Author: Andrew Nishimura
The overall Asset Manager Directors & Officers/Errors & Omissions insurance market added yet one more challenge for asset management firms in an already challenging year. Continuing the trends that we saw in the second half of 2019, the market continued to firm throughout this past year. In addition, while we began 2020 with modest increases, insurance renewals toward the back half of the year saw larger material increases. It was not just pricing that was affected; we also saw the hardening market impact insurance coverage terms and the amount of capacity an insurer would offer to any one insured. Unfortunately, for anyone expecting the turning of the calendar year to subdue this market, we expect these trends to continue for at least the first half of 2021.
Pricing affected by hardening insurance market
For the five years leading into 2019, most asset managers received favorable renewals, earmarked by premium decreases and expanded insurance coverage. In 2019, we saw small single digit increases at the start of the year turn into modest high single digit increases to finish it. 2020 largely picked up where 2019 left off, with an average increase of 9.83% for the first half of 2020, which swelled to 14.5% for the second half of 2020.
This average is for a mix of private equity funds, hedge funds, mutual funds and investment advisors for separate managed accounts (no fund exposure). To their credit, insurance underwriters differentiated between these four major types of advisors. Mutual funds, due to the low claim frequency, were still aggressively targeted by underwriters. Typical increases for mutual funds were 5%–15%. Advisors for separate managed accounts received typical increases of 10%–20%, while hedge funds' typical increase was 10%–35%. Private equity funds faced the most challenges, with typical increases in the 10%–45% range. Claims against a Private Equity fund and their employees following the bankruptcy of a portfolio company continue to be one of the most likely high-severity claims against private equity funds. The significant increase in bankruptcies following COVID-19 was a major factor for the hardening of the Private equity insurance market.
During the prior soft market, even if an investment advisor saw a premium increase (due to a significant increase in exposures for example), that increase was often limited to the primary layer of insurance. In a layered insurance program with multiple policies, the primary policy is the one that is closest to the risk and responds first in the event of a claim. In the soft market, that increase would often not extend to the excess insurers. In some cases, excess insurers would cut their pricing to offset the increase on the primary. The reverse actually played out in 2020. Excess insurers would often look for larger percentage increases than the primary and would be willing to walk away from a relationship if they could not hit certain metrics for either a minimum premium or a minimum increased limit factor. This trend further exasperated the firming market.
Coverage terms and conditions for 2021
For the majority of insureds, coverage terms and conditions will be relatively stable for 2021. If the current policy already contained many enhancements that were negotiated during the softer market conditions, then the program should be in good shape. However, if that's not the case, it can be challenging to obtain broader terms and conditions in the hardening market.
Two of the biggest areas of focus are coverage for regulatory investigations and cost of corrections coverage. In the soft market, insureds would look to expand the amount of coverage for these issues; now in the hardening market, underwriters are scrutinizing both coverages and potentially pulling back in some situations:
- Regulatory investigations: The main issue is understanding when the policy triggers during the investigative process, specifically how coverage responds once the regulator initiates an informal investigation of the asset management firm itself. The most basic policies provide no coverage for an informal investigation, some policies provide a mechanism for retroactively insuring informal investigations if they turn into a formal investigation (called pre claim look back coverage), and the broadest forms cover the informal investigation from the beginning. If an insured does not already have it, getting the broadest informal investigations coverage now is challenging. For clients that have informal investigations coverage, we have seen instances where insurers are dialing back the broad informal investigations coverage and changing it back to pre-claim look back coverage.
- Cost of corrections coverage: Cost of corrections coverage has been around for a long time; the basic premise was to preemptively remedy a wrongful act before it turned into a claim or actual litigation. However, the early versions of the coverage were difficult to use; they often had coinsurance, high retentions, stringent reporting requirements and limited types of incidents that would trigger coverage. Like informal investigations coverage, the breadth of cost of corrections coverage has broadened significantly over the years. However, during the past year, underwriters scrutinized this coverage as well. As an example, we have seen underwriters look to sublimit coverage and add more stringent reporting requirements.
Capacity on limits
Overall, there continues to be a significant amount of capacity, with approximately 25 insurers writing policies on their own asset manager D&O/E&O policy forms. By way of comparison, if we went back 10 years, there were about half as many insurers with specialized policy forms. This significant capacity created competition and was part of the reason why the asset manager D&O/E&O insurance market had been soft until two years ago.
However, insurers are starting to reduce the amount of limits that they will offer to any one insured. Not very long ago, having a single insurer offer $10 million in limits for an insured was the norm. Now, most underwriters prefer to only offer $5 million in limits for any single insured. Therefore, if you had a $30 million insurance program with three policies providing $10 million of coverage each, that now will typically be built with six policies providing $5 million of coverage.
Other trends to impact 2021
COVID-19: The COVID-19 pandemic affects just about every aspect of the business, from the stock market and volatility to employees' safety and the overall profitability of the firm. By now, most insureds will have gone through a renewal cycle during COVID-19, but for those that have not, most underwriters have questionnaires designed to identify the impact of COVID-19 on the business, resiliency, ability of employees to work from home, etc.
Cyber: This continues to be one of the top concerns for compliance managers, regulators and insurers. There are many components to a robust Cybersecurity program, but one aspect that has changed quite a bit over five years is Cyber insurance. The survey results from a leading compliance firm showed that only 10% of advisors bought a separate Cyber Liability policy in 2014. According to the most recent survey, about 75% of advisors buy some type of Cyber insurance.1
Blended coverages: While the focus of this report is on D&O/E&O coverages, they are often blended with two other liability coverages.
- Fiduciary liability: To note, in this context this is the fiduciary liability that Investment advisors owe to their own employees of their own retirement plans, not the fiduciary responsibility to clients which is addressed on the Errors and Omissions coverage. Any advisor that offers any proprietary funds, products or services to their own retirement plans will be under intense underwriter scrutiny. There has been a significant uptick in these types of claims, and underwriters have responded with significant increases, very large retentions (often $5 million to $25 million) or outright exclusions.
- Employment practices liability: There are two main trends impacting investment advisors employment practices liability insurance.
- Impact on COVID-19 on the workforce: As noted above, underwriters will often ask additional questions about COVID-19, any downsizing, ability to work from home, etc. To address these new dynamics from a claim prevention perspective, more insureds are taking advantage of the free risk management resources that large insurers offer to their insureds.
- Retention increases: Not specific to investment advisors, but for any industry that tends to have highly compensated individuals (doctors for example), insurers are looking to add higher retentions for anyone making over a certain salary.
2021 expectations for asset management
Unfortunately, we expect the current increases that we saw in the second half of 2020 to continue through at least the first half of 2021. For most clients, that will likely be about a 15% increase due to market forces, but it may be higher or lower depending on the type of advisor, changes in exposures or claim activity. However, we have been seeing positive signs that the firming market is slowing down. Over the last three months, a handful of new underwriters have entered the management liability space, often bringing over seasoned underwriters from other insurers. New underwriters tend to enter a hardening market when they feel the premiums are sufficient to undercut their competitors and win new business. Should that happen, the market may look much more promising during the second half of the year.
Please note, a client's risk profile is the primary variable dictating renewal outcomes. Loss experience, industry, location and individual account nuances will also have a significant impact on these renewals. Now more than ever, it's important to start renewals as soon as possible, and work with your Gallagher team to deliver a comprehensive and professional submission to underwriters.