The book of Ecclesiastes tells us there is nothing new under the sun. But to some actuaries, insuring ride sharing, cyber exposures and marijuana dispensaries certainly seem outside the norm.
Attorney Eric Voigt, a partner at Mound Cotton Wollan & Greengrass LLP, a New York law firm known for its insurance and reinsurance practices, gave a detailed look at insurance-related case studies of emerging exposures in cyber liability, social media, medical marijuana and the sharing economy.
To price those and other emerging exposures, Karen Landrum, FCAS, consulting actuary at Merlinos & Associates, goes back to the basics.
Landrum outlined her approach during “Emerging Claim Issues and How to Price and Underwrite Them,” the closing session at the CAS Annual Meeting in Anaheim in November 2017.
In his discussion, Voigt focused on key cases in emerging risks:
In cyber liability, which cost the global economy more than $400 billion a year, Voigt’s discussion included cases that:
- Discussed whether computer records that fell off a truck were a personal injury. (No, the records weren’t published anywhere.)
- Examined whether a general liability policy covered a phishing scam in which a fraudulent email induced a person to transfer money in a phony transaction. (No, there was no unauthorized entry into a computer system.)
- Determined whether a restaurant chain had coverage that would reimburse a credit card issuer for charges it had to void because the restaurateur’s data had been hacked. (No, its coverage didn’t include language that specifically covered such payments, and the policy’s “privacy injury” coverage didn’t cover the loss either.)
Voigt also examined the insurance industry’s use of social media to investigate claims, often looking for evidence of insurance fraud. He noted that these kinds of “desktop investigations” are common but cited privacy laws that might apply. Insurers can also seek social media content during discovery, but the inquiries must be specific in what they seek and what they are likely to find.
Medical marijuana opens myriad questions for insurers, Voigt said. The federal-state conflict is a large issue here, too.
Workers’ compensation insurers, for example, must struggle with whether a marijuana prescription should be covered. Voigt noted that some states have laws or court cases that instruct insurers and that, in all cases, medical marijuana is seen as alternative medicine. There is, however, a recent trend for insurers to pay for marijuana if a doctor recommends it and it is deemed “medically necessary.”
He also discussed whether a homeowners policy covers weed that burned up in a house fire. (No, insurers don’t cover illegal substances.) He also looked at marijuana use in the context of auto and general liability policies.
The sharing economy — including operating ride-sharing services or renting rooms via the internet — opens up unique insurance questions, Voigt said, because of the fundamental shift in the definition of ownership. The traditional personal auto and homeowners policies didn’t anticipate the hybrid of commercial and personal use.
For ride-sharing, the sponsor (think Uber or Lyft) and the driver need to ensure they cover all the stages of an engagement: while the driver is waiting for rides with an app operating, while the driver is en route to a rider, and while the rider is being taken to a destination.
Home sharers also need tailored coverage, some of which is provided by the sponsor (think Airbnb). ISO recently crafted endorsements for homeowners policies to address new exposures.
Voigt’s discussion outlined a number of important cases in a detailed slide deck that can be found at http://bit.ly/CAS_AM17prog (key word: Voigt).
Landrum, meanwhile, said that pricing these emerging risks is a three-step process:
Step 1: Look at the CAS Principles of Ratemaking.
The principles act almost like a recipe, telling you what you need to think about when developing a rate.
The principles help from the outset, even when considering the type of entity issuing insurance — whether it is an admitted company, a surplus lines carrier, a risk retention group or a captive.
Take the tradeoff between homogeneity and heterogeneity. Admitted insurers have the ability to diversify their portfolio. Risk retention groups have homogeneous exposures. Captives insure a single entity, so there is no heterogeneity (unless the captive writes different lines of a single risk).
Expenses differ by type of entity. Excess and surplus lines carriers have a different premium tax. Risk retention groups don’t focus as much on profit. These obviously affect the final price.
Landrum said it is also important to know policy language: knowing what the policy excludes, what limits it covers and what actions trigger a claim. The final rate depends on all of these.
And the exposure base is important, she said. Most policies are rated on payroll — as is common in workers’ compensation — but sometimes there is a desire for something different, like the number of employees.
Step 2: Create a framework for rate development.
The heart of the actuary’s work is estimating expected loss, Landrum said, but some losses (short-tailed ones) are easier to estimate than others. The easier ones tend to be the ones that depend on the location of the risk — a part of the property coverage, usually.
Catastrophes and earthquakes, Landrum said, “Don’t really care whether you’re a cannabis-related business or McDonald’s. They are going to hit you no matter what.”
Insurers can also seek social media content during discovery, but the inquiries must be specific in what they seek and what they are likely to find.
Ideally, of course, the actuary has historical information to price in a traditional way. Often that is not the case, so Landrum suggested these alternatives:
- Study industry filings of similar products. (Before the actuary develops the rate, she said, it is important to peel out the expense load from the rate, thus isolating the loss cost.)
- Perform mathematical simulations to estimate expected loss. (This helps the actuary understand how widely varied the rate could be.)
- Buy estimated loss costs from an advisory service like ISO, NCCI or the American Association of Insurance Services.
Sometimes information is available from a foreign market, Landrum said, though that route should be approached cautiously. “[Foreign] laws are different,” she noted. “Their behavior patterns are different.”
Step 3: Consider what things make the risk unique.
Landrum gave up-to-date examples on various emerging risks.
Sharing Economy: How much should an Airbnb landlord or an Uber driver pay for coverage? The characteristics of the items insured have not changed (an Airbnb home is just a home; an Uber car is just a car), but the way they are being used has. The homeowner has become a landlord; the driver now operates a taxi.
The risk clearly changes, she said, making it important to audit how the policy is used and making the underwriter’s job that much more important.
The actuary should also pay attention to any insurance the creator of the system (for example, the Airbnb and Uber) provides.
The policy being priced will likely combine characteristics of standard commercial and personal policies, so understanding those will help develop the price. And it is possible to glean industry data by attending conferences and reading publications that follow the new industries.
Data simulations will help the actuary understand how wide the range of outcomes could be, Landrum said. And she noted that these policies may have a seasonal element to consider.
Cyber Liability: The cyber market is competitive now, Landrum said, but there is no broad agreement on what a policy covers. When pricing, “policy language is critical,” she said.
The line has low frequency but high severity, so the data available has limitations. Also some insurers partner with loss mitigation services; these reduce losses, but their costs should be considered in the rate.
Data can be difficult to come by, Landrum said. The actuary can analyze information from known breaches, and publicly available information can be a useful benchmark.
“This is a perfect opportunity to simulate” losses, Landrum said.
It is critical to consult experts when pricing cyber, she said.
Additional considerations include:
- Exposures vary greatly by the size of insureds and by industry.
- Some industries (e.g., hospitals) keep more information about exposures and losses than others.
- A firm can be hacked by a party that holds no malice. But there can still be losses, particularly in reputational damage.
Marijuana-Related Businesses: Though more than half the states have legalized some dispensing of marijuana, it remains a Schedule I drug to the federal government.
“Almost all traditional policies exclude coverage for anything to do with Schedule I drugs,” Landrum said. “Anybody that operates in this space is technically violating federal law, even if it is legal in that state.” That makes data hard to come by.
The actuary can liken dispensaries to pharmacies to help benchmark, she said. Grow houses are similar to greenhouses.
There are seed-to-sale tracking systems, Landrum said, which help in understanding the product liability exposure, but it is important to adjust those rates.
Furthermore, each state regulates cannabis its own way. The regulations can “gravely” change the exposure, Landrum said.
“If you go to a dispensary in Colorado you are going to have a completely different experience than if you go in Washington [state] or California,” she said. Rates should reflect that.
The strict federal ban has other repercussions. Marijuana-related businesses are effectively prohibited from using banks. All their sales are conducted in cash.
Typically the dispensary has an ATM near the front of the store. Customers use the machine and pay with cash. At the end of the day, the owner returns the cash to the ATM.
This system has insurance implications. For instance, all that cash floating around could invite theft. Also, sales can be an exposure base for rating, but if all sales are cash, there is potential for sales to be underreported — meaning the insurer risks underpricing.
Even the most basic underwriting tool — the background check — can be difficult. The best weed cultivators have been breaking the law for decades.
“For years this has been a black-market business,” Landrum said. “You can’t just call a former employer and find out how long this person has been in the business.”
Landrum’s presentation can be found at http://bit.ly/CAS_AM17prog (key word: Landrum).
James P. Lynch, FCAS, is chief actuary and director of research for the Insurance Information Institute. He serves on the CAS Board of Directors.