Opportunity Created for Surplus Lines Market in the Wake of Regulatory Financial Reform
The surplus lines specialty casualty market has always been in the forefront in responding to new and innovative management and professional liability products for financial institutions. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Act”) bill may be just the catalyst for the E&S market to outperform the standard property & casualty (“P&C”) market.
The basis of this opportunity is two-fold: First , Title V – (Insurance), Subtitle B (State-Based Insurance Reforms) of the Act eliminates the diligent search requirement for US-domiciled “exempt commercial purchasers”. Exempted commercial purchasers are those commercial buyers that that have paid aggregate P&C insurance premiums in excess of USD$100,000 in the past year and meet one or more net worth or net revenue thresholds and related criteria. This exemption has the potential to eliminate a competitive barrier that has hindered growth and creative risk solutions in the surplus lines market in recent memory. Consumers of products of all types benefit in a marketplace that favors competition, and commercial insurance should not be an exception. Subject to final rulemaking and enactment in 2011, the elimination of the diligent search requirement for larger commercial insured’s should provide ample opportunity for growth if the surplus lines market is prepared to innovate new and expanded coverages in exchange for the appropriate level of premium.
The second opportunity for non-admitted specialty casualty insurance markets resides within Title IV of the Act – referred to as the Private Fund Investment Advisers Registration Act of 2010. Title IV requires hedge funds and other private fund advisors previously exempted from SEC registration to register as investment advisors under the Investment Advisers Act of 1940. Private Funds with less than $150M would remain exempt from SEC registration, but may be subject to register as an investment advisor in the state it maintains its principal place of business. The new registration requirement and accompanying reporting and disclosure requirements, combined with heightened regulatory and corporate governance oversight requirements (including the expansion of authority of the Securities and Exchange Commission in the form of its mandate to write dozens of new rules, create five new offices, and increase enforcement) contain a number of procedural and substantive provisions that will likely increase SEC enforcement actions and securities litigation. The non-admitted and surplus lines market is uniquely well positioned to meet these new perils rapidly with enhanced coverage grants and endorsements.
By 2011, the demand by first-time purchasers for blended “1940-Act” Financial Institution management (D&O) and professional (E&O) liability policies should increase significantly. This demand will be driven by the real and perceived personal liability exposures imposed upon fund managers, advisers, sub-advisors and independent directors of these newly regulated funds as a direct result of the enforcement of the “Act.” And, if past is prologue, private securities litigation will follow. Whereas the Act authorizes the SEC to engage in the oversight and protection of hedge fund and private funds investors , it remains to be seen if the Act will be stretched to also give private right of action for injured private fund investors, as the statute does not expressly provide for such a right.
The Act did however address the issue of scheme liability. Prior to the enactment of the Act, the SEC was required to demonstrate that individuals charged with aiding and abetting a fraud “knowingly” provided assistance to another person in violation of securities laws promulgated under the Securities Act of 1933, The Securities Exchange Act of 1934, the Investment Advisers Act of 1940 and/or the Investment Company Act of 1940. Section 929 will make it easier to target those who allegedly “aid and abet” federal securities fraud as the new provision lowers the requisite state of mind of the offender from a “knowledge” standard to a “reckless conduct” standard. This statute will likely not only affect hedge funds and private funds, but will likely create additional securities litigation risk for publicly-traded companies.
The Sarbanes-Oxley Act of 2002 was the last legislative sea-change that the specialty casualty and D&O insurance market had to respond to. It is arguable that the domestic insurance market responded slowly at the time and that many fund advisors, directors and officers lacked certain explicit insurance coverage grants that an efficient marketplace should had been able to quickly deliver to the corporate consumer of insurance. This lackluster response was in-part a result of an almost non-existent Lloyd’s of London appetite for D&O insurance in 2002 (as certain Lloyd’s syndicates were still recovering from adverse loss development as a result of securities litigation losses as a result of the technology risk implosion in 1999-2001) whilst the surplus lines E&S market was concurrently being held hostage to the anti-competitive “diligent search” requirement. Almost a decade later, neither of these two constraints exist. The question remains however, will knowledgeable surplus lines E&S brokers and diligent underwriters collaborate to provide state-of-the-art policy wordings that better protect directors, officers and fund advisors from the rapidly evolving regulatory and judicial perils, or will the industry yet again allow the standard market to take the lead in due course?
- Scott Uhl, EWI Specialty Casualty