sigma No 5/2009 Commercial liability: a challenge for businesses and their insurers 3 Executive summary 5 Introduction: characteristics of liability insurance 9 How much insurance do businesses buy and why? 19 What are the key issues? 26 What can insurers do to keep liability risk insurable? 34 Conclusions Published by: Swiss Reinsurance Company Ltd Economic Research & Consulting P.O. Box 8022 Zurich Switzerland Telephone +41 43 285 2551 Fax +41 43 285 4749 E-mail: [email protected] New York Office: 55 East 52nd Street 40th Floor New York, NY 10055 Telephone +1 212 317 5400 Fax +1 212 317 5455 The editorial deadline for this study was 5 October 2009. Hong Kong Office: 18 Harbour Road, Wanchai sigma is available in English (original Central Plaza, 61st Floor language), German, French, Spanish, Hong Kong, SAR Chinese and Japanese. Telephone +852 2582 5703 sigma is available on Swiss Reʼs website: Fax +852 2511 6603 www.swissre.com/sigma Authors: The internet version may contain slightly Dr Thomas Holzheu updated information. Telephone +1 212 317 5190 Translations: Roman Lechner CLS Communication Telephone +41 43 285 2344 Graphic design and production: sigma co-editor: Swiss Re Logistics/Media Production Dr Brian Rogers Telephone +41 43 285 2733 © 2009 Swiss Reinsurance Company Ltd Managing editor: All rights reserved. Thomas Hess, Head of Economic Research & Consulting, is responsible for the sigma The entire content of this sigma edition is series. subject to copyright with all rights reserved. The information may be used for private or internal purposes, provided that any copyright or other proprietary notices are not removed. Electronic reuse of the data published in sigma is prohibited. Reproduction in whole or in part or use for any public purpose is permitted only with the prior written approval of Swiss Re Economic Research & Consulting and if the source reference “Swiss Re, sigma No 5/2009” is indicated. Courtesy copies are appreciated. Although all the information used in this study was taken from reliable sources, Swiss Reinsurance Company does not accept any responsibility for the accuracy or comprehensiveness of the information given. The information provided is for informational purposes only and in no way constitutes Swiss Reʼs position. In no event shall Swiss Re be liable for any loss or damage arising in connection with the use of this information. Executive summary Liability is a key risk for corporations … Liability is a key risk for corporations. It typically ranks high in surveys conducted with risk managers. The only insurance risk that ranks higher is business inter- ruption. … with insurance providing effective The cost of liability risks can vary significantly depending on the size of the protection. company, the industry and the jurisdiction. Liability insurance provides efficient protection against this significant low-frequency, high-severity risk. In the US, the average cost of commercial liability insurance was about 0.2% of revenues in 2008. The average cost of liability insurance is lower in other countries. Worldwide liability insurance premiums In 2008, businesses spent approximately USD 142bn on liability insurance. were approximately USD 142bn in 2008. This is about 25% of the premiums corporations spent on insurance and slightly less than 9% of the global non-life market premium volume of USD 1 585bn. The developed economies account for roughly 95% of commercial liability premiums. The United States, which is by far the largest market, generates 54% of premiums worldwide. The demand for commercial liability insurance in the US is driven by the size of the economy and the sheer volume of lawsuits that are filed in the country. Liability insurance is growing faster The amount spent on liability insurance continues to expand rapidly, exceeding than world GDP. the overall growth of world GDP, due to increasing litigation in almost all regions, rising healthcare costs and the overall increase in damages awarded to plaintiffs. The market is dominated by global and The liability market is dominated by global and national insurers with ample national insurers. capacity, financial strength, expertise in dealing with large and complex claims and international experience needed to support clients relative to their inter- national exposure. As a result, the market is more concentrated than other commercial lines markets. The unique aspects of liability insurance The following characteristics distinguish liability insurance from other lines: pose challenges for the industry. ̤ Liability insurance may cover unknown and unexpected risks. New emerging risks can lead to significant losses that are the result of the interaction of tech- nological innovation and changes in the social and legal environment. ̤ The long-tail nature of liability risks results in a higher exposure to inflation, social claims escalation and investment risks. Dynamics in the liability system can create surprise exposures and unexpected changes in the number of claims and claims costs, which were not considered at the time of under- writing the policy. ̤ Over the long run, the profitability of liability insurance has been insufficient. The current profitability is low The industry is currently in a phase of a rapidly decreasing profitability, especially and rapidly declining. in the US. Rates and conditions have been weakening since 2004. Results have been boosted by massive reserves releases and the market has not yet adjusted to the current low-yield environment. Swiss Re, sigma No 5/2009 3 Executive summary Insurers must actively maintain control How can insurers and their clients respond to these challenges? Insurance buyers over exposures and profitability. need to include liability risks in an integrated risk management process. Risk assessment and mitigation play an important role in reducing the overall cost of risk and keeping certain risks insurable. Insurers must better understand and monitor the drivers of liability claims costs and then reflect this in the actuarial models. Insurers must also pay closer attention to wording and policy language in order to manage their exposure to liability risks that are rapidly changing. Finally, the underwriting process must at all times remain focused on maintaining control over exposures and underlying profitability. 4 Swiss Re, sigma No 5/2009 Introduction: characteristics of liability insurance Third party liability insurance is basically Third party liability insurance is usually an ”all-perils” insurance. It protects the an “all-perils” insurance. insured against the legal obligation to pay compensation to third parties for losses or damages for which the insured may be liable. The insurance of liability risks can be The insurance of liability risks is a relatively new line of business compared to traced back to the early 19th century. marine, fire or life insurance. It has its roots in the industrialisation of the early 19th century. Interestingly, the introduction of third party liability insurance was heavily disputed among scholars and politicians. While the proponents empha- sised the compensation of innocent victims, the opponents perceived the insur- ance of “negligence” as frivolous. Today, the concept of insurance is not contest- ed anymore. Moreover, current tort law and compensation levels would not be possible without a well organised liability insurance system. Exclusions are used to separate insura- The often broad coverage provided by liability insurance differs from property ble and uninsurable risks or to assign insurance, which is mostly designed on a ”named perils” basis. Property insur- risks to other lines of business. ance provides cover only for losses associated with explicitly defined causes and where claims cannot exceed the value of the insured goods. Table 1 Differences between liability and property covers Commercial liability insurance Commercial property insurance Trigger event Usually all events which are not excluded Often confined to named perils Insured risk Refers to liability claims of third parties; Refers to an insured object scope of insurance uncertain Size of a claim Payout restricted by policy limit Payout restricted by policy limit or the value of the insured object Time between premium payment Claims may be discovered with a lag and Usually no lag and quick settlement and claims settlement settlement needs time Source: Swiss Re Economic Research & Consulting Compensation of liability claims Liability claims on the other hand, are only restricted by policy limits, which are is only confined by the limits of often set high enough to deal with unexpected events, and exclusions. Because the insurance policy. the trigger events are usually not restricted and because the claim is only defined by the size of the cover and not the value of an insured object, liability claims are much more dependent on changes in the risk landscape.1 While the majority of losses are small high-frequency losses, high-severity events occur. Since large companies tend to buy policies with high deductibles, claims tend to be larger. 1 For a discussion of uncertainty associated with all-perils policies, see Kunreuther, Howard and Pauly, Mark (2004), What You Don’t Know Can Hurt You: Terrorism Losses and All Perils Insurance. Wharton School Discussion Paper, December. Swiss Re, sigma No 5/2009 5 Introduction: characteristics of liability insurance Commercial liability claims can The key difference, however, is that in commercial liability the manifestation of