Finding Insurance: A Test For The Entrepreneurial Scientist

The entrepreneurial scientist who needs insurance for a start-up, high-technology business--especially in biotechnology or hazardous waste remediation--may find that liability coverage is hard to get. The reasons are simple. "Insurance is a business that depends on the status quo and experience," says Peter Huber, a senior fellow at the Manhattan Institute, a New York-based think tank, and a critic of the liability system. It's no wonder that life insurance, with its rich data bank on mortality, is a such a good business. Death is what an insurance company would refer to as a "frequency exposure": many losses of a predictable amount. On the other hand, companies in fields such as biotech present a much higher level of hazard, a "severity exposure," to insurance companies because losses tend to be few, but catastrophic. Biotech is a new field, and that works against it from an insurance standpoint, according to Lyn Rossano, vice president and manager of the advanced technology department at New York-based Continental Excess and Select, a subsidiary of Continental Corp., one of the companies that will write liability insurance for the biotechnology industry. Biotechnology products may or may not be extremely safe. But partly because so few biotech products are on the market, there have been very few losses sustained by insurance companies as a result of claims against biotech companies. Although encouraging, that makes underwriting difficult because there are few statistics to guide underwriters in setting rates and terms. As more and more biotechnology products make their way to market, more insurance companies are joining the race, and premiums are becoming more competitive. But in the back of underwriters' minds is a nervous "so far, so good." Since no one knows the long-term effects of drugs produced by biotech, underwriters tend to see the ghost of DES behind every new product. The drug diethylstilbesterol, which is commonly known as DES, was found in the late 1960s to have caused cancer and other disorders in the daughters of women who took it between the 1940s and 1960s to prevent miscarriages. According to Rossano, losses to insurance companies as well as manufacturers and distributors of DES were "catastrophic," amounting to hundreds of millions of dollars. DES claims are still being paid today. Risk Factors A startup in solid financial shape will have a much easier time obtaining liability coverage than a company without much capital behind it. David Sterling, a broker with Sterling & Sterling Inc., a brokerage serving the New York metropolitan area, explains the bias toward financially secure companies this way: "If a well-heeled company finds a defect in a product, it will recall it and fix it. Its insurance company will not be put at great risk. "A less well-heeled company in the same position can't afford to recall its product. It will go out of business and leave potential claims to the insurer." An insurance company that is licensed to write a particular kind of policy in a state is referred to as a commercial lines company; its rates are set by the state's insurance commission. An unlicensed, or surplus lines, company typically handles tougher risks, in which the loss potential is so high that few companies are willing to allow their rates to be set by state regulators. Commercial lines companies enter potentially hazardous fields, such as biotech, cautiously, dealing only with the strongest firms. They tend to charge less than surplus lines companies, according to Sterling. For example, take a company that makes nonhazardous medical devices, such as surgical instruments. The firm desires a product liability policy--coverage that will protect it in the event of injury caused by defects in its products. A typical rate from a commercial lines company, says Sterling, might be $2 to $3 for every $1,000 in sales. From a surplus lines company, the rate might be $10 or more for the same coverage. One of the first steps for any group of scientists starting a technical firm, according to several insurance industry representatives, is to confront the risk issues posed by the firm's proposed products. "Often, scientists say nothing could go wrong with their product," says Philip Edmundson, executive vice president at William Gallagher Associates, a Boston firm that specializes in finding insurance for high-technology businesses. David Shuey, a vice president in the Hunt Valley, Md., office of the national firm Willis Corroon Corp., says he often finds that "insurance is not on the top of the minds" of entrepreneurial scientists. Speaking specifically of those in biotechnology, which he specializes in, Shuey says that some scientists "think that because their product is biological, it's inherently safe and they don't need liability insurance." Clear Explanations In deciding whether to write a risk, one of the first things an insurance company looks for is a clear explanation of what the firm to be insured is doing, written for the nonscientist. Scientists must realize, says Edmundson, "that they will meet people in the insurance industry with very little technical background. They have to translate the science into easily understood terms." Luckily, scientists rarely enter the insurance marketplace alone. Liability insurance is not typically purchased as an automobile policy often is, directly from the insurance company itself. Almost always, a broker serves as a middleman, working with the customer to determine insurance needs, then venturing into the marketplace to find the right coverage at the best price. In fields in which innovation is happening fast, brokers play an important role in convincing carriers to underwrite risks. Entrepreneurial scientists, insurance underwriters, and brokers interviewed for this article all agree that choosing a broker who understands the scientist's field is one of the most important insurance decisions an entrepreneur will make. Finding such a broker isn't always easy. In the early and mid-1980s, for example, emerging biotechnology companies typically turned to "main-street" brokers, perhaps the same ones who insured the company presidents' homes or cars. Some of those brokers have since developed an expertise in biotechnology or some other high-tech field and may specialize in serving the needs of companies in that field in their local areas. But turning to a personal insurance broker is often not the best choice for the entrepreneur. "The main-street broker needs to be all things to all people [and may not have that capability]," says Willis Corroon's Shuey. A few years ago, Willis Corroon surveyed biotechnology companies, asking them about their insurance needs. Shuey says that the companies expressed frustration "that their insurance representatives didn't understand what they did, and therefore couldn't assess the risks and communicate them to the big insurance companies." The best way to find a broker who understands your field is through word of mouth. Trade associations may also have recommendations or lists of brokers. Alternatively, an entrepreneur may call the local offices of a few of the national brokerage houses, as well as a few regional brokers, and ask about their experience in a particular field. The Hard Way The executives of MedImmune Inc., a young Gaithersburg, Md., biotech firm, discovered the difficulty of obtaining insurance--and the importance of having a knowledgeable broker--the hard way. Even before it had a product, the company had trouble getting general liability insurance, which covers physical injury to people or premises as a result of the company's business (but not its products). After a year, the company was dropped by its carrier; its agent obtained another, poorer general liability policy at great cost. When their agent sent them a product liability form to review, MedImmune's executives knew it was time to rethink their insurance needs. The form contained an exclusion for cherry pickers, snow mobiles, and the like. MedImmune --which researches, develops, manufactures, and markets immunotherapeutics--was being asked to consider a specialized product liability policy for the trucking industry. That was when MedImmune turned to David Shuey, whom they found through the Association of Biotechnology Companies, which had selected Willis Corroon to develop a product and professional liability insurance program for its members. According to Willis Corroon's survey of biotechnology companies, 55 percent of the companies did not purchase product or professional liability insurance. Respondents cited two reasons most often for not buying coverage: It was too expensive or they were not at the stage of marketing products. Insurance Needs Indeed, when a scientific company is in the research and development phase, its insurance needs are largely the same as those of any other business. It needs insurance to protect its property and other assets in the event of fire and other disaster, or in the event that a third party--not an employee--falls and is injured on the company's premises. It also must, by state law, protect its workers through workmen's compensation. "Until a product is tested in humans," says Continental's Rossano, "a company doesn't need products liability. The mice aren't going to sue." As soon as clinical trials of a drug or medical device are contemplated, a company should seek liability coverage specifically for them. Often, such insurance will be required by the facility where the trials are held. Clinical trials coverage protects a company and investigators in the event that a trial subject has an adverse reaction and brings a claim. Stephen Lindell, a vice president with RLI Special Risk of Hartford, Conn., another underwriter for the biotechnology industry, suggests that investigators seek trials liability before applying to the Food and Drug Administration for approval to conduct a clinical trial, since it takes 60 to 90 days to get coverage, but trials can begin 30 days after FDA approval. Before deciding to underwrite the trial, the insurance company will want the same documents the FDA requires to approve the trial. One of the documents that an insurance company will examine closely is the form subjects sign to give informed consent, says Rossano. Suits arising out of clinical trials are infrequent, for a variety of reasons. Informed consent does not prevent someone from bringing a suit, but it diminishes the possibility. Trial participants are often already extremely ill, sometimes pinning their last hope on the experimental treatment, and so are not likely to sue. Also, relatively few people receive a drug or device during the trials, limiting the statistical chance of a bad outcome. But when the product is approved and marketed, exposure to product liability multiplies. As Harvey Dann, a broker in New York City, puts it, "In a litigious climate, if you give a drug to 10,000 people and two have adverse reactions, you could have two $1 million lawsuits." Product Liability Insurance companies study products carefully before issuing liability policies for them. The underwriter will want to know about the history of comparable products on the marketplace, how the new product will be labeled, and how it will be distributed. If the product is a piece of equipment or a medical device, the underwriter will want to know how it is operated and will study the manuals written for it. How much product liability insurance should a company carry? Layla Ganji, a casualty underwriter with Eastern Risk Specialists Inc. of Philadelphia, says that "when there is a loss, no one feels there is enough coverage." The amount of insurance to carry is a business decision, based on a company's size, its products and sales, and how much it can afford to pay. Companies typically carry at least $1 million of liability coverage for a product. Premiums may range from a few thousand dollars for a well-understood, nonhazardous medical device to $40,000 or more for a drug. Companies participating in the Association of Biotechnology Companies program may be able to qualify for a minimum premium of $7,500. Pollution Coverage Most general liability policies specifically exclude coverage for pollution. Yet high-technology companies in many fields, from biotechnology to hazardous waste remediation, may have pollution exposures. Three kinds of pollution coverage are common. Pollution legal liability covers a company if, as a result of its business, people away from its premises are harmed. A hazardous waste incinerator would carry such coverage to protect it from claims brought by people downwind of the plant who claim that pollutants made them ill. Contractor's pollution liability covers a company when it causes pollution at someone s site, as might happen if a hazardous waste remediation company causes greater pollution at a site where it is working. Professional pollution liability policies cover "errors and omissions" and are appropriate for consulting firms that tell others how to handle hazardous waste. ECOVA Corp., a Redmond, Wash.-based company that specializes in biological remediation, carries contractor's and professional pollution liability, says chief financial officer Alan Fuhrman. The premiums are substantial--about $60,000 each for $1 million in coverage. Only two companies write legal and contractor's pollution liability, says Paul Murdoch, the head of the pollution and professional liability group at ECS Inc. of Exton, Pa., a subsidiary of the Philadelphia-based Reliance Insurance Co. ECS is one of the two (Commerce and Industry Insurance Co., a subsidiary of the Chicago-based American International Group, or AIG, is the other). Pollution was once covered under general liability policies, Murdoch says, but insurance companies experienced sizable losses--in part because they lacked expertise in the field--and the market collapsed. Frivolous claims of pollution damage are common, Murdoch says, making it important that anyone entering the field discuss insurance needs carefully with brokers and underwriters. In a typical situation, a contractor may enter a site as part of an agreement to clean up hazardous waste. "The contractor should be liable only for the pollution it causes," says Murdoch, "but if it's on a hazardous site, the contractor may be sued" along with any other companies that have anything to do with the site. It is important that the contractor's liability insurance cover the cost of investigating the claim and defending it. Changing Needs As a company grows, its insurance needs grow, too, and its options multiply. For example, in some fields with difficult insurance risks, companies band together and create their own insurance company. In the medical device field, MEDMARC Insurance Co. and Risk Retention Group of Fairfax, Va., is such a "captive" insurance company; with about 500 member companies, it has the largest share of the market, says Kevin Quinley, vice president for risk services. Biomet Inc., the fourth largest orthopedic device manufacturer in the world, with more than $200 million in sales, has adopted a different strategy. From its founding by a quartet of entrepreneurs in 1977 until three years ago, the Warsaw, Ind., company purchased product liability insurance, says vice president and general counsel Daniel Hann. By 1988, a $200 million limit carried a $2 million premium. Claims are made regularly against Biomet, in common with other orthopedic device manufacturers, although few are lost. Hann says the company decided it was no longer cost-effective to purchase insurance with a normal deductible, and so it did what many large pharmaceutical companies--and many home and car owners--do. It self-insured, setting up a fund out of which insurance claims are settled, with the insurance company paying the excess. The company itself pays all settled small claims out of its self-insured fund, thus shielding the insurance company from having to pay out these claims, and thereby lowering the premium. For what broker David Sterling refers to as "monster claims that happen once in a lifetime," Biomet purchases excess liability coverage with the Minnesota-based St. Paul Companies. Billy Goodman is a science writer based in Brooklyn, N.Y.

Finding Insurance: A Test For The Entrepreneurial Scientist

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