Risk Management

Ghastly Calculations

Corporations are buying higher levels of liability coverage to cope with wrongful death awards.
David KatzDecember 14, 2000

Maybe it’s the fear that a car crash or a food contamination, mixed with a class-action lawsuit, can subtract hundreds of millions of dollars from a company’s bottom line.

Maybe it’s the cheap price of liability insurance. Whatever the cause, however, corporations have been buying higher and higher limits of liability coverage over the past few years.

That’s the finding of a new report on limits of liability by Marsh, a leading insurance brokerage. The survey of 2,247 companies found that the average upper limit of liability insurance coverage bought by companies this year was $105 million, up 5.6 percent from the $99 million average recorded by a similar sample in 1999.

Marsh says it’s particularly impressed, however, by how much the limits of general, auto, and product-liability coverage bought by corporate buyers have risen over time. Overall, liability limits soared 34.8 percent this year in comparison to 1994, when the average limit stood at $77.9 million.

Marsh asserts in a press release that the ascent of the limits of coverage being bought is a “response to escalating tort awards.” At the same time, although insurance has been cheap for the last few years, the New York City-based broker isn’t emphasizing pricing as a reason for the rising towers of coverage.

Timothy Brady, a managing director of Marsh, says, “I think it’s more the wisdom of the buyer” than price that explains the rush to buy high levels of liability coverage. The abundance of $50 million to $200 million in legal claims can “attract the attention of anyone,” he argues.

Referring to wrongful-death court awards, Brady refers to some ghastly calculations CFOs might make in determining the “maximum potential loss” to their organizations if they cause bad accidents. Brady says, for instance, that $3 million to $5 million per person “is not an unusual number in today’s legal environment.”

Then, adds Brady, there are injuries “that can be far more expensive” to corporate defendants, such as paralysis and serious burns. For those, he says, $10 million to $20 million would not be an unusual number.

Then there are the “outliers”—extreme cases that are nonetheless “not unusual,” Brady says. For example, a wrongful death award, Brady says, could conceivably reach a figure as high as $20 million per person, while a victim of paralysis or burns could be awarded as much as $25 million to $30 million.

Brady also advises CFOs to devise scenarios involving multiple claimants. One hypothetical example he provides is that of a corporate-owned motor vehicle found to have wrongfully hit a minivan with nine highly compensated executives in it. With the awards valued from $10 million to $20 million and if all nine executives died, that could amount to “a nine-digit number” in terms of the dollar loss to the corporation that owned the motor vehicle.

Brady dips into a childhood memory for another example. Referring to an accident involving a tractor-trailer truck and many other cars, he says, “my dad was number 20-something in a pileup. He was driving a Volkswagen bug.” Brady notes that although he and his mother were lucky in that his father emerged unscathed, people in the first cars struck by the truck died, and others in cars behind the truck were injured.

While such pileups happen infrequently, corporations need to factor them into their risk planning because of the potential dollar losses involved, according to the broker.

Other examples of potential sources of big liability losses are the hospitality and restaurant industries, he adds. In a hamburger served in a restaurant, says Brady, “a piece of glass could injure one person.” But, he asks, “What if I served [hamburgers] that had E. coli, and I served 100 hamburgers?”

Brady believes that such high levels of risk have grabbed the attention of senior financial executives and gotten them involved in decisions about whether to buy higher limits of coverage. Marsh’s 1999 report on liability limits found, in fact, that at 35 percent of the 2,181 companies covered, the CFO was the ultimate decision-maker on the issue of how much coverage to buy.

At 17 percent of the companies, the chief executive officer, president or chief operating officer made the final call, while at 19 percent of the firms the treasurer or controller was responsible for making it. Risk managers or insurance buyers had the final say on limits at 20 percent of the companies.

The possible effect of a whopping lawsuit on share price has sent insurance-buying decisions up the corporate ladder, says Brady. “You hear [of] companies being pummeled for missing a penny or two a share,” he contends, adding that senior financial executives need to ask themselves, “What would an unexpected $50 million [legal] expense mean to my organization?”

For example, he says, if a company has $50 million of primary coverage and has a $100 million incident, the CFO has to ask, “What does that mean to my organization’s balance sheet? What would that do to my earnings?” The answer, he adds, varies with the size of an organization.

To be sure, insurance brokers stand to benefit from client fears of grisly accidents and whopping liabilities. With the insurance market hardening, brokers have an interest in keeping the commissions flowing.

But the assumption that the excess-liability insurance that fills in the higher limits of coverage is a “good buy” seems sound under current market conditions. Excess coverage, after all, is a relatively cheap form of insurance because losses tend to be less frequent at that level than they do at the level of primary insurance. The comparative infrequency of excess-insurance claims also tends to lower costs for the carrier, and the decreases are passed along to buyers.

Brady says high-level excess insurance “is very cheap by any measure. It’s not unusual if you spend a dollar to get $1000 worth of coverage” in the excess layers of insurance.

Would excess-liability insurance still be so seductive a buy if the insurance market should harden? Not surprisingly, the broker says yes. Reasoning that if a dollar can buy a $1000, and prices go up by as much as 10 percent, $1.10 would buy the same amount of coverage. Considering the good night’s sleep such coverage can provide a CFO, Brady asserts that that’s still an “excellent payback ratio.”

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