The second quarter of 2013 marked the 10th consecutive quarter of price increases in the U.S. property/casualty marketplace. But while the market has been hardening, the upward rate movement has been moderate since it began in the first quarter of 2011. And although rate increases accelerated in 2012, they seem to be stabilizing in 2013.
The main culprit of these inconsistent fluctuations is poor underwriting results across the industry. While overall industry results are improving, the industry is still not delivering acceptable returns. In today’s environment insurers have few levers to pull other than underwriting profits to generate a return. As a result, insurers still need to move rates upward in an effort to improve overall performance, so there is no reason to expect the moderate rate increases to subside in the near term. Fortunately, these increases should remain moderate.
The reality is that it is highly unlikely that we will see a dramatic market hardening unless there is a cataclysmic loss event that impacts the entire industry. The wild market swings that the industry has historically experienced are much less likely today than they were 10, 20 or 30 years ago. Better quality information, improved regulation and more efficient flows of capital are creating a much more stable market than we have seen in the past. Having said that, the world is an increasingly uncertain place and external factors, from climate change to geopolitical instability, will always keep things interesting.
Catastrophe’s Drag on Profits
2011 and 2012 were two of the worst catastrophe years that the industry has experienced in the last 40 years. 2011 was the worst year for insured losses in modern history, with global catastrophe losses exceeding $120 billion according to reinsurer Swiss Re. Superstorm Sandy in 2012 is estimated to have contributed between $30-35 billion to the industry loss experience, bringing 2012’s loss total to $77 billion.
Catastrophe losses in 2011 and 2012 added over 9% and 7% respectively to the combined ratios for the U.S. P/C industry, according to A.M. Best. What is most remarkable is that while these catastrophic losses helped to create poor underwriting results for the industry, they were generally absorbed as earning events that the industry was able to shrug off. The U.S. P/C industry remains well capitalized and well positioned to take on what may lie ahead.
While the 2012 industry results represented an improvement over 2011, the improvement was not strong enough to significantly impact overall industry performance. According to A.M. Best, after-tax return-on-equity (ROE) for the industry improved from 4.6% in 2011 to 6.9% in 2012. The improvement in 2012 was largely a result of a smaller underwriting loss, but these returns are well below the ROEs that investors and management target. Accident-year combined ratio improved from 109.6% in 2011 to 105.2% in 2012, reducing the industry underwriting loss from $30 billion to $14 billion.
Underwriting profit is critically important in today’s low-interest-rate environment. Low interest rates create anemic investment yields for the insurer whose portfolios are heavily weighted in fixed income. This puts increased emphasis on underwriting performance. According to the Insurance Industry Institute, the P/C industry needs 3.6% reduction in combined ratio in order to offset a 1% reduction in interest rates. In addition, prior-year reserve releases—which help bolster insurer’s performance—have slowed, placing even more pressure on underwriting profit.
Strategies for Today’s Market
In order to achieve the best result at your upcoming renewal and make sure you stay within your budget, the following suggestions may be helpful:
Start early and look for an early commitment. In today’s environment, most insurers are running lean, which can slow the renewal process. Get in the market early and look for your insurer to provide an early commitment on the renewal. If you can come to an agreement on acceptable renewal parameters, you can avoid the hassle of marketing and the insurer can lock in its renewal. If you can’t come to agreement, you have time to look for alternatives.
Market aggressively if need be. The dirty little secret of today’s market is that while all insurers are pushing rate on renewals, almost all of them will aggressively pursue the right piece of new business. New accounts do not go into an insurer’s rate-change reports. As a result, an insurer will view the same account differently depending on whether it is a renewal or new business. If you do not like the message your incumbent is giving you, test the market. If you are a good quality risk, you should do well.
Improve your risk profile. While it may be self-evident, high-quality risks receive better treatment in the marketplace. At this part of the cycle, insurers are focused on their profitability—they are all still trying to grow. The name of the game is risk selection. This includes a complete and high-quality submission. The better you present yourself, the better you will do in a discriminating market.
The good news for insureds is that, while insurers are looking to move rates, the industry dynamics will not allow aggressive behavior—and in some cases can conspire against price increases altogether. As mentioned, rate increases have generally been moderate over the last two and a half years of this market correction, increasing on average between 2% and 5% based on data collected by Advisen, MarketScout and the Council of Insurance Agents and Brokers. While prices have slowly trended upward, this rise is not expected to accelerate.
With $598 billion of policyholder surplus, most believe that the market remains overcapitalized by as much as $100 billion, according to some estimates. Regardless of the amount, by most measures the industry is awash in capital. At a gross written premium/policyholder surplus ratio of 0.8/1.0 there is certainly a high level of capital chasing a limited amount of risk.
There are other signs that the market increases will remain moderate. New market entrants like Berkshire Specialty are creating more competition in the less-efficient/higher-risk end of the P/C spectrum. This should smooth out some of the areas currently experiencing the greatest price increases.
There is also plenty of evidence that insurers do not always demonstrate the same level of price discipline on new business as they do on renewals. Insurers who push rate too hard often find themselves in fierce competition with other markets. In addition, while the insurance market remains “hard,” the reinsurance market continues to soften. By most reports, reinsurance treaties in the second quarter of 2013 were down 10%-15% providing insurers with access to inexpensive capacity. This insurance/reinsurance price deviation typically does not last too long, and the markets sync up over time.
In the longer term, overall conditions should improve. Recent signals from the Federal Reserve that it will end its policy of quantitative easing some time in 2014 may create upward movement in interest rates, which could benefit insurers by improving investment returns. At the same time, as the economy continues to improve, insurers will also benefit from healthier clients that are in a better position to manage risk.
Further down the road there are two major trends that, over a longer horizon, could permanently change the industry and will continue to reduce the cyclical swings that it has historically experienced. While not new, the continued growth of alternative capacity—such as insurance-linked securities, side cars and other vehicles—for quickly bringing capital to risk will continue to wring the inefficiencies out of the market. Alternative capacity now represents 15% of the global property catastrophe market, according to Guy Carpenter, and is predicted to continue to grow. As the industry becomes truly global and capital markets converge on insurance and reinsurance markets, historic inefficiencies will be eliminated.
Perhaps more importantly, the industry is investing heavily in data and analytics. Predictive modeling is now beginning to take hold in the commercial P/C industry. With improvements in data collection, analysis, modeling and computing power, the industry’s ability to accurately assess and price risk will change fundamentally. While never perfect, the industry will have a much clearer view of the risk in its portfolios and what an individual risk is worth.
The future is bright for commercial insurance buyers—even in the short term. Rate increases should persist until market dynamics allow for insurers to generate a more acceptable return, but these increases will generally remain moderate across the industry. Good quality risks with favorable loss experience will enjoy easy renewals, and the market will continue to punish risks that are in tough industry segments or have poor individual loss experience.