The Condition of the Professional Liability Market

1. The Condition of the Professional Liability Market Brian Turner, FCAS, MAAA, CPCU 2002 CAS Annual Meeting

2. E&O - A Changing Environment • Recent rate increases of 10-20% per year for the last 2 years with more to come • Medium to large carriers pulling out of many lines of E&O • Multi-year offerings have been reduced substantially • First dollar defense and zero deductible offerings are being pared back

3. E&O - Rate Increases Why Now, Why So Much? • Poor underwriting results in late 90’s • Lower Investment Income • Hard reinsurance market • Economic downturn’s effect on loss costs • Certain unprofitable market segments have been subsidized by better performing segments

4. Professional Liability Overview • Drivers of Profitability within a Class • Mix of business - Size of firm • Mix of business - State • Underwriting (in house vs. MGU or similar) • Claims staff expertise

5. Professional Liability Overview • Size of Firm • Large firms demonstrate higher loss ratios • Marquis accounts always see many competing markets; leverage from national brokers • Rating is more flexible on large accounts • Instant production - profitability, a secondary motive • Higher deductibles, harder fought large claims result in longer payout patterns

6. Professional Liability Overview • State by State Differences • Regulatory differences make some states difficult to file rate changes in • Legal environment varies significantly from state to state • State rate relativities often smoothed, resulting in significant loss ratio differences by state • Impact on ILF’s often ignored

7. Professional Liability Overview • Underwriting • In House Underwriting • More control and accountability • Able to adapt to changes quicker • Rate increases • Form changes • MGU or Program Manager • Can work if: • Profitability goals are aligned • Both partners keep expenses down • Black box rating plan is used

8. Professional Liability Overview • Claims Expertise • Dedicated In-House Claims Staff • Most effective in controlling claims settlements and minimizing defense costs • Effective communication between Claims & U/W can prevent problems from perpetuating • Generalized In-House Claims Staff • Maintain control, but lose out a little on expertise • Third Party Administrator or MGA • Lose control, but expertise may be strong

9. Architects & Engineers • Basics • Claims Made Coverage for errors & omissions • Full coverage for pollution, asbestos, mold • Full Prior Acts, First Dollar Defense, and Multi-Year Policies are common • Exposure base is billings • Discipline factors modify base rates

10. Architects & Engineers • Small to Medium Size Firms • Admitted (filed) rates, rules and forms • Specialist firms • 3 year policies still common for the small firms • Average annual premium ~ $8,000 • Typical limits of $500,000 - $1,000,000 • Typical deductibles of $0 - $10,000

11. Architects & Engineers • Large to Jumbo Firms • Often non-admitted for rate and form flexibility • Multi-discipline firms • Design-Build firms • Very high limits - large excess marketplace • Typical SIR’s of $100,000 - $10,000,000

12. Architects & Engineers • Most Hazardous Disciplines • Structural Engineers • Geotechnical Engineers • At-Risk Construction Managers • Least Hazardous Disciplines • Landscape Architects • Land Surveyors • Electrical Engineers

13. Architects & Engineers • Most Common Causes of Loss • Design Errors • Inadequate oversight of construction • Specification Errors • Negligent preparation of cost estimates • Survey Errors (Land Surveyors)

14. Architects & Engineers • Most Common Claimant Types • Owner (will occupy) • Private • State Government • Local Government • Federal Government • Developers (will not occupy) • Contractors

15. Architects & Engineers • Emerging Issues • Economic downturn increases loss exposure • Cost overruns less likely to be tolerated • Fewer projects > More competition > Lower Bids > Thinner Staffing > More mistakes • Mold • Not frequent, but can be attached to the more frequent complaint of leaky roofs/walls • Computer Aided Design (CAD) • Reduced the incidence of design errors, but... • A CAD error can manifest in many separate projects

16. Architects & Engineers • Historical Trends • Exposure Trend • 2% to 4% based on Bureau of Census Implicit Price Deflator (Construction Values) • Severity Trend • Keeping pace with exposure trend • Frequency Trend • Flat • Net Trends seen in recent filings • 0% to 4%

17. Architects & Engineers

18. Real Estate Agents • Basics • Claims Made Coverage for errors & omissions • Coverage for failure to advise (not detect) pollutants, asbestos, lead, radon, etc. • Full Prior Acts, First Dollar Def. are common • Exposure base is # of agents or revenue or some combination of the two

19. Real Estate Agents • Residential Real Estate • Sales, Leasing, Property Managers • Frequency driven - low severity • Claims made by homeowners - often emotionally charged • Frivolous claims lead to high alae costs, often as high as indemnity in the aggregate • ULAE is significant • Short payout pattern

20. Real Estate Agents • Commercial Real Estate • Sales, Leasing, Property Management, Business Consulting • Severity driven, low frequency • Clients demand higher level of expertise, due diligence & professionalism • Commercial plaintiffs have more legal savvy and the financial resource to go the last mile.

21. Real Estate Agents • Most Hazardous Services • Business Consulting/Brokerage • Sales where the agent is also the seller • Residential firms dabbling in commercial real estate transactions • Commercial Appraisal & Property Management • Least Hazardous Services • Residential Sales and Appraisals • Mortgage Brokering

22. Real Estate Agents • Common Causes of Loss • Misrepresentation • Innocent, Negligent, or Intentional • Failure to disclose • Breach of Fiduciary Duty • Fair Housing Violations • Few claims, but usually costly judgements • Antitrust Laws • Environmental Liability

23. Real Estate Agents • Claimant types • Buyers (70-75% of all claims) • Sellers (~20%) • Lessees (2-3%) • Others (2-3%) • Landlords • Other real estate agents • Contractors

24. Real Estate Agents • Historical Trends • Exposure Trend • Varies depending on the exposure base • Revenue trend difficult to determine (my guess, 2%) • Severity Trend • Estimated to be 1% • Frequency Trend • Estimated to be 3% • Net Trends seen in recent filings • 2% to 4%

25. Real Estate Agents

26. Big 5(4) Accountants • Generally reinsurance of captives • Two types of programs • Straight Excess of Loss • Structured Deals • More complex (e.g. aggregate attachment points) • Protect against multiple big losses in same year • A lead (re-)insurer with over 25% share of a layer sets the terms • Covers Attest Services Only

27. Big 5(4) Accountants Top 4 Accountants E&O Claims Top 5 Pending Claims

28. Big 5(4) Accountants • Life After Enron • Public attitude towards accounting firms may adversely impact court proceedings and settlement values. • Is Accountants E&O becoming the UI/UIM coverage for D&O?? • Insurance availability for Second Tier firms is drying up.

29. Big 5(4) Accountants • Where does the audit work go? • D&T acquired 70% of AA’s European Firms • U.S. partners spread out to other Big 4. • Second Tier firms not seeing much. • For a summary of defecting accounts go to http://www.forbes.com/2002/06/28/0627andersen.html

30. Conclusion • Recent E&O rate increases are: • Certainly justifiable • A few years overdue • Insufficient in many cases • Profitability in this hardening market: • Must meet stricter targets • Is not automatic - must still find the profitable market segments