comment
Mind The Wording Gap
| March 29, 2010 by Rob Morris
Michael Gertsch, chief underwriting officer at Gulf Re, bemoans the downward spiral created by the undercutting of terms and conditions to grow premium volumes.
What keeps you awake at night? Hopefully not your policy wording. But then again, maybe it should.
Many of today’s economical problems have been allocated to the current global financial downturn; it’s being used as an excuse for almost everything. But in some cases the issues actually existed long before the crisis, they were just not that apparent. In a wealthy environment like the one our industry has experienced for a number of years, coverage issues did not need to be followed up vigorously and a lot of goodwill was used in interpreting scope of cover and exclusions. As long as a portfolio delivered positive cashflow, significant investments were made into stock markets and real estate with the resulting returns covering attritional losses easily. And while some reserves were set for large losses, they don’t happen that frequently, leading to a misperception of having enough margins in the original rates that would justify further reductions at the next renewal.
But then the financial downturn started to set in and with that exuberant investment returns disappeared. The profitability of a portfolio, therefore, is now mostly dependant on premium income and loss activity. And while it seems that the deterioration of terms and conditions will continue for some time, there seems to be a trend of looking into coverage issues a little more carefully.
I’m covered. Am I not?
Whether it’s our own car insurance or the programmes bought by large corporations, there are certain expectations as to what would be covered under what circumstances and what not. And whilst these expectations exist equally on both, the seller’s as well as the buyer’s side, they can vary in their content quite significantly. From an insured’s perspective this is rather simple: They want to be covered for everything, everywhere against anything, no matter what. The insurer, while agreeing in principle, needs to set a certain framework of when the coverage applies, be it because of restrictions under their own reinsurance treaties or because they consider certain exposures to be unmanageable for accumulation, regulatory or any other reason. But are these views and expectations aligned? Does an insured know that “All Risks” doesn’t mean all risks? Do they understand the potential impact of an average clause? Do they have the exact wording for NMA2918 and do they know what the implications are for them? Yes, it’s a terrorism exclusion clause, but what does it exclude and under which circumstances?
And it’s the same for the reinsurer, whether they are providing facultative or treaty reinsurance. It might be very clear in their own mind what coverage they are granting, especially when subjectivities are applied. But does that really fit the actual requirement a ceding company has? And if not, is the insurer aware of that?
There is a lot of room for mis-interpretation and in our industry that can turn out to be very costly. As profit margins reduce, claims will be checked much more thoroughly for coverage under the policy wording, actual values being affected by a claim versus reported sums insured, and application of deductibles and exclusions. Judging by the amount of arbitration workshops being held in the region over the past few months and the increasing number of legal firms providing such services, the courts will be fairly busy.
Timing is everything
One might think that there’s a bigger probability in sustaining coverage gaps for smaller companies that don’t have in-house professionals analysing the actual policy wordings. But what about the World Trade Center loss? One or two events? Or the broken levies in New Orleans after Hurricane Katrina. Windstorm or flood?
Very basic parts of the policy wording that were not phrased properly and had to be decided in court. In the case of WTC the policy had not even been issued at the time of the loss. Whether these losses could or should have been avoided is a different topic altogether but what could have been prevented is the ambiguity, the significant legal expenses and the delay in making a payment to the insured and recover from reinsurers respectively.
The ideal moment to address all coverage issues is before inception. The introduction of contract certainty in the US, the UK and Europe attempts to address this issue in such a sense that all policy wordings have to be signed by all parties before the start of the policy period.
With his observation on long neglected coverage issues, in his article, Mr. Gertsch brought another angle to the topic that is the centrepiece of the various regional seminars and conferences, which is “getting back to basics”. In these current testing times, the need for insurers to think before they offer coverage is of paramount importance. The overall ambiguity in the coverage wordings will no doubt proliferate the losses in the region. The article also addresses the very problem that is now a widespread practice amongst the insurance companies across the middle east – blaming everything on “financial downturn”, a pretext that is being used for almost everything these days, be it a discounted premium at renewal or reduction in deductible levels, or even for widening the coverage.
Given the investment profits for insurers are now dwindled, one would feel it is time the insurers get back to basics and re-think their strategies with a long term perspective. Or else, the risk of accessing those large loss reserves more frequently is not a remote possibility anymore. However, it appears more concerted efforts from insurers are yet to be seen that rightly address the issue and drive it home with their brokers and direct clients. The insurers blame the intermediaries for worsening the situation, while the latter maintain that price driven customers cannot be retained if significant earnings are not offered at renewal at better coverage. This vicious circle, if not handled properly, would be a much greater issue at hand. As international reinsurance markets are becoming more and more vigilant in terms of coverage, the local markets would be lagging behind and exposing themselves to the risks of unfavourable decisions by court if they do not get up to speed with getting their act together.
Unchecked wide coverage written at half the technical premium makes it a double-edged sword. If this conditions prolongs, then the losses would primate, both in terms of actual claims (costly litigation and claims payable due to ambiguity in wording) and also in operating losses (attritional losses that erode the profitability and incommensurate premium base inadequate to meet large losses). It is not important how many big ticket accounts are underwritten, but how profitable your portfolio had been. Some insurers are realising this as they are walking away from some large risks, when the prices deteriorated below levels they can no longer stomach.
Low premium and deductible levels, as it appears, are here to stay for some time. However, I feel this is the right time to introduce regulation similar to Contract Certainty in the market place. This would prompt the parties to review the coverage issues and deal with ambiguities prior to inception, avoiding expensive dispute resolution proceedings and litigation at a later stage.