Is the cost of insurance worth it?

Whether it's protection against property loss, cyber attack, weather damage or D&O liability, the risk of being underinsured could far outweigh the costs.

Prices for general insurance are increasing sharply and are likely to keep rising thanks to the impact of the COVID-19 crisis. Side C (securities class action cover) directors and officers (D&O) insurance is now so expensive that many companies are considering whether it is worthwhile, insurance industry figures say. The insurance market is in “a hardening cycle” where prices are rising, says Robert Kelly, co-founder and managing director of Steadfast, Australia’s largest general insurance broker network.

It’s the combination of several years of underpricing by insurers trying to gain market share and some significant disasters — including the bushfires that swept through large parts of Australia last summer — and the COVID-19 pandemic.

Paul George, managing director of MGA Insurance Group, says COVID-19 has been a powerful catalyst to the pressures on the general insurance market, parts of which are now in crisis, particularly property. “We as brokers need to sit down with customers in certain areas, or who have certain businesses with certain construction,” he says. “We have to say to them: ‘I’m sorry, we can’t get insurance cover for you for the risks you present’.”

Compounding pressure on insurers is the current low-yield, low-interest rate environment on their reserves. “Low interest rates mean that insurers can no longer rely on their investment returns to bolster unprofitable results,” said Kirsty Owens, national portfolio manager SVU at Berkley Insurance Australia, in a note to clients. “When interest rates are low, insurers focus on underwriting profitability, which means raising premiums, tightening underwriting guidelines and being more selective about risk.”

The net result is that general insurance premiums are rising sharply. Global commercial insurance prices rose 20 per cent in the third quarter of 2020, the 12th consecutive quarter of price increases, according to the Marsh Global Insurance Market Index. The third-quarter rise in pricing was the largest year-over-year increase in the index since its inception in 2012.

Property

The price of property insurance has risen sharply, particularly in regional areas with a high fire risk, such as the ski fields of NSW and Victoria, says MGA’s George. “Someone who might have been looking at a $25,000 premium last year might be looking at a $300,000 one this year,” he says. “That’s almost like a walkaway price. There is certainly significant underinsurance there and it’s not for want of trying.”

Properties in cities aren’t exempt from high prices, either, with insurers becoming increasingly concerned about flammable insulation or cladding. Additionally, some insurers are raising the deductibles — the business insurance equivalent of an excess — so high, or putting so many conditions on the cover, that it becomes commercially difficult for companies to commercially accept the terms.

Any business with a large property asset base would be advised to get an up-to-date risk survey, so insurers can assess the buildings to provide them with the best possible outcome, says George. In fact, most insurers won’t even consider insuring a property without a risk survey.

Steadfast’s Kelly says that when company directors think about property insurance, they need to look beyond the cost of the physical damage alone and also consider the cost of loss of goodwill. A fire, for instance, can stop a business’ operations for months, paving the way for a competitor to steal market share. “People should look at not only the physical impact of replacing the building or the affected goods, but the impact on the goodwill of the company,” he says. “Give some thought to whether they should attempt to quantify what that [goodwill] is and make sure they’re protected for that as well in the event of a material loss.”

Lynette Schultheis, Australian operations manager of insurance mutual FM Global, told a recent Company Director roundtable that business owners with a sharp eye on expenses can do much to manage risks by taking proactive steps to prepare and protect their property. “Everybody is looking at their expenses, but there are so many things a business can do to prevent or mitigate the loss from natural catastrophes — whether that’s a bushfire, or a flood — it’s very low-cost.”

She said it can simply be a matter of looking at physical risks around buildings, cleaning out gutters reducing combustible loading, and moving ignitable liquids to a safer area; or for flood, to elevate expensive equipment. “It’s not very complicated, you might think a lot of it is common sense, but you’d be amazed how many people don’t take that precautionary measure.”

Business interruption

When the COVID-19 pandemic broke out, many insurers argued it was excluded from business interruption policies. However, a test case in the NSW Court of Appeal found that the exclusion of interruptions caused by “quarantinable diseases” was invalid. Many of these policies mistakenly referred to the Quarantine Act 1908, which was repealed in 2015 and replaced with the Biosecurity Act. The court found. IAG, Suncorp and QBE were among the insurers to make the error and have had to raise more capital from investors.

“All around the world, the pandemic has caught insurers out completely — they’ve not been pricing for this,” says Kelly, adding that the judgement certainly won’t help prices come down. “What the insurers have been handed is a flaw in the policy, which means the consumer is getting a free ride on coverage that was never priced when it was sold to the consumer.”

The result is that business interruption coverage will be more difficult to obtain and more expensive.

Project delays

Project delay insurance is similar to business interruption, but covers losses arising from project delays in the construction sector. Like business interruption, it remains available in the market, but is costly. “It’s a class of insurance that is expensive to buy and difficult to claim on because there are various triggers that are required to have access to it,” says Kelly.

Political risk

There is a growing interest in insuring political risk thanks to Australia’s deteriorating relationship with China, which has resulted in problems such as Australian coal ships being prevented from unloading or live lobsters sitting unprocessed on Chinese docks. Political risk, a subset of marine cargo insurance, insures against political interference in the landing and distribution of a product at its destination. “It will become expensive, but people will want to get it because of the fear of products dying or wilting on ships,” says Kelly.

Cyber risk

COVID-19 has exacerbated cyber risk, says Kelly Butler, Pacific cyber practice leader at Marsh. “The pandemic saw a rapid shift to remote working and overall internet user traffic, which also came with the rapid uptake of outsourced technology,” she says. “As a result, organisations are further exposed to potential attacks.”

Marsh has noted a significant upturn in supply chain attacks and ransomware activity. International victims have included engineering, pharmaceutical, metals and chemicals companies.

In Q3 of 2020, cyber insurance premiums continue to increase, many between 10–20 per cent. A Standard & Poors report in September predicted cyber insurance premiums, which now total about US$5b annually, will increase 20–30 per cent per year on average in the near future.

Weather events

Relatively new to the market, but growing in demand due to greater frequency of extreme weather events, is parametric weather insurance, according to Liberty Specialty Markets. The mutual provides customised insurance solutions to protect businesses from the impact of such events.

Michael Lincoln, Liberty’s vice-president crisis management Asia Pacific, says the trigger for these covers are conditions such as temperature, wind, rain and humidity, as measured by the Bureau of Meteorology (BOM).

“We’ve worked with a wide range of industries including cyclone cover in North Queensland, heatwaves impacting retail outlets, bushfire cover for forestry, property risks, rainfall and flood cover for construction companies, and bushfire smoke taint for wineries,” he says. “A key advantage of this kind of policy is how fast payments can be made. Once the weather event has been confirmed by BOM, we can make the claim payment.”

D&O Insurance

The price of D&O insurance continues to surge to the point where some companies are considering whether they are better off doing without some cover, says Craig Claughton, MD and head of FINPRO at Marsh.

Following rises of 100 per cent in previous years, the price of D&O insurance has risen by about 200 per cent in the past year. “To say it’s gone through the roof is an understatement,” says Claughton. “It’s really starting to hit the pain threshold.”

Where a company might have previously spent perhaps $1m–$3m for its cover, Claughton says they are now looking at having to spend $15m–$20m. But they are actually receiving less for their money. Claughton says insurers are placing lower limits on the total sum insured.

Deductibles or excesses for D&O policies have also risen through 2020 and are higher than they have ever been. For instance, where a company might have had a $2m or $5m deductible, some are now faced with a $10m, $20m or $50m deductible. “Not only are they having to pay more for this product than ever before, they’re also having to take more of the risk themselves,” says Claughton.

“There’s all this money going out the door for not that much protection.”

It will mean a rethink of D&O strategy for many Australian companies, which in the past were prolific buyers of D&O cover because it was cheap and readily available and because of concerns about Australia’s relatively onerous continuous disclosure regime. Some are considering wither they would be better off managing the risk internally and doing without insurance.

“That’s the conversation we’ve had with virtually every listed company this year,” says Claughton.

Many companies are deciding to go without Side C cover — insurance typically purchased by a publicly listed company to insure against liabilities arising out of securities market conduct breaches — and just insure to protect the individual directors and officers from legal action, known as Side A cover.

“An insured doesn’t have a great lot of motivation to take Side C cover. It’s almost like they are giving the insurers a free kick,” says Claughton. “If insurers keep going the way they are — increased prices, higher deductibles, lower limits — clients might have no option but to revert to buying Side A cover only.”

The likelihood of a Side A claim is much lower as the policy is only triggered where the company cannot grant a director an indemnity for certain actions or if the company is insolvent and can’t fund the defence of an action against a director. Even so, says Claughton the pricing of Side A cover alone “is all over the place”. Some insurers are charging 70 per cent of the total premium cost for Side A alone and others are charging 50 per cent, but in reality they should be charging 20–30 per cent, he says. Much of the rise in premiums is because companies undercharged in the past and are now having to make up the difference to cover the long-term liabilities D&O policies typically incur.

When it comes time for a company to renew its D&O policy, Marsh suggests that directors go right back to the beginning and ask themselves why they are buying a D&O policy and what they want the policy to do. It may be for balance sheet protection, or profit and loss protection, or to protect the individuals.

“These questions are quite confronting for a lot of boards and a lot of executives or risk managers who are putting these covers in place, because what the executives and risk managers think is quite different to what the board thinks,” he says.