The Changing Market for Product Liability Insurance

One of the most important types of insurance in any manufacturing business is Commercial General Liability Including Products & Completed Operations, which provides coverage on behalf of the insured business for sums it may be legally required to pay to others as a result of the insureds actions or negligence. It customarily includes coverage for bodily injury, property damage, personal injury, medical payments and additional supplemental payments specified in the policy as one limit and Product Liability as a separate limit. Another important feature of a Commercial General Liability policy is that it provides funds that cover the cost to defend the insured when they are sued for an accident or negligent act.

In the United States, as opposed to many foreign countries, Liability Insurance is not required to operate a business. It can, however, be required by the existence of a contract, written or assumed, that any business might enter into. Today, very few companies would agree to buy products from a dietary supplement manufacturer that does not have insurance to cover losses for which the manufacturer might be responsible. Likewise, the distributors need protection for a mistake they might make in the way the product is sold to the customer, etc. Basically, the insured trades the cost of insurance for what the insured could become liable for, up to the limits of the insurance policy. If there is no insurance then a business might be required to forfeit real and personal property. This could put them out of business.

When the American Herbal Products Associations (AHPA) product liability insurance program was started in 1996, the market for product liability insurance was not only increasing in cost, but the number of companies willing to insure the industry was shrinking fast. The reasons for this included:

Another major factor that kept premiums high was the use by insurers of the Occurrence Form versus the Claims Made Form for liability. The primary difference between the occurrence form and the claims-made form liability coverage has to do with what triggers the coverage. The occurrence form coverage is triggered by injury or damage that occurs during the policy period but greatly extends the potential claims by allowing coverage for claims that occur during the policy period but do not actually manifest themselves until after the policy period. This form allowed claims to be made years after a policy had expired as in the case of asbestos claims, etc. The claims-made coverage is triggered when a claim is first made against the insured, but the claim will only be paid if the claim is made during the policy period. This form limits the liability to the insurer and makes it possible to more accurately predict what their losses might be going forward.

These concerns, for the most part, have been reduced significantly by the banning of ephedra, a favorable loss experience over the past five years, the push by the dietary supplements industry to standardize labeling practices, the push by the industry toward certification of manufacturers and very favorable claims experience of the insurance companies.

The High Cost of Insurance

Insurance market conditions for all classes of business continued to worsen in 2000, 2001 and 2002 due to the huge increase in losses worldwide. The return on investments for insurance companies plummeted along with the stock markets and economies around the world. Cost of insurance during the period escalated by as much as 500 percent, and Sept 11th pushed the insurance markets completely over the edge. The concern on the part of insurance underwriters over terrorism and the damage that can be inflicted forced insurance companies to become very selective.

Insurance premiums never remain constant. Insurance companies operate by collecting premiums from many insureds that have been carefully underwritten. Then they try to successfully invest the premiums so that a reserve large enough to meet forecasted claims will be available. They build into these rates business expenses, claims and profit. Many factors are taken into consideration when a premium, or rate for insurance is calculated but insurance companies are businesses that are supposed to make a profit for their owners and stockholders. When it becomes more difficult to make these profits then premiums usually must be increased. The insurance companies of late have not been making an underwriting profit due to the losses they have suffered; they have experienced a severe downturn in the return on their investments, and they are confronted with a whole new exposure related to the threat of terrorism losses and professional liability.

Standard and surplus lines insurers normally do not retain 100 percent of the risk. Even the soundest underwriting cannot prevent all insurance losses from occurring. Consequently, insurance companies need other means to reduce or share the chances of loss. The means devised for this purpose is called reinsurance.

Reinsurance is a contractual agreement between an insurance company (called a ceding company, reinsurance terms) and one or several other insurance companies (known as reinsurers). Simply put, reinsurance is insurance for insurance companies. The ceding company transfers part of the risks it has assumed under its contracts to one or more reinsurers. Unfortunately the reinsurers suffered the same fate as the standard and surplus lines insurers. Worldwide reinsurance markets were severally restricted. Investors that supply the money for the reinsurance markets were not entering the arena due to the problems of terrorism, high property and liability losses, stock market conditions, medical malpractice, war in Iraq and a host of other problems.

Alternative Considerations

When standard insurance companies refused to insure dietary supplement companies and surplus lines insurance companies found it necessary to charge premiums far above what they had been charging, many dietary supplement businesses looked for alternatives. The alternatives were going uninsured, becoming selfinsured, or forming insurance captives. A captive insurer, in the simplest terms, is a privately owned and operated insurance company where the policyholders (insured/s) are owners of the company and are required to put up their own money as security against the losses. The captive is often formed outside the United States, though some are formed within the United States in states where they are permitted. They are formed to provide liability, property, workers compensation and other lines of insurance just as standard insurance companies offer. The basic consideration behind forming an individual or group captive is to enable the insured/s to have more control over the risks that are insured in the captive, to regulate claims payment and to help reduce premiums, if possible. In all but a few cases even the insurance captive will arrange for reinsurance to prevent it from suffering huge losses on its own.

Some captives have been successful. Some have grown large enough that they eventually became standard insurance companies. Most captives do not enjoy this kind of success. One reason is the continuously fluctuating and changing insurance market. Captives are most popular when insurance premiums are very high and the number of insurance carriers is limited. When the insurance market finally arrives at a profitable point, generally competition will cause the cost of insurance to drop and more insurers will reenter the market, making the insurance easily available. When this happens, most of the captives cannot compete, and they terminate.

The Good News

The upward cycle of increasing costs of insurance ended in late 2005 and early 2006. It is the end of a 16-year cycle of escalating costs that have been the most severe during the past three to five years. Dietary supplement companies will remain in the surplus lines market, but the cost of products liability insurance will continue to go down over the foreseeable future. Just in the past few months, we have seen decreases in the range of 5 percent to 15 percent for many companies. This reduction in cost will likely continue for a minimum of 10 years. The reduction is due to many factors, but the largest factors are a fast growing economy both in the United States and worldwide and the absence of large insured losses in the United States and worldwide. Billions of dollars are now available, from investors on Wall Street and around the world, to be used as capital for funding offshore reinsurance markets in Bermuda and at Lloyds.

Dick Griffin is the owner of Grifcon Enterprises Inc., and the AHPA Insurance Program manager; he can be contacted at (916) 434-8874 or [email protected]. Griffin works with CRC Insurance Services Inc. in Chicago in insuring dietary supplement industry companies.