Liability loss records drive limit levels: Study

Companies that have experience with sizable casualty losses buy significantly more liability coverage than those that have thus far escaped similar fates, according to a study by Marsh Inc.

In 2006, firms that experienced losses of $5 million or more in the past five years purchased liability coverage limits averaging $220 million, which is nearly four times the level of protection—an average of $56 million—bought by those without such losses.

And even though the cost of liability coverage continued to decline in 2006, risk managers in general did not take advantage of the lower pricing by buying higher limits, according to Marsh's report, "Limits of Liability 2006," which provides a range of information on liability limits.

The findings of the Marsh survey, which includes responses from risk managers at 7,196 companies from 53 countries, demonstrate that "experience is a great teacher," according to George C. Pallis, managing director of the New York-based insurance broker's national casualty practice in Morristown, N.J.

"While overall limits have been dropping on the overall population, the limits for the companies that have had a large loss have been relatively stable or growing," he said. "So the people who have had the large losses recognize the potential."

Mr. Pallis said that the coverage limits many risk managers are buying today are not keeping pace with inflation, which, he said, could leave some companies underinsured if they are hit with bodily injury claims that take several years to adjudicate, such as those involving paralysis or brain damage.

"Wrongful death can be very expensive, but wrongful injury can be even more expensive because of the ongoing health costs required for the injured party," he said, pointing out that, over the past decade, medical costs have surged 120% while the U.S. consumer price index has grown 37%.

Using these rates of increase as a gauge for future inflation, "what is a $50 million claim today could be a $60 million to $70 million claim five years from now," Mr. Pallis said.

Despite two consecutive years of price declines in the cost of liability coverage, risk managers worldwide aren't buying more coverage, Marsh's study found. Instead, the average limits purchased in 2006 fell 19% to $47 million from $58 million in 2005.

"Sometimes purchasing will follow market pricing. When prices go up, people buy less, and when prices go down, people buy more," Mr. Pallis said.

However, the past two years of price decreases still haven't made up for prior years' rate hikes, Mr. Pallis said. As a result, even though U.S. firms paid an average of $11,895 per $1 million in coverage in 2006, which was 11% below the 2005 average price of $13,222 and 13% below the 2004 average of $13,727, the price is still 153% higher than the $4,694 U.S. companies paid for the same amount of coverage in 2000.

But Mr. Pallis insists that price should not be the primary basis for liability insurance buying decisions.

"What we try to tell our clients is, when it comes to buying excess limits, you're protecting the future of your organization from catastrophic loss. So the purchase shouldn't be a matter of pricing; it should be a matter of protection," he said.

For example, a company with a 5% profit margin that has a $70 million loss but only $50 million in coverage will need $400 million in revenue to cover the $20 million gap between its insurance coverage limits and its actual liability, he said.

But, "when you think of what that $20 million would have cost on a price-per-million basis, it's relatively inexpensive. So we're trying to get people to see the big picture and not be short-sighted," Mr. Pallis said.

Copies of the report, "Limits of Liability 2006," are available at no charge from local Marsh offices or by calling Donna Mohan at 212-345-5343.