Lilly decides to self-insure for product liability

Eli Lilly and Co. has picked an insurer it knows extremely well to cover future problems in the high-stakes world of product liability litigation–itself.

The Indianapolis drugmaker, which paid $700 million last year to create a settlement fund for legal claims against star-seller Zyprexa, opted for self-insurance after struggling to find coverage in what it terms a "very restrictive insurance market."

Skyrocketing premiums and insurers reluctant to provide full coverage for entire product lines have forced Lilly and other large drug companies into alternatives like self-insurance in recent years, industry observers say.

The move exposes them to greater risk. But many say it's a worthy gamble because third-party insurance has become limited and expensive–in some cases, hundreds of millions of dollars a year.

"It becomes part of a smart money-managing criteria for [drug companies]," said Keith DeCoster, Indianapolis-based managing director of the life sciences group of Aon Corp., a Chicago-based insurance broker. "You're talking large amounts of capital."

Lilly became entirely self-insured after its coverage for Zyprexa expired in 2004. It uses Elco Insurance Co. Ltd., a Bermuda-based wholly owned subsidiary. Lilly pays premiums to Elco and in return receives a better deal on coverage than it could find through a third-party insurer, company spokesman Phil Belt said.

He declined to say how much the company pays Elco.

Last year, Lilly sued several of the insurers that had provided coverage for Zyprexa for defense costs associated with the drug's legal woes. In court papers, the insurers contend they shouldn't have to pay. They argue Lilly failed to reveal the extent of the litigation against Zyprexa and that the antipsychotic drug triggers diabetes-related side effects.

Belt said the major driver behind Lilly's switch to self-insurance was the lack of any "quality, meaningful coverage in the marketplace."

Lilly, which has $15 billion in annual sales, and other big drug companies all use self-insurance to some extent, DeCoster said.

Some have been doing it as long as 20 years.

Premiums for third-party insurance have spiked as much as 700 percent since 1998, according to DeCoster, whose company arranges coverage for several large pharmaceutical firms. He called that increase a "very conservative estimate."

Companies can expect to pay up to 20 percent of their coverage limit in annual premiums. That means coverage with a $1 billion limit costs $200 million. And chances are, that policy won't cover every product in the portfolio.

Many insurers start negotiations by noting which products they'll exclude from coverage, DeCoster said. That might include a whole class of drugs, such as hormone-replacement therapies.

"The pharmaceutical companies … are saying, 'What's the value of paying $200 million for coverage, if I can get it, and then not getting anything covered?'" DeCoster said.

He added that drug companies would be hard-pressed to find coverage that extensive these days. Most likely, they can find a $300 million limit if they cobble together policies from several insurers.

"Typically, it's not uncommon to get multiple carriers," he said. "They don't want to get hit on a total class of drugs."

Even if a drug company finds coverage, it still has to spend millions on legal fees or settlement costs before that coverage will kick in. Then the drug company foots the rest of the bill after the coverage limit is reached.

A rise in class-action litigation and huge payouts have tightened the insurance market.

Law firms that specialize in rounding up patients for class-action cases have grown more prominent over the past decade, said Stephen Ware, senior managing director for the insurance group at the Chicago-based investment firm Mesirow Financial.

Some of those cases lead to massive payouts. Lilly's $700 million Zyprexa bill, its largest-ever product liability payout, is modest compared with the more than $21 billion in charges New Jersey-based Wyeth has rung up for legal matters involving diet drugs, including one commonly known as "fen-phen."

"Pharmaceutical companies are a difficult class of companies to insure for product liability," Ware said.

Self-insurance is enticing to them for many reasons. For starters, the drug company saves money by avoiding an insurance company's administrative expenses, said John F. Fitzgerald Jr., Ball State University professor of finance and insurance.

The company that self-insures also avoids being lumped in a pool with other companies covered by the same insurer, which can prompt rate increases.

"If a company has a good loss experience, it's in their interest to do what Lilly's doing," Fitzgerald said.

But the approach can be risky, too. It removes the safety net an outside insurer would provide to blunt litigation costs.

That means the drugmaker is responsible for the entire cost, which could hurt a company stuck with a large payout or a string of claims involving a single product, Fitzgerald noted.

However, DeCoster doesn't see it as undue risk. A $200 million insurance policy would do little to help a company hit with a charge the size of Wyeth's.

He also noted that drug companies spend hundreds of millions of dollars developing new products, and all the trials and evaluations each drug goes through help mitigate that risk.

"They're managing the risk from the time they find the molecule," he said.

Besides, massive payments like Wyeth's are rare, noted Herman Saftlas, an analyst who covers Lilly for New York-based Standard and Poor's.

"It's just the manner of doing business," he said. "The business involves certain risks."

Whether Lilly's strategy pays off may depend on how a bevy of still-unresolved product liability claims plays out and how many new ones surface.

In a filing with the Securities and Exchange Commission, the company notes that while it has reached agreements to settle the majority of the claims against Zyprexa, more than 1,400 lawsuits fall outside those pacts.

It's also facing more than 360 suits over vaccines containing the preservative thimerosal. Some parents allege that mercury in thimerosal poisoned their children, causing autism and other neurological ailments.