Challenges Ahead for Insurers and Brokers
Fitch Ratings expects a challenging year for U.S. property/casualty insurers in 2016, but anticipates that ratings will remain stable.
The majority of ratings in the sector is not expected to change in the next 12 to 18 months, according to Fitch’s “2016 U.S. Property/Casualty Insurance Outlook Report.”
Near-term earnings deterioration is anticipated, but a shift toward sharply inadequate premium rates or profit levels approaching operating losses is unlikely, the report stated.
“Market conditions for U.S. property and casualty insurers will be less favorable in 2016 and overall industry performance will likely decline next year.” — James B. Auden, managing director, Fitch Ratings
“Market conditions for U.S. property and casualty insurers will be less favorable in 2016 and overall industry performance will likely decline next year,” said James B. Auden, managing director, Fitch Ratings. “However, statutory capital adequacy will remain strong.”
“The U.S. property/casualty insurance industry faces underwriting challenges, particularly in the commercial lines segment, as a softening premium environment will promote future deterioration in underwriting results,” he said.
“Performance for the P&C universe as a whole is anticipated to deteriorate in 2016 toward a break-even underwriting result.
“P&C underwriters face greater difficulties in generating adequate returns on capital beyond underwriting and pricing,” Auden said.
“The investment contribution to earnings continues to decline as falling portfolio yields reduce investment income, and investment gains reported in the last three years are less likely to continue given economic growth prospects and current equity valuations.”
Factors that promote future movement toward a negative industry outlook include large events that significantly affect the industry’s capital position such as a large natural catastrophe, discovery of adverse claims experience, reserve deficiencies or a large market downturn, Auden said.
“Shifts in underwriting trends resulting in prolonged underwriting losses for insurers could also lead to consideration of negative sector outlooks,” he said.
Outlook for Brokers
As for U.S. insurance brokers, revenues and earnings are likely to improve only modestly in 2016, according to Fitch.
“Continued flat or declining premium rate changes in commercial insurance segments and a soft reinsurance market will pressure brokers’ 2016 organic growth,” said Gretchen K. Roetzer, an analyst and director in Fitch’s insurance group.
“However, global brokers’ revenues from diverse product and geographic platforms, including health care and benefits, should help offset these headwinds.
“Strong retention and insured exposure growth from a slowly improving economic environment will also promote revenue expansion,” added Roetzer, who has analytical coverage responsibilities for property/casualty reinsurance companies and insurance brokers.
Fitch’s “2016 U.S. Insurance Broker Outlook” report said that near-term operating performance and balance sheet strength support a stable credit ratings outlook for the brokers it covers.
Profit margins are projected to remain stable with modest improvement due to reduced expenses, said Roetzer. “On average, profit margins were relatively flat in 2015 with two of the five publicly traded peers in Fitch’s peer group reporting reduced margins in part from one-time items,” she said.
“Private equity firm interest in brokers remains strong, though banking institution interest in insurance broker diversification has waned,” said Roetzer.
“We expect brokers to continue supplementing organic revenue growth with selective acquisitions.”
Roetzer said that lower rates on commission-based business would affect profit margins and organic growth.
“We expect brokers to continue supplementing organic revenue growth with selective acquisitions.” — Gretchen K. Roetzer, analyst and director, Fitch Ratings insurance group
“This would impact certain brokers more than others based on the mix of business, commission versus fee-based, and depending on the broker’s geographic diversity,” she said.
“A poor economy can affect clients’ willingness and ability to spend resources to outsource or conduct projects, or hire new employees,” she added. “Interest rates may also be pressured and cause lower than normal rates. All of these factors can affect brokers’ revenues and growth.”
Financial leverage increased for several organizations, including the Big Three brokers (Aon, Marsh and Willis) while interest coverage remains favorable and supportive of current ratings levels, the report noted.
There was some uncertainty about Willis Group Holdings, due to its proposed merger with Towers Watson. Fitch noted that the merger’s closing still needs approval by Towers Watson’s shareholders.
Fitch expects debt to EBITDA for most of the peer group to improve moderately in 2016 if debt levels remain stable or even decrease modestly with various debt maturing, and if EBITDA grows as anticipated.
The firm anticipates few rating changes over the next 12 to 18 months, despite expecting improvement in some credit fundamentals in 2016.
Battling a Nasty Bug
Periodic large outbreaks of Legionnaires’ disease, like the one that occurred in New York City this summer, grab a lot of headlines, but in fact many lesser-known cases of the disease are regularly recorded in the United States on a year-round basis.
The Centers for Disease Control reports that 8,000 to 18,000 cases of Legionnaires’ disease are identified annually in this country. Many of those cases resulted in death and/or life-threatening medical conditions, presenting insurance, risk management and legal problems for building owners and managers on a significant scale.
“Some people say legionella [the bacteria that causes the illness] is making a comeback, but the fact is it has never gone away,” said John Eichenberger, a Charlottesville, Va.- based engineering services manager for Marsh & McLennan Agency Environmental.
“It’s interesting that Legionnaires’ disease wasn’t identified by the scientific community prior to 1976 when a mysterious disease surfaced at an American Legion convention in Philadelphia,” Eichenberger said.
“It was a devastating outbreak that sickened 221 people and caused 34 deaths, hence the name Legionnaires’ disease.”
People become infected with the disease when they inhale microscopic water droplets containing legionella bacteria. Although it’s possible to contract Legionnaires’ disease from home plumbing systems and outdoor sources, most outbreaks occur in large buildings.
“Some people say legionella [the bacteria that causes the illness] is making a comeback, but the fact is it has never gone away.” — John Eichenberger with Marsh & McClennan Agency Environmental
Common locations for an outbreak of legionella are hot tubs and whirlpools on cruise ships, cooling towers for building air conditioning systems, and swimming pools and water systems in hotels, apartment complexes, hospitals and nursing homes.
The Mayo Clinic said individuals who are most susceptible to Legionnaires’ disease are people who smoke, have a weakened immune system, have a chronic lung disease or who are aged 50 or older.
“Legionella is similar to other high-profile indoor air calamities encountered in recent years such as asbestos, flesh-eating bacteria and mold,” said Bill Nellen, Atlanta-based executive vice president, national environmental practice, Alliant Insurance Services Inc.
“The legionella bacteria incubates in heating, ventilation and other water-based systems, including cooling towers, but also showers and public water features have been shown to be the causal links for outbreaks.
“Legionnaires’ disease can result in severe financial and public relations consequences and insurance claims,” Nellen added.
At Willis’ environmental practice, New York-based Executive Vice President Anthony M. Wagar said, “People can be exposed to legionella when they breathe in a mist or vapor from a water source that has been contaminated with the legionella bacteria. Unfortunately, it can have symptoms similar to many forms of pneumonia, making it difficult to initially diagnose.
“While most insurance policies exclude coverage for Legionnaires’ disease via various ‘pollution’ and ‘contamination’ exclusions, many environmental insurance carriers have built in affirmative coverage grants to their forms via a modification to their definition of ‘pollutants’ to include legionella pneumophila in any structure on land or the atmosphere contained in that structure,” Wagar said.
Mitigating the Threat
Experts agree that the best way for owners of hotels, resorts, nursing homes and other buildings to combat the spread of legionella is an effective risk management program wrapped around environmental insurance.
“Yes, I think that is right,” said New York-based Bill McElroy, senior vice president, Liberty International Underwriters and leader of its global environmental practice.
“If you have a complex water heating and cooling ventilation system, you should be doing things to maintain and periodically inspect the facilities. That’s just good risk management by any institutional building owner.
“From an insurance point of view, we do provide insurance that covers an owner from any claims brought by third parties for injuries caused by what we refer to as biological contamination, which could include legionella or things like mold or other biological injuries and things like certain types of viruses that are transmitted through airborne contact,” McElroy said.
“If you buy this type of insurance you can buy cover for an enhancement for biological contamination for airborne pathogens,” said McElroy.
A major breakthrough in the prevention and mitigation of legionella came on July 1, when the American Society of Heating, Refrigeration and Air-Conditioning Engineers (ASHRAE) promulgated a long-awaited set of guidelines for building water quality and legionella concerns.
This standard is written in code-ready language, facilitating integration into existing building codes, and will have the force of law. ASHRAE 188 will create a benchmark standard for legionella prevention, experts agreed.
“If the injury has been fatal, then the family has a potential claim. These claims in and of themselves are very significant claims for recovery of pain and suffering, and economic damage.” — David Rieser, head of the environmental, regulatory and redevelopment law practice at Much Shelist
Documented compliance with the standard will help to refute allegations of negligence, minimize liability exposure and create underwriting standards from which insurability can be determined.
“A combination of adhering to ASHRAE guidelines and a risk management program makes a great risk management tool,” said Philadelphia- based Marcel Ricciardelli, senior vice president, environmental, Allied World.
“As a business, you may buy insurance coverage specifically for Legionnaires’ disease as part of a legal liability policy. If you buy a pollution insurance policy, you can get legal defense and you can get clean-up coverage. Then the third leg of the stool is you can get risk management services.”
Atlanta-based Elizabeth Bannister, managing director of the Marsh environmental practice, noted that the specialized environmental market does offer coverage for Legionnaires’ disease within its specialized pollution policies, which may be obtained from specialty carriers.
“A competitive marketplace has resulted in the introduction of many different industry- or risk-specific policy forms,” Bannister said.
“As a result, coverage may differ between carriers and may be offered with a base form or added on by endorsement. It is important to review your policy and understand the extent of coverage provided.”
Further, Bannister said, clients should engage their risk advisers to confirm whether coverage is excluded from property and casualty programs.
“These policies may often be subject to pollution and/or bacteria exclusions and it is important to know how the courts have treated these exclusions in specific legal jurisdictions,” she said.
Chicago-based environmental law expert David Rieser, head of the environmental, regulatory and redevelopment law practice at Much Shelist, said a building owner faces numerous issues on the claims front.
“First and foremost, there are the third-party claims brought by the people who are injured by the disease,” said Rieser.
“If the injury has been fatal, then the family has a potential claim. These claims in and of themselves are very significant claims for recovery of pain and suffering, and economic damage,” he said.
Rieser noted that 95 percent of cases are settled before they ever get to trial because of the high cost and uncertainty involved.
An outbreak at large public facilities like hotels, resorts or cruise ships can result in significant damages.
“So you’ve got everybody cancelling their reservations, thus the reputation risk, plus the cost of remediation, trying to figure out how the facility component gave rise to the claim and figuring out what has to be done to clean up so it doesn’t happen again.”
Many companies have provisions in their pollution liability policies that include the third-party claims as well as first-party damages arising out of Legionnaires’ disease.
Eichenberger said that a critical component in establishing a good legionella risk management program is selecting an individual to assume ownership of the program. Then the program has to be put into play and not get put on a shelf to rot.
“This person has to be an active manager who makes sure the program is fully implemented and adapts as new conditions come forward,” Eichenberger said.
“Once a risk management program is created, all building water systems should be evaluated to identify any risk for legionella colonization.”
The next step, Eichenberger said, is to develop specific control measures for vulnerable building water systems.
“As with any effective risk management program, it is critical to have good recordkeeping to document activities and determine what’s working,” Eichenberger said.
Online, Direct Sales Continue to Grow
Online direct sales of insurance to small and medium-size businesses in the U.S. has become a hot market.
While no one is predicting that commercial insurance will be primarily sold online any time soon – and may always primarily require the use of a broker or agent — insurers that do offer coverage to small and mid-size businesses are seeing substantial growth.
Ted Devine, CEO at Chicago-based Insureon, predicted that five percent of small to medium-size insurance in the U.S. will be sold online within 10 years.
“Our online platform is about 10 years old, but the Insureon brand and our real focus on it started four years ago, and we’ve been growing at about 30 percent a year,” said Devine.
Pioneer in the Market
Hiscox USA was the pioneer in direct-to-small business online sales in November 2010.
“We’ve grown from zero in business in 2010 to over 100,000 customers currently, and with sales of thousands of new policies each week,” said Kevin Kerridge, head of small business, direct and partnerships, at the company. He started a similar program in the United Kingdom before moving to the U.S.
Hiscox and Insureon will soon be joined by Berkshire Hathaway Direct, which planned to launch its online product next year. ACE Group also has online small business products, although they are targeted to brokers and agents.
Warren Buffett’s Berkshire Hathaway is pivoting away from its once lucrative, but now lagging reinsurance business in favor of Berkshire Hathaway Direct, an online, direct distribution system for small and medium-size businesses.
“I wouldn’t play it any other way,” Chairman and CEO Buffett told the “Wall Street Journal” in July. Buffett is banking on a success similar to the company’s popular Geico Internet-only, direct-to-consumers auto policy service.
“We plan to launch this service sometime next year,” said Kara Raiguel, president of Berkshire Hathaway Direct, beginning with Business Owners Policy (BOP) and workers’ compensation.
“As we move along, we plan to add other products such as umbrella, commercial auto and professional lines,” she said.
Raiguel added that Berkshire Hathaway Direct is currently licensed in 48 states. “We expect to be licensed in all 50 states when we launch next year,” she said.
The Hiscox online direct sales program for small businesses began with professional liability. Since then, the online commercial lines program, the first in the U.S., has expanded to offer BOP and general liability coverage.
The solutions are currently available in 38 states and D.C., and will be available nationwide within a year, said Kerridge.
“Technology empowerment is what this effort is all about.” — David Charlton, president, micro & specialty products, ACE Commercial Risk Services
“Consumers expect their online business insurance purchase to work the same as it does for all of their transactions online. You can purchase cars online directly without any human interaction and you should be able to do the same for business insurance,” he said.
“To take full advantage of the online channel you need to commit to creating a fully automated process. Every workaround and human review adds time and cost to the process and makes it less appealing to consumers.”
Starting its online, direct distribution for small businesses four years ago, Insureon currently represents about 35 carriers and 175,000 clients, with $210 million in annual premiums.
Devine noted that Insureon, which is licensed in 48 states, gets about 400,000 hits a month on its website, all driven by online digital marketing strategies.
At its start, Insureon offered BOP, workers’ compensation and liability. Since then, it has added commercial auto and cyber, Devine said.
The company also has a B2B business, Insurance Noodle, which Insureon acquired last year, which provides “access to our markets through technology for about 6,000 independent agents,” said Devine.
Empowered by Technology
ACE Commercial Risk Services (ACE CRS), which targets small U.S. businesses, also uses appointed agents and brokers as part of its move into the online market on March 30, when it launched new packaged BOP insurance products.
“Small businesses continually struggle to find proper insurance coverage due to a lack of optimal choices, issues with cost, or uncertainty about the scope of coverage that is most suitable for them,” said David Charlton, president, micro & specialty products, ACE CRS.
“Technology empowerment is what this effort is all about.”
The underwriting platform, ACE Solutions Fast Track, quotes and issues small business and specialty insurance for brokers in less than five minutes, according to the company, by utilizing real-time third-party data analytics.
In early August, ACE CRS launched an expanded list of online products and coverages to include Lessor’s Risk BOP; Liquor Liability; Commercial Umbrella; Employment Practices Liability Insurance BOP Enhancement; Privacy Liability & Data Breach Insurance BOP Enhancement (Cyber) and Professional Liability BOP Enhancement.
Then in late October, the company launched a Producer Portal, which focuses on increasing functionality and simplifying the user experience. The new online portal gives the company’s small business clients an easy-to-use application, providing brokers real-time access to ACE’s systems and expertise, according to ACE.
Regardless of the technology advances made, Devine said, agents and brokers will continue to be the majority distribution channel for reaching small and medium-size businesses for at least the next 10 years.
He noted that selling auto insurance online did not really reach a tipping point until about 10 years after it was introduced in the market.
“Given the complexity of the product, it’s always going to have to be delivered with a lot of advice,” Devine said. “Whoever delivers the best advice is going to win.”
He added that each industry is different. “A mobile food truck is different from a contractor, etc.,” he said. “So you’ve got to have a lot of different industry expertise.”
“This is not going to be a commodity business, even though the technology will continue to make delivering the business easier and easier,” Devine said. “But we will always need people as well.”