The market cycle has been in its “hard” phase for some time, characterised by significant reductions in insurer capacity and appetite for risk; narrowing of coverage they’re prepared to provide; large premium rate increases; and imposition of higher deductibles.
These market conditions are not peculiar to a few sectors – they apply to all policyholders, with some being impacted even more severely than others. It’s not always clear, however, why life should be so difficult for insurance buyers or what can be done to achieve a better balance of cost and protection.
In this article, we explain what lies behind the current market conditions and share some examples of where clients are changing their insurance buying strategy to reduce premium spend.
What’s caused the hard market?
The current hard market conditions arise from a number of contributing factors. The global nature of insurance and reinsurance markets means loss-producing events worldwide have an impact.
Impact of reduced investment returns and low interest rates
Historically, insurers have used investment returns to offset underwriting losses. This hasn’t been possible since interest rates have been at the low levels seen in recent years. Insurers are therefore seeking rate increases to achieve underwriting profit.
Reduction in market capacity
Insurers withdrawing capacity to de-risk their book forces up pricing and makes terms more restrictive amongst insurers still willing to provide cover.
Increased cost of reinsurance and restrictions imposed by reinsurers
Reinsurance is a key component of an insurer’s pricing model. Reinsurance rates are increasing significantly and commercial insurers pass on these will have no option other than to reflect these increases in their rates.
Increased frequency and severity of natural catastrophe claims
News bulletins regularly report destructive events such as wildfires, tornadoes, floods, tropical cyclones, earthquakes in various parts of the world.
The rise in attritional (non-catastrophic) storm losses continues to impact the insurance industry. This year alone, losses in the US from hurricanes, storms and severe weather total nearly USD50bn – with the financial impact of summer wildfires/firestorms, droughts and Hurricane Sally still not accounted for.1
Increased frequency and cost of class action claims
Securities Class Action claims have increased significantly. US Federal filings have gone up from 232 in 2015 to around 430 in each of the last three years.1 This has led to significantly increased costs in the Directors’ and Officers’ liability market.
Claims inflation
Claims costs are increasing at a far greater rate than general inflation. This means insurers have to increase premiums to compensate.
Regulatory intervention
Solvency II, launched in 2016, has meant that insurers’ spare capital requirements have more than doubled. This has caused a number of insurers to leave the market whilst others have significantly reduced their capacity.
Solvency II has also created a significant barrier to entry meaning that lost capacity in most cases is not being replaced.
So what can I do to reduce my premium spend?
The default way for a business to reduce its premium spend is to increase the level of risk it retains for its own account through higher levels of self-insurance. However, insurers don’t always give a premium reduction which buyers think is an acceptable reward for taking more risk. And in difficult economic times it’s not always prudent for businesses to expose themselves to the increased volatility inherent in higher levels of self-insurance.
Depending on size of business, sector, premium spend and other factors, the following options may be available to insurance buyers:
Increased deductible or excess
The simplest and most common way to retain more risk is through a higher policy deductible or excess. In exchange for this, insurers should give a premium discount to recognise that they are no longer on risk for lower level losses.
In a hard market, however, an insurance buyer may find insurers impose a higher deductible without a premium reduction as part of their renewal offer.
Retrospectively-rated programmes
This risk financing model is most commonly seen with liability exposures and can be attractive where there is good data, the claims experience is stable and there are strong risk management practices.
The premium paid is adjustable according to the insured company’s own losses, rather than those across the insurer’s book of business.
Typically, the insurer charges a basic minimum premium to cover expenses, claims handling and insurance to cover losses above an agreed level for an individual claim and in the annual aggregate.
Claims are paid by the insurer or a third party administrator from funds held in escrow and topped up periodically by the policyholder. Adjustments are performed periodically after the policy has expired.
The premium is adjusted periodically to reflect actual claims experience compared to that expected at the start of the insurance period.
Captive insurance company
Arguably the most sophisticated form of self-insurance, this involves an organisation setting up a subsidiary company which is an insurance company formed to underwrite some or all of the parent company’s risks and, sometimes, those of other organisations.
The cost and complexity of setting up and running a captive mean that this tends to be done only by the largest organisations.
In soft insurance market conditions, captives tend to fall in popularity as it can be cheaper overall to pass the financial consequences of risk to the insurance market.
When the market hardens, dissatisfaction with the conventional insurance market over availability and cost of cover may influence large organisations to consider captive feasibility.
It’s usual for experts to conduct a feasibility study of the organisation’s risk profile, which includes actuarial reports, investment models, insurance market conditions and an assessment of regulatory, legal and tax issues. This will recommend risk management options for the client and establish whether or not a captive makes sense.
Cell captive
Cell captives have become an integral component of the self-insurance market in many of the established captive domiciles. The growth of such vehicles now outpaces that of traditional captives.
Cell companies can be used in two ways:
- A parent company can own the whole company, using its separate cells to segregate its risks into different accounts.
- Parties can rent individual cells which are independent of the cell company owner.
This has become a popular risk solution for smaller companies as the capital requirements of individual cells are significantly lower than those for a captive.
1. www.ncdc.noaa.gov
2. NERA Economic Consulting: Recent Trends in Securities Class Action Litigation: 2019 Full-Year Review 12 February 2020
Conditions and Limitations
This note is not intended to give legal or financial advice, and, accordingly, it should not be relied upon for such. It should not be regarded as a comprehensive statement of the law and/or market practice in this area. In preparing this note we have relied on information sourced from third parties and we make no claims as to the completeness or accuracy of the information contained herein. It reflects our understanding as at 03/12/20, but you will recognise that matters concerning COVID-19 are fast changing across the world. You should not act upon information in this bulletin nor determine not to act, without first seeking specific legal and/or specialist advice. Our advice to our clients is as an insurance broker and is provided subject to specific terms and conditions, the terms of which take precedence over any representations in this document. No third party to whom this is passed can rely on it. We and our officers, employees or agents shall not be responsible for any loss whatsoever arising from the recipient’s reliance upon any information we provide herein and exclude liability for the content to fullest extent permitted by law. Should you require advice about your specific insurance arrangements or specific claim circumstances, please get in touch with your usual contact at Gallagher.
