February 6th, 2009

E&O’s Dual Pressures

Posted at 1:00 AM ET

Harry Oellrich, Managing Director

A feeding frenzy in the primary market pushed the cost of errors and omissions (E&O) insurance lower in 2008, with the exception of Financial Institutions (FI) coverage. This led to downward pressure on reinsurance rates, as well, which markets sought to resist at the January 1, 2009 renewal. A marketplace that should have been driven by the cost and availability of capital, not to mention loss history, had to cope with an additional factor that few anticipated. The changing primary market landscape led insurers to pursue market share aggressively, even at the expense of rate integrity.

In mid-September, enormous pressure on the financial services industry led to several high-profile acquisitions, as well as U.S. government intervention. The changes in the marketplace resulted in a perceived opportunity for E&O insurers. They priced business for buyers in order to take advantage of this unusual market situation. Competition on rates snowballed, particularly in the fourth quarter of 2008. Other pricing factors, such as loss history and the condition of global financial markets, were dulled, as competitive considerations set the agenda.

E&O reinsurers, on the other hand, were not as eager to accept a continuing drop in rates. As an industry, they sought to hold the line on pricing, largely because of financial market factors, such as hits to investment assets and an increasing cost of capital (including the inability to raise capital at all). Discord in capital markets impaired reinsurer investment assets severely and left many unable to write long-tail business at the rates cedents wanted. Reinsurers covering property-catastrophe lines as well as E&O felt the additional pressure of Hurricanes Gustav and Ike on their balance sheets.

The consumption of capital in 2008, along with the shift in the primary market, made for difficult negotiations. Actual reinsurance rate results varied widely by the underlying risks covered. Perhaps more important than rate changes at the recent renewal, though, is the effect of the 2008 market on both insurer and reinsurer perspectives on the coming year. The price competition in the primary market underscored the maturity of the E&O sector. Carriers seeking above-average growth will need to find new risks to cover.

So far, innovation has not moved quickly. The last major E&O product to be introduced was cyber-insurance-about 10 years ago. Online business has already been absorbed into the fabric of global commerce, carrying the attendant threats with it. Thus, while the internet is still in its infancy in many ways, a platform for insurance coverage has been developed that can mature alongside the risk environment.

Both insurers and reinsurers would benefit from expending more energy in identifying exposures and creating solutions for them. Innovation delivers the accelerated growth that simply is not possible in a mature market. The visionaries, as usual, will secure an advantage that the followers will be unlikely to overcome.

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