Liability underwriting is a risky business

Firstly, we have seen an increase in global capital entering the insurance industry and with it, the gradual depression of the premiums charged for the underlying risks. Secondly we have seen an increase in government regulation as public trust in business continues to decline and there is the ever growing pressure on natural resources as the global demand for energy, agricultural products and raw material continually increases. Finally, even though liability risks have increased, brokers are still not comfortable advising on liability risks and indeed brokering liability insurance products.

Lloyds of London chairman John Nelson recently issued a warning about the amount of cash flowing into the insurance industry and the systematic risk such rapid capital flows pose to the industry as a whole. "We all remember the systematic problems that arose in the banking sector when capital became detached from the underlying risk. It’s no surprise that money is going into the insurance industry; this is being driven by money managers who are desperate for yields after they have had a hard time gaming the equity market in a economically depressed global environment and low global interest rates.

 

The worry is that, as capital becomes easily available in the insurance industry and competition for business increases, there is the growing trend of insurers competing on price alone. This is what Nelson meant about the danger of capital detaching from the risk. Underwriters no longer write business on the basis of its risk profile, but on charging as low a premium as possible.

 

But the local liability insurance industry has not been spared this trend. This problem is compounded by the fact that liability premiums are decreasing at a time when liability risk is on the rise, as result of increased government regulation and the increased concern about environmental, social and corporate governance issues (ESG).

Corporate liability risk is increasing as jurisdictions around the world adopt liability laws that mirror the stringent framework of the US. In a lot of instances, regulatory changes in the regulatory framework have been gradual to the detriment of corporations and the boards that make decisions on the behalf of the company.

In South Africa, one only has to look at the introduction of the Consumer Protection Act and the changes in the new Companies Act to see how companies regulatory risk profiles have changed for worst.

Though it is generally accepted that that the objectives of regulation is to prevent market failure, these objectives are limited by the broader objective of regulation which can be broadly stated as the protection of public health, welfare, safety and the environment.

Even though business plays an important role in society, their activities can also generate negative impacts on the environment, present a hazard to human health or negatively affect local communities as a result of improper planning or management.

It is also true that ESG risks associated with business operations of an individual company are generally limited, but aggregated across all businesses these risks can be significant and need proper management/mitigation, starting with individual companies.

 

For example companies my face E&S liabilities due to related damages caused by its operations. These could include remediation actions for land or ground contamination (pollution liability) and or claims for compensation for damages or injuries to third parties. These potential Liability claims can be extremely costly and can represent a significant financial burden on the business.

The complexity of understanding liability risks and the global financial crisis has created an environment where underwriting liability risks is more difficult than ever.