A Change Gonna Come


By all accounts, 2010 was another predictable year in the soft market cycle that has characterized the U.S. commercial property and casualty industry for the last seven years. Rates across all lines of coverage continued to slide by single digits. The industry saw a reduction in gross written premium for the fourth consecutive year, representing the longest such stretch since record-keeping began in the 1940s. Catastrophe losses around the world, while dramatic, were not severe enough to move the needle in any perceptible way.

On the surface the industry seemed to be able to withstand the soft market conditions. Results measured in terms of surplus growth, return on equity and combined ratio, while not spectacular, were all acceptable for insurers. As we entered the first quarter of 2011 many wondered whether this market constituted a “new normal.” Perhaps the dynamics of past market cycles no longer applied? Regardless, at the end of last year, most prognosticators predicted that the soft market had a ways to go and 2011 would simply be year eight of a favorable market cycle for insurance buyers.

Over the last six months things have changed, however. Already, 2011 is the worst catastrophe year of all time with total economic losses of $265 billion, according to Munich Re. Insurers are on the hook for an estimated $60 billion of that record total. Perhaps most troubling of all is that all this came before the first named storm formed over the Atlantic.

To compound matters, changes in hurricane catastrophe modeling are forcing insurers to rethink their pricing, capital allocation and reinsurance buying patterns. Other lines of business beyond property have deteriorated more quickly than expected. By mid-year the mood of the industry began to shift and talk of a market firming has become more prevalent and consistent than during the false starts over the last few years when markets attempted to “will” a turn in the absence of an underlying rationale.

As a result, parts of the market are poised for a turn by next year. And the market corrections that we will see in 2012 and beyond will not constitute a general market turn like the one we experienced from 2001 through 2004. Instead there will be line of business corrections that will move rates and capacity in certain lines and allow other lines to continue to slide. While most expect that turn to be led by the property market, it is the casualty lines that have the worst experience and will likely generate the largest and most sustained change.

To further clarify the road ahead, here is a breakdown of what to expect for different market sectors in the months and years to come.


In the first six months of 2011, the global insurance industry was hammered by disasters. Virtually every insurer and reinsurer was touched by the estimated $60 billion in insured losses between January and July. These losses included the Japanese earthquake and tsunami, the Christchurch earthquake, Australian floods, U.S. floods, and the tornadoes and storms that decimated the Southeast, Midwest and even Massachusetts.

The first quarter losses in Japan and New Zealand largely missed the U.S. insurers with limited exposure in the Asia/Pacific region. Nevertheless, these losses will impact reinsurance pricing, and recent disasters in North America will affect second quarter results for many domestic insurers. Worse still, the National Oceanic and Atmospheric Administration has predicted an above normal hurricane season of 12 to 18 named storms, six to 10 hurricanes and three to six major hurricanes.

As insurers try to determine the impact of these catastrophes and prepare for hurricane season, they have been given an additional challenge. Risk Management Solutions (RMS), the largest provider of catastrophe modeling tools to U.S. insurers, released the latest version of its Atlantic hurricane model (version 11) in late February. This update incorporated data from the last three years of Atlantic hurricanes into its model and in many cases significantly changed the loss forecast of an insurer’s portfolio of risk. Reportedly, inland areas will be the most affected and force insurers to re-assess their portfolio, pricing and reinsurance purchasing strategies.

The combination of catastrophic losses and RMS 11 is having a significant impact on property pricing for wind-exposed risks. Rate increases of 5% to 10% are commonplace and even higher on larger schedules where catastrophe capacity is needed. Insurers are also looking to raise deductibles and lower sub-limits when they can. While insurers have not left the market, due to modeling constraints they are offering lower limits per risk and being more selective as to which risks they will participate on. Other markets are sitting on the sidelines, taking a wait-and-see approach to gauge how the rest of the market responds to RMS 11 and how the hurricane season plays out.

How the market responds to risks that are not exposed to catastrophes remains to be seen. To date, property rates outside of cat zones continue to drop by single digits. Rate levels remain well above the levels we saw at the bottom of the market in 2000. According to Advisen, property rates are still more than 35% higher than they were in 2001. Combined ratios for property have been acceptable and in line with historic averages. On that basis, rates can still drop substantially before we reach the bottom of the market. Should we have another benign hurricane season, it is likely that the firming that we are seeing in cat pricing will also quickly dissipate.

Workers Compensation

While the current catastrophe loss experience and revised modeling methodology only impacts the property marketplace, we expect to see changes in workers compensation lines due to the poor performance of their underlying fundamentals.

According to NCCI, the workers compensation industry reported an accident year combined loss ratio of 114% for 2010 — the worst performance in the last decade. A.M. Best is projecting a 121.5% combined ratio in 2011. This projection is 12.6% above its 10-year average of 108.9% and above the worst year in history of 120.8%. The industry has been plagued with declining premium levels (down 29% since 2005) and rising medical claims costs. This performance is clearly not sustainable and premium levels will have to rise, particularly in the worst-performing states.

Major workers comp writers like Chartis are pulling back. Between 2006 and 2009 Chartis’ workers compensation writing volume dropped 44%. “I think the one line of business that we’ve been saying for a couple years that has been underpriced is workers comp,” stated Chartis then-CEO Kris Moor in January. “We’ve exited in the U.S. over $2 billion of that business in the last couple years, and we’ll continue to do that as we go forward into this year because we still don’t see the pricing favorable in that line of business.”

Other carriers, like ACE, that have previously been aggressive writers are also pulling back. Many are becoming much more focused on a state-specific strategy and concentrating on class codes under which they think they can make money. This will mean that price pressure will manifest itself on a state and industry basis.

General Liability

The liability side faces similar challenges. For the lines A.M. Best categorizes as “other liability including products,” the 2010 combined ratio was 118% and will increase to 119.5% in 2011. While these long-tail lines can be tougher to predict accurately, over the past few years we have seen admitted carriers expanding their appetite to write what has traditionally been excess and surplus lines business.

As these losses begin to develop, many of these insurers will retreat to their standard markets. At the same time, E&S insurers have become frustrated by the soft pricing and broad coverage offered by the admitted competitors and, in some cases, have either scaled back or shut down their primary liability operations.

While we have not seen general price increases in liability, we would expect a change in 2012 for the tougher classes. Certain areas that have been challenged, like New York construction, are showing strong increases. As more classes demonstrate poor results they will begin to move up as well.

D&O/Professional Liability

The lines of business that should see a continuation of soft market pricing are directors and officers, professional liability and medical malpractice. These lines continue to show price reductions and ample capacity.

Although results are coming under pressure, the available capacity and competition will likely lead to continued soft pricing for the foreseeable future.

The Big Picture

The market is clearly exhibiting signs of stress that will manifest itself in hardening conditions in certain segments for the remainder of 2011 and into 2012. Catastrophe-exposed property, particularly windstorm, will experience the most immediate change as a result of RMS 11 and some losses that have hit both insurers and reinsurers.

By 2012, look for tougher general liability and workers compensation classes to follow suit as years of underpricing are finally coming home to roost. Other classes like non-cat property, D&O and professional liability seem to be positioned to continue down the soft market path for at least the next several years.

Nevertheless, as industry results continue to deteriorate and the market continues to transition, anything can happen.

Good luck.

Christopher M. Treanor

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About the Author

Christopher M. Treanor is the president of Preferred Concepts, LLC, a specialty insurance broker and program administrator.


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