Insurance Pricing Heading Higher in 2009

Insurance carriers make money historically in one of two ways; taking in more in premium than they pay in losses, or thru investment returns on the premiums they charge their customers. Usually for most companies it's an amalgam of both. I this current economic environment the return on investment model has crashed into the recession built wall, with the bear perched prominantley atop. That puts pressure on insurance carriers to generate a profit by returning to the fundementals of properly pricing the risk the accept. Back in the good old days they called that underwriting.

For a carrier to generate consistent underwriting profits they need to find that equilibrium between premium dollars taken in, and losses (claims paid plus carrier expenses). In industry parlance that is referred to as a combined ratio. Simply put if an insurance carrier has a combined ratio of 95% what they are telling you is that for every premium dollar they take in, they are paying 95 cents in claims and fixed expenses. Fixed expenses are what it costs an insurance carrier to do business, from facilities to employees to marketing. I am offering this macro look at the insurance industry to provide you a basis of why I believe rates are headed higher.

According to a December 08 report issued by Towers Perrin managing principle Jeanne Holiister , "We expect to see abatement in soft market conditions in the U.S. Property & Casualty market, as companies consider a number of factors in their pricing decisions, including equity and credit related losses to asset portfolios, a continuation of poor underwriting results in many sectors, heavy weather related losses and a forecasted spike in directors & officers liability claims. In our view the industry is fast approaching a point where underwriting results are no longer favorable relative to economic hurdle rates, and that generally signals a 'tipping point' in terms of insurance companies pricing actions."

1. In a survey of Re-insurance carriers by the Re-Insurance Association of America, 20 re-insurance carriers have reported a combined ratio of 104.2 % for the nine months ending Sept 30th. This same group of 20 reported a combined 94.1% a year earlier. Just as a primer, Re-insurance is coverage insurance carriers buy on the risk they retain and underwrite. Without re-insurance the capacity to underwrite and retain risk by most of the name recognized insurance companies you know would evaporate leaving little insurance coverage available to the general marketplace. In my opinion it is doubtful that the carriers who purchase this coverage, will be able to absorb this increase without passing some if not all of the cost back down to policyholders. The margins are so thin coupled with their losses on the investment side most property & casualty insurance carriers just can't absorb the increased cost .
2. The substantial decrease in construction volume erodes the scale necessary keep down insurance rates, thus without all the scale and capacity rates will head north to make up for the loss of premium due to the decrease in insurable exposure. The net effect will put pressure on construction company margins as rates charges per thousand of sales increase, eroding already thin margins these constructions firms are operating under right now.
3. Only Construction firms with pristine loss histories will be offered the most competitive prices. As carrier put more emphasis on generating profits thru underwriting only firms with a proven historical track record of returning underwriting profits to their insurance carriers thru demonstrated low claims frequency and payouts will see sustained competiton for their business keeping rates stable. Those construction firms with significant or even moderate losses will not have many carriers fighting for their business, creating a take it or leave environment for those carriers that remain who have not outright declined the risk. Construction firms are deemd profitable if their 5 loss ratio ( premium versus loss paid & reserved) is less than 35%. If a firm goes above 35% it's up to the individual underwriter to calculate if their insurance company can make a future profit on your account, above 50% expect a decent rate increase to drive the ratio downward.
4. Carriers will look to underwrite more stringently a construction firm's cash flow, and credit worthiness. Historically firms that have a strong cash position, and have a good credit rating have historically lower incidence of claims. It's one of their fundemental acturial axioms. More constructionfirms are experiencing financial pressures than ever before, thus the expecttion that they will cut back, notably on safety, yielding higher incidences of claims, and furture insurance losses.
5. In down economic cycles insurance carriers typically see a rise in insurance claims as people strapped for cash use insurance as a subsidy and not a risk transfer tool. The combination of expected increased claims activity, poor investment results, and historically low insurance rates will drive carriers to try and achieve that profit equilibrium back. You cannot continue to post combined ratios in excess of 100, for a sustainabe period of time without increasing rates to off set losses.

Performance of Insurance Companies (Stock) versus the Rest of the Market

• Consumer Staples -19%
• Healthcare -31.1%
• Telecom -33.0 %
• Utilities-35.3%
• Energy-37.2%
• Consumer Discretionary -38.6%
• S&P 500 -41.8 %
• Industrials -43.4%
• Information Technology - 45.7%
• Materials -49.5 %
• Financials -58.4 %
• INSURANCE - 61.8%

SOURCE: Saturday NY Times Dec 6th, 2008

Many insurance carriers are bleeding losses, some thru both nostrils (investment & underwriting resuts), it's only a matter of time before the market loses some of it's capacity, and rates adjust to reflect the reality of their balance sheets, the big question is when, and not if. The smart construction firms should calculate thier own 5 year historical loss picture to determine how potentially attractive they are in the market place, and run a quick D&B report on their firm to poll their credit score. If you are on the cusp of profitablity it may be wise to budget for a 5 to 7% increase for your G.L. and comp rates. If your loss pic is over 50% , budget somewhere between 10 and 15%. If it's over 70%, you need to have an aggressive action plan to improve your loss experience, and solict the help of a qualified construction insurance broker who can help you engineer and better result, and craft the right message to the insurance marketplace. If you email me, I have just the right person who could help right the ship.