Blog Posts - U.S. CAPTIVE INSURANCE LAW

Product Liability and Product Recall: Key Risks for Manufacturers

10/26/2018

My favorite product recall story involves Bluebell Ice Cream. In the summer of 2016, Bluebell had to recall their product due to contamination at their Brenham, Texas plant. It was big news in Texas because in occurred during the hottest part of the notoriously warm Texas summer. I have no idea if Bluebell had product liability and product recall insurance coverage before the incident, but rest assured they have it now.

Any manufacturer that places a product into the “stream of commerce” faces these two risks: product liability and product recall. The former is derived from tort law, which places a duty of care on all economic actors to provide safe products . The second happens when a manufacturer has to remove its product because it is somehow unsafe. Both risks are very expensive. Product liability may involve wrongful death costs and can also be pursued through a class action suit. Product recall involves pulling the product from shelves, transporting it back to a warehouse, sending new product to retailers, regaining lost income caused by the inevitable decline in sales, and rehabilitating the company’s public image.

This recent story about ground beef contamination got me thinking about this risk, which happens more often than you think.

Embezzlement: Very Common and Costly

10/23/2018

Embezzlement is far more common than you think. I receive a daily update from Google news that contains embezzlement headlines. Here are several screen shots from that report:

Granted, sometimes the email only contains a single headline. But more often than not, there are a few news items each day.

This is a very costly and complex risk. Consider the following points:

Nearly one-quarter of employee thefts reported involved large-scale losses of over $1 million. High-loss cases often result from schemes that repeatedly divert small sums of money over time, making them extremely difficult to detect. These schemes typically go on for years. In fact, 29 percent of employee theft persisted for more than five years. The average loss for cases that continued for five years or more was $2.2 million, and for cases lasting 10 years or more, the average loss was $5.4 million.

The American Society of Fraud Examiners recently released a comprehensive report on fraud. Here are some key findings:

Occupational fraud is extremely costly. Twenty-two percent of occupational frauds caused at least $1 million in losses.
Fraud schemes can be very difficult to detect. The typical occupational fraud lasted 16 months before it was discovered.
Tips are the most effective way to detect fraud. Forty percent of cases were detected by a tip — far more than by any other method.
Anti-fraud controls work. Eighteen anti-fraud controls were analyzed, and every one correlated to lower fraud losses and faster fraud detection.
High-level perpetrators do the most damage. The median loss in frauds committed by owners/executives was $850,000. Among non-owners/executives the median loss was $100,000.
Criminal fraud referrals are declining. Over the past 10 years, the percentage of occupational frauds referred to law enforcement has declined by 16 percent.

Just Who Should Think About Forming a Risk Financing Facility?

10/11/2018

A day does not go by when I do not talk about the requirements for putting together a risk financing facility (RFF). Oddly enough, while I have written about it in pieces across several platforms, I haven’t talked about it comprehensively in a single place. That is the topic of this piece: who is a truly viable RFF candidate?

Let’s start with attitude – that is, what is the attitude of the parent company’s management towards risk management? It is here that I break down insurance purchasers into two categories: the perfunctory purchaser and the knowledgeable purchaser.

The perfunctory purchaser treats the insurance purchase like the three-year-old views eating vegetables: they will do it, but there is a large amount of reluctance on their part. Here is the way I describe the process in my book Captive Insurance in Plain English (You can request a FREE copy on our homepage):

Insurance is a grudge purchase. No one wants to buy it, but people know they need it. So once a year they call an insurance agent, get a quote, buy and receive the policy, and then promptly place it in the lower right-hand drawer of their desk, never to be seen again (until they need to file a claim).

This describes about 90% of all insurance purchases. These companies are extremely poor candidates for RFFs. They simply do not have the right attitude to start and then maintain a self-funding program. They will not implement risk mitigation strategies; they will not want to attend a yearly meetings; they will not want to file claims. In short, they will not want to do anything required to maintain an insurance program.

What we really want are “knowledgeable purchasers.” These are people who had what I call an “aha moment” where they have suddenly become aware of the idea of risk and its management. Four scenarios typically create or cause this attitude.

The insured tried to file a claim with his insurer and had it denied
The insured filed a claim with his insurer but had a very difficult time resolving it.
The insured tried to find insurance but couldn’t find it or could only find very expensive coverage
The insured as achieved a great deal financially and suddenly realized they could lose it due to an entirely fortuitous event.

These people will do what is required to form and run an insurance company. These are the people you want.

Second, what size company should do this? Here is an area where reasonable minds will differ. However, I like the company to have a minimum size and “financial girth” because at that level and higher, the company can put together a pure captive, or, a captive that doesn’t need to participate in a risk pool. The minimum is usually about $10 million in gross revenue with 20-25 employees. It’s possible that the amount could be smaller, but it becomes progressively more difficult.

So, there you have it: a summary of the requirements of a real RFF candidate. I should stress that the attitude is – by far – the key issue. If they don’t want to do, walk away.

Cyber Risk and Fault Tree Analysis

10/9/2018

I've been trying to think of a business that does not have exposure to cyber risk. I can't think of one. At minimum, everybody stores confidential data on a computer, which means they have a valuable commodity subject to data breach.

Let's take a higher-level view of this risk by using a fault-tree analysis. Here's what that would look like:

The left side focuses on compromised data. Here's the general process criminal use to get your information:

Research: The cybercriminal looks for weaknesses in the company’s security (people, systems, or network).
Attack: The cybercriminal makes initial contact using either a network or social attack.
Network/Social attack: A network attack occurs when a cybercriminal uses infrastructure, system, and application weaknesses to infiltrate an organization’s network. Social attacks involve tricking or baiting employees into giving access to the company’s network. An employee can be duped into giving his/her login credentials or may be fooled into opening a malicious attachment.
Exfiltration: Once the cybercriminal gets into one computer, he/she can then attack the network and tunnel his/her way to confidential company data. Once the hacker extracts the data, the attack is considered successful.

The right side discusses network breaches. Here are some of the ways hackers will use to infiltrate networks:

Emails containing viruses and malware - This is one of the most popular methods of spreading malware hidden in an attachment in the email. Once the attachment is opened, the malicious software executes and/or downloads onto the computer that receives it.
Emails with links to malicious websites - Often referred to as phishing these emails attempt to emulate legitimate emails from well-known organisations that the receiver would tend to trust such as a bank. The html links lead to fake websites which try and trick the user entering sensitive information such as passwords and banking details. Sometimes these websites also attempt to install malware, viruses or spyware on the recipient’s computer.
Probing for weaknesses - Sometimes hackers send out mass emails in an attempt to compromise firewalls, intrusion detection systems and intrusion prevention systems to gain access to computer systems behind these defences. It’s a numbers game with millions of emails going out to identify malfunctioning, misconfigured or un-patched equipment.
Social networking pages - People tend to let down their guard and be less wary on social networking sites. With this method, a fake profile entices real users into following links to malicious websites or giving up sensitive personal information.
Inserting malicious packets - This relies on access to a swathe of zombie computers to send out large quantities of data packets to a large number of recipients targeting a specific port. The aim is to identify a router or firewall with the specific port open and gain access to the computers behind the firewalls
Hijacking ads - Cybercriminals often place ads containing malicious code on legitimate websites. They do this either by purchasing ads directly, hijacking the ad server or hacking someone else’s ad account.
Malware sold as legitimate software - Fake antivirus programs have infected millions of computers. Software is offered as free, available through the internet that includes malware designed to infect computers.
Advanced Persistent Threats (APTs) - APT means a sustained multi-pronged attempt to break into a specific organization’s or institution’s data networks. With APTs, hackers use many methods from sending fake promotional material to network attacks. The aim is to breach the network and steal information. APTs are different from other forms of attack because generally take place over the long term and can last months and years.

Risk Financing Facilities (RFF), Cyber Liability and Supply Chain Disruption

10/8/2018

A recent story from Bloomberg's Business Week highlights two risks: cyber and supply chain disruption. The story chronicles how the Chinese government inserted a unique microchip on mother boards. The chips allowed the Chinese military to continually monitor all activity processed through the board. Here is how the hack worked:

1. A Chinese military unit designed and manufactured microchips as small as a sharpened pencil tip. Some of the chips were built to look like signal conditioning couplers, and they incorporated memory, networking capability, and sufficient processing power for an attack.

2. The microchips were inserted at Chinese factories that supplied Supermicro, one of the world’s biggest sellers of server motherboards.

3. The compromised motherboards were built into servers assembled by Supermicro.

4. The compromised motherboards were built into servers assembled by Supermicro.

5. When a server was installed and switched on, the microchip altered the operating system’s core so it could accept modifications. The chip could also contact computers controlled by the attackers in search of further instructions and code.

That a third party could now monitor an entire computer network clearly highlights cyber liability. Tech companies would now have to shift their supply chains out of China and into the another country, clearly triggering supply chain disruption.

Handling both for risks internally through a risk financing facility (RFF) is far more advantageous than utilizing traditional insurance allowing the parent company to process both claims internally and confidentially, keeping key company information away from third parties.

Please call us at 832.330.4101 if you'd like to learn more.

Risk Financing Facilities Help Insureds Avoid the Post-Disaster Problems of Slow and Delayed Claims Management

10/2/2018

If you're an accountant, CFP, or Texas insurance agent, please sign-up for our 1-hour captive insurance continuing education course on Friday, October 12 at noon.

Claims management seems like such an ephemeral concept, doesn't it? Most insureds probably don't even give it a second thought when looking at a carrier, instead assuming it will happen quickly and efficiently.

But that's not going to be the case after a major disaster like Hurricane Florence. While insurers "flood the zone" with adjusters, the sheer magnitude of the event can slow the process. And that's before we get to the "3 D's of deny, delay, and defend" which insurers will argue are a myth but which insurance lawyers argue are gospel.

A recent article in the Insurance Journal contains some of the standard post-disaster complaints experienced by an insurance company regarding claims:

“Why haven’t I heard from a claims adjuster?”
“I haven’t heard anything from my carrier for two weeks.”
“Where is my check?”
“Are they going to pay? When are they going to decide?”
“The adjuster said something about not having the right coverage, what does he mean?”
“You mean flood wasn’t covered?”
“Why haven’t you come by to look at the damage?”
“My neighbor got paid for ‘X,’ why didn’t I?”
“When is someone going to get these trees off my roof?”
“When is the carrier going to remove these trees from my yard?”
“When can I start rebuilding?”
“How do I pay for my hotel bills while out of my house?” “What about additional food costs?”

Taking control of your risk by forming and running a risk financing facility (RFF) eliminates this problem, especially if you run claims in-house. Here, we recommend that at least one person on your staff obtains an Associate in Claims designation from the Institutes.

Hazard Coverage Costs are Increasing in Texas. Expect the Same Along Most of the Coastal US

10/1/2018

If you're an accountant, CFP, or Texas insurance agent, please sign-up for our 1-hour captive insurance continuing education course on Friday, October 12 at noon.

Two stories from the Insurance Journal highlight the increasing cost of property coverage in Texas.

Let's start with this projection of the increasing possibility of 100-year rain incidents in the Lone Star State:

Decades of additional weather data have led federal officials to reconsider rainfall totals in Texas that define 100-year weather events and caution that extreme rainstorms will strike the state more frequently.

The National Oceanic and Atmospheric Administration on Sept. 27 released a study finding that in the Houston area, for instance, 100-year estimates increased from 13 inches to 18 inches for a 24-hour period. Rainfall previously classified as 100-year events are now more frequent 25-year events.

Yet, despite the increased cost of property coverage due to higher rain possibility, Texas lawmakers are asking the Texas Department of Insurance to deny a 10% rate increase:

More than 20 state legislators have signed a letter addressed to Texas Insurance Commissioner Kent Sullivan requesting that a 10 percent rate increase filed by the state’s property insurer of last resort for wind and hail along the Texas coast not be approved.

The Texas Windstorm Insurance Association in August filed with the Texas Department of Insurance a 10 percent rate increase for residential and commercial properties that would go into effect next year.

This shouldn't be surprising; no one (including politicians) like rate increases.

This simply highlights that the underlying fundamentals of property coverage are changing, which usually means the increased implementation of risk financing facilities.

Will Hurricane Maria Prove to be the Event that Perpetuates Puerto Rico's Problems For a Generation.

9/26/2018

If you're an accountant, CFP, or Texas insurance agent, please sign-up for our 1-hour captive insurance continuing education course on Friday, October 12 at noon.

If you have a captive located in Puerto Rico and would like to move to a more structurally sound jurisdiction, please contact us at 832.330.4101

In several blog posts, I've documented Puerto Rico's fundamentally unsound economy (see here, here, and here). To recap, they are in a depression; there is a fundamental problem with the labor market such that it hasn't reached full employment in decades; there is a net capital outflow from the economy. If this were not a U.S. territory, the financial press would probably be using phrases like "currency crisis" and "balance of payment" crisis.

It's been one year since Hurricane Maria hit the island. It's starting to look as though this event will negatively impact the island in the medium and long term.

This video link to CNN shows that Maria is negatively impacting an entire generation.
This story from the Times shows that after a year, the island remains in poor shape.

Both stories demonstrate that Maria's impact is far, wide, and extremely negative. Only time will tell, but it could be "the" event that prevents the economy from being anything but a perpetual cycle of poverty and dysfunction.

Product Recall is a Prime Example of a Risk That Should be Managed Through a Risk Financing Facility

9/22/2018

If you're an accountant, CFP, or Texas insurance agent, please sign-up for our 1-hour captive insurance continuing education course on Friday, October 12 at noon.

Remember when you were a kid traveling by car with your family and the issue of "clean bathrooms" was of prime importance when looking for a place to stop? Buc-ee's solved that problem. If you are ever driving between Texas cities (which Texans do regularly), Buc-ee's has become the stopping place because of their attention to cleanliness. Buc-ee's is also a great store. They use the Costco HR strategy -- pay your people well, thoroughly develop their talent, and they will actually work more efficiently. Trust me -- it pays off in spades.

I feel the personal need to begin this blog post with a thorough defense of the chain because Buc-ee's recently had to recall a product, which is never a good development. However, it's part-and-parcel of running a retail store. Let's look at the the potential costs associated with this event:

The labor cost of removing the product from the shelves
The shipping cost of moving damaged product from point A to point B.
The cost of moving replacement product from point B to point A
The labor cost of placing the product back on the shelves.
Lost income from a decline in sales of the replaced product.
Potential litigation costs associated with defending the company in the event the product causes harm
Rebuild the company's and the product's image.
Potentially changing the way the good is manufactured, or changing producers if there is a systemic problem with the old company.

This is a complicated risk. Not only should a company develop a customized plan for dealing with it (because it's not a matter of if but when it will happen) but it should also develop a specialized plan to deal with it. And that's where a customized risk financing facility comes into play. It allows the company to have a good idea up front how to pay for this eventuality.

Higher Losses and More Events Mean It's Time to Consider Establishing a Risk Financing Facility

9/22/2018

If you're an accountant, CFP, or Texas insurance agent, please sign-up for our 1-hour captive insurance continuing education course on Friday, October 12 at noon.

When should a company consider establishing a risk financing facility (RFF)? Being a good lawyer, I would say, "It depends." But 1.) an increase in the number of individual events, along with 2.) a rise in the total claim amount per event, are two factors that would support a decision to establish and maintain an RFF. The reason is simple: higher probability of a claim along with a higher claims amount per event means taking control of risk will help to lower the total bill from an event. And that is exactly what occurs when a company established an RFF.

A recent study from MunichRe indicates the number of events and total amounts per event are rising:

Both overall and insured losses from natural disasters in 2017 were significantly higher than the corresponding averages for the last ten years, which, after adjustment for inflation, amount to US$ 170bn and US$ 49bn respectively. The hurricane season in the North Atlantic proved particularly costly, accounting for US$ 215bn in overall losses, of which US$ 92bn is expected to be insured. There were also two earthquakes in Mexico with a combined loss of over US$ 8bn, and widespread flooding in China which caused losses of more than US$ 6bn. Severe wildfires were raging in the USA until the end of the year. Losses from the October fires alone exceeded US$ 10bn, with the bulk of this amount – more than US$ 8bn – insured. By the end of the year therefore, losses from wildfires are likely to be substantially higher.