A soft reinsurance market is looming, and with it come fears of a rise in claims disputes as underwriters take bigger risks to drum up new business. We warn of the need to stay focused under pressure
While the spotlight has traditionally shone brighter on the claims sector during a hard market, history has shown that a soft market can present opportunities – and challenges – to reinsurers when it comes to avoiding problematic claims and contract disputes. As the sector is faced with a pending soft market, the big question is: what can reinsurers do to avoid the common pitfalls of past cycles?
This need for sharper focus on claims was highlighted in October by Lloyd’s performance management director Tom Bolt, who announced that, having tackled underwriting discipline with its franchise performance board, Lloyd’s will now be paying similar attention to claims as market conditions get tougher.
The aim is to “build a claims reputation that is as strong as our underwriting reputation”, Bolt said recently. “A homogenised or ‘one size fits all’ approach to handling claims, regardless of simplicity or value, is no longer appropriate,” he added.
Undoubtedly, the arrival of a soft market brings a number of challenges for claims departments. In the past, soft markets have triggered a rise in contract disputes because of looser wordings in those periods. Barlow Lyde & Gilbert partner Clive O’Connell has pointed out that, since the 1970s, “every soft market has given rise to a flurry of disputes caused by underwriting or broking indiscipline”.
In addition, the rise in recession-related claims from clients, together with softening prices and lower premium income means that reinsurers need to become more vigilant about ensuring that they pay out exactly what they owe on claims.
“When times become tough and the market is soft – coupled with lower investment returns and less of an ability to release further funds from reserves – reinsurers naturally look to save money elsewhere, including via disputes that would otherwise have been resolved,” Herbert Smith partner Christopher Foster says.
According to Clyde & Co partner Nigel Brooke, the past five years have seen a decline in contract disputes because reinsurers have favoured maintaining healthy commercial relationships over a hard-line claims approach.
But he predicts that, as certain reinsurers start to exit certain markets because of poor rates, these relationships will decrease in importance, leading to greater scrutiny of the claims process. “I think reinsurers will be looking more carefully at claims than they would have done,” Brooke says.
Outside the comfort zone
So why does the soft market generate problems for the claims sector, and what can be done about them? Legal experts warn that one of the main problems reinsurers face is that as underwriters come under increased pressure to win and retain business, they may be tempted to write looser wordings on policies.
Dewey & LeBoeuf managing partner (London) Peter Sharp warns that underwriters may be encouraged to offer more favourable terms to hit premium targets.
He adds that reinsurers can also be tempted to write new classes of business or enter new markets that they have relatively little experience in to drum up more premium. “In a soft market, reinsurers can be persuaded to underwrite some novel or unusual risks outside their comfort zone and they get it horribly wrong because they don’t understand it,” he says.
In fact, Sharp points out that the current soft market has already given rise to such practices and warns: “Reinsurers should maintain their technical underwriting discipline at all times … and not give in to the temptation to write business on uncertain or inadequate terms, because it will come back and bite them. History shows us that it always does.”
But in a soft market, reinsurers can often be caught in a Catch 22 situation. While looser wordings can lead to problems in the long run, a hard line approach on policy wordings can leak business in the short term. “In a competitive marketplace, if you are seen to exclude more perils, that has potential commercial ramifications if there are other policies out there that offer broader cover,” Alterra’s claims director Rob Turner explains.
Choose words carefully
It seems that now, more than ever, reinsurers need to be vigilant about the quality of their wordings. Law firm Elborne Mitchell partner Edmund Stanley believes that the sector needs to take note of current trends in litigation and case law.
He points to the recent controversial ruling in the employer liability trigger litigation case, which challenged the traditional understanding of which policies respond to asbestos claims, as an example of how insurers can fall foul of poor wordings.
“At the moment, there is a tendency in the courts to look at the literal meanings rather than at the commercial background,” he says. “That is one lesson: people shouldn’t necessarily think they know what something means just because that is what it has always meant in the past,” he warns.
Part of the problem is that the sector suffers from a dearth in expertise when it comes to writing the wording of policies. Consequently, as Beachcroft partner Julian Miller points out, while there have been improvements in the formulation of policy wordings in recent years, terminology inconsistencies remain in the marketplace.
“There is some way to go with wordings. The difficulty is that it requires enormous skill to do wordings and it hasn’t always been adequately resourced by insurers. The people doing it haven’t always been the most experienced members of the team. There has been progress in this area but there is more yet to be made,” he says.
In addition to developing more claims expertise, legal commentators believe that there needs to be greater interaction between underwriters and claims departments.
“There needs to be a joined-up process, where the experience of the claims department is communicated to the underwriters, so that the implications are taken on board by the underwriters. The drafting of the wordings is an adjunct to the underwriting process,” Miller says.
He adds that it is helpful if underwriters spend time in claims departments as part of their training to foster a greater understanding of the relationship between underwriting and claims.
O’Connell notes that reinsurers, in addition to maintaining careful underwriting, should keep records of conversations, models and calculations and above all “avoid deals that are too cheap”.
Legal experts also urge reinsurers to be more determined about pursuing subrogated claims, a practice that can often be neglected during hard markets. “I think reinsurers need to be more vigilant and more assertive about pursuing subrogation rights where they have them,” Sharp says.
But while the soft market can create future challenges for claims departments, the current marketplace is better placed to meet these than in the past and is arguably in a better position to throw a sharper focus on the relationship between the claims and the underwriting departments. “Checks and safeguards are in place, and an underwriter is no longer a law unto himself but must report every risk to be scrutinised,” O’Connell notes.
He warns, however, that reinsurers must continue to err on the side of caution and avoid the hazards of the past. “It is fair to say that the market is well placed to face a soft market. It must also, however, be recalled that in 2008 the banking industry was subject to regulation, rating and enterprise risk management. These were not sufficient to protect that industry from catastrophic failure.”
It seems that the challenge for reinsurers is to ensure a compromise between its underwriting discipline and its claims departments during a soft market because, ultimately, it is this balance that will protect against problems in the future. GR