State of the Insurance Market…and What it Means to You!

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by Jeff Cavignac, CPCU, RPLU, ARM
Patrick Casinelli, RHU, REBC, CHRS
Jim Schabarum, CPCU, AFSB

Many of our clients are starting to budget for 2014.  One of the major expense items is insurance and the purpose of this article is to explain where the industry is in the insurance cycle and what you can expect to see in 2014.  Recognize that these prognostications are general in nature.  Every risk (that’s one of the names that insurance companies call insureds) is unique and rates will be affected by individual loss experience and other factors that collectively make up a company’s risk profile.

In order to look forward, we need to understand how the industry’s cycle works and what drives it.  It is also important to look at past industry metrics since they will directly impact insurance industry objectives moving forward. 

Insurance Cycles Defined

Like many industries, the insurance industry is cyclical. However, the insurance cycle generally runs independently of other business cycles. Insurance companies make money in one of two ways:

  • Underwriting profits
  • Investment income

An underwriting profit is achieved when losses plus all expenses are less than premiums. When you divide the former by the latter, you come up with what is called the combined ratio. A combined ratio of less than 100% means there is an underwriting profit, and a combined ratio of more than 100% means there is an underwriting loss.  If you review Table 1 below, you will note that in the last 10 years, the industry has only generated an underwriting profit three times. 

Insurance companies also make money on the interest they earn on the reserves they have set aside to pay future claims.  This represents an insurance company’s policyholder surplus. During periods of substantial investment returns, insurance companies may be willing to underwrite at a loss because they can make up the deficit on the investment side.

Policyholder surplus is critical to understanding the economics of the insurance business. While demand for insurance remains relatively constant, supply (surplus) fluctuates up and down. If surplus goes down, insurance companies become more selective on which accounts they will consider, the industry becomes less competitive, and policy terms become more restrictive. This is known as a “hard” market. 

Conversely, if surplus goes up, the industry becomes more competitive.  Rates go down, underwriters are willing to consider risks they wouldn’t consider in a hard market, and they are willing to offer broader coverage in order to attract business. This is referred to as a “soft” market.

So Where in the Cycle Are We and What Does This Mean for 2014?

The industry is in an interesting place. A true hard market is driven by poor returns and decreasing surplus. Return on net worth continues to be weak.  2012 was the fifth year in a row with returns under 6%.  This is attributed to poor underwriting results and lousy investment returns. But despite poor returns, policyholder surplus is at an all-time high, growing over 28% in the last four years. 

Although surplus is currently more than adequate, in order to remain healthy the insurance industry needs to continue to generate capital.  In order to attract investors, however, the industry has to provide an acceptable return on equity. Most investors seek at least an 8% return and ideally want 12% or more.  The insurance industry’s 60-year average is 8.9%.  Once again referring to Table 1, you will note that in the last 10 years, the industry has only exceeded 8% five times and hasn’t done so in the past five years.  The industry has averaged a 7% return in the past decade and a meager 3.7% in the last five years.

For the five years from 2003 through 2007, the industry averaged returns of 10.3%.  These hefty returns fueled competition and accordingly rates came down.  If you look at Table 2 below you will note that average property and casualty rates started dropping in 2004.  From 2004 through 2011, rates for the property and casualty industry dropped nearly 40%.  2012 was the first year average rates had increased since 2004.  With an average increase of 4% in 2013, rates will have increased 9% since bottoming out in 2011; however, they will still be 33% below where they were in 2004.

What we have right now is a moderate hard market, lousy returns, but plenty of surplus.  Insurance companies need to increase rates in order to improve returns, but the substantial surplus creates aggressive competition which is moderating what would otherwise be substantially higher rates. So what can you expect in 2014?

Property, Liability, Auto and Excess

As mentioned above, all the insurance companies we work with want five to 10 points of rate on renewal.  Unfortunately (for the insurers), the industry remains competitive and insurance companies don’t want to lose their preferred customers to other opportunistic competitors.  For preferred risks, we expect on average to see renewal rates ranging from flat to plus 5%.  We would suggest using 5% as a budget number increase.  Note that this is rate, not premium.  Premium is determined by multiplying rate times exposure (property values, sales, payroll, etc.).  For non-preferred businesses (high hazard industries or poor loss experience), you can expect larger increases.  Property risks in wind-exposed areas are also seeing substantial rate increases.  If you feel your firm may be considered non-preferred, it would be wise to talk with your broker or underwriter now, to get their thoughts on what you can expect. 

Professional Liability

Rates vary depending on the industry and desirability of the risk.  Overall, however, market trends are similar to the rate changes mentioned above for property, auto liability and excess.  Preferred architects, engineers and construction managers can expect flat to plus 5%. Similarly, preferred accountants and attorneys shouldn’t expect anything more than plus 5%, but higher risk professionals such as structural engineers, geo-techs and environmental consultants may see rate increases higher than that. 

Executive Risk

Executive risk includes directors and officers liability (D&O), employment practices liability (EPL) and fiduciary liability.  While results for fiduciary liability have remained decent, experience for both D&O and EPL has been poor.  The down economy and resultant high unemployment has substantially increased the claims against directors and officers and the number of employment-related lawsuits has escalated dramatically as well.  On average, we are seeing 10-15% rate increases on these lines, but 25% or higher is not uncommon.  It is wise to start early on these renewals and market your program effectively with a specialist broker.  Recognize that all of these policies are unique to each insurance company and coverage varies dramatically.  Make sure you get appropriate coverage at the lowest realistic cost.

Workers’ Compensation

Workers’ compensation continues to be a huge challenge for the insurance industry, especially in California.  Nationally, the combined ratio in 2012 was 108%, which was down from 114% in 2011.  In California, the 2012 combined ratio was 117% and this was a substantial improvement over 2011, which was 137%.  Over the last four years, the combined ratio in California has averaged 132% (Table 3).

If underwriters in California want a 5% underwriting profit, they need another 22 points (at least) of rate!  This is in addition to the rate increases the industry has experienced in the past several years (35%).  Rates bottomed out in California in 2009 (Table 4).  The average rate charged in the state was $2.10 per $100 of payroll.  Since then, average rates have increased to $2.83. While this is significant, it needs to be put into perspective.  Rates peaked in 2003 at $6.29.  From 2003 through 2009, rates dropped a staggering 67%.  This was attributable to reforms in the system that moderated expenses as well as intense competition which mirrors the insurance market in general, as discussed previously.  The current average rate of $2.83 is still 55% less than it was in 2003.  Even if the industry was able to get the additional 22 points that they need to be profitable, average rates would still be 45% below the 2003 rates.

Ultimately, what you pay for workers’ compensation is determined by your net rates.  A net rate is the rate after application of insurance company credits or debits and your experience modification.  Underwriters generally have latitude to adjust your base rate plus or minus 25-40% based on how they feel about your account.  This underscores the importance of a thoughtfully completed submission to the underwriting community which extols the virtues of your firm, why you are a good risk, and why your company deserves significant credits.  You should also understand your experience modification (click here to see a previous newsletter) and have your 2014 mod projected.  Certain factors in the experience modification equation have changed in recent years and this has adversely affected some employers.  The Workers’ Compensation Insurance Rating Bureau (The Bureau) usually releases experience mods 30-90 days prior to policy expiration; however, a competent broker can project your mod confidently five months out or earlier if there are few or no open claims. 

Recognize that this discussion involves average rates. There are hundreds of class codes in California (and every other state) and each one is evaluated separately and has its own rate.  We are seeing some class codes go up as much as 40% or more, while others have actually decreased.  Overall, we expect to see pure rate increases of 10-15% in 2014 (before application of underwriting factors and your experience modification).  It is prudent to begin discussions with your underwriter early.  Find out what their current base rates are compared to the ones on your policy.  Ask about the types of credits you can expect to see and determine if your underwriter will be submitting another rate filing before you renew. 


Consistent with most of the financial markets, the surety industry currently remains profitable despite the increase in loss activities this year. However, just as the country recently averted a near-miss budget crisis with only temporary relief, the industry will likely continue to struggle in 2014.  Further increases in loss frequency are anticipated, but hopefully significant and severe losses will be avoided. 

While defaults have been on the rise in the past two years, most of the surety failures have been isolated to trade subcontractors which led to the demise of a few general contractors. What cannot be ignored is the drastic increase in project financing disputes and payment bond claims. The intense magnitude of project financing claims may only be stalling the inevitable–more serious looming performance bond claims that have not yet been fully recognized. Today, many owners and contractors simply do not have the adequate financial strength they once had to manage cash flow through financial disagreements.

Surety capacity remains plentiful. There is feverous competition among sureties for small contractors and even jumbo contractors are enjoying rate reductions with tremendous mega-project opportunities. Sureties have a growing cautiousness with mid-size contractors. Underwriters are continuing to closely scrutinize financial statements, paying close attention to cash flow, work in progress, realization of estimated profits and overhead. Sureties are focused on under-billings, aged receivables, cash balances and availability to preferred bank lines of credit. To get the added comfort needed on often-stressed balance sheets, sureties are increasingly requiring project fund control agreements, cash infusions and other tightening underwriting conditions. As losses continue to rise in 2014, sureties will be maintaining a closer eye on their credit partners.

Health Insurance

Medical insurance costs in 2013 trended between 6-9%, with most companies receiving single digit increases on their health insurance plans.  All companies with between 2-50 employees have been asked to consider renewing early on December 1, 2013.  These December renewal increases have been coming in between 0-10%.  The main reason to consider an early renewal is to delay the effects of the Patient Protection Affordable Case Act (PPACA or ACA), sometimes referred to as Obamacare. Click here to see our August newsletter for detailed information on PPACA. 

All plans for non-grandfathered small groups (2-50 employees) are changing in 2014.  The medical benefits, prescription benefits, networks, age bands, Rate Adjustment Factors (RAF), waiting periods, taxes and fees will change for every insurance carrier in this category next year. Rates are expected to increase between 20-40% because of these changes. 

Renewing early in December may only delay the inevitable, but it will buy some time for small businesses to plan and to educate their employees.  It is also possible that the cost for coverage will be less than the projected 20+% in the fourth quarter of 2014.

Some of the provider networks we currently enjoy may also be changing in 2014.  Insurance carriers are asking for greater discounts from hospitals, medical groups and doctors and are offering patient exclusivity in return. Similarly, hospitals and doctors are joining together and forming Accountable Care Organizations (ACO) to offer the same.  Smaller networks with greater discounts equal lower medical premiums.  The narrow network options should be considered when renewing in 2014.

Dental, life, vision, disability and worksite products continue to remain extremely popular benefits for employees.

Best Practices

An insurance policy is a contract between an insured and an insurance company.  In exchange for the premium, the insurance company agrees to bear risk as spelled out in the policy.  So what can you do to lower the cost of your insurance?

Create a Culture of Safety 

  • Make certain you have an effective and compliant safety program.       
  • Your safety culture needs to be supported by senior management and supervisory employees responsible for implementing it need to be rated and evaluated on their efforts in this area. 
  • Develop post-accident best practices.  The way a claim is handled and managed in the first 24-48 hours can make a huge impact on the ultimate result.

Start your renewal process early. Discuss marketing with your broker and engage your underwriter as well, if appropriate. 

Work with the right insurance company–one that offers risk control services and proactive claims management in addition to a policy and reactive service.

Work with the right broker.  Brokers vary dramatically in the services they offer.  Unless you have a full-time risk manager, your broker needs to coordinate your risk management efforts.

The insurance industry will continue to vacillate between hard and soft market cycles and there isn’t anything you can do about it.  What you can do, however, is proactively manage your operations to lower the frequency and severity of claims that drive your insurance and risk management costs.