, a simple issue of supply versus demand assisted in price correction.
But with the perception of vastly improved trading conditions there has been an influx of new capacity during 2002 and 2003 in both classes and particularly in non-US D&O. This has naturally resulted in rate increases levelling off which is to be expected. But the more concerning issue is the recently detected over-aggressiveness of some insurers.
Is this justified and defendable? No doubt they feel so and they have budgets and income targets to satisfy. But even with the current level of rates some classes of business are still marginal and some still need to see meaningful increases.
It would therefore be naïve to think that rates can be cut in the order of 20% and the business remain profitable. Only relatively recently Europe experienced its own mini-Enron with the collapse of Parmalat.
Any form of financial collapse or failure will undoubtedly cost the insurance market directly or indirectly. We are also living in a more litigious world, which coupled with claims inflation is resulting in more frequent, larger claims.
My word of caution is that we must not forget the past but learn from it. The past has produced, generally, unprofitable returns for too many years and not surprisingly has resulted in the collapse or cessation of business for several insurers.
To be credible, we must not only be perceived to be, but demonstrate that we are, a stable, secure and professional market place that can provide continuity to our clients now and in the future.