A rise in Brokers’ Errors & Omissions premiums presents a hard market to tackle
Brokers’ Errors & Omissions (E&O) insurance premiums are dramatically on the rise, with some industry commentators citing three and even four-fold rate increases in recent months. Here, we consider the main drivers of this rapid market adjustment; specifically, whether these changes are principally a function of the coronavirus pandemic, or instead caused by pre-existing cyclical factors that have left premiums vulnerable to dramatic repricing. Anecdotal evidence indicates that the pandemic has catalysed, rather than caused, this hardening of the E&O market.
The FCA (Financial Conduct Authority) test case
The recent judgment in the FCA’s business interruption insurance test case held that some, but not all, disease outbreak and prevention of access/public authority wordings cover losses as a result of the government’s lockdown measures. There will inevitably be a raft of E&O claims against brokers, whereby disgruntled insureds seek damages to recoup their uninsured losses, which they will say ought to have been insured. Whilst such claims may be difficult to pursue, defending them will be costly and time-consuming for brokers. Those costs may engender a further hardening of the market but only time will tell. The FCA and some insurers have lodged their Notice of Appeals and permission to “leapfrog” applications to be heard at the consequential hearing on 2 October. Some insurers may await the outcome of an appeal before determining policy cover.
The market cycle
Many commentators consider the predominant driver of the sharp repricing largely to be a long overdue adjustment to premiums that had been “too cheap for too long”, as described by Sean Finnegan, a retired insurance broker formerly of Arthur Gallagher. Intense competition and aggressive pricing from new entrants to the market appear to have led to artificially depressed prices that did not adequately compensate insurers for potential losses. Mr Finnegan considers that the fight for market share led to unsustainable deals which saw insurers experiencing large losses. In the wider market, the underwriting disciplines and controls of some insurers have, in Mr Finnegan’s view, become too lax over the last 10 years. This factor, combined with a decline in the quality of advice provided by some brokers, have been catalysts in the increasingly poor performance of E&O business. Consequently, a number of insurers have withdrawn from the market. Capacity is now scarce and that triggers premium increases. Soft markets often lead to a “knee jerk reaction” which make “premiums rocket and cover becomes more restrictive.” Mr Finnegan’s sentiments are corroborated by historical patterns which show that hard markets tend to occur abruptly, often sparked by a significant domestic or global event and can recover just as quickly. It therefore seems unlikely that rates will quickly revert to the low and arguably unsustainable pricing of the recent past.
Lloyd’s of London Remediation Plan
It has also been argued that the Lloyd’s of London (Lloyd’s) recent Remediation Plan was one of the first triggers to bring about a flurry of change within the market, culminating in a harder market. The Remediation Plan aims to consolidate insurance cover and apply a stricter approach to loss-making syndicates. This has possibly resulted in Lloyd’s being less active in the E&O marketplace. This performance review has been a driving force for businesses to analyse their portfolio, make cutbacks in necessary areas and exit the market altogether, depending on their underwriting losses. Syndicates that have remained active were asked to provide an action plan to ensure viable profits moving forward. Accordingly, the market’s loss of capacity has enabled many syndicates to increase premiums due to lack of competition in the market.
Many E&O policies are up for renewal at the beginning of October which will bring about further challenges in this shrinking market. Technology provider Acturis has reported that, on average, E&O premiums have risen 21% year-on-year with a particularly noteworthy spike in the second quarter of this year. It is expected that this will grow even further in the third quarter. Brokers are anticipating that professional firms with turnovers of £50-100 million will be confronted with premiums increasing by 40% minimum. If brokers do not proactively explore their options ahead of their renewal date, they risk being left uninsured or insured on less favourable terms.
Tom McGrath CBE, an expert witness in insurance disputes, believes that, as brokers’ clients increasingly prefer an “all price and no advice” approach, brokers need to be prepared to come under additional scrutiny. The implication here is that brokers are focusing on obtaining business and maintaining existing clients through competitive pricing. To avoid liability consequences, brokers should look more closely at policy wording and actively explain to policyholders what the terms mean and their consequences. In addition, they need to be alert to the burden which the Insurance Conduct of Business Sourcebook and Insurance Act 2015 places on them in relation to selling unsuitable or poor value insurance products. A widespread failure to do so may lead to a further hardening of the market.
Australia is seeing a similar, if not worse, hardening of market conditions. Given the pandemic’s global reach, it is of little surprise that UK market trends have been mirrored on the Australian E&O market. It is reported that rate increases in Australia are between 50-100%, eclipsing the average London rate increase predicted by Acturis. Similarly to the UK, Australia has experienced a decade of soft and arguably unsustainable rates. Alongside this, an increase in the number and severity of E&O claims in the construction sector has contributed to a rapid change in the E&O market over the last 12-18 months.
These changes, in combination with the global pandemic, have encouraged insurers to consider infectious disease exclusions in business interruption policies. Last month, an application, similar to the FCA test case, was filed in the Supreme Court of New South Wales (NSW) and the case has now been referred to the NSW Court of Appeal. This should provide clarity around whether infectious diseases exclusions can be relied upon, since coronavirus has been classed as a human disease under the Biosecurity Act 2015 (Cth). The case has been actively supported by the Insurance Council of Australia (ICA) and the Australian Financial Complaints Authority (AFCA). The hearing is listed for October 2020 and will hopefully provide guidance which can be applied across the industry. As with the FCA test case, the outcome of this case may have a material impact on any claims brought against brokers.
The US market’s approach to E&O insurance varies across states, but the law generally imposes a high standard of care and due diligence on brokers when arranging insurance products. That places an additional pressure on them when discharging their obligations and seeking cost-effective E&O cover. Although many management liability lines are likely to be affected as a result of the pandemic, the US E&O marketplace appears to have been less impacted. However, this may simply be evidence of a delayed reaction to the global insurance crisis. At present, it is too early to assess the severity of any hardening of the market.
Overall, it is predicted that the global E&O market will continue to contract and harden throughout 2020. Brokers can attempt to minimise the effects of a lingering hard market, and reduce the potential for loss, through early and careful preparation of their own PI insurance renewal documentation. Brokers can also reduce their long term exposure to future increases in E&O premiums by ensuring consistently thoughtful communication with policyholders and confirming that policy terms align with their clients’ assessment of risk.