Liability Underwriting - Beware the X Factor
The rapid growth in demand for Liability insurance in Asia has given underwriters unprecedented opportunity, but what about the downside? Raj Ahuja of EMB says it can be very easy to under-estimate exposures. 
One of the few certainties in our industry is that demand for Liability cover in Asia will rocket over the next decade. This is an aspect of insurance where the North Americans and, to a lesser extent, the Europeans have been the mainstay of global premium spend. That is changing fast.
The driving forces have already been well-documented in this publication and elsewhere: the strong rate of economic growth in Asia; legislative changes; the globalisation of trade, so that products made in Asia are subject to Liability laws of other countries around the world; increased awareness of employee rights leading to greater demands on Employer’s Liability; exposure to D&O and other professional risks in overseas markets, especially the United States; the demands of foreign investors; higher trade volumes.
These factors – and others too numerous to list – have made Asia a continent of opportunity for Liability underwriters. The question is, however, are they fully aware of the down side? And do they have the technical processes in place to ensure that they write profitably?
Over the past few decades American and European underwriters have demonstrated, to their capital providers’ great cost, that it very easy to under-estimate Liability exposures. Once written, apparently profitable portfolios sink under seas of red ink as the initial reserving proves inadequate.
This scenario is not inevitable, but it is an ever-present danger. Part of the answer is to understand the risk that you are accepting, which depends on having the systems to store, retrieve and analyse data. True, the same could be said of any class of insurance, but Liability underwriters have found it more of a challenge to acquire the necessary data than their colleagues in some other classes. This can be even more of a problem in Asia, where the Liability market is younger and less well developed and there is less historical information.
In these circumstances, it is essential to gain access to as much market-wide data as possible; there is generally more of this available than people realise. It is also useful, I would argue, to study market-wide data from more mature Liability markets, such as Europe and North America as a guide to how a Liability portfolio might develop.
Equally important is the way you log your own data. Is it consistent? Is it detailed and is it easily accessible? Can it be used as a strategic management tool? Will it pick up adverse claims developments quickly, and will it do so on a granular basis? In other words, will it flag up specific classes and sub-classes that are running into trouble, rather than just give an aggregate overview?
These may seem obvious questions, but it is surprising just how often even experienced Liability underwriters cannot answer these questions adequately. They probably have the professional skills, but Liability is a far more technically demanding class of business than most others.
What makes the class really hazardous, however, is what I call the ‘X factor,’ which is the tendency for the rules to change after you have written the business. In other words, past loss experience is not a reliable guide to what will happen in the future. Underwriters who ignore the ‘X factor’ will lose money.
One of the most notorious examples of this trend was Superfund, introduced in the United States in the 1980s. Insurers found themselves exposed to all kinds of environmental claims that they could not have anticipated and, worse still, on a joint and several basis. Whilst Superfund is an extreme example, it illustrates how retrospective legal developments can cause claims costs to escalate.
Changes to the law, or how the judiciary choose to interpret the law, can affect insurers just about anywhere and create exposures that underwriters had not factored into their calculations. In the United Kingdom, for example, a court decided that people who receive a lump sum as compensation for personal injury could only expect to earn 3.0% interest annually, whereas previously insurers were allowed to assume 4.5%. Claims costs soared overnight, as did reserving requirements.
You can be sure the same upward tendency will happen in Asia; in fact it has already started. There are clear signs of increasingly litigious environments in many Asian markets, including China, which has seen rapid change in its legal and regulatory climate. Throughout the continent rising expectations and awareness of consumer rights are feeding through into claims and, as affluence continues to spread, we can expect that this will just be the beginning.
Liability underwriters should take account of the ‘X factor’ when pricing their risks and setting terms. It will vary from contract to contract but, in some cases, it is necessary to add as much as 20% to the rating. Such prudent underwriting may lose you business in the short run, but it will eventually pay dividends.
This article appeared in Asia Insurance Review in October 2006