This article was originally published in February 2018.
When I first started putting together professional liability policies I, like everyone else, would start to build every policy from the same template. I would then tailor the coverage for the profession I was dealing with and then adjust the final wording and structure to suit the particular client. Every client ended up with, if not exactly a unique policy, a policy tailored specifically to their needs.
Today, thanks to the internet, professional liability insurance is easier to buy than ever and broad coverage is readily available to most buyers. But as is often the case, that doesn’t tell the whole story. Since I started in the industry, business, businesses, risks, and risk management have all become more complex and they now also change faster than they used to. At the same time, however, as insurance has become ever-more competitive, most insurers and brokers have simplified their business models to focus on commoditized product sales.
The resulting compromise for a buyer is a familiar one; easy to buy insurance but untailored coverage or tailored coverage but a more complex buying process…?
For insurance buyers (and their brokers or consultants) with new, complex, unusual, hard to manage or distressed risks, where commoditized (untailored) coverage just doesn’t give the buyer what they need (we estimate about 10% of buyers), whether to compromise isn’t a factor; the ‘design’ approach is their only option.
This post is the first in a series designed to de-mystify the design process. It is not that the process is complex in and of itself; it just isn’t as ‘easy’ as either of the commoditized approaches. The descriptions focus on process rather than details; we cannot describe for all possible needs but we hope that buyers and their brokers will develop comfort with the design process by reading this series.
This first post compares the design approach to the other 2 most common ways of buying professional liability insurance and explores who (the 10%) might benefit from designed insurance coverage.
Professional liability is generally bought in one of three ways:
1. “Off the shelf”
We estimate that 60% of professional liability insurance buyers take the ‘off the shelf’ policy they are offered. This works for most firms most of the time. This is because most firms buying professional liability coverage reasonably expect never to have to use the coverage. They mainly buy the coverage because customers expect them to have it – and may even require them to demonstrate that they have it. To clarify, in a typical professional liability portfolio, maybe 1% of insureds will notify a potential claim in a given underwriting year, and maybe only 30% of those will actually need a payment in excess of their retention to satisfy a claimant. As a result, buying coverage designed for the mean of a target market is often the simplest, quickest and cheapest way to buy acceptable professional liability coverage.
2. “Spreadsheeting”
30% (we think) of buyers take a more proactive approach to tailoring professional liability coverage, to ensure it is appropriate for their circumstances – often using a broker or consultant to help them. The process of tailoring coverage most often involves ‘spreadsheeting’ the terms on offer. ‘Spreadsheeting’ means assessing the terms on offer compared to a list of possible adaptations to an ‘off the shelf’ policy. A problem that can often arise is that the resulting tailoring, which can certainly produce broad and competitive terms for most buyers, usually reflects what the broker or consultant have achieved in previous market negotiations. And so, because the reference points are the ‘off the shelf’ policy and previous broker or consultant success in the market – and not necessarily the specific needs of the buyer – the resulting terms may not always be as appropriate for the buyer as they could be, even though some of the adaptations are fiercely negotiated.
3. “Design”
The third, and least frequently (10% of buyers) used approach, is to design the policy, either for specific details or entirely, from scratch. This approach is most often used where the buyer has unusual (and maybe even unique) or novel exposure. It is also necessary where the buyer has had or expects in the future to have claims as an inevitable result of the nature of their activities. It can also be a helpful approach where the buyer’s business model is sufficiently regularly subject to change, such that only a constantly re-designed policy will work for them. Another reason can be that, as far as the buyer is concerned, the reputation or disruption risks of their professional activities are as great – and maybe greater – than the financial risks. The ‘design approach’ takes longer than “spreadsheeting” and is more complex but the result should be broad coverage that meets the buyer’s needs and is highly competitive; for the right buyer, the time and effort are well rewarded.
Some of the reasons you know you will need to look at a design approach are:
- The coverage offered by the market – whether “off the shelf” or “spreadsheeted” – contains material gaps in terms of, for example, the activities undertaken or the possible types of claim that could be made;
- The amount of coverage available from the market is inadequate for the potential severity of claim that could be made;
- The frequency and/or severity of past or potential future claims are outside the expected range of your peers. You will know this if coverage is denied or the terms offered are spectacularly unattractive – as a guide, the premium is (say) higher than 5% of the sum insured;
- You want to incorporate a captive into your insurance program;
- As a buyer, you want to realistically test how well your broker and the market have understood and responded to your needs or, as a broker, you know your client expects and/or needs a tailored approach that the standard market cannot respond to;
- You have in-house claim handling ability that exceeds what an insurer can offer – maybe because you ‘do this every day’, your field is particularly specialized, or you are geared up to handle the nature or volume of claims more effectively than any third party;
- Your claims are a key ingredient in your business model – for example, you operate at the edge of what is feasible in your field and need to intimately understand risk in all its complexity – and work with your insurer accordingly – to deliver your own services effectively; or
- Your risk is low frequency but evidences potentially ruinous severity – to the point where you cannot prudently delegate responsibility to handle claims to anyone else.
In future posts, we will explore:
Part 2 – Setting objectives
The critical, initial stages of the insurance policy design process – understanding the buyer, their risk and the relationship they have with their risk
Part 3 – Choices, choices…
The main choices that must be made in designing professional liability insurance
Part 4 – Going to market
How to approach the market so that it delivers the designed insurance
Part 5 – The long-term
How to maintain designed professional liability coverage over the long term, as – inevitably – you, your risk, your risk management, your insurer(s) and the environments in which all of these operate change over time
Note: This series of posts concerns the design process for one company’s professional liability policy. We use professional liability to demonstrate the process because it is the most common policy we design. We use the same process for every policy we design.
Disclosure: We specialize in designing insurance policies. In addition to professional liability, we also design – for example – sexual abuse liability, cyber, employment practices liability, financial institutions and crime coverages.