General Liability Trends: Captive Insurers Beware

General liability, which has long been a staple business line for captive insurers, is starting to show some troublesome development trends. In a recently released white paper, titled P&C Industry Data Shows Deteriorating Trends for General Liability, Milliman looks at what this means for insurers. We think it would be beneficial to highlight some of the findings from the report and examine their potential impact on the captive insurance industry.

The National Association of Insurance Commissioners notes the majority of captives provide coverage for business, including general liability, product liability, professional liability, auto liability, and directors and officers liability. For many captives, these lines have proved to be profitable from a strict underwriting sense (i.e., premiums collected cover the costs from losses and the expenses associated with handling those losses). While we were unable to locate reliable data concerning the actual premium volume of general liability underwritten by captives, estimates indicate it could approach 30 percent or more of total premiums. Whatever the actual amount is, if losses are starting to accelerate, captive insurance companies need to be aware.

The Milliman authors note, "The US property and casualty (P&C) insurance industry as a whole has experienced significant deterioration in loss ratios for general liability in calendar years 2015 to 2018." As shown in the report, in 2014, the industry reported a loss and allocated loss adjustment expense ratio of 61.8 percent. By 2018, that figure stood at 74.9 percent, an increase of 13.1 points.

According to the report, the major contributors to this development were the extension of statutes of limitations for sexual abuse claims, opioid litigation, and increased awards from juries, which led to an increase in the severity of claims. For the most part, captives probably have fairly limited exposure to the opioid trend; however, they are less immune to sexual abuse claims and especially to the overall increase in claims severity.

Milliman questions whether the industry has booked sufficient loss reserves in prior years to sufficiently account for these trends or if there will be a need to continue to strengthen reserves in older accident years. On this count, Milliman seems to be pessimistic and believes the industry may still be behind the curve in booking the necessary reserves. If so, loss ratios will continue to climb.

With regard to the increase in severity, Milliman notes four trends it believes are contributing to the problem, as follows.

1. Medical costs. Medical cost inflation has always been a driver of claims severity. However, for a period of time, medical cost inflation seemed to have slowed, rising closer to the overall general inflation trend. That is no longer the case due to advances in medical technology and the cost of prescription drugs. Neither of these factors shows any signs of slowing, which will only lead to increases in both frequency and severity.
2. Litigation funding. This is a relatively new development where outside investors are willing to provide the capital in order to pay plaintiffs legal fees in exchange for a percentage of any settlement or judgment. In the past, where plaintiffs were open to settlement prior to trial, the advent of litigation funding has led more to be open to going to trial. With the guarantee their fees will be paid, plaintiffs' counsel is also more amenable to pursuing a jury award.
3. Increased jury awards. This factor really needs no explanation. As a society, we have come to believe that someone has to pay, which leads to higher awards and the addition of increased noneconomic damages to the claims.
4. Traumatic brain injuries. With increased awareness of this danger, these injuries are now alleged more frequently than in the past even in minor slips, trips, and falls. Coupled with item 3 above, this then leads to an increase in estimated future medical costs and larger claims payouts.

From our perspective, captive insurers should take a proactive approach to this problem. Here are some basic suggestions for how to go about addressing this issue.

1. Open a dialogue with your actuary. Ask the actuary about the impact on your own book of business and what the actuary is seeing with other clients.
2. Listen to your actuary. If you only update your actuarial calculated reserves annually, consider doing a midyear analysis. If the analysis shows the need to increase reserves or recommends an adjustment in pricing, do so. The quicker you deal with the problem, the better you will be in the long run.
3. Consider lowering your retention or deductible amount and increasing your reinsurance. Again, your actuary and reinsurance broker can help you do a cost-benefit analysis to determine whether this option makes sense.
4. For group captives, make sure you are pricing your members' risks appropriately. One-size-fits-all pricing is especially dangerous in periods of increasing frequency and severity. In essence, your best-performing members are subsidizing your poorer-performing members. You risk adverse selection as good members seek better pricing options elsewhere, which will only compound your problems when they depart. If you are individually pricing each member, make sure it is priced accordingly.

Unfortunately, this is a trend that shows no signs of disappearing anytime soon. It may take several years or more to fully adjust pricing and reserves to reflect the development we are now seeing in general liability. For captives, stay vigilant and be proactive.