Demand for D&O and Professional Indemnity cover in Asia is certain to rise, but how do you price these risks in such a rapidly changing environment? The question will be a critical challenge to underwriters, says Raj Ahuja of EMB.
It is only a matter of time before Asia witnesses a boom in the D&O and Professional Indemnity (PI) markets similar to those already experienced in the United States and, more recently, in Europe. The question is not whether it happens, but what form it will take and what eventually triggers it.
For underwriters, the prospect is one of enormous opportunity and, with it, the hazards that you expect when writing volatile, hard-to-measure classes of business. It is very much in the interests of Asian underwriters to learn from the experiences and mistakes of their counterparts in the United States and Europe.
This article will consider how you rate risks when, because of the immature and fast-changing nature of the market, they are very difficult to model. It concentrates on D&O, though the underlying principles work equally well for PI.
Asia accounts for an estimated $100 million of annual premium spend on D&O. According to Aon, demand has risen partly in response to the amount of new capital being raised on the Chinese and other stock markets and the resulting need to protect directors from exposure to shareholder law suits. Nonetheless, Asia still represents under two per cent of the global D&O market, much less than the continent’s overall contribution to the global economy. It will not remain that small indefinitely.
All around Asia, jurisdictions are introducing sophisticated corporate governance regulations designed to set standards and make firms transparent and accountable. Companies, meanwhile, are becoming larger and exposed to risks outside the region, especially the United States. In other words, the potential D&O exposure is already in place.
So why has the market not taken off? It is partly a question of mindset. It is not the traditional Asian way to sue when things go wrong. D&O claims can come from many sources, including employees and regulators, but let’s consider shareholders by way of example. The Japanese stock market collapse of the 1990s might have led to a spate of shareholder class actions against directors if it had taken place in, say, the United States.
By the same token, most directors of Asian companies would not think it right to buy insurance to cover their own bad decisions. Although risk managers may suggest the idea, it is simply not the way that Asian boards think. In the United States and much of Europe, by contrast, many actually demand it. Without D&O provision their firms would find it much more difficult to recruit or retain directors.
Partly no doubt as a result of differences in culture, there have been relatively few D&O claims in Asia, despite a few recent cases in South Korea, Singapore and Australia. This lack of activity is making it much more difficult for insurers to interest their clients in purchasing cover.
It may, perversely, be in the interests of underwriters to pay out on their D&O policies if that is what it takes to kick start the market by demonstrating the value of their products. Alternatively, directors may eventually do their sums – perhaps driven by European and American experiences – and regard D&O as a prudent form of protection. After all, we are in a global economy and many of their shareholders will come from countries with a less tolerant approach towards failure.
When the demand for D&O does eventually take off, it is going to present underwriters with an interesting dilemma. How do you price risks that you cannot easily model, at least not by conventional methodologies? Even if there is a claims history, it is likely to be patchy. Past experience will, in any event, be an unreliable guide to what might happen in future because the regulatory environment is changing so rapidly.
The one thing that insurers must avoid under these circumstances is to rely solely on instinct and flair. Without the benchmarks that modelling provides, undisciplined underwriting is almost unavoidable. At worst, it will lead to a scramble to chase prices down to disastrous levels. This is more than just a theoretical possibility, as the experience of London and US-based D&O underwriters in the late 1990s demonstrates. Modelling may be difficult, but it is still essential.
Most insurers recognise the need to find out as much as practical about their potential clients before quoting prices and terms. Examine their internal checks, procedures and reporting structures, assess the quality of their people and get a feel for corporate culture. Ask about the steps they have taken to identify and then reduce their largest D&O risk exposures. Perhaps even create a scorecard that measures compliance with best risk management practice. The exchanges where the shares are listed remains a vital consideration for some companies as is the extent of concentration in the shareholder register.
Underwriters should consider, in addition, benchmarking Asian corporations against European claims experience. The advantage of this type of exercise is that you can exploit data from a more mature D&O market. Of course, you must also take into account Asian and country-specific conditions, as well as the individual characteristics of the corporation being rated. Once you have done so, you will have assumptions upon which you can base your modelling and underwriting.
Such an approach will provide underwriters with the guidelines needed for a disciplined approach to D&O, even where claims data would otherwise be inadequate. It will enable management to create a strategy consistent with their appetite for risk and desire for market share and the level of capital allocated internally to D&O. The model can then be modified over time as the insurer acquires more data based on Asian experience, which will test the assumptions made at the outset.
D&O may be an exciting prospect for insurers in Asia, but it still requires a hard-headed approach to underwriting.
This article appeared in Asia Insurance Review in January 2006
