
One minute every insurer in town is undercutting each other to make new business revenue targets, the next moment it’s hard to find an insurer willing to write anything!
Welcome to a hard market.
This must be so hard to articulate to a client especially in a way that they can understand. They probably realise if they have claims, their cost will rise, but they can’t understand why they are paying for everyone else’s claims when they are loss free and have invested heavily in risk management?
All a client really wants is pricing consistency to enable them to reserve an amount for insurance in their annual budget, which may have a small variance each year, but not multiples we are currently experiencing!
The Cycle
How do we explain the insurance pricing cycle, which in one season will go down and then when the winds change due to adverse events, go up slowly or sometimes exponentially, which we are all currently experiencing.
Insureds must be confused with these cycles compared to costs in their own industry when the price of materials normally only goes one way being upwards and not down.
Insured’s perception at times must be “you’re the professionals you never seem to be able to get it right”.
There is a lot to balance in the insurance industry and that’s why Insured’s use Insurance to hedge their risks from their balance sheets, so it’s not all bad. However, the insurance market has become too reliant on untested loss modelling practices.
So why does this pricing Cycle happen?
It’s probably best explained that when interest rates are low the insurance industry decides to chase revenue and not profit, as there is an oversupply of capital, and this capital needs to be utilised. The only investor questions and key metrics are the quarter-on-quarter growth. This situation is known as a soft market.
In a soft market, risk selection is paramount for underwriters as rate adequacy is non-existent, so underwriters are reliant on writing the best performing risks. As you can imagine, everyone wants this type of risk due to over availability of capacity and underwriters can't ask too many questions to determine risk quality otherwise brokers move onto the next available user-friendly market!
In a hard market, risk selection is still important, but becomes slightly less of an issue as rate adequacy returns “en-masse” due to higher rates and more variance of risks.
The whole scenario is driven by supply and demand and is totally counter intuitive caused by the flock syndrome.
Underwriters who take a long-term approach to rate adequacy will adjust their books of business according to the market cycle instead of chasing revenue, these underwriters are just chasing profit. They are a small group in terms of count, but still exist and normally will come into their own in a hard market and start coming off risks in a soft market when the policy rates go below their own perceived rate adequacy for the class of business.
When interest rates are high, the industry must focus on profit to attract capital as there are several alternative lower risk opportunities which the capital is attracted to. This is when everything gets corrected as insurers need capital to write business.
Insurance is a very capital-intensive industry due to the liquidity ratios required of premium to capital, and the purchase of reinsurance protection to write catastrophe business is used as a hedge against the insurers balance sheet.
In a very hard market, the quality insurers survive, and the poor performers disappear as they are unable to raise fresh capital to maintain liquidity ratios.
We haven’t seen many insurers pull out of classes or even fail/become insolvent due to increased oversight, but do now expect to see some casualties along the way.
This effect basically creates a run to the good insurers (flight to quality as it’s known), new business demand will dramatically increase and they themselves will start becoming full of business!
We haven’t quite seen this yet, but in the coming months in the USA, Southeast and other natural cat prone areas we will see insurers / underwriters routinely say they are full of aggregate in individual counties and states in the USA. We haven’t really seen this for a decade or so, not since the last hard market, and this effect is caused by the lack of available reinsurance at a reasonable price versus the capital base of the company.
This is why if you’re an insurance buyer it’s crucial to think about buying Windstorm cover in a high-risk area in the first 4 months of the year to lock in the available capacity, rather than later in the year, when it’s most likely to be gone.
So, what caused the current dramatic turn of events, was it Hurricanes, war in Ukraine, Oil Prices, Inflation, Covid, Supply chain delays, cyber claims, Interest rates, under declared replacement cost values, climate change? Probably all these things. Plus, if everyone is really honest the insurance industries over reliance on pricing models, rather than a series of checks and balances, which not only use the models but blend them with traditional underwriting methods and experience.
The Insurance industry is poor at using historical data, this is probably due to the quality and availability, which is a shame. To have a hundred years’ worth of data would greatly assist in many fields with pricing and rate adequacy over the longer term coupled with some forward-thinking assumptions.
Rate adequacy is a key long-term metric, if the pricing you offered on your business seems too good to be true, it probably is, and it won't last long! Have you ever looked at the proposition yourself and said wow, I wouldn’t offer that deal, or looked in the rear-view mirror of what’s happening on your current insurance programme?
The current market situation has been brewing for the past few years and has become so bad it caused a lack of capital in the retro market. This is where the reinsurance market hedges their balance sheet which basically caused a systemic domino effect across the industry causing a significant increase to the cost of insurance to both the commercial and consumer market. Capital in the retro market was so frustrated that it simply dried up causing the correction effect.
So, what does a client really want, they probably want Insurance at a consistent price, over the long term, with a stable insurer, to give themselves piece of mind and confidence that the insurer will be there to pay the big loss without fuss.
What are some of the things you can do to control this in a hard market?
a) Control your Cat limits, only buy up to what you really need and not what you were offered last year. Invest in an independent professional report to manage the amount of limit required, as this will be a big driver of the price.
b) Larger deductibles – show underwriters you believe in your exposures and are willing to take higher retention's.
c) Multiyear deals – fix in capacity at the current price, the market doesn’t feel as if it’s going down, but even if it does, this gives a company some certainty over a 3-year period of pricing.
d) Swing deals – This is a method for clients with poor loss history to attract capacity if they are failing to do so, simply put. In a bad year you pay additional premium and in a good year underwriters return premium.
e) Aggregate Deductible - If your account is big enough you can certainly introduce a self-insured captive aggregate into your programme and then buy your own unique Insurance programme above the captive with the view over the long-term expanding the captive out. This really depends on your business and risk management controls.
f) If you can, try to look at a longer-term approach for your clients as a whole and then try and match insurers to clients.
Lastly, we keep getting asked: “Have you seen it this bad before”?
Simply put, yes, and in fact worse than this. We have been in the market since 1986 which was a hard market caused then by a casualty crisis and consequently the risk retention act was formed to allow capital to flow into the casualty market and for like-minded industries to form their own alternative insurer.
During the later years of the 80’s and the 90’s – we saw a whole run of significant losses, they seemed never ending at the time. The Exxon Valdez spill, Piper Alpha, Asbestosis, San Francisco Earthquake, Los Angeles Earthquake, Hurricane Hugo and Andrew.
In days gone by, we would finish a placement on a Friday and then the following Monday we would have to replace the line with another insurer as the Friday market was out of business!!
We hope we don’t get back to this place again but, as Insurance brokers who have navigated many hard and soft markets in the past and present, we are here to offer our services, advice and help in placing business for you in the future.
Comments