Economic crisis – tackling impact on claims and bottom line!

What casualty (re)insurers should watch out for to avoid getting caught. Adeline Chua from Swiss Re’s Casualty expert team in Asia discusses how casualty (re)insurers can tackle new challenges amid the economic downturn.

Everyone knows that the financial tsunami has driven the global economy into a deep recession. But what does this mean for casualty (re)insurers?

Certainly, the financial crisis would affect financial lines for banks and financial institutions. But other professionals, such as lawyers and accountants, are also on the firing line.

Lessons from US and European markets can help underwriters in Asia-Pacific spot issues and avoid the pitfalls. Here are examples of where the economic crisis might impact on:

Professional indemnity lines

Lawyers: We have seen many US property investors and lending institutions recoup their investment or property losses by alleging poor legal advice and seeking compensation from their solicitors. Insurance companies which try to steer clear of providing coverage to these professionals should also monitor whether they are diversifying into any new areas of law to replace business lost during the downturn. Moving out of their core competency might expose them to higher risk business.

What’s more, as some areas of work such as residential conveyancing might see reduced earnings or profits, this could result in shortcuts taken and more mistakes made in practice.

Accountants: Where investors sue a company’s directors for misrepresentation of investment, these investors can also go after the company’s accountants, accusing them of aiding and abetting that misrepresentation.

In the event of business failure, the plaintiffs’ lawyer might argue that the accountants failed to give prior warning to the management.

Aside from financial lines, various liability insurance products could be affected by the economic downturn.  Here are some examples.

Workers compensation lines

A recent study shows that the growth rate of workplace injury and illness decreases during recessions, as workforces tend to shrink[1]. Also, some companies might retain more experienced employees, which could also lower the claim frequency.

On the other hand, workplace safety may be compromised due to cutbacks in funding of safety programs. This could adversely impact the frequency of claims.

In the case of redundancy, any unfair dismissal could result in employees taking legal action against the company. For instance, Hiscox has seen a threefold rise in insurance claims over the last quarter of 2008 from small and medium enterprise employers being sued by former employees for unfair dismissal[2]. If a higher proportion of older and higher-paid employees are laid off to maximise cost saving, the company could be sued for higher retrenchment benefits. Usually, terminated employees take a longer time to find a job during recessions, and this too could increase the severity of claims.

Product and pollution liability insurance

To save costs, some companies may switch to material substitution resulting in inferior products. This would increase the probability of high product defect which could then fuel claims against product liability insurance.

For some industrial companies, preventing potential spillage and leakage of industrial substances could become less of a priority. This may raise pollution exposure, thus impacting the severity of claims against pollution liability insurance.

Insurers need to take preventive measures

So, what should insurance companies do to avoid getting caught? A number of measures can be taken:

  • Awareness: Identify insured or potential clients and any specific industries which are at high risk. Recognise the high risk factors and calculate the worst possible scenarios.
  • Education: Educate staff and insured. Train staff to always identify clients at high risk and raise professional skepticism. For instance, in employment practices liability insurance, make sure the insured maintains all proper employment practices and procedures, consults a lawyer before terminating any employee, and requires a terminated employee to sign a written agreement.
  • Risk management: Conduct regular reviews on risk management measures taken by the insured. Pay special attention to those insureds which are moving into new business segments out of their core competency. Stringent review on claims notifications should be in place.

Premium will also be affected

Let alone the impact on claims, the economic downturn is also expected to affect the premium.

With the reduction in revenues and payrolls affecting the rate base for different lines of business, insurance companies need to be aware that a reduction in premium base will likely be greater than the corresponding reduction in exposures.

For example, exposure of current product liability would come both from products manufactured and sold during the insurance period, as well as those manufactured and sold earlier (as they are still in use today), however the sales/revenues per unit will be lower. Therefore, when premium is based on sales/revenues per unit, the premium will be reduced more than the reduction in exposure. Similarly, when premium is based on payrolls, during economic crisis, wages are generally lower hence premium is driven down -- but more than its exposure.

Also, some industries may experience a rapid increase in revenues or payrolls as the recession ends, which can lead to a more rapid increase in exposures than the corresponding increase in premium. Such fluctuations need to be taken into account in setting the premium.

In a nutshell, insurance companies need to step up measures such as those mentioned above, to weather the storm and protect the bottom-line.

[1] “Workers Compensation and the Business Cycle – An Overview”, Harry Shuford, National Council on Compensation Insurance, 8 May 2009.
[2] Press Release: Growing redundancies leading to sharp rise in ‘unfair dismissal’ claims, Hiscox, 3 February 2009.

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