We asked an expert panel of 6 top risk management industry professionals to share their thoughts about the current hard market. Read their thoughts on the reinsurance market, claims costs, demand and shrinking insurance capital.
Stephen Buonpane of Chubb believes, “For a hard market to exist you need three things to happen. The first is inadequate loss reserves, the second is inadequate profitability, and the third is inadequate capitalization. I want to touch on the first two and then get back to the industry’s capital position, because that’s a bit of an anomaly, at least with respect to this market cycle. But inadequate loss reserves and inadequate profitability. You might think those two are related, yes and no, and there’s obviously a correlation that’s there, but when you have to strengthen your reserves for adverse loss development, it doesn’t mean that insurance companies are not profitable.
You can have an underwriting loss, which tends to happen when you need to increase reserves, but you can still operate profitably if the investment income can offset it.
However, when we’re operating in a historically low interest rate environment, the investment income isn’t really there, then that puts more pressure on the underwriting results to get to your required ROI. And underwriting results have been very poor in a number of areas. According to The Institutes, from 2007 to 2013, auto claim severity rose at an annualized rate of 1%. Only 1%. And then from 2013 to 2018, severity rose at an annualized rate of nearly 11%. So from 2007 to 2013, just a 1% severity rate increase compared to five years later an 11% annualized severity rate increase. And we said that rates started to creep up in 2018. The number of class action suits that US companies have handled in 2020 were nearly four times as much than it was a decade ago. The number of verdicts and awards of over $20 million is up by more than 300% compared to the annual average a decade ago. So very simply, claim costs have risen at a much higher rate than what was assumed when policies were originally underwritten and that’s key. Therefore, you have inadequate loss reserves and then low interest rates on top of that are leading to both underwriting and operating losses. But where things get interesting here is that we don’t have inadequate capitalization, policyholder surplus in the USP&C industry has never been higher. I’m going to repeat that, policyholder surplus has never been higher. That means the industry is well capitalized, the supply is there, it’s just a lack of willingness to use that supply or deploy capacity, and that’s because of the massive loss increases we see from a severity standpoint. But balance sheets are healthy.
The capital is there, but putting out large excess limits, however, is just not sustainable in this environment. Insurance companies are saying we would rather spend a billion dollars buying back our own shares of stock than put out another $25 million limit.
Jonathan Luca of Starr gave his perspective, “In the excess space, you have the practice policy and your project policy. In the practice policy space, we’ve seen large rate increases over the last few years on virtually all classes of business, magnified by the tougher classes of business. On the difficult classes, there’s not only been the shrinkage of capacity, there’s also the markets who have left the space. So, a situation where you have a contractor who just cannot find coverage is becoming more common. As the brokers are trying to replace these markets, these increased rates along with the scarcity of markets on tougher classes have made things very difficult for insureds. The dramatic changes behind a practice policy from 2018 to 2020 is just phenomenal. This includes all the terms and condition changes, with tightening of exclusions and capping aggregates.”
Jonathan Luca continued, “Once you have a large claim in your 7 year window involved on a practice policy, the hardening is even more The verdicts in this space have been massive, coupled with the increased frequency in auto, carriers have, and they’re going to continue to raise rates in this area to seek profitability. The practice policy space in all venues are affected by this. New York is clearly one of the most difficult venues for underwriting companies to remain profitable and we’ve also started to see hardening in other states, recently Colorado, the State of Washington, and a few others all based on recent large unpredictable verdicts. From a venue standpoint, and for good reason, New York seems to be the hardest for small, mid-sized, and large business on practice policies. Then once you get to the project space, again, large rate increases, capacity reductions, similar to the practice policy, certain venues a lot more difficult than others, Florida, Colorado, and New York, very difficult to find capacity on project specifics.
Capacity shrinkage probably hurt this product the hardest based on the amount of limit that is purchased from this area. Larger projects are buying a hundred million of capacity. You once were able to achieve that with four or five carriers, but now to build a hundred million in tougher venues, you may need double the number of carriers than you used to, with each carrier wanting to maintain their larger per million-layer pricing. So again, you have more carriers seeking larger per million-layer pricing, just driving the overall up.”
Jonathan Luca continued, “When you look at a large two-line wrap, $400-$500 million, excess carriers have been pushing for increased attachment points, and in some situations, better aggregate structures for the excess carrier. In New York, a 5/10/10 attachment is pretty much turned into a mandatory requirement, which is putting more pressure onto the insured for the larger retentions and the primary carriers putting up more limits. The carriers that are willing to put out the larger GL limits, may be looking to the facultative reinsurance market for this capacity, but similar to the direct space, the facultative space has shown this tightness again, all for the same reasons, less players, and the remaining players are charging a lot more than they once have.
This increased attachment requirement also is putting pressure onto the buyer, the larger retentions, larger deductible levels are being required by the primary carriers in order to put up the more limit, and these larger retentions start to create increased collateral requirements, which is another factor to consider when clients are moving forward with this product.”
Mildred Claire of AECOM, “We felt a little bit less pain on the practice program renewal, bearing in mind that our portfolio is mostly New York-centric, mostly within the Northeast. Within our organization, we have another construction business, which is non- New York. Even on their practice program renewal, the lead access numbers were coming in double digit increases. We’ve seen it across our practice programs, and across our contractor-controlled insurance programs. The attachment point has changed over the last several years and the five, 10, 10 is pretty much the mandate.
And with that comes other factors, so that aggregate rates are higher in addition to paying more premium. We’re taking on more risk. Over the last couple of renewals and couple of project placements that we’ve gone through, there’s more due diligence in the underwriting, whereas previously there was underwriting, but it’s sort of taken it to another level. The credit divisions from the carriers like to get a little bit more involved, so there’s more due diligence going. In addition to the increase in deductibles, we’ve seen our deductible structure on our CCAMS program nearly quadruple over the last couple of years. And with that comes heftier collateral requirements and higher aggregate rates under those programs.”
The Hard Market added, “Yes, there’s some instability, a lot of change in the owner of GC project specific markets. It’s becoming increasingly more expensive, if not impossible, for sub-contractors to obtain insurance that meets the minimum requirements, so managing those types of programs is more onerous than it’s ever been before.”