Category Archives: Risk Management

BEWARE THE CONVENTIONAL PRIMARY LAYER / UMBRELLA EXCESS “FOLLOWING FORM” STRUCTURE FOR GENERAL LIABILITY INSURANCE

New Trends in primary insurance terms may leave the company with NO insurance for major items, like defense costs, and excess carriers “following form” will be off the hook too

It used to be a safe and sensible way to go. Secure your primary (or “lead”) insurance with a deductible or self-insured retention (SIR) that matched your risk appetite, then attend to large losses with an umbrella policy above it, further burnished by a series of excess general liability policies atop the umbrella. The primary policy was necessarily complex because it also addressed the routine and frequent problems associated with auto liability and workers compensation. The excess policies were there to address the big general liability issues that might come along. It made a tidy package.

You could sleep secure in the knowledge that the umbrella and excess policies “followed form” to the underlying insurance, including the primary lead. So long as you did truly understand your primary policy, and so long as that primary policy actually spelled out favorable terms, your peaceful sleep was justified.

But recent trends in the terms of primary liability insurance have called this premise into serious question. Insomnia may now be the more appropriate state than happy dreams. Here’s why.

EXCESS POLICIES ARE ONLY AS GOOD AS THE PRIMARY TERMS THEY FOLLOW

We often find in our portfolio reviews that policyholders tend to focus on the importance of “follow form” protection from the top down. By that we mean that they view the feature of following form to be a safeguard working to their benefit, because it serves to prevent an excess carrier from issuing coverage that varies from the terms of the insurance beneath it. This is of course true. But it is also true that a policy that is following the form of policies beneath it will be only as favorable to the policyholder as those underlying policies are. And excess carriers will jealously guard their ability to rely on the restrictive terms of underlying policies—and without exception will specifically state that in no event or circumstance will they ever provide insurance that is broader than that provided below.

We believe companies should look at the “follow form” principle from the bottom up. In our view, nothing is more vital than the terms of the primary lead policy. Get that policy right first. Then lock in the identical terms above it.

ONE KEY EXAMPLE OF HOW SERIOUS POTHOLES IN THE PRIMARY POLICY, COMBINED WITH FOLLOW FORM EXCESS POLICIES, CAN DEVASTATE COVERAGE

Terms for defense costs

Primary liability carriers, for good reason, have become seriously concerned with skyrocketing legal fees and other litigation costs. They have pounded on law firms for lower and lower rates, but there is only so low you can go. So some primary liability insurers are now creatively transferring the responsibility for very large legal fees to the policyholder. They are doing this by getting companies to agree, normally in a lengthy endorsement to the policy, that even though the base policy provides a “duty to defend” the policyholder, the policyholder will pay ALL legal defense costs—even when those costs exceed the deductible or SIR—in any case in which no liability is actually paid. In other words, if you win, the whole legal bill is on your head, and none of it will be paid by the insurer.

Any general counsel will tell you that the expense of defeating a meritless claim can be huge. And most risk managers believe (and until recently have been usually correct) that the legal fee “bleeding” at least ends once the deductible or SIR is reached by the legal expenses.

This limitation on what was once accepted coverage also benefits the following form insurers who sit above.

And this divergence from the conventional notion of coverage for defense costs also results in a deadly minefield of conflict of interest in expensive, but flimsy, claims. If the merits of the claim look weak, but the depositions and extensive discovery needed to defeat it on summary judgment or at trial will run into the millions, the insurer, often controlling settlement, has an incentive to take it all the way, knowing that if the policyholder wins the case, it (the insurer) will pay nothing and the policyholder will pay the millions needed to achieve the good result.

SOLUTIONS

Many companies would be better off moving away from the conventional format of broad form primary coverage (for autos, workers compensation and the first portion of general and products liability), sitting beneath separately purchased umbrella / excess policies that follow form. By buying coverage for auto and workers compensation alone (for a reasonable premium driven by just those exposures), it can address all other operating and products liability with carefully worded policies. For example, if it is comfortable with an SIR of, say, $1 million, it can buy a lead general liability policy with a per occurrence limit of $15 million or more, and build into that lead policy optimal terms. It can then secure successive layers above it, to the total level it desires, and make certain that each follows the favorable terms of the first. Importantly, by breaking the general liability policies away from the complexities of the auto and workers compensation components, the GL program can usually be purchased at lower cost—sometimes very substantially lower cost. It is worth your while to take a fresh, independent look at the possibilities.

WHAT THE LAW DEPARTMENT DOESN’T KNOW COULD HURT YOU

Risk Managers Will Benefit by Sharing Insurance Policies with Inside Lawyers

In most American companies, the insurance procurement and management function resides in the finance division, reporting up through the treasurer’s office and, ultimately, to the CFO. The legal department is normally not involved in the process, with the usual exception of the D&O liability insurance (because that particular policy often draws the interest of the CEO, board and CFO, who ask for legal review).

This characteristic is unfortunate. When management takes a step back to examine this isolation of insurance matters within the finance function, a few important questions emerge. Why are these complicated legal contracts not provided legal review, when countless other supply chain contracts, involving much less money, receive such review? If the legal function is expected to manage liabilities when they “arrive”, shouldn’t it be at the table when liability insurance terms are agreed to? What possible downside is there to more collaboration between the risk management and legal groups?

Interestingly, the separation of these two functions is pretty much an American fact that is not shared globally. In Europe, for example, (where the business insurance industry and profession is rooted in places like England, Switzerland, Germany and, more recently, Ireland), it is much more customary for the company legal department to manage and purchase insurance for the enterprise.

We do not suggest that companies should move the insurance management function lock-stock-and-barrel to the legal department. There is no “one and only” group that is uniquely suited for the role. But we do believe that all companies would benefit from increased collaboration between the risk management and legal functions; that the benefits can be large in terms of contract terms more favorable to the company and in correctly understanding as an enterprise what is and what is not covered by the contracts; and that there is no downside in any event to increasing the collaboration.

Just One Example: Treatment of Defense Costs in the General Liability Insurance Program

Even in large companies that ask us for an independent review of their insurance terms and program structures, we often find surprisingly adverse terms in the liability insurance as to who bears the burden of high defense costs in litigation matters. Too frequently, the legal group is under the impression that the risk management group has purchased insurance with a “duty to defend” the company, and that therefore the insurer will be handling the defense of cases by hiring law firms to represent the company, and paying them for their work. This is an understandable assumption. It is also nearly always wrong, unless there has been collaboration between the two groups in securing the liability insurance.

Where there has not been collaboration, we normally find that the contract terms require the company to pay all legal expenses and other defense costs in nearly all cases that are likely to occur, in addition to the expected “self insured retention” or deductible that applies to each and every loss, judgment, or settlement.

On the other hand, where there has been collaboration, affording the legal department the opportunity to negotiate with the broker and the insurance company, there will usually be much more favorable terms. For example, the expenses paid by the company for legal defense will often be applied toward the SIR or deductible, so that the company at least enjoys that benefit in return for paying them.

Take a case that settles for $250,000 after legal expenses of another $250,000. If the policy contains an SIR of $250K, and the insured must pay legal costs in addition to the SIR, the outcome is: company’s total loss=$500K; insurer’s loss= $-0-. But if the policy states that legal expenses paid by the policyholder apply towards the SIR, the outcome would be: company’s total loss $250K; insurer’s loss=also, $250K.

Given the chance to see this in advance, a law department will see the significance of this difference in a New York minute. And, clearly, the insurance producing the second outcome is much more valuable than that producing the first outcome.

In our experience, good insurance companies (and nearly all of them are reputable and well-run) welcome the involvement of the customer’s legal group in reviewing and understanding their insurance products. Like any other producer, insurers believe they are offering value, through many options, and they want their customers to properly understand what they are buying, and what they have chosen not to buy.

If your company is one of the many with a wall running between risk management and the law department, consider poking a hole through it and building a gateway. You won’t regret it.

PROPERTY INSURANCE POT HOLES

Avoiding Them Will Reduce All-In Costs and Improve Coverage Too

The cost associated with global property insurance is for most companies—especially manufacturers—the largest spend in the insurance portfolio, often comprising fully half of all insurance costs. Because of its complexity, it is also often the least understood in the C-suite. This is unfortunate since catastrophic property losses, and their concomitant business interruption/lost profits losses, are larger and more likely to happen to most global companies than a very large liability loss.

Why is it so unattended?

For one thing, global property insurance involves not one insurance contract, but often dozens, depending on the number of countries in which assets are owned or leased. The “paper challenge” alone is daunting. Once a “master policy” is decided upon and purchased in the United States, foreign counterpart policies need to be issued in nearly all foreign jurisdictions in order to comply with the laws and insurance regulations of those places, which normally require that a separate policy be issued “in country”, and that it comply with local insurance requirements as to terms, conditions, language, and taxes.

Second, the property policy is the least standardized in regard to terms and language of all commercial insurance. Property policies for large companies are truly “manuscript” policies with individually negotiated terms, conditions and endorsements. No two are alike, and even fundamental concepts can differ wildly from one policy to another, even when issued by the same insurer. And the policy will always be the lengthiest contract in the portfolio, perhaps exceeding 100 pages when amending endorsements are included.

Unintended consequences

For these reasons, we usually find very heavy reliance by companies on the judgments and decisions of brokers when it comes to the structure and terms of the property insurance program. While all of the brokers with whom we have worked have skilled personnel well connected to the many markets and want to do a good job for their clients, there are two common issues that crop up time and again:

  1. Brokers cannot possibly understand your varied global operating risks as well as internal managers and executives. And, importantly, they do not deeply understand the “profitability map” of the company—which sites are contributing what kind of profit stream to the overall entity. For example, it may be that several of your plants process and fabricate materials using expensive cutting equipment that incorporate precious metals for their functionality. Many insurers consider precious metals that are part of machinery to be “Excluded Property” altogether. You can be sure those plant chiefs are aware of this manufacturing fact. But is your broker, especially one located in India who is working as one of 20 from his organization procuring and placing foreign policies? And, we almost always observe anomalies in the reported values for estimated business interruption, which must be reported on a site-by-site basis for purposes of computing the policy premiums, both domestic and foreign. A CFO reviewing a list of reported values will surely note that something is wrong when a very small site, say in Malaysia, is listed as having a very large lost profits estimate equating to 20% of global EBITDA. But will the broker, who relies on what he has been told, often year after year, on a schedule that is really not carefully srubbed. (For every over-estimated dollar of lost profits, you are paying premium that you should not be paying.)
  2. Global brokers face global pressures—from within their own organizations and from the insurers. Inside their own firms, they are pressed to produce more placement activities for their foreign colleagues. For this reason, we are beginning to see large companies choosing to have their broker handle all of the foreign property insurance placement activities, instead of paying a modest “fronting fee” to a global insurance company to be responsible for getting all of the foreign policies issued and documented in an integrated global master control program, which they are well staffed around the world to do. In our experience, when the broker rather than the global carrier performs this administrative function, it in all cases results in much larger costs associated with the foreign policies. And it also may—and often does—result in the broker securing policies from other insurance companies, causing inevitable non-concurrency in terms and creating the possibility that the principal domestic insurer will not be responsible for a primary layer of property insurance purchased abroad from a different company that chooses to reject a claim.

The Solution

We find that companies that take the time to put a careful eye to the structure, content and costs of their global property insurance programs nearly always find important areas for improvement in terms and lower all-in costs. For companies with global premiums exceeding $3 million, these savings can approach 7 figures on an all-in basis (premiums, fronting fees, engineering fees, inspection fees, broker fees and commissions). An independent fresh set of eyes in this exercise can be a big help too, and is likely available to you for a very small percentage of your customary brokerage fee. Your internal risk or legal group, fortified by an independent consultant, can likely deliver immediate impact to the company’s bottom line by substantially lowering global insurance premiums and associated costs and fees.

Does A Lurking Liability Worry Keep You Up At Night? Data Organization And Analytics May Be The Medicine You Need

For twenty years I served as the general counsel of a global company. NYSE traded. Eight thousand employees in 30 countries. Dangerous manufacturing processes. Our products and components were used in everything from wall coverings to transmission fluids; flooring to electrical cable; cosmetics to over-the-counter drugs.

I know a little about things that keep you up at night.

When will that next train derailment put us into the news and a dozen courthouses? What if that contract manufacturer fails again to follow FDA required quality control practices, triggering another recall? And other worries.

Now, as an advisor to companies on risk management, insurance content, and insurance dispute resolution, I’ve come to learn something I wish I had better understood when it was my job to worry.

It’s this: When you get a true grip on the data and information relevant to and influencing existing or nascent complex liability problems, you can understand and analyze it. You can realistically assess its scope and importance. You can know what to be concerned about, and what not to be so concerned about. Knowledge, secured through organized and digitized data, is more than power and might. It’s a good night’s sleep.

Let’s take an example

Your company uses Substance X in much of its manufacturing processes, and has been since the 1960s. Concerns about the toxicity of this substance were, at best, vague and unsubstantiated until the 1990s. But now it is clear that a small, but perceptible, percentage of persons exposed on a regular basis to this substance can be expected to develop a serious disease. So far, the liability problem has been manageable. A few suits were filed; a few settlements have been made. But what does the future hold?

This hypothetical company, whether it appreciates it or not, possesses historical information that, properly organized and interrelated, can provide it with realistic—and ongoing—analytic reports that will greatly clarify the true—from the imagined—potential risk it faces as an enterprise.

The usual approach and its shortcomings

Wise business leaders know that hope is not a strategy. When it comes to brewing liability problems, “wait and see” is not a strategy either. But far too many companies adopt it, because their professional advisors—usually a trusted law firm—really has no other strategy to offer. Litigators are good at litigating. When accurate information is available to them, they can assimilate, synthesize, and present it to fashion effective defenses. But litigators are neither forensic or technology experts. They need accurate information to do their job well, but they do not have the skill sets required to find, organize, analyze, and digitize that information in a relational database so that it can be used by them to most effectively protect the company. This is true even when “national coordinating counsel” has been engaged, and perhaps utilized for years.

So what usually happens? Matters are examined individually, usually by starting with cases that look particularly ominous. Cartons of miscellaneous records are plowed through by staff attorneys and coded for reference. But it is not realistic or economical to take a holistic approach this way. Most importantly, errors and unfounded presumptions will often be made. Many records will never be reviewed that should be, and many that are studied will be misinterpreted to mean things—good or bad—that are unwarranted when examined in the context of all of the data and the projections and modeling that can be performed on the basis of the entire picture.

It can be done much better, with real benefits

There is a much better way. A specialized resource with deep skills and experience with technology to capture miscellaneous complex data and build it into a relational database can work with your legal counsel. I call these specialists “liability data masters”, but the moniker is not important. The best of them combine strong accounting backgrounds with technology savvy and deep programming skills. These attributes allow them to analyze and report out the information from unlimited perspectives—geographically, demographically, sensibly. Whether you appreciate it or not, if you are a company with substantial legacy or ongoing liabilities, you are already paying somebody for an attempt to capture and use your information. You may be very surprised at what it will cost you to do it right, instead of the way it is being done for you now. And you will probably find that the benefits of your new ability to accurately forecast and understand trends—and report them competently to senior management to formulate moderate and long-term strategies, far outweigh any incremental increase in outside expense.

It’s not only about big liability exposures—the small stuff counts too

Even if your company does not face obviously serious exposures in the nature of mass torts, you can achieve important benefits and reduced long-term expense by expertly digitizing and understanding your information for more routine exposures. For example, if you have ongoing voluminous employment law matters because you have a large employee base, or unavoidably high numbers of parking lot liabilities, you will find that these expert resources can help you identify and address trends and much more accurately track and forecast future financial implications.

What is the value in knowing—and being able to prove through competently organized and reported data—that if future store locations are managed wherever possible by persons over the age of 50, employment law expense will be reduced by 50% for those locations? Or that, based on ten years of history and incident reports, parking spaces that are 12 inches wider result in 60% fewer injuries to customers and visitors in your locations?

It may just be a good night’s sleep. But it will also improve your bottom line.

Joseph W. Bauer is the principal of Bauer Advising LLC. For 20 years he was the chief legal officer of The Lubrizol Corporation, prior to its acquisition by Warren Buffett’s Berkshire Hathaway, Inc. in 2011. Now his firm advises companies on matters of risk and insurance management, and which facilitates the resolution of insurance coverage disputes. The firm also assists companies match outside resources to corporate needs in the effective management of risk and liability.

Rethinking Deductible Strategies: Are You Stuck In The “Same Old, Same Old”?

When asked to comment on liability insurance policies, we are often struck by the deductible or retention structure we find, and it’s close cousin, policy premium. We see many financially strong companies with modest deductibles or retentions and the high premiums commanded by them. And we are often surprised at the limit purchased—usually it is lower than we would expect in a risk-sensitive company carrying a low deductible or retention.

Many companies go year-in and year-out with the same deductible structure. For companies with revenues between $500 million and $2 billion, we often see a general liability (GL) deductible of $250,000, and sometimes even lower. At renewal, a routine conversation occurs with the broker. Benchmarking data is consulted. The outcome is almost reflexive. Usually, the deductible stays the same, even as limit is increased. (It is remarkable how as companies grow, the amount of insurance purchased tends to increase more significantly than the retention or deductible.) And keep in mind that benchmarking data is merely a way of seeing what others are doing. It does not mean others are doing it right!

Get the CFO’s Insights

In most companies the CFO receives an annual insurance renewal briefing. But how often is the following proposition put to the CFO: “Our current retention is $250,000. We’re a fairly large company. Would it really be a serious financial problem to us if we suffered a $2 million loss in a given year?” In our experience, many CFOs will answer: “No. But I wouldn’t want two or three of them in a year.”

In other words, most CFOs look at liability risk in periodic aggregate terms. Repeated big hits must be insured against because they aggregate to serious consequences. But the rare, single big hit can be tolerated, as can routine lower value losses. Conventional thinking about retentions and deductibles, on the other hand, almost always looks at the risk in terms of per occurrence or per claim, with the same retained exposure for each and every one of them, whether it’s the first claim or the fiftieth in the policy period.

Where is it written that all SIRs and deductibles must attach or apply at the same level for all occurrences or claims? It isn’t written anywhere. It’s just the way it has nearly always been done, and, unfortunately, without enough linkage to the company’s true risk appetite or consideration of alternative structures.

We think “drop down” retentions (sometimes referred to as “corridor” retentions or deductibles) deserve much more attention than they receive, especially for companies without high frequency loss histories and good cash flow. A $1 billion revenue company with a good loss history and a per occurrence or per claim deductible of $250,000 or less, will significantly reduce premium cost by moving to a $2 million retention for the first (or first two) covered occurrence or claim in the policy period, with its original lower retention or deductible applying to additional occurrences or claims, should there be any to pierce it. For most good risks, there won’t be.

The Bottom Line:

There are ways to work from the CFOs appetite and look at deductible structure more creatively. And many CFOs will be pleased by the results. Why? Because by rethinking your deductible approach, the true concern of the enterprise—losses large enough to impair the balance sheet—can be protected, while the premium component, (the certainty component) of Cost of Risk (COR), can be reduced, or redeployed to increase limits, thereby meeting what should be the real objective: insurance against disaster. You may well find that by restructuring your deductibles, you can buy smart, and buy more, if you should be, for the same overall expenditure.