Outside on the Professional Liability Playground

The PLUS 17th Annual International Conference held in San Diego, Calif., Nov. 3-5, opened with an insightful panel discussion of well-known “outside the industry” professionals who routinely play the game of professional liability insurance.

The panel, titled “Outside Perspectives on the Professional Liability Insurance Industry,” was moderated by Tom Baker, Connecticut Mutual Professor of Law and director of the Insurance Law Center, and offered viewpoints from the worlds of regulation, finance, defense and plaintiff litigation.

Baker began by probing the panelists on the topic of financial strength and the industry’s long-term ability to attract viable financial markets to subsidize an industry that historically yields poor performance on returns on capital.

The topic is something that has often amused financial investor and panelist Leandrow S. “Pedro” Galban Jr., vice chairman of Credit Suisse First Boston and co-chairman of Global Insurance in the Financial Institutions Group in New York City. “While this is going to continue to happen,” Galaban said, “it’s going to get harder to do.”

Galban inquired, “Are we at a point where underwriters that are going into a soft market will exercise some strength and discipline?” The question is certainly nothing new and has been asked countless times.

Panelist Dave Diehl, deputy commissioner of the California Department of Insurance, said “the industry” must look at this dilemma from a team perspective. “We are all in this together,” he said. Diehl, a 30-year veteran who has worked for four other state insurance departments (North Carolina, Washington, Colorado and Maryland), said the blame lies on the overall industry, not just one particular segment.

“If good things happen, they happen to the insurance industry,” Diehl said. He reminded the audience when negative publicity strikes–such as the recent investigations on broker compensation–it happens to the entire industry. “We’re in this together and we need to focus on being proactive versus reactive.”

Diehl, who has also held numerous positions with various insurance companies, said contingent commissions have been around at least as long as he’s been in the business, 30 plus years. “But what we need to look at is the practice itself bad or are there a few bad apples.”

Representing the defense side of the professional liability civil litigation landscape was Gandolfo V. “Vince” DiBlasi, a partner at Sullivan & Cromwell. As one of the leading defense lawyers in major securities, banking and commodities litigations, DiBlasi, told the audience from his perspective the directors and officers (D&O) marketplace has “a fundamental product design flaw.”

The problem DiBlasi said is that in many cases the coverage that currently exists in D&O doesn’t come close to offering adequate protection for the damages that could conceivably be proven by plaintiffs in litigation. Industry experts have reported recently that a string of major claims already made by executives facing litigation could cost the insurance industry up to $25 billion.

“It’s the opposite of catastrophic coverage,” DiBlasi said. “It frequently becomes a hurdle to climb over for management that needs to settle a case for more than their limits.”

DiBlasi said that in addition to the disparity between coverage offered and the rising cost of litigation settlements in D&O, there is a fundamental change in the risk that’s being underwritten in the marketplace. The increased activity of prosecutors, whether they are state or federal, creates enormous incentives on the part of companies under investigation to settle, or “do things that completely subvert the ability to defend a civil case.”

DiBlasi said more and more companies “wave the privilege, confess all wrong-doing in order to show cooperation, and be the first one to make reparations, or the first one to make restitution.” This trend poses an enormously strong incentive for companies slapped with huge civil cases to offer negotiations that will ultimately empower the plaintiffs’ side of the litigation suit.

Representing the plaintiff’s side of the professional liability playground was Mark Solomon, a partner at Lerach Coghlin, Stoia, Gller, Rudman & Robbins LLP, the west coast spin-off of the Milberg Weiss Bershad Hynes & Lerach LLP. “To the extent there is a problem in the model of D&O, the answer perhaps is to raise the premiums and raise the policy limits,” Solomon quipped. “Certainly no insurance is not good insurance.”

But Solomon said the primary problem that plagues the business world is not insufficient coverage or skyrocketing civil settlements, but is a pure question of honest professional practices.

“There’s a lot of people in business (financial services as well as the insurance industry) that have to stop being in denial,” Solomon said. “We’ve had Enron, we’ve had the mutual funds, we’ve had the New York Stock Exchange, we’ve had the IPO and now you have contingent commissions. It’s time to start treating … and start attacking the disease.”

Underwriting cycle goes on
Baker asked each of the panelists if the role of the regulator and capital markets should be to force the industry to exercise some discipline the next time the market gets soft? Could the industry learn from past lessons and would it react differently or chase market share yet again?

According to Galban, stressing the importance of earning an adequate return on capital is the primary factor changing the industry today. Not that the industry had previously undervalued earning an adequate return, he said, but that today it’s a view that is more often a commitment shared by both management and the underwriter in day-to-day activities.

“It’s been very hard for companies to monitor,” Galban said. “There is no perfect system … it’s a cultural thing.” Galban says companies have to have a commitment to earning return on invested capital, and not let their “hard-earned” gains in the hard market evaporate in the soft market. “And we’re there … this is exactly where we are today.”

He ultimately believes things will play out somewhat differently than they did in the last hard to soft market cycle transition. “You won’t see the rapid deterioration but fundamentally the task is still daunting, and I don’t see within the companies the kind of pressures to protect markets.”

Galban asked the panelists to add up all of the investment earnings–interest, dividends and rates–that the industry has earned over the last 30 to 40 years. “You’ll find that virtually all of that got eaten up by underwriting losses. It doesn’t make any difference whether interest rates were high or low,” he said.

So what has kept the industry growing from a capital base standpoint?

The stock market has been a big driver in growth and capital, and the public investor who has been responsive in raising needed capital, he said.

Diehl, who has served on both the company and regulatory sides of the industry, said times have changed since his days as an underwriter.

“When I first started as an underwriter 30 something years ago, one thing my supervisor tried to pound into my head was that you have to get proper premium for the exposure,” Diehl said. “Proper premium, proper premium!”

But perhaps that was merely a situational circumstance given the industry’s thirst for growing market share in soft market times, Diehl stated. “Management would come to us and say, ‘We’re not writing enough new business, our good accounts are going someplace else.'” Then the move to properly pricing product came into play. “Whatever we need to do to get the business,” became the driving force of carrier management. But needless to say, losses catch up to the market and there again revealed the need to raise rates and reduce credits.

“I think the majority of underwriters and company people know what needs to be done,” Diehl said. “But many times they are not the decision makers.” Today, Diehl said, such decisions are being made by the financial rating organizations and other financial concerns.

“If we as an industry want to make a change it has to be the entire industry working together to make that change,” he claimed.

So if the capital markets are not going to discipline the underwriters, and the insurance regulators aren’t going to discipline the insurance companies, maybe it will be the lawyers who discipline the industry to break the tumultuous cycle. Well, perhaps they already are.