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Premium increases and extensive policy exclusions are driving pharmaceutical manufacturers and medical device companies to search for risk financing alternatives.
Adding to the industry discomfort in the U.S. insurance market, capacity has shrunk considerably and companies with annual revenues of $10 billion or more are being asked to accept huge retentions.
The situation varies by line of insurance and size of the policyholder. Product liability and directors and officers liability present the greatest challenges, while other lines, including property, business interruption and cargo coverage, are less difficult. Smaller and midsize companies are finding more capacity with lower retentions than larger companies with greater potential exposures.
So far, there are few risk financing alternatives.
"It's a split buying pattern in the pharmaceutical industry," said Bruce Belzak, managing director and head of the life sciences practice for Marsh Inc. in New York. "The 'megapharmas' basically have gone bare on product liability."
A trend to avoid buying even excess liability layers in the traditional market began about three years ago. Several factors created the impetus for this trend, he said.
"The capacity available has been cut in half," Mr. Belzak said. Insurers are offering $500 million to $600 million in capacity today vs. $1.3 billion in 1999.
Retentions that once were $25 million to $35 million have ballooned to $400 million while premiums have tripled or quadrupled to reach 10% of liability.
"The megapharmas are saying, 'We have a very strong balance sheet. We're just not going to buy insurance,"' Mr. Belzak said. While most big companies once financed retentions through captives, after leaving the market even funding just some of the risk through their captive becomes too costly, he said.
Jim Walters, managing director of the life sciences and chemical group for Aon Corp. in Chicago, said, "Clearly, there has been a sea change. We used to start negotiations with a blank sheet of paper. Now there is a big long list of exclusions." Drugs that have had product liability problems or entire classes of drugs that have generated concern, such as hormone replacement therapy, are being excluded, he said.
Even with these exclusions, policyholders were being asked to retain more than $500 million in risk, he said. "We used to be able to put together $1 billion pretty easily. Now a major U.S.-based company is lucky to get $300 million to $400 million in coverage."
The picture is different for medical device companies, said Scott Bayer, senior vp of general liability for Liberty International Underwriters in Boston, a unit of Liberty Mutual Group Inc. LIU writes primary coverage for all liability exposures for small to midsize companies.
"The hard market is not affecting medical devices," Mr. Bayer said. Coverage is widely available and rates are stable, he said.
However, Mr. Bayer pointed out, LIU avoids writing coverage for any type of permanent implant. Most insurers avoid those products that have the potential to result in class action litigation, he said.
Insurance market conditions reflect, in large part, underwriters' difficulty in forecasting product liability exposure, Mr. Belzak said. "No one knows how to understand this risk," he said. "Their solution has been raising prices and raising retentions."
"Frankly, when you have problems like Phen-Fen, how do you finance a problem of that magnitude?" Mr. Walters said. "For companies any smaller (than the large pharmaceutical companies), it would be life threatening to have this amount of litigation."
The situation is similar for directors and officers liability coverage. "Disappointment in clinical trials or product withdrawals cause stock to take a nose dive," said Mr. Walters. That, in turn, exposes directors and officers to liability.
Some large companies are using actuaries to study their products and calculate what would be a reasonable amount to set aside for the exposure, Marsh's Mr. Belzak said.
'Numbed by the cost'
Many pharmaceutical companies with $1 billion to $5 billion in revenue cannot afford to go without cover, so they are still in the market, he said. However, those companies "are increasingly feeling numbed by the cost of it." For example, a $5 billion medical device company said it will not purchase liability insurance at the end of its current program because it is having good claims experience and is choosing to leave the market, he said.
Another company with $3 billion in revenue is "playing hardball with underwriters" and worked out a quota-share arrangement, Mr. Belzak said.
Companies with less than $1 billion in annual revenue are getting retentions between $1 million and $10 million, he said.
"The picture changes dramatically when you're talking about a startup and smaller biotech and medical device manufacturers and neutraceuticals," said Pamela Haughawout, Boston-based senior vp with broker Hilb Rogal & Hobbs Co.
Tom Heim, Atlanta-based national director of HRH's casualty and risk management practice, said venture capitalists who back many of the smaller companies won't risk going without insurance.
HRH recently renewed coverage for a $165 million neutraceutical company and was able to get $50 million in liability coverage in the United States, Ms. Haughawout said. Another $150 million was available using the Bermuda markets, but the client opted not to purchase it, she said.
Part of what makes risk financing for the pharmaceutical and medical products industry so different from others is the pressure created by being "out there to improve the human condition," said Mr. Walters. For that reason, other important lines such as business interruption and cargo insurance are available, but not always with sufficient capacity or the most favorable rates and terms.
Marsh is working with clients to write technical proposals and bring underwriters together with chief scientists from potential policyholder companies to try to make the exposure picture as clear as possible and elicit more favorable terms, Mr. Belzak said.
Drug makers, for example, cannot afford to have their operations interrupted. "If your facility or your supplier's facility burns, they have to be inspected by the (Food and Drug Administration) before reopening. We spend a fair amount of time helping (those companies) to get their arms around those risks," Mr. Walters said. In the case of a catastrophe, business interruption won't entirely cover losses, he said.
Cargo insurance also is needed because these companies are transporting highly regulated, high-value shipments that are sensitive to external factors such as temperature, Mr. Walters said.
In response to rising deductibles, several large pharmaceutical companies formed a Hamilton, Bermuda-based mutual insurance company, Pharmaceutical Insurance Ltd. Because their factory operations are located in Puerto Rico, property and business interruption deductibles were increasing significantly even though there had not been a major hurricane or similar event in that location, Mr. Walters said.
The facility, which also underwrites risks for medical device companies, provides coverage of $150 million excess of $50 million per loss, paying out a maximum of $300 million of claims. Swiss Reinsurance Co. reinsures the risk.
In the search for risk financing alternatives, nothing has turned up in the capital markets because of the difficulty in forecasting risks. "People are still out there pushing the envelope trying (to find ways) to use the capital markets," said Aon's Mr. Walters.
Mr. Belzak said Marsh's view is that creating an insurance facility for the megapharmas still makes sense. "Perhaps in the future a combination of capital markets with traditional markets" might work, he said.