AM Best slaps negative outlooks on E&S, professional liability and other lines

In response to the Covid-19 outbreak, AM Best has revised its outlooks to negative for US market segments including excess and surplus lines (E&S), professional lines and workers compensation as well as maintaining negative outlooks on medical professional liability and commercial auto.

AM Best yesterday (7 April) had revised its outlook for the overall US commercial lines segment.

The ratings agency does not expect significant claims activity as a direct result of the pandemic but it said the rapid deterioration of the economy will be felt throughout the commercial insurance segment.

AM Best has followed that up with actions on individual segments, revising its outlooks to negative from stable for workers compensation, E&S, professional liability, surety, title and private mortgage insurers. It also maintained the negative views it already had for commercial auto and medical professional liability.

Declines in E&S demand

The negative outlook for the E&S segment is down to the disruption Covid-19 will cause to the US economy. The segment had grown strongly for several years, coinciding with an expanding and strengthening economy.

“The contraction in economic activity has already had an acute, overwhelming impact on small businesses throughout the country, and US economic indicators show that a majority of US businesses have experienced declines,” AM Best commented.

“Further deterioration at the pace economists are predicting will reduce the need for insurance for the traditional surplus lines market of unique, specialised risks. Markets in which many surplus lines carriers participate – contractors, commercial business, manufacturing, construction, to name just a few – may experience significant declines in demand.”

The ratings agency added that a contraction in exposures brings some benefits but that decreased underwriting cash flow, potential increases in claims frequency and severity and the challenging investment market conditions “’will leave many companies swimming against the current”.

It added that surplus lines carriers are also likely to be subject to the coverage creep issue that state legislatures are already attempting to undertake for business interruption losses. Six state legislatures have introduced bills that would force insurers to pay Covid-19-related business interruption losses regardless of any policy exclusions.

The ratings agency did point, however, to the surplus lines segment’s fundamental strengths that will help them overcome these tremendous challenges.

Professional liability

The negative outlook for professional lines is the result of a variety of dynamics in the lines comprising this segment, as well as the potential for more lawsuits resulting from Covid-19 and the accompanying stock market decline “which at the very least would result in a rise in claim defence costs,” AM Best said.

D&O is the largest line in this segment. Here, AM Best cited social inflation, the higher level of capital being invested in litigation financing, new event driven exposures and a record number of class action lawsuits as specific reasons for the outlook change.

“Whether the higher rates and tighter terms and conditions can keep up with the constantly evolving risks is in doubt,” the ratings agency commented. It pointed to the $240mn Wells Fargo derivative suit settlement in early 2019 as a case in point.

The ratings agency believes Covid-19-related third-party liability claims filed against companies and their boards may be higher than they were in previous coronavirus outbreaks such as Mers and Sars.

“We expect claims will be filed in the form of securities class actions and shareholder derivative claims related to affirmative acts of mismanagement or the failure to act/disclose by officers and directors in response to the outbreak,” it said.

As this publication has reported, two securities class actions have already been filed in response to statements around coronavirus: one against a cruise line company and the other against a pharmaceutical company.

For cyber, exposures are growing with increasingly complex risk characteristics. New data protection laws have also added to the minefield of potential litigation. “The Covid-19 situation could lead to more claims, as companies’ security systems may be overwhelmed by the vast number of employees working remotely,”’ the ratings agency said.

In the employment practices liability (EPL) segment, a growing number of harassment lawsuits have been filed in the past few years as a result of the #MeToo movement. Some states have also introduced laws that made it easier for individuals to file suits alleging harassment and discrimination for incidents that took place years before.

US surety

The US surety segment’s outlook was changed because of Covid-19’s effect on the construction industry and the overall economy. Before the coronavirus crisis, surety premiums had been growing with relatively low loss activity.

The availability and cost of construction materials could be impacted by the increased potential for disruptions in the supply chain, while government restrictions on labour could adversely affect construction spending. In addition, stay at home orders have shut down non-essential construction projects in some states.

“As contractors face more Covid-19-related restrictions, we expect there will be significant project delays, an inability to complete certain projects, and lower levels of new construction,” said AM Best.

The ratings agency commented that the economic fallout from Covid-19 could result in a prolonged downturn in the construction industry, which would likely result in more contractor defaults, and cause surety writers to incur losses in their in-force books of business, particularly with regard to the payment of performance bond claims.

“Business opportunities in other classes of surety, including custom and licence and permit bonds, which are very closely connected to the economy, are likely to be impacted, Furthermore, reinsurance may cost more in the future to offset the potential for elevated losses,” AM Best said.

It added: “Given the significant excess capacity available to meet lower demand, we also expect the already heightened competitive environment in the surety sector to escalate.”

The $2trn planned infrastructure spending bill would bolster infrastructure projects, if passed, and result in more business opportunities for the surety companies, AM Best said.

US workers comp

The pandemic’s impact on the economy has also prompted the change in outlook for workers comp, the largest component of the US commercial lines market.

“While there may also be some upside to the workers compensation sector as a result of the event (less fraud, fewer workplace accidents, lower defence costs), these are outweighed by the aforementioned economic and financial market concerns,” said AM Best. “Furthermore, workers compensation premiums are generally based on payroll, and a decline in payroll when workers are laid off will drive a reduction in revenue to the insurers.”

The workers comp segment had already been under pressure, with the direct loss ratio increasing as a result of many states experiencing rate decreases. But the line had continued to perform well in recent years because of a fall in lost-time claim frequency and a concerted effort to improve workplace safety.

Commercial auto

AM Best said its commercial auto outlook remains negative because the underwriting performance for 2019 is likely to show deterioration despite price increases and because adverse reserve development is likely to continue.

“Price increases and underwriting actions are expected to continue through 2020, although the economic effects of Covid-19 may increase pushback,” the ratings agency said. “As a result, AM Best expects a modest improvement despite expectations of another year of unprofitable underwriting for the line.”

The ratings agency added the persistently challenging legal environment makes it likely that this line will remain a drag on the industry’s profitability.

Covid-19 is not likely to have a substantial net effect on the commercial auto line, AM Best believes.

Accident frequency may decline as commercial vehicles encounter less traffic as a result of stay-at-home orders. But some of this effect will be nullified by lower premiums for policies with user-sensitive premium bases.