2011: Soft market finally ends?
There are more questions than answers concerning where pricing is headed
By Michael J. Moody, MBA, ARM
In the late summer of 2009, major reinsurers were looking forward to their annual getaway to their Rendezvous in Monte Carlo. If the rumors were true, renewal rates coming out of these meetings would move upward and would finally put an end to the long-standing soft commercial property and casualty insurance market. Prior to the meeting, speculation ran high among many industry observers that rate increases in the 10% to 20% range could be expected. But as history has shown, that was not the case. In fact, not only were rate increases lacking, pricing continued its journey downward with further reductions in both 2009 and 2010.
As a result, the insurance industry now finds itself at the beginning of yet another year facing uncertainty with regard to pricing. By all accounts, 2011 is loaded with unresolved issues and unknowns for underwriters; however, a number of sources have provided some insight into how 2011 will settle out. Here is a summary of some of the historical background, projections about 2011 rates and some concerns that the industry will face as they move through 2011.
2010—a turnaround year?
For the most part, 2010 has turned out to be yet another year of soft market pricing in a long stretch of insurance buyer-friendly years. A number of sources have indicated the estimated results of 2010, based on preliminary data. For example, the Risk and Insurance Management Society/Advisen latest survey data shows that while rate decreases continue, "The pace of premium decreases slows." It should be noted that the RIMS survey is made up of its corporate risk management members who either participated in their trademarked benchmark study or provided data directly from their brokers. Despite slowing rate declines, the study noted, "Every line of insurance tracked posted a decrease in average premium."
The Council of Insurance Agents & Brokers (CIAB) which has been tracking rates since 1999, found a similar result. According to the CIAB data, "the average commercial account renewed during the first half of 2010 was down 6.4%." They also noted a slowing in the trend of rate decreases, stating that the magnitude of price decreases gradually diminished from a 13.8% drop recorded in 2008 to only a 5.3% decline during the first part of 2010. The average range of reduction during 2010 was estimated to be 5% to 6.5%.
Additionally, a recent survey of 40 insurance companies that account for about 20% of the commercial insurance market was performed by Towers Watson. This survey also observed annual premium reductions within the insurance industry. The impact of these reductions on the overall loss ratios based on Towers' proprietary modeling data is that "accident year-to-date 2010 loss ratios deteriorated 4% related to same period in 2009." This trend is similar to the 2009 loss ratios, which were 4% higher than 2008. The data also confirms that the majority of the premium reductions were occurring in large accounts, while small and middle market accounts had flat renewals.
A Marsh study also indicated similar results. The broker points out: "Soft insurance market conditions persisted during the third quarter of 2010." They also indicate that, for the most part, "lower rates on average, have occurred across all major coverage lines." Further, they note that, "Even with an estimated $18 billion in worldwide property catastrophic losses during the first half of 2010, property rates declined in the U.S. by 5% to 10% in the third quarter."
Dr. Robert P. Hartwig, CPCU, president of the Insurance Information Institute, points out that, despite the continued erosion of commercial insurance premium, there may be some valid reasons for this intense competition. "Annualized statutory rate of return on average surplus was 6.3% during the first half of 2010." These numbers showed meaningful improvement over 2009's 5.8% figures, and significant improvement over the 0.6% figure in 2008.
However, Hartwig is quick to add, "These numbers by themselves are encouraging to the insurance industry," but the improvement had little to do with traditional premium growth. Claims cost trends and lack of catastrophic losses also had little to do with the improvement; rather, he says, "All of the improvement came from a massive reversal in asset values."
So while 2010 had been considered by most as a continuation of the premium reduction cycle, in reality it may have only affected the larger accounts. This left many small to mid-sized accounts with either flat renewals or even modest rate increases.
2011—light at the end of the tunnel?
So now, the $64,000 question becomes what's on tap for 2011? Certainly, it is common knowledge just how self-destructive the insurance industry can be, and many believe that 2011 will be the year that yet again illustrates this tendency.
At the end of the day, the RIMS/Advisen study provides the real crux of the issue: "There is still too much capacity chasing too little premium." To make matters worse, the global recession has had an adverse effect on many corporations worldwide, causing many to either significantly downsize or go out of business altogether. This of course reduces the "amount of insurance premiums in the market, thus encouraging insurance companies to vigorously compete for their share of a shrinking pie."
"Barring any unforeseen events," notes the CIAB report, "there is nothing on the immediate horizon that suggests a dramatic change in the market's direction." Marsh also concurs with this assessment, stating that "a surplus capacity, continued profits and a stable litigation environment" should lead to continued price declines for 2011. Willis, in its review of the 2011 commercial insurance market states, "We see no major disruptions on the horizon, and buyer-friendly market conditions are expected to prevail in 2011."
However, not everyone is quite as optimistic about the direction of the 2011 market. Lockton, for example, in its review, notes: Underwriting capacity remains plentiful across most lines of commercial insurance." But, it goes on to say that, despite this fact, most industry experts realize that "the current pricing situation is unsustainable in the long run."
William R. Berkley, chairman and CEO of W.R. Berkley Corp., has stated he is optimistic that the cycle will turn sooner than later." He also believes that "the industry as a whole is running at an operating loss," and says "companies cannot continue to write business knowingly at an operating loss." Further to the point, Berkley is "confident that the pricing cycle is currently in the process of correcting itself."
Whenever it comes, the hardening market should provide some welcome relief for insurance companies' financial statements and insurance agents' commission income. Obviously, higher rates and increasing premiums will certainly add to the revenue streams of most insurers. However, as with most things in life, there always seem to be storm clouds on the horizon, threatening the silver linings. A couple of issues will illustrate this point.
First, let's look at the effects of the past few hard markets, beginning with the 1970s, or even earlier. The hardening commercial insurance market was largely responsible for forcing many insureds into the alternative market. And, for many of the good accounts, they rarely returned to the traditional market. Affordability and availability issues that arose in later hard markets did the same thing, but by then, movement to the alternative market was easier than ever. Insurers should be mindful of this fact; insurance buyers no longer have any trepidation about leaving the commercial insurance market. Thanks in large part to numerous friendly domicile regulators and third-party service providers, it is easier than ever.
Obviously, pricing is the major issue that everyone is concerned about today. However, there is another major aspect to the current competitive insurance market that will need to be dealt with. This issue revolves around an aspect that is getting little to no attention when discussions are occurring about the competitiveness of this market. The issue at hand is the expansion of the scope of coverage.
Every study and white paper is quick to point to changes in pricing (i.e., a decrease in liability rates of 4.26% over last year's). Almost as an afterthought, they may note that terms and conditions continue to be broadened. It's this broadening of coverage that may well cause the insurance industry the most heartburn in the future. With the majority of casualty coverages being written on an occurrence form, exposures created by these expanded terms and conditions will be with insurers/reinsurers for years to come. This issue alone may be the lasting legacy from the current soft commercial insurance market.
With regard to the current commercial insurance market, 2011 is shaping up to be a year of unknowns. Many questions remain about both the world and the U.S. economy. Many of the results of the insurance industry are tied in one way or another to the overall economic results of the international business community. However, the bigger question is, will the insurance industry be smart enough, and start soon enough to have a "soft landing" with regard to rates and pricing? Or will they once again fall victim to their own self-destructive practices?
Based on the current data provided from a number of sources, the insurance industry is extremely well capitalized and could withstand some very large-scale losses. However, we are still left with that age-old issue: Just because you can do something (i.e., continue to beat each up on pricing, and terms and conditions) does not mean you should. Will common sense return to the underwriting department, or will insurers continue to want to maintain their market share regardless of the long-term ramifications? Unfortunately, the smart money appears to be on the continuation of the current price reduction strategies of the major insurers/reinsurers.