Liability dynamics: friend or foe?

A string of high-profile cases of defects in products manufactured in Asia underscore the potentially huge liability risk faced by businesses.

These types of events, plus the evolving market landscape, bring new opportunities and challenges for managing and insuring liability risk. How should insurers position themselves amid such liability dynamics?

Third party liability is among the most important risks that businesses and professionals face. Liability insurance includes very different risks, from companies seeking protection against claims resulting from product defects to improper use of certain products by the consumer.  Professionals such as medical doctors and hospitals insure themselves against medical malpractice, just as boards of directors or management may also seek cover against claims relating to violations of the duty to exercise care.

Liability insurance is growing rapidly in Asia Pacific

According to Swiss Re’s new sigma study “Commercial liability: a challenge for businesses and their insurers”, businesses spent approximately USD 142 billion on liability insurance worldwide in 2008. Premiums in the US and the UK, the two largest markets, were USD77 billion and USD 12 billion respectively. Japan and Australia, the largest markets in Asia-Pacific, contributed USD 5 billion and USD 4 billion respectively (see table at the bottom).

China is the first emerging insurance market with significant commercial liability premiums, estimated at USD 1 billion.  Since 2000, growth has been very strong at an annual average rate of 22%, although penetration is still low.

“The strong growth in liability exposure in Asia Pacific is based on vibrant economic fundamentals and a broadening of liability regimes.  Examples are the adoption of stronger consumer protection legislation and the enactment of product liability laws,” said Clarence Wong, Swiss Re’s Chief Economist for Asia.

The financial crisis has accelerated liability developments

What’s more, participants at the 6th International Liability Regimes Conference recently held at the Swiss Re Centre for Global Dialogue, Zurich, agreed that the global financial crisis has accelerated some developments in the liability landscape.

Martin Oesterreicher, Head of Casualty Division and Member of Swiss Re’s Group Management Board, highlighted some of the drivers underlying the global evolution of liability regimes:

  • Introduction of collective redress mechanisms to improve access to justice;
  • Changing acceptance of one’s fate results in an increasing willingness to sue;
  • Product liability developments lead to facilitated access to compensation; and
  • Environmental liability expansion tends to extend liability to new areas.

Well-known drivers of litigation from the West are also increasingly at work in such Asian countries as India, where consumer activism is gaining momentum. The growing internationalisation of many Indian companies also leads to increased exposure to liability claims that may emerge from claimants outside of India. Given the still very low levels of liability insurance penetration and density - with liability premiums only accounting for 2.2% of gross written premiums – the Indian market has a huge growth potential.

Profitable liability business: a challenge for insurers

However, turning growth into profits is most challenging.  “After a few profitable years, there is a risk that insurers again under-price the business,” said Swiss Re’s Thomas Holzheu, an author of the new sigma study. Because liability insurance is a long tail business, insurers have to price in the rising claims trend and the impact of economic changes on this business. Holzheu added: “Under-reserving, which usually goes along with underpricing, is very dangerous not only for insurers’ long term profitability, but also for policyholders, since it undermines the sustainability of insurance protection.”

Holzheu noted: “Commercial liability rates are declining in all markets. Because interest rates are low, business cannot be cross-subsidised with investment results; therefore, prices should instead be increasing.”

Growing concerns from emerging risks

Emerging risks due to technological and social developments are a constant challenge: new insights into and changing standards around food safety, environmental pollution, employment practices and the compensation of financial loss are, for example, risks that insurers closely monitor. The problem is that emerging risks cannot be assessed with traditional actuarial methods. Other methods must be used until such time enough claims have accumulated to use standard methods.

Another growing concern is the rapidly changing culture of compensation. Damage awards are increasing, especially those related to pain and suffering.  Inflation is another area of concern, which is quickly attracting attention.

Insurers must maintain control over exposures and profitability

How to tackle these challenges? The first line of defence for avoiding increasing liability costs is risk prevention. Companies and their risk managers need to assess and mitigate the risk in their businesses. Insurers must systematically monitor the drivers of liability claims and build them into their actuarial models.

Insurers must also pay closer attention to wording and policy language to manage their exposure to liability risks that are rapidly changing. The underwriting process must at all times remain focused on maintaining control over exposures and underlying profitability.

Remember, the best products and the best underwriting methodology for liability risk are no substitutes for adequate pricing. Prices should reflect escalating claim trends and the uncertainties of a rapidly changing technological and legal environment.

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