Article

Maximizing the Value of Your Excess Casualty Tower

Considering the crucial role that excess casualty plays in protecting a balance sheet from the unthinkable, risk managers and CFOs should be provided with meaningful decision-support tools that go beyond simple benchmarking and provide actionable data to assist in answering this difficult question.

While risk managers are increasingly relying upon sophisticated analytics to guide decisions aimed at reducing their casualty cost of risk (CCOR), choices around excess casualty limit adequacy have historically been driven more by art than by science. Considering the crucial role that excess casualty plays in protecting a balance sheet from the unthinkable, risk managers and CFOs should be provided with meaningful decision-support tools that go beyond simple benchmarking and provide actionable data to assist in answering this difficult question.

Inflationary Impact on Excess Casualty Limits

Average tort trends have continued to increase at an alarming rate over the past 10 years.

The number of closed claims paid by excess casualty insurers — in excess of US$10 million —has increased 500% over this period, from only nine in 2003 to 50 in 2011. Furthermore, the industry’s top 10 jury verdicts increased for the sixth consecutive year in 2011, with the average rising to US$184 million.^[1]

Despite this escalating frequency of severity losses, most companies have kept their excess limit purchase relatively stagnant during this period.

One way to look at this issue, as it relates to excess casualty limit adequacy, is to examine the “value” over time of an excess casualty tower taking this inflationary impact into account.

The graph below illustrates the effect of loss trends on a limit purchase over time. Based on a 5% trend, a US$100 million excess casualty tower in 2003 would conservatively equate to only US$61 million in 2013.

Taking this into consideration, it is crucial that companies reevaluate their excess casualty limit purchase to ensure that their organization is adequately protected in today’s world.

Benchmarking: Opportunities for Improvement

Historically, questions regarding limit adequacy have been answered via the use of peer benchmarking. This approach typically provides risk managers with a broad industry-based comparison of average limits purchased as well as general cost information. While these comparisons are indeed an important aspect of validating an insurance purchasing decision, benchmarking alone is not able to provide the informative and actionable data that companies are increasingly relying upon to manage an overall risk portfolio.

In a world where complex global corporations can manufacture products and provide services that span various industry groups, it has become increasingly difficult to pinpoint what is defined as a true “peer company.” Furthermore, even when a valid industry peer grouping is available, how do you know that other companies are making good risk-financing decisions or what historical information might be influencing their limit purchase?

For example, one would expect a company that has sustained a catastrophic liability loss to genuinely value the earnings protection provided by an appropriate excess casualty limit purchase. On the other hand, it can be difficult for some companies that have a “clean” loss history to rationalize the need for purchasing higher limits.

It would seem that industry-based peer comparisons often fail to account for these important exposure-based factors, such as risk profile or loss history, and almost never include analysis of a company’s balance sheet and ability to retain large losses that breach the top of an excess casualty program.

Excess Casualty Analytics: The Future of Benchmarking

More than ever, it is crucial that risk managers be provided with improved decision-support tools that will allow for better purchasing decisions relating to excess casualty limits.

Using traditional benchmarking information drawn from a large excess casualty client portfolio and comparing it in conjunction with industry-sector and client-specific financial, exposure, and loss-based metrics is the way to accomplish this goal.

Furthermore, risk managers should be provided with specific and relevant examples of industry jury verdicts in order to supply context for potential case outcomes that could be brought against the company.

Through the increased use of client-specific and industry-sector exposure information, as well as loss simulations, risk managers would be provided with impactful comparison data, including answers to questions such as:

How often should I expect losses to exceed my limits purchased based on my loss history? How does this compare with industry losses and limits purchased?
If losses exceed my limits, what can I expect the uninsured portion of the loss to be?
What is the potential impact on earnings if I sustain a catastrophic loss?

The chart on the top (Excess Casualty Client Total Limits vs. Industry Gross Loss Distribution) shows a company that currently purchases US$125 million in excess casualty limits. Taking industry loss simulations into account, the company’s total limits are expected to be sufficient up to around the 97th percentile of possible outcomes (or the 1 in 33 year liability event before uninsured losses would impact the client’s bottom line). The 1 in 200 year event (99.5th percentile), however, would result in uninsured losses of well over US$400 million.

The chart on the bottom (Excess Casualty Client Estimated Uninsured Loss vs. Client Expected Earnings) illustrates the impact of potential large losses on annual earnings. If this company has expected annual earnings of slightly under US$1.2 billion, uninsured losses from the 1 in 33 year event would have a 3% impact on annual earnings; whereas, uninsured losses sustained in the 1 in 200 year event would represent 43% of earnings.

Using this increasingly accurate view of potential loss events to set the foundation, this analysis will allow risk managers and CFOs to make educated purchasing decisions based on the potential impact of large claims and how best to manage this exposure through a well-constructed excess casualty tower.

Debunking the ‘Follow Form’ Excess Policy

Believe it or not, while the term “follow form” is often displayed at the top of many excess liability policy forms (that is, layers above the lead umbrella), insurance carriers that provide this coverage have historically insisted upon using their own policy form and, with it, a whole host of coverage variations throughout a tower.

These layer-to-layer inconsistencies or “nonconcurrencies” can unfortunately lead to claims being denied or payments being delayed when corporations need balance sheet protection the most; in the case of a catastrophic liability claim.

It is crucial that risk managers be aware of these potential issues and realize the importance of an in-depth layer-by-layer review in order to identify and eliminate these inconsistencies where possible.

Several problem areas to be aware of include the following:

No broader than underlying clause: Many carriers’ excess casualty forms contain a “no broader than underlying” clause, meaning that any coverage restrictions below them in the tower are automatically incorporated into their policy.

Duty to defend wording: Duty to defend language can vary significantly from carrier to carrier, which can result in the insured being responsible for costly defense payments.

Independent exclusions: Many excess casualty forms include their own exclusions, either within the policy form or attached separately. These exclusions restrict coverage regardless of what is provided in underlying policies. One particular area of concern is the broadened named peril/time element pollution language that may be provided in the lead umbrella policy.

Other insurance wording: Various carrier forms include troubling “other insurance” wording that includes broad terms, such as “indemnifications” or “other mechanisms,” used by a company to fund legal liabilities.

Negotiated partial settlement problems: Various carrier forms recognize the exhaustion of underlying limits only through payments made by insurers. In cases where insureds negotiate a partial settlement agreement with the underlying carrier, an excess insurer could dispute whether their policy has been triggered.

With proper attention paid to addressing these items, your excess casualty tower will take a big step in the direction making “follow form” a reality.

^[1] 2012 AIG Excess Casualty Producer Conference presentation, Current Award Trends in Personal injury – “Jury Verdict Research and Lawyers USA”

Casualty Newsletter Spring 2013

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Maximizing the Value of Your Excess Casualty Tower

Debunking the ‘Follow Form’ Excess Policy

Related insights

Maximizing Insurance Recovery for a Manufacturer’s PFAS Claim

What the DOL’s new worker reclassification rule could mean for businesses

Utilizing collateral solutions to manage the impacts of economic inflation

Four actions to mitigate rising product recall risks