Understanding the Role of Loss Mitigation Insurance

Loss Mitigation Insurance transfers an unknown or unwanted exposure from one company to an insurance company for a price. LMI caps what would otherwise be an unknown amount and is particularly effective if the company with the liability is in the process of merging or being acquired.

Employers of all sizes can benefit from a LMI policy. The coverage helps risk managers dispose of costly litigation that could damage the bottom-line and impair their ability to complete a refinancing arrangement. Before LMI, when an uncertainty in a merger or acquisition came up, both sides walked away until the lawsuit or financial impediment was resolved.

One solution used in such cases required the seller to deposit funds into an escrow account to cover the estimated losses from the claim or lawsuit. This tied up capital and there was no guarantee that the amount deposited would be enough to cover the final settlement. With a LMI policy, these problems can be resolved and the transaction put on track again.

LMI Takes Many Forms

There are several ways in which LMI programs can be structured. LMI can be underwritten to apply either in conjunction with, or independent of other insurance in force, such as Directors and Officers liability or general liability. For example, a deal to merge ABC Company with XYZ was delayed because of XYZ's concern over the catastrophic exposure for a potentially adverse judgment against ABC. ABC arranged for a LMI policy to be written which responds if the loss exceeds the limits of ABC's existing liability insurance. LMI relieved ABC of a potentially damaging award and the merger proceeded.

Another example of how a LMI policy helped solve a legal problem within a rigid time limit involved a consumer products company that was in the final stages of buying a company in an Eastern European country. The target company had been involved in litigation with a former employee regarding a patent and though most of the complaint had been dismissed, and a damage analysis of the remaining counts showed potential damages to be minimal, the purchasing company was reluctant to move forward. Further, the acquiring company's option to purchase the Eastern European company was to expire in less than three months.

Although the investor wanted to exercise its option to purchase the company within the time limit, the patent litigation would not be resolved before that date. Also, the investing company was unfamiliar with the legal system in the target company's country, which caused further concern. The solution: a LMI program was purchased by the target company that would cover excess losses from future settlements of the patent claim and the acquisition was completed before the time limit expired.

                                        

Premium Commitment

The size of the premium for a LMI policy depends on a combination of the risk analysis by the underwriter and the policy's structure. Most LMI contracts are structured so the policy's limits are never reached. If the policy is not breached, there is no claim. Because the risks covered by LMI policies usually have lengthy tails, it takes a long time for them to be settled, which permits insurers to realize investment gains from collected premiums.

Although LMI has only been written for a little more than five years, premium volume has skyrocketed from zero to more than $500 million annually in this time. Insurers are writing more of this coverage because underwriters have become more experienced in determining the extent of the exposure as well as drafting and pricing the appropriate policies.

An insurer's willingness to underwrite LMI depends on the state of the insurance market and the availability of reinsurance. If the insurance market hardens, insurers have less access to the capital to support their underwriting efforts. In a soft market, insurers seek out opportunities to expand premium volume and are more willing to write LMI.

Comments

Got something to say? Join the discussion »

Leave a Reply

 [Quick Submit with Ctrl+Enter]

Remember my details
Notify me of followup comments via e-mail