Q1 2020 - Financial Lines Market update
The following article was completed in early March, just before the scale and severity of efforts to contain Covid-19 became apparent and as such it does not make reference to its potential impact on the market. Aon has released, and will continue to release, various communications concerning the potential impact of Covid-19 on businesses, their directors, and insurable risks. The effect this crisis has on the wider insurance market will be addressed in the next Market Update.
Market update - General
As the dust settles on 2019, a torrid year for many, and the 1.1.2020 reinsurance renewals are done, there is much to comment on in the financial lines market. Opinion is divided as to whether we are in the grip of a “true” hard market or this is just the beginning. What is certain is that market conditions have changed dramatically over the last 12 months and continue to change. Possibly more significant is that the rate of change continues to accelerate, making it very difficult to predict market conditions, even in the short to medium term.
We’ve heard the 1st January 2020 reinsurance renewals appositely described both as “asymmetrical” and, less politely, as “all over the place”. What is clear is that, although the 1.1 renewal season was not as attritional as some had anticipated, there was a perceptible hardening across most classes with some areas, financial lines included, hit significantly. Whilst global reinsurance capacity is still high (estimated at $625bn at October 1st 2019), the drive for profitability now dominates the supply-driven market we have become used to over the last decade. As Aon’s Peter Trunfio commented recently, “this is not necessarily a capacity-driven hard market. I think it’s a results-driven hard market”. 
Market update – Financial Lines
The financial lines market is very much part of this new dynamic. (We have used the term “financial lines market” to cover particularly the global market for Directors’ and Officers’ liability (“D&O”) and for various coverage lines for financial institutions (“FI”). Though many of the following observations are relevant to other product lines, in particular the non-FI professional liability lines, we have not specifically addressed changes in these markets). Whilst concerns over an imminent “casualty catastrophe” may be considered over-dramatic, it is clear that rates have not kept pace with claims inflation over past years. The long tail nature of much of this business (meaning that claims may take years to mature) means that an the underwriter may not know the true cost (to them) of their product for some years after it has been sold. As a result, the pricing corrections, when they come, tend to be significantly greater than in shorter-tail business. For the financial lines market, these corrections are now happening and we are seeing some dramatic movement in premiums across the book and, also, more drastic book corrections with underwriters withdrawing completely from unprofitable business lines (and in some cases shutting down completely). The dynamics are inevitably complex but some of the key underlying factors are:
- Continuing claims reserve deterioration of back years. Reported actuarial concern over claims reserving in prior year is borne out by increasing regulatory scrutiny (see note below).
- Concern over growth in litigation costs and awards, and the number of lawsuits. This is particularly the case in the USA and Australia, with Securities Class Actions in these jurisdictions a very prominent and specific issue with regard to D&O liability.
- With respect to Financial Institution business in particular, the increase in regulatory-imposed settlements is driving growth in professional liability claims. Conduct regulators across the globe continue to focus on past business practices, with apparent increased focus on insurance companies and asset managers.
- The other side of the regulatory coin is the seemingly more granular approach of prudential regulators, in the UK at least, in pushing insurers’ profitability. Whilst Lloyd’s Decile 10 initiative, starting in 2018, may not have started the drive back to profitability in various lines, it has certainly lent it both focus and impetus. The PRA have issued a number of “Dear CEO” letters over recent years clarifying their expectations around profitability and, specifically reserving practices, as mentioned above. Again, whilst not initiating the wider changes in the market, these represent a force for change that has not been seen in previous hard market cycles.
The clearest results of these factors in the Financial Lines markets are:
- Significant contractions in capacity and risk appetite across all lines (but particularly in specific areas noted below)
- Increased selection, firstly by class, geography and industry, but also on an individual risk basis. There is intense underwriting scrutiny of D&O for US and Australian listed companies (and any non-US company with any ADR exposure – see commentary below re Toshiba). Other sectors that are very much under the spotlight include Pharmaceutical and Life Science companies (D&O) and Life Insurance companies and US-exposed General Insurance companies (Professional Liability)
- Scrutiny of excess rates on large limit programmes, with specific focus on historic increased limit factors (“ILFs”) on excess layers
- Capacity monitoring by underwriters with some significant shrinkage in the overall amounts that carriers will put at risk across any programme.
- Increased overview of coverage terms and conditions, although to date largely confined to entity investigation costs coverage (D&O) and mitigation language (PI)
- Increased overview of underwriting decisions within carriers and limitation of individual authority. This means that markets are generally less accommodating, with an uptick in subjectivities and information requirements and overall decision making significantly slower.
To summarise, all these indicate a fundamental change in Financial Lines underwriters’ attitude. Underwriters are now prepared to “walk away” from risks that, in their opinion, do not fit their risk appetite or, if they do, fail to attract adequate premium. Much depends on the broker’s understanding of the underlying risk factors and of the complex market dynamics involved in any placement today. Only then can they effectively differentiate their client in this fickle and still-evolving market.
- Toshiba Securities Litigation
Following the Morrison decision in 2010, the D&O market has viewed non-US companies with unsponsored, unlisted American Depository Receipts (“ADRs”) as a “benign” exposure, at least compared to companies with a full US listing or sponsored Level I, II or III ADRs. The market’s comfort in this perceived status quo has, however, taken a nasty knock following the outcome of a preliminary motion to dismiss a US securities claim against Toshiba on behalf of investors in unsponsored ADRs in the case of Stoyas v. Toshiba Corp. The motion brought by Toshiba was initially granted by the California District Court but was then appealed to the US 9th Circuit Appeals Court. In July 2018 the 9th Circuit allowed the plaintiffs to amend their case and sent the motion back to the California District Court for a fresh ruling. In January 2020, the trial judge then denied the motion following the guidance from the 9th Circuit and allowed the case against Toshiba to proceed.. The specific facts of the case are complex (although an excellent recent summary can be found here), but a key element is that the court determined that the foreign issuer (Toshiba) was sufficiently involved in the sale of those securities for the plaintiffs to plausibly argue that the “in connection with” element of the relevant federal securities laws could be established. As a result, the current position, very simply, is that even if a non-US company’s ADRs are unlisted and unsponsored, it can still be subject to a US securities class action (although, as ever, the specific points of each individual situation should be taken into consideration) and while this is an important preliminary decision it is not a final statement of the law in this area – watch this space.
- Mis-selling risks for UK Life Insurance Companies
The market for life insurance companies’ professional liability has been hit hard in recent years by mis-selling claims deriving either from regulatory investigation or from self-reporting of issues identified in a company’s own internal investigation. Below, we identify two specific instances (both in the public domain) where the London financial lines market has been hit by claims arising out of the FCA’s October 2016 thematic review of annuity sales practices (TR16/7). Prudential plc’s 2018 annual report reveals that Prudential has “agreed with its professional indemnity insurers that they will meet £166 million of the Group’s claims costs….” following its agreement with the FCA “to review annuities sold without advice after 1 July 2008 to its contract-based defined contribution pension customers”. This is part of a gross provision of £400 million. Similarly (and with reference to issues deriving from the same FCA review) Standard Life Aberdeen plc’s 2018 Annual Report comments that “...substantially all of the £100m being sought by SLAL under insurance policies to mitigate the financial impact was received by the Group in January 2019…”. These two losses, and a number of other, less public, mis-selling issues have made the market for life insurers’ professional liability a nervous and uncertain place, with considerable pressure on capacity, and rates increasing.
 Aon’s Reinsurance Market Outlook, January 2020
 Peter Trunfio (of Aon) quoted in Business Insurance 16.1.2020
 See letter from Anna Sweeney, the PRA’s Director, Insurance Supervision to Chief Executives of specialist general insurance firms regulated by the PRA, dated 31st May 2018. https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/letter/2018/market-conditions-facing-specialist-general-insurers-feedback-from-recent-pra-review-work.pdf
See letter from Gareth Truran, the PRA’s Acting Director, Insurance Supervision to Chief Executives of specialist general insurance firms regulated by the PRA, dated 5th November 2019 https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/letter/2019/letter-from-gareth-truran-pra-current-areas-of-focus-for-general-insurance-firms.pdf?la=en&hash=8E5ED1FB3B6AD154D8E76504C4C6579A42015396
Morrison v. National Australia Bank, 561 U.S. 247 (2010)
Stoyas v. Toshiba Corp., No. 15-cv-4194 DDP (JCx), (2020)
 From Prudential plc 2018 Annual Report and Accounts, Balance Sheet Notes, C11, Provisions.
 From Standard Life Aberdeen plc 2018 Annual Report and Accounts, Group Financial Statements Note 41 d(iv) “Estimates and assumptions”
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