UNITED STATES INSURANCE MARKET REPORT 2013

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1 Marsh Risk Management Research MARKET PERSPECTIVE UNITED STATES INSURANCE MARKET REPORT 2013 FEBRUARY 2013

2 CONTENTS Foreword 1 Executive Summary 2 Reinsurance 4 US Property/Casualty Industry 7 Major Coverage Lines Property Casualty International Casualty Financial and Professional: Directors and Officers...18 Commercial Errors and Omissions...20 Employment Practices Liability...21 Fidelity/Crime Insurance...23 Fiduciary Liability...24 Lawyers Professional Liability...25 Insurance Markets by Specialty Aviation Energy Captives Environmental Employee Benefits Marine Political Risk and Structured Credit Surety Trade Credit Insurance Markets by Industry Chemical Communications, Media, and Technology Construction Education Entertainment and Events Financial Institutions Health Care Hospitality and Gaming Life Sciences Manufacturing and Automotive Mining Power and Utilities Public Entity Real Estate Retail/Wholesale, Food, and Beverage Transportation: Rail...73 Road...74

3 FOREWORD It seemed in late October that the 2012 hurricane season would end on a benign note. Then nature reminded us that it pays no heed to our arbitrary deadlines and timelines. Sandy became a hurricane on October 24, rolled through the Caribbean, and took aim on the mid- Atlantic seaboard. Although downgraded to a tropical storm by the time it made landfall in New Jersey, New York, and Connecticut, Superstorm Sandy hit with fury and wreaked havoc across a wide area, including throughout New York City. The loss of life was high; the economic losses, still being tallied, are in the tens of billions of dollars; and Sandy ranks as one of the costliest storms in US history. And yet, while insurers will pay substantial claims, the impact on the overall insurance markets will not be devastating. Sandy may contribute to the slow upward trend in property insurance pricing that we have seen in the past year, but it will not on its own force a rapid hardening of the market. As was the case through the deepest parts of the slowly receding recession and through the historic global catastrophe losses of 2011, insurers weathered the storm, made good on their policy commitments, and worked with brokers to help clients begin to recover. Every major insurable event, however, sparks some changes in both attitudes and processes, and adds some lessons to be learned. It is still too early to predict Sandy s ultimate lessons, but one of them will surely touch on the changing climate and weather patterns. In Sandy s wake, climate change no matter its root cause was on the minds of many insurers, politicians, and risk managers. Some of the specific risk issues Sandy raised include: Concentrations of risk. The mix of insurance products companies require. The importance of such insurance contract items as limits, sublimits, terms, conditions, and definitions. And in this early part of 2013, there are many other issues those of us involved in risk management and insurance are required to pay attention to and develop plans for, including: The ongoing evolution and understanding of cyber risk, including the potential for hackers to unleash a digital superstorm. Political risk, not only in emerging economies but in developed ones. Continuing global economic conditions, which, while improving, still generate a certain unease among many. Regulatory environments, which in the US will include looming decisions over the future of the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA), the implementation of health care reform, efforts in many states to control workers compensation costs, and more. But through it all, we should keep an eye on the positive. For all its ferocity, Sandy reminded us of the strength of the human spirit and the overall resilience of the business community. Companies will rebuild, and will do so with lessons learned in mind. The insurance and risk management industry will evolve with a more mature understanding of risk, bringing creativity and a genuine sense of innovation to help ensure that organizations have the balance sheet protection and resiliency needed to realize their growth strategies. At Marsh, we will continue to invest in our longstanding commitment to be there for our clients whenever and wherever you need us. As always, we thank all of our colleagues for their efforts on behalf of our clients and for their contributions to the US Insurance Market Report We offer it to you with our compliments. And we invite you to contact your Marsh client executive or any other member of your client service team to discuss this report in greater depth. The need to plan for scenarios that may seem to some unlikely. David Bidmead, Chief Executive Officer, US Marsh, Inc. Marsh 1

4 EXECUTIVE SUMMARY Following are some key takeaways from Marsh s US Insurance Market Report MAJOR COVERAGE LINES PROPERTY Superstorm Sandy s affect on the property insurance markets, while still being determined, likely will be to temper what had been a generally improving rate environment in late Decreases in property insurance pricing generally are unlikely in early Sandy highlighted the importance of flood insurance issues including the definition of flood versus storm surge, the role of the National Flood Insurance Program, and erosion of flood limits. CASUALTY Casualty insurance markets in general are expected to continue in a state of transition in 2013, one that will be felt unevenly across various lines of business and client demographics. Workers compensation will remain a key issue for many employers, and the impact of recent reforms in California will be closely monitored. Umbrella and excess insurers generally are seeking to manage limits more conservatively, in part to limit their exposure to any one class of business or single event. Entering 2013, pressure generally continued to build in the lead umbrella insurance market, with a particular focus on attachment point and price. FINANCIAL AND PROFESSIONAL The directors and officers (D&O) liability insurance market, after a decade of declining rates, generally began to firm in 2012, a trend that appears likely to continue in Insureds should be prepared for risk differentiation to play an increasingly important role in their renewal processes. Commercial errors and omissions (E&O) insurance and cyber insurance rates generally began trending upward in 2012, and are likely to continue doing so in Employment practices liability insurance (EPLI) rates, after a few years of decreases from many insurers, typically firmed in Entering 2013 insurers generally are expected to seek modest increases from most insureds, particularly those with significant loss history. SPECIALTY COVERAGE LINES AVIATION The aviation insurance market was generally stable entering 2013, with rates decreasing slightly at renewal and capacity abundant. Barring an extraordinary event, large-scale changes to the marketplace are unlikely in Capacity and rates are likely to remain generally stable. CAPTIVES The captive insurer market is expected to continue to grow in 2013, as it has for the past 15 years, with US states becoming more competitive in the captive marketplace. Issues related to various state regulations and cyber security are likely to continue. EMPLOYEE BENEFITS With the future of health care reform seemingly secured by the re-election of President Obama, employers in 2013 generally will focus on absence management, aggressive health management, and account-based plans. Employers will also evaluate and work with the next generation of cost management strategies, including the use of private exchanges, a private-sector alternative to the state health insurance exchanges. 2 Insurance Market Report 2013

5 ENERGY The energy industry largely escaped losses from Superstorm Sandy. Insurance capacity for the energy industry was adequate entering 2013, which should generally temper the size of any rate increases from insurers. However, sectors that recently were hit hard with losses likely will experience capacity constraints and commensurate upward rate pressure. Pricing generally is trending upward in excess liability insurance markets for the energy industry. ENVIRONMENTAL The overall market for environmental insurance products was fluid and highly competitive entering Rate increases were being seen from some insurers, although not across the entire market. Many environmental insurers focused rate increases or coverage restrictions client by client. Claims frequency continued to rise, with leading markets reporting increases in first-party claims. Superstorm Sandy resulted in the potential for significant environmental losses and claims; however, the impact if any on environmental insurance rates will take time to determine. MARINE The marine insurance market entered 2013 in an unsettled state. Capacity generally remained abundant, but the market appeared to be in the first stages of a firming cycle, following years of flat or declining rates. The high-profile marine liability class losses suffered by insurers on their net account plus the average 30% reinsurance premium increases faced by some Lloyd s Syndicates drove this year-end market change. Cargo and stock throughput underwriters are looking more closely at their catastrophic risk exposures and aggregates following Superstorm Sandy and may attempt to modify coverage terms and conditions or to seek slight premium increases for higher hazard risks. POLITICAL RISK AND STRUCTURED CREDIT Conditions in the political risk market remained generally stable in 2012, despite volatility in some regions of the world. Competition and capacity generally remained strong entering 2013, although underwriters have limited capacity in some countries. Pricing generally increased in some countries in the Middle East and North Africa at the end of 2012, a trend that appears likely to continue in Some private insurers have been reluctant to underwrite certain high-profile and potentially sensitive risks, including infrastructure and power projects. Structured credit insurance rates were stable in 2012, and are likely to remain so in 2013, barring unforeseen events. After several years of slowly shrinking demand, many multinationals have expressed a renewed strong interest in purchasing multi-country political risk insurance programs. SURETY Surety capacity continues to expand as losses have not affected capacity or the reinsurance that supports it. Entering 2013, surety underwriters generally anticipate diminishing profitability due to a significant increase in surety loss frequency and severity, particularly due to contractor defaults. Contractors should be well prepared to demonstrate their prequalification process to underwriters. There is growing use of an independent financial profile or benchmarking reports to complement the prequal process. TRADE CREDIT Despite continued concern about the European sovereign debt crisis and other global events, conditions in the US trade credit insurance market generally favored insureds at the end of Rates at renewal were generally flat to down slightly in the fourth quarter of 2012, a trend expected to continue into The trade credit insurance markets generally have been more diligent in underwriting since the credit crisis. Insurers continue to carefully deploy their capacity and require additional information from insureds. The private insurance market is still covering risks in Spain and Italy, both on a portfolio and select basis, but are scrutinizing these risks and requiring higher self-insured retentions. Note: For specific insurance market and risk trends by industry, see the Industry Specialties section of this report. Marsh 3

6 REINSURANCE 2013 RENEWAL RATES The reinsurance market at January 1, 2013, was characterized by ample dedicated capital and stable pricing with only loss-affected lines and regions experiencing price volatility. The Guy Carpenter Global Property Catastrophe Reinsurance Rate on Line (ROL), Index (see Figure 1) fell marginally at the renewal. This is the seventh consecutive annual renewal in which changes to the index have equaled 10% or less, indicating a global market with capacity appropriate to meet demand. Over this period the reinsurance market has responded well to financial crises, increasing international losses, and numerous Atlantic Basin and European wind events. There was variation regionally, with US property catastrophe pricing most affected by the landfall of Superstorm Sandy while other regions were flat to down (see Figure 2). Price movements for non-catastrophe lines of business were also mixed. Marine and energy saw noticeable rate increases but many other lines experienced reductions. SUPERSTORM SANDY AND OTHER DRIVERS The stable renewal was driven by a combination of factors including new reinsurance capacity, reduced catastrophe losses, and high levels of capital. Fully dedicated reinsurance capital rose to record levels during the first nine months of 2012, exceeding $190 billion at the end of the third quarter. It was against this backdrop that Sandy s late landfall along the densely populated northeast US coastline in late October caused an expensive and complex loss for insurers and reinsurers. Sandy was a unique event in that atypical meteorological conditions combined to create one of the most expensive weather-related catastrophes on record. There has been concern for some time about potential losses from a major weather event in the Northeast region as the area is densely populated with highly valued real estate. The concern was warranted as thousands of buildings were destroyed in the states of New Jersey and New York, including southern parts of New York City, by Sandy s FIGURE 1: GLOBAL PROPERTY CATASTROPHE ROL INDEX 1990 TO / Source: Guy Carpenter & Company, LLC 4 Insurance Market Report 2013

7 devastating storm surge and strong winds. Sandy s landfall, combined with historically high crop losses in the United States and other severe weather outbreaks across the globe, resulted in global insured losses exceeding $50 billion in This was nevertheless significantly less than the $120 billion of insured loss sustained in The sector therefore entered 2013 in a strong position despite capital levels likely stagnating in the fourth quarter of 2012 due to Sandy. The sector continues to be challenged by the macroeconomic environment. Lackluster and diminishing gross domestic product growth in both developed and developing economies continues to pressure top lines. At the same time, the ongoing debt crisis in Europe and fiscal uncertainty in the United States have prompted insurers to seek higher-grade investments. This reduces near-term credit risk but lowers investment returns and increases interest rate sensitivity. Finally, evidence continues to suggest that insurer reserve releases are diminishing and will not be able to bolster earnings for much longer. All of these developments mean that underwriting performance, adaptability, and capital management are now manifestly at the center of any profitable growth strategy. SOLUTIONS FOR PROFITABLE GROWTH In this challenging market, insurers and reinsurers require sophisticated solutions to identify, mitigate, and transfer an evolving range of risks. Guy Carpenter, one of the Marsh & McLennan Companies, has identified six key areas where carriers can successfully enhance profitable growth and create franchise value. These include optimal capital management, clear and consistent communication to rating agencies and regulators, appropriate domicile selection, and capital markets opportunities, including strategic mergers and acquisitions (M&A) as well as convergence solutions. CAPITAL MANAGEMENT CAPITAL TRANCHING Optimizing capital significantly enhances profitability. Reinsurance plays a crucial role in reducing capital costs, but it is most effective when those costs are precisely understood. One way to do so is through tranching, or calculating the effect of reinsurance on companies cost of capital. Unlike other approaches, capital tranching introduces a priority order within capital to help clients measure and improve the cost of capital. FIGURE 2: REGIONAL PROPERTY CATASTROPHE ROL INDEX 1990 TO / Source: Guy Carpenter & Company, LLC US EUROPE UK Marsh 5

8 CONVERGENCE OF CAPITAL MARKETS The convergence of traditional reinsurance and capital markets capacity has now occurred. Nontraditional capital, a term that is fast becoming obsolete, today accounts for approximately 16% of total property catastrophe risk transfer limit purchases. Indeed, the catastrophe bond market in 2012 saw primary issuance of $5.45 billion, the highest level since the financial crisis and second only to The influence of capital markets capacity is set to expand strongly over the next few years. This development will provide carriers with additional flexibility to offload and diversify risk and truly establish capital market solutions as a sustainable complement to traditional reinsurance. MERGERS AND ACQUISITIONS Strategic M&A is another means of enhancing franchise value. The current environment of low valuations and limited economic growth may encourage firms to consider an acquisition as a key component of growth strategies. Although M&A activity continued to slow in 2012, several potential catalysts exist for successful transactions in 2013 and beyond. RISK, RATINGS, AND REGULATION The evolving criteria and requirements of risk management, rating agencies, and domicile selection also have a significant impact on carriers operations. Gaining a better understanding of catastrophe risk, adapting to changing rating agency criteria, and reevaluating the suitability of domicile are all paramount in achieving profitable growth. CATASTROPHE MODELING It is no surprise that regulators and risk managers are increasingly scrutinizing the assessment of catastrophe risk through the use of numerical models in today s marketplace. Insurers and reinsurers are therefore increasingly looking to develop their own view of risk by acquiring a deeper understanding and more sophisticated use of catastrophe model results. The deeper the understanding that they can derive from the models they use, the better they will be able to communicate the rationale behind decisions to regulators and rating agencies while also supporting reinsurance structure and pricing. RATING AGENCIES The need to manage and understand the requirements and criteria of rating agencies has been reinforced by significant rating activity over the last 12 months. Many of these actions have been in response to the challenging economic environment. With only moderate improvement expected in 2013, commercial ratings are expected to continue to reflect variation in insurers fortunes. The need to convey a clear and consistent message has never been more important as rating agencies demand increased interaction and transparency. The process needs to be carefully managed to ensure that insurers and reinsurers attain an optimal financial strength rating. DOMICILE SELECTION Choosing the right domicile is pivotal to every company s growth strategy as it can significantly impact carriers bottom line. Recent years have seen an increase in relocations, with companies shifting operations and domiciles from one country to another. The largest insurance and reinsurance markets have traditionally been and remain the United States, the United Kingdom, Continental Europe and Japan. However, companies are increasingly analyzing the relative merits of other regions. Regulatory environments, Solvency II equivalence, tax rates, access to talent, and proximity to major markets are all important factors to consider when deciding whether to relocate to domiciles such as Bermuda, Switzerland, Ireland, and Singapore. This chapter is taken from the executive summary of Guy Carpenter s January 2013 Renewal Report: The Route to Profitable Growth. For more information, visit Guy Carpenter s website at 6 Insurance Market Report 2013

9 US PROPERTY/CASUALTY INDUSTRY At the end of the third quarter of 2012 (the latest information available at this writing), the US property/casualty (P/C) industry boasted a strong balance sheet; the industry overall was financially strong entering Strengthening of the income statement is likely to remain a top priority for insurers in the quarters ahead. US PROPERTY AND CASUALTY INDUSTRY NINE-MONTH 2012 FINANCIAL HIGHLIGHTS (DOLLAR AMOUNTS IN MILLIONS) 9 MONTHS MONTHS 2011 CHANGE Net Premiums Written $345.4 $ % Net Underwriting Gain (Loss) ($4.4) ($30.4) NM Net Investment Income $35.8 $ % Net After-Tax Income $31.2 $ % Policyholders Surplus $579.4 $ % Combined Ratio Source: AM Best Company Insurers profitability faces pressure in 2013 given the slow economic recovery, low interest rates, and an expected reduction in reserve releases. Slow economic growth could affect total insurable risks, while the natural increase in prices due to inflation generally leads to rising claims costs, causing insurers to play catch up by increasing premium rates. Competition among insurers is expected to remain intense in 2013 as insurers are pressured to generate returns that meet their cost of capital and improve their market share. Nonetheless, as with previous years, P/C insurers can be expected to focus on fundamentals in 2013, which means protecting their balance sheets through such measures as pricing adequacy, underwriting discipline, capital planning, and preparing for major catastrophe (CAT) events. The industry s financial performance through the first nine months of 2012 improved substantially over the same period in 2011, with strong earnings growth and a significant increase in net income. CAT losses declined significantly through the third quarter of 2012 especially when compared to the record levels posted in 2011 although they remained elevated compared to recent years. Superstorm Sandy, however, will negatively affect fourth quarter earnings results as preliminary loss estimates were in the $25 billion range. The storm losses could eliminate the industry s full-year earnings, although the industry s overall solid capital position should remain intact. The industry s net income through the first nine months of 2012 nearly tripled when compared to the same period in 2011 due to a dramatic drop in underwriting losses reported for the period and, to a lesser extent, to more adequate pricing from the industry perspective. The improvement materialized despite mixed trends in net investment income. Moderate CAT losses through the first nine months of 2012, higher earned premiums, and insurers liberal capital positions will considerably offset the financial affects of Sandy for most insurers through the end of 2012; however, the storm s ultimate financial toll is still being determined. Insurers investment performance continued to be challenged in Although insurers generally manage very conservative investment portfolios, the global financial crisis was a reminder of just how volatile and unpredictable investment returns can be. Despite the overall turnaround in investment performance in recent years, the P/C industry faces near-term investment challenges as historically low interest rates continue to produce lower yields. Because investment income remains a major component of profitability for insurers, increased pressure falls on underwriting profitability. Issues in the European bond markets have had minimal impact on the US P/C industry as insurers generally invest their portfolios domestically. Although US-based global insurers do have modest exposure to the European bond markets, their portfolios tend to be of high quality with little exposure to incidental European banks and sovereigns. Insurer results are likely to be affected in 2013 and beyond by the continued decline in the pace of reserve Marsh 7

10 US PROPERTY AND CASUALTY INDUSTRY OPERATING RESULTS 1980 TO NINE MONTHS 2012 (IN BILLIONS) $80 $60 $40 $20 $0 -$20 -$40 -$ Source: AM Best Company INVESTMENT GAINS NET INCOME NET UNDERWRITING GAIN/LOSS releases. Although reserve releases continue to support earnings to some degree, reserve redundancies are gradually shrinking and some insurers reported higher levels of adverse development in the third quarter of Overall, the reserves for the P/C industry are adequate; however, their release will not boost underwriting results by as much in 2013 as they have in the past. The US P/C industry continues to maintain a strong capital position. The industry entered 2013 with adequate capacity to endure adversity; however, earnings challenges will likely cause those capital cushions to abate. Share buybacks continue to remain on insurers agendas given that many P/C insurers are trading at or below book value. A reduction in dividends and share repurchases over the longer term is likely as profitability is challenged, lower investment returns persist, and more modest reserve releases impact earnings. conventional hardening of the market as price changes are not uniform and are being seen in specific areas. In addition, the industry is not starving for capital. Steadily rising rates and an increase in insurable exposures contributed to an increase in net premiums written, with A.M. Best estimating a 4% increase through the first half of 2012, year over year. After navigating fairly well from a capital perspective through a financial crisis, high levels of CAT losses, and a year that ended with Superstorm Sandy, the US P/C industry faces continued challenges in Underwriting discipline and profitability will be crucial to maintaining financial strength as investment returns and reserve releases are not expected to support earnings to the level they had in the past. Insurers in 2013 need to focus on underwriting profitability (having produced combined ratios in excess of 100% during the past four years) in combination with pricing adequacy. Many US P/C insurers reported premium rate increases across all business lines at the end of These increases were primarily driven by earnings shortfalls as opposed to capital necessity. Above average losses, subdued investment returns, and receding reserve releases are likely to support this pricing trajectory in the near term. This should not be considered signs of a 8 Insurance Market Report 2013

11 Marsh 9

12 MAJOR COVERAGE LINES 10 Insurance Market Report 2013

13 PROPERTY INSURANCE MARKET CONDITIONS COVERAGE SEGMENT RATE CHANGE Q RATE CHANGE Q Property Non-CAT-Exposed Organizations 5% decrease to 5% increase 10% decrease to 10% increase (depending on use of incumbents) Moderately CAT-Exposed Organizations (1% to 30% of values in CAT zones) Flat to 10% increase Flat to 10% increase Largely CAT-Exposed Organizations (more than 30% of values in CAT zones) 5% increase to 15% increase 10% increase to 30% increase or higher if exposure was severe Loss-Driven Organizations Flat to 15% increase 10% increase and higher The above represents the typical rate change at renewal for average/good risk profiles. MARKET COMMENTARY The US property insurance market rebounded in 2012, following a year of near-record losses from natural disasters, poor investment income, and a still-sluggish global economy. Losses from Superstorm Sandy, however, are likely to temper what had been a generally improving rate climate for insureds in the late third and early fourth quarters of Decreases in property insurance rates are unlikely in early 2013, with some insurers pushing for rate increases, especially for clients with losses from Sandy. Flat or declining premium rates at renewal typically will likely be reserved for insureds with favorable loss histories and low catastrophe (CAT) exposures, but are likely to be more broadly available by midyear, barring a large CAT event. half of the year, CAT-exposed companies averaged 5% increases at renewal; in the third quarter, the average increase had fallen to 3.5%. A company s loss history is also important in determining individual rates, and there may be upward pressure on rates in 2013 as losses from Sandy are fully quantified. SUPERSTORM SANDY In late October 2012, Superstorm Sandy made landfall in southern New Jersey and wreaked havoc on the US PROPERTY ALL RISK CLIENTS PERCENT OF ACCOUNTS WITH RATE CHANGES The first three quarters of 2012 saw relatively minor insured losses from catastrophe events; in fact, many insurers posted positive third quarter financial results, leading to a stable US property insurance rate environment. Renewal rates began generally moderating by the fourth quarter and, prior to Superstorm Sandy, many insureds were able to renew with flat to slight increases in pricing. 58% 59% 57% 57% Just over 25% of insureds renewed with decreases in the first three quarters of While nearly 60% of insureds experienced a modest increase at renewal, the level of increases fell with each quarter, from an average of 3.9% in the first quarter to 2.5% in the third. As expected, companies with significant CAT exposures were most likely to experience higher increases at renewal than companies with little to no CAT exposures. In the first 16% 14% 15% 16% 26% 27% 28% 27% Q Q Q Q Source: Marsh Global Analytics INCREASE NO CHANGE DECREASE Marsh 11

14 Eastern Seaboard, becoming one of the costliest storms in US history. It caused widespread property damage and disrupted the operations of thousands of businesses. Approximately 8.6 million homes and businesses lost power, some for more than two weeks. Although the business interruption losses have yet to be fully quantified, modeling firm RMS has estimated insured losses may reach $20 billion to $25 billion, with total damages topping $50 billion by most estimates. Only Hurricane Katrina, which totaled $41.1 billion in insured losses, would rank as more costly. Although losses from Sandy will affect insurers bottom lines, it is not expected to be a market-changing event, but rather an earnings event. Most losses will likely be contained within the insurers retention, although some reinsurance treaties may be triggered; therefore, Sandy should have little to no effect on the treaty reinsurance market. Overall, insurers were well capitalized to absorb the loss, and most are not likely to reduce capacity in 2013, barring unforeseen events. Individual insurers, however, may more carefully scrutinize their catastrophe aggregates. TERRORISM AND POLITICAL VIOLENCE The standalone terrorism and political violence insurance market remains relatively stable; pricing remains generally competitive and capacity abundant except in certain high-risk cities for terrorism, or in high-risk countries for political violence where capacity may be limited. The government-backed scheme in the US the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA) is set to expire on December 31, As the program s expiration approaches, whether to extend it and in what form will be increasingly debated by industry and government officials. RISK TRENDS The US property insurance market is well positioned to absorb the losses from Superstorm Sandy. The storm, however, is likely to cause insurers to look at a number of risk issues. BUSINESS INTERRUPTION Insurers and insureds learned a tough lesson about the unpredictability of business interruption costs during the 2011 floods in Asia, resulting in insurers increased scrutiny of business interruption exposures and, in some cases, altered terms and policy limits. In 2012, Superstorm Sandy caused significant disruption to thousands of businesses on the East Coast. As a result of the storm, business interruption coverage is likely to be an issue at the forefront for both carriers and insureds in Insureds should expect more critical analysis of their exposures and potential limits MAJOR GLOBAL MARKET PROPERTY (CATASTROPHE-EXPOSED RISKS): TYPICAL RATE CHANGES IN Q Source: Marsh DECREASE > 30% DECREASE 20-30% DECREASE 10-20% DECREASE 0-10% INCREASE > 30% INCREASE 20-30% INCREASE 10-20% INCREASE 0-10% PROPERTY (CAT-EXPOSED) Australia Increase 0-10% Canada Stable -5% to +5% Chile Stable -5% to +5% China Stable -5% to +5% France Stable -5% to +5% Germany Increase 0% to 10% India Increase 10% to 20% Indonesia Increase 0% to 10% Italy Increase 20% to 30% Japan Increase 0% to 10% Korea Stable -5% to +5% Mexico Stable -5% to +5% Russia Stable -5% to +5% South Africa Increase 0% to 10% Spain Stable -5% to +5% Turkey Increase 20% to 30% UAE Decrease 20% to 30% UK Increase 0% to 10% US Increase 0% to 10% 12 Insurance Market Report 2013

15 placed on their programs by carriers. Companies should undergo a comprehensive review of their exposures in order to better understand their needs and design effective programs. SANDY HIGHLIGHTS FLOOD ISSUES FLOOD VS. STORM SURGE A significant issue in determining how coverage will apply following Sandy or any similar event will be the distinction between flood and storm surge within a particular policy. Some policies may state that storm surge is encompassed within the definition of flood while others may stipulate that it is part of the named windstorm definition. Such distinction may determine the available limit and the deductible that will apply to the loss. It is expected that there will be increased scrutiny of definitions and deductibles relating to windstorm, flood, and storm surge in the months to come. This discussion may also include tsunami, specifically whether the peril belongs in the flood definition or in earthquake. NATIONAL FLOOD INSURANCE PROGRAM (NFIP) Many companies supplement their commercial flood insurance limits with coverage through the NFIP, a federally funded program. In the summer of 2012, the program was reauthorized through September The legislation contained sweeping provisions, designed to improve the program s fiscal stability as it was more than $18 billion in debt even before Sandy. Included in the legislation are provisions to increase rates over a period of five years, require lenders to accept non-nfip-backed insurance, and permit multifamily owners to purchase commercial flood policies. ERODING FLOOD LIMITS Superstorm Sandy may cause the erosion of some insureds flood aggregate limits for their policy periods. As a result, if another flood event occurs, insureds with eroded flood limits would have only what remains of their original limit, which for some could be nothing. It is thus important for companies to consider their options for reinstating flood limits. Typically, reinstating coverage with the carrier(s) in the primary layers can be costly, and underwriters may not be willing to reinstate limits so soon after the event. single-carrier placements, where the flood limit is with one insurer, the remaining limits will drop down and coverage can be sought from another carrier at the top/ excess of the remaining limit. Insureds should discuss the details of these situations with their brokers. CAT MODELS Catastrophe models have become increasingly important in the property insurance marketplace. Properly used, CAT models help clients make informed decisions, proactively design a marketing strategy, differentiate their risks for underwriters, create transparency, and implement risk-based allocations. In early 2011, RMS released its latest model update, which took into account lessons learned from recent windstorms. It dramatically increased loss estimates in Texas and Mid-Atlantic states, and significantly increased the storm surge potential in the Northeast. AIR Worldwide also updated its modeling software in It remains to be seen what effect Sandy will have on future models. Models help insureds and insurers understand what their expected losses may be from various CAT events, and thus to develop acceptable program sublimits. Insurance brokers and their clients use the modeling results to help design the program structure, as modeling can be performed on each individual layer as well as on the overall program. This allows analyses of various options, such as insureds self-insuring layers that may be too costly or transferring risk to various insurers where they see value and efficiency in so doing. The rating agencies use modeling to assess catastrophe risk as a primary threat to an insurer s solvency. They run the models on an insurer s aggregate exposure, which, depending upon how exposed an insurer is, may impact its rating. In fact, RMS 11 has had the effect of significantly increasing aggregations and the amount of available capital insurers need to avoid insolvency following a large catastrophic event. Contact: DUNCAN ELLIS US Property Practice Leader For shared and layered programs where the flood coverage resides in multiple layers it is recommended that a properly written drop-down wording be in place. With such wording, it likely makes more sense to purchase limits at the top of the program (excess limits) rather than to reinstate the eroded primary limits. For Marsh 13

16 CASUALTY INSURANCE MARKET CONDITIONS COVERAGE SEGMENT RATE CHANGE Q RATE CHANGE Q Workers Compensation Guaranteed Cost 5% decrease to 5% increase 10% decrease to 10% increase Loss Sensitive 5% decrease to 5% increase 5% decrease to 5% increase General Liability Guaranteed Cost 5% decrease to 5% increase 10% decrease to 5% increase Loss Sensitive 5% decrease to 5% increase Flat to 10% decrease Automobile Liability Guaranteed Cost 5% decrease to 10% increase 5% decrease to 5% increase Loss Sensitive 5% decrease to 10% increase 5% decrease to 5% increase Umbrella and Excess Liability Lead Flat to 5% increase Flat to 10% increase Excess Layers Flat to 5% increase Flat to 5% increase The above represents the typical rate change at renewal for average/good risk profiles. MARKET COMMENTARY Entering 2012, casualty insurance markets were in a state of transition, one that continued in an uneven fashion across various lines of business and client demographics. The trend held throughout 2012 and is expected to continue into in general experienced increasing rate pressure as the year progressed. Some insureds secured decreases at renewal, typically those with exceptional loss histories, strong safety controls, and lower hazard exposures. Rates for GL insurance traded in a wider range than in 2011, typically GENERAL LIABILITY The general liability (GL) insurance market was generally stable in 2012, although there was some moderate firming. Insurers typically sought rate increases entering 2013; however, capacity and competition remain adequate and generally mitigated the size of increases. Fewer companies saw rate reductions than in the previous quarter and the number of flat renewals increased. US GENERAL LIABILITY CLIENTS PERCENT OF ACCOUNTS WITH RATE CHANGES 42% 40% 49% 54% Premium rates at renewal for about half of insureds were flat to some increases. The predominant exposure base revenue generally showed a moderate, single-digit increase in 2012 compared to Increasing rates caused a minimal migration in program structures from guaranteed cost to loss sensitive, as well as increased deductibles for 12% of insureds with loss sensitive programs. In industries that showed signs of more aggressive growth, rate increases were generally moderated to balance the degree of overall premium increase. Loss sensitive GL placements 18% 40% 19% 41% 13% 38% 18% 28% Q Q Q Q Source: Marsh Global Analytics INCREASE NO CHANGE DECREASE 14 Insurance Market Report 2013

17 from 5% reductions to 15% increases. Terms and conditions remained relatively unchanged; however, increased underwriting scrutiny required more time to prepare submissions, increased management sign-offs, and strong analytical backing. AUTOMOBILE LIABILITY Auto liability insurance rates generally remained stable in 2012, with some reductions and more renewals experiencing flat rates. Insurers sought higher attachment points on large fleets, which resulted in more insureds marketing their programs than had been the case in recent years. Most insurers sought rate increases, but typically agreed to lower rates than in their original quotes. A minimal number of insureds moved to loss sensitive programs, with about 6% increasing deductibles on existing loss-sensitive programs. Many insurers used auto liability insurance to help balance their workers compensation line of business. Auto liability insurance rates at renewal traded in a wider range than the prior year, generally from 5% decreases to 10% increases, excluding those clients whose retentions changed. Additional underwriting scrutiny was common in auto liability insurance renewals, as was the case in other casualty lines. Clients with best-in-class fleet management strategies and favorable loss histories typically saw the best rates and terms. WORKERS COMPENSATION The workers compensation line of business continued in 2012 to operate at a historically unprofitable level for insurers. Insurers are likely to seek rate increases and higher retentions in 2013 in order to return the workers compensation line of business to profitability. Employers that favorably differentiate their claims management and loss-control programs generally will fare best, and those willing to take more control and explore loss-sensitive programs to control costs may be more insulated from any sweeping market trends on rate increases. The workers compensation insurance market experienced another challenging year in 2012 as insurers faced continued economic challenges and medical costs continued to increase. The magnitude of rate increases will depend on such characteristics as: Program structure, whether it is guaranteed cost or loss sensitive. Concentration of a client s risk in a particular geography. Individual risk factors, including industry, employee concentrations, loss mitigation techniques, and historical loss experience. As insurers look to increase rates or change program structures, more clients are looking to market their business as they seek alternatives to achieve optimal results. The overall time needed to complete renewals has increased, and underwriters are applying their guidelines in a more prescriptive fashion. There have also been some new insurer entrants into the primary casualty space, which has been a welcome addition for many insureds. Workers compensation is significantly influenced by state-directed activity, on both legislative and rate issues. In California, often viewed as a bellwether for the industry due to its size, there have been clear indications in recent years of stress in the underlying technical workers compensation market. Against this backdrop, California in 2012 passed its most significant workers compensation legislative reform since 2004 in an effort to create efficiencies in the system, reduce costs, and increase benefits for permanently disabled injured employees. It will take time to realize the full impacts of the new legislation. In 2012, more than half of clients experienced flat rates at renewal or rate increases. For guaranteed cost structures, the rate increases became more challenging as the year progressed, prompting a small number of clients to move to loss-sensitive programs, and just over 10% of those with loss-sensitive programs to increase their deductibles. WORKERS COMPENSATION CLIENTS PERCENT OF ACCOUNTS WITH RATE CHANGES 46% 17% 23% 14% 37% 45% 32% 49% 51% 16% 37% 33% Q Q Q Q Source: Marsh Global Analytics INCREASE NO CHANGE DECREASE Marsh 15

18 Underwriters are inundated with submissions, so it is important to initiate the renewal process early ideally 120 days prior to the policy or program effective date. Developing a communications strategy around all key attributes of a company s risk profile will benefit the renewal process. It is imperative that organizations provide underwriters with complete, accurate, and thorough data and analysis in order to differentiate their risk profile in areas such as large losses, loss trends, and safety programs. EXCESS CASUALTY Entering 2013, pressure continued to build in the lead umbrella insurance market, with a particular focus on attachment point and price. The mid-excess layers, however, generally continued on a stable path, with significant competition and capacity moderating the effect of firming rates experienced in the lead market. To limit their exposure to any one class of business or single event, umbrella and excess insurers are seeking to manage limits more conservatively, especially where there is clash potential between different insureds. In 2012, excess casualty insurance could be viewed in several ways as a tale of two markets: new versus renewal, lead versus excess, US versus international, and complex versus standard. Carriers reacted differently depending on which side of the market they were on, many times within the same segment and within the same industry. Ample global capacity will likely continue to push the supply side of the equation in 2013 as markets waiting on US EXCESS CASUALTY CLIENTS PERCENT OF ACCOUNTS WITH RATE CHANGES 47% 47% 47% 56% the sidelines are opportunistic in competing to replace traditional incumbents. Structuring non-traditional excess liability towers became the norm in 2012, using, for example, buffers, shorter limit leads, and captives as alternative structures to be contemplated in many renewals. These restructurings were not limited to what are generally considered to be the more difficult industries of construction, energy, chemical, and life sciences. The majority of markets saw an increase in average attachment points, while overall limit deployment decreased. This was especially true for those more difficult classes of business, where many insureds saw an increase in premium with an increase in attachment point, and in many cases, restrictions on capacity at renewal. Generally, the excess casualty insurance market saw rate increases in the mid-single digits in 2012, leveling off in the latter half of the year as the trading market overtook the technical market. There was modest exposure base growth with an abundance of mid-excess capacity fueled by new entrants with strong balance sheets. Several insurers rebalanced their portfolios and re-entered the excess liability marketplace, helping to level off any drastic pricing increase for the general industries. In 2013, casualty experts expect to see a stabilizing excess marketplace as insurers see opportunity to be more aggressive throughout the year. More use of predictive modeling, including in umbrella and excess casualty, is expected, especially with the frequency of severity increasing. Carriers are looking at different ways to deploy their capacity, and are willing to split limits. Actual renewal terms will vary depending on several risk-specific factors, including the class of business, emerging risk potential, clash likelihood, excess loss history, number of viable lead umbrella carriers, and the change in risk retention appetite of the insured. Contact: 33% 41% 38% 29% JONATHAN ZAFFINO US Casualty Practice Leader % 13% 15% 15% Q Q Q Q Note: Not all stacked bars will add to 100 due to rounding. Source: Marsh Global Analytics INCREASE NO CHANGE DECREASE 16 Insurance Market Report 2013

19 INTERNATIONAL CASUALTY INSURANCE MARKET CONDITIONS COVERAGE SEGMENT RATE CHANGE Q RATE CHANGE Q International Casualty Controlled Master Program Automobile Controlled Master Program Guaranteed Cost 5% increase to 5% decrease Flat to 5% decrease Loss Sensitive Flat to 5% increase Flat to 5% decrease Guaranteed Cost Flat Flat Loss Sensitive Flat to 5% increase Flat to 5% decrease International Package Policy Guaranteed Cost 5% increase to 5% decrease Flat to 5% decrease MARKET COMMENTARY The international casualty insurance market remained stable entering 2013, with typically moderate price decreases on favorable risks. Competition remained strong, with new capacity in the international package policy (IPP) segment. Insurers expanded their appetite to more aggressively write IPP and other international casualty products. Notably, a number of insurers that previously pursued only large-program business expanded into the package space; while a few historically IPP-only carriers broadened their appetite to write more challenging large risks. There now are more insurers competing for the same risks relative to prior years, creating more alternatives for insurance buyers. Insureds that secured decreases at renewal typically did so by virtue of favorable loss experience. In the third and fourth quarters of 2012, underwriters showed increased discipline in managing their administrative and nominal risk transfer costs. Buyers of guaranteed cost programs benefitted from somewhat better market conditions compared to those on the loss sensitive side. A notable exception is in the Defense Base Act (DBA) niche, which has experienced some firming. This has been due in large part to the winding down of the Department of State s single-source program, and the resulting exposure and claims growth in the open DBA market. Any further pricing increases in 2013 likely will be determined by loss development and US government contracting volumes overseas. As for fronted programs, more often than not large accounts experienced growth in their aggregate exposures and saw greater lawsuit activity outside of the United States. Both factors contributed to increased loss projections and corresponding upward pressure on fronting fees. Although competition among insurers remained strong entering 2013, the international casualty market is experiencing the gradual firming that first emerged in the US domestic market. Contact: STEPHEN KEMPSEY International Casualty Leader Marsh 17

20 FINANCIAL AND PROFESSIONAL: DIRECTORS AND OFFICERS INSURANCE MARKET CONDITIONS SEGMENT RATE CHANGE Q RATE CHANGE Q Large Cap ($10 billion and higher) Flat to 10% increase Flat to 10% decrease Mid Cap ($2 billion to $10 billion) Flat to 10% increase Flat to 5% decrease Small Cap/Micro Cap (up to $2 billion) Flat to 10% increase Flat to 5% decrease Private Companies Flat to 15% increase Flat to 5% decrease The above represents the typical rate change at renewal for average/good risk profiles. MARKET COMMENTARY After a decade of steadily declining rates, the directors and officers (D&O) liability insurance market entered a state of transition by the second quarter of 2012, when insurers generally began to firm and even increase premiums, starting with primary program layers. Insureds should be prepared for underwriters to continue seeking rate increases in Until the fourth quarter of 2012, excess capacity remained competitive and overall program rate reductions were still achievable. But by the end of 2012, total program renewal premiums were generally flat to up as much as 10%, signaling excess insurers more disciplined approach to capacity. Stated market capacity remains abundant, exceeding $1.5 billion. But several factors have put pressure on insurer profitability in the broader space, including the prolonged period of rate decreases, a decline in the number of public companies, low interest rates, an aggressive plaintiffs bar, and litigation trends, particularly in the private company arena. Primary D&O insurance rates increased more than overall D&O program rates until the fourth quarter, when total program rate increases began to equal or even surpass those of the primary layers in a few instances. The market for side A difference-inconditions (DIC) coverage remained stable for insureds heading into Meanwhile, the market for small cap companies tightened at a slightly faster rate than that for large cap companies; more than two-thirds of the small caps saw rate increases in 2012, compared to just over half of the large caps. This was driven in part by increased claims and litigation activity related to mergers and acquisitions involving smaller companies. Insureds should be prepared for risk differentiation to play an increasingly important role in their renewal processes. Those insureds that prepare thorough submissions with high-quality analytics, communicate with their broker directly to underwriters, and start the renewal process early will be best positioned to negotiate competitive renewal terms. Accessing all insurers appropriate to a company s risk profile and program will be important as testing pricing against the market will be critical throughout RISK TRENDS DODD-FRANK The Dodd-Frank Wall Street Reform and Consumer Protection Act is driving significant plaintiff attorney activity around executive compensation. After an initial spate of derivative lawsuits alleging breach of fiduciary duty stemming from negative say-on-pay shareholder votes, the plaintiffs bar appears to be taking a new approach in the form of front-ended, class-action lawsuits. These suits seek to enjoin the say-on-pay vote up front by alleging inadequate and/or misleading disclosure in proxy statements relating to underlying components of executive compensation, including authorization and/or reserving of underlying shares and goal setting with results accountability. Further, these suits are seeking injunctive relief, not damages, and are being brought in the company s principal place of business versus Delaware. These suits are increasing in number and significant activity is expected for the 2013 proxy season, with plaintiffs attorneys noticing investigations of public companies as a matter of course when proxy statements are filed. 18 Insurance Market Report 2013

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