P&C Outlook for 2015
Rate increases that will slow or outright decline for the property and casualty insurance industry is just one of the major trends as we enter 2015.
Keefe, Bruyette & Woods analysts expect insurers’ operating earnings to improve modestly in 2015, mostly from the “earn-in” of 2014 rate increases versus still-benign loss cost inflation, partly offset by fading reserve releases and normal catastrophe losses.
KBW’s Managing Director Meyer Shields said workers’ comp and some other casualty lines, general liability and commercial auto liability will see rate increases, albeit at a slower pace, while property lines will continue to decline.
“There are a lot of insurance carriers and so it remains a very competitive marketplace,” — Meyer Shields, managing director, KBW
“There are a lot of insurance carriers and so it remains a very competitive marketplace,” Shields said. “Companies believe they can earn an adequate return and still price competitively, which should drag down prices” but he noted that pricing was “on a line-specific basis.”
KBW also expects loss cost inflation to pick up somewhat, “but not materially so,” as insurance loss cost trends has been very suppressed lately, he said. Moreover, given the decline in interest rates, there will be a continuation of lower investment income and overall returns will also come under pressure.
Potential Pricing Challenges
In a report released in December, KBW analysts wrote that two scenarios could disrupt the trend of decelerating or declining prices.
“First, a resurgence of claim cost inflation could quickly erode prior and current accident-year profitability, which would produce a year or so of weak earnings, but would also probably jump-start rate increases,” the analysts wrote.
“On the other hand, persistently low investment yields could drive the providers of third-party capital to expand their participation into other reinsurance lines beyond property catastrophe and similar short-tailed lines.
“We don’t think an expansion is imminent, both because it would tie up capital for longer, and because expected returns for most lines are much lower than was the case for property catastrophe almost two years ago,” they wrote.
“But we believe that the traditional industry players are rational and disciplined enough to avoid obviously destructive pricing, so it would probably take external forces to really disrupt pricing.”
The P&C industry’s underwriting performance continues to lag behind 2013, but remains favorable, according to A.M. Best’s Nine Month Financial Review of the U.S. P&C industry published Dec. 16.
The pure loss ratio increased by 2 points to 58.2 for the nine months through Sept. 30, 2014, primarily as a result of higher catastrophe losses and reduced benefit from favorable development of prior accident years’ loss reserves.
Favorable Commercial Lines Outlook
While net premiums written (NPW) grew, the pace of that growth has slowed. However, increased NPW has benefitted the underwriting expense ratio, as those expenses climbed at a slower pace than NPW, according to the rating organization.
The commercial lines segment posted another set of favorable results for the nine months ended Sept. 30, although some underwriting performance deteriorated somewhat year over year, according to A.M Best’s report.
Through the first nine months of 2014, the segment’s combined ratio was 97.6, compared with 95.6 posted the same period in 2013. Net income totaled $19.2 billion, down $9 billion from a year earlier.
A.M. Best’s analysts are seeing a continuation of the trends exhibited earlier in 2014, said Jennifer Marshall, an assistant vice president in the property casualty ratings department.
“We also now have a negative outlook on the reinsurance sector, but we have seen some solid results, so we expect the industry will post an underwriting profit for 2014.” — Jennifer Marshall, assistant vice president, property casualty ratings, A.M. Best
“Moderation in catastrophic losses continues, as it was yet another year without a major hurricane hitting the U.S. East Coast, which typically is a substantial driver of losses for third quarters,” Marshall said.
A.M. Best’s analysts are also seeing a slowing in premium increases, she said. They also believe the industry in general is well-capitalized, though they have concerns in the commercial line segment, specifically related to questions about reserves in recent years for companies that write a significant amount of long-tail business.
“We also now have a negative outlook on the reinsurance sector, but we have seen some solid results, so we expect the industry will post an underwriting profit for 2014,” Marshall said. Overall, “the industry seems to be performing in line with what we expected for this year.”
Morgan Stanley researchers believe that alternative capital such as catastrophe bonds is driving “secular changes” in the global (re)insurance ecosystem, according to a report released in December.
“We estimate that alternative capital currently accounts for 15 to 20 percent of global reinsurance capacity,” the analysts wrote. “We see it as a secular shift that disrupts balance sheet-based reinsurance models with a goal of directly matching risks with the most efficient capital.”
However, the trend also offers opportunities for primary insurers to re-enter markets and lines of business, to lower operating costs through lower-priced reinsurance, and to open up new revenue streams by managing third party capital.
“Those that adapt can not only survive but thrive, in our view,” the analysts wrote. “Longer term, we believe thriving reinsurers that adapt to this secular change should (1) maintain strategic relevance (size and breadth), (2) manage third party capital, (3) become closer to the end customers, or (4) focus more on investments (asset-manager-backed reinsurers).”
Insurers Using More CAT Bonds
Insurers of the last resort are increasingly using catastrophe bonds and other similar products to transfer some of their peak exposures to the capital markets, according to a rating agency A.M. Best.
Insurers of the last resort are those that include Fair Access to Insurance Requirements (FAIR) plans, quasi-state-run insurance companies and beach/windstorm plans.
According to a report by A.M. Best, these entities have welcomed the growing availability of insurance-linked instruments such as catastrophe (CAT) bonds, insurance-linked funds and industry loss warranties (ILWs).
“Given an increase in exposure to loss for insurers of the last resort, CAT bonds have provided another alternative for these entities to cede part of their peak exposures as a complement to the traditional reinsurance market,” said Asha Attoh-Okine, author of the report.
“Catastrophe bonds also provide multi-year coverage as opposed to most traditional reinsurance programs,” he said.
Approximately $5.6 billion in CAT bonds have been issued by seven of these entities from 2009 through Sept. 30, 2014, according to the A.M. Best report.
The two main perils that were covered were hurricanes and earthquakes occurring in the respective regions that the bonds were placed.
Hurricanes accounted for approximately $4.53 billion, or 81 percent, with earthquakes taking the other $1.05 billion, or 19 percent, for these entities during the period reviewed by the ratings agency.
“The increased use of these insurance-linked instruments is due to growth in investor demand,” said Attoh-Okine.
“We have specialized insurance-linked securities funds, whose mandate is to invest in insurance exposure, hedge funds, and pension funds all participating in this market. Investors have been attracted to these products given the low-interest environment for fixed income securities of similar quality and the perceived minimal correlation to the general financial market.
“Sponsors have also continued to increase the use of CAT bonds and other insurance-linked instruments to cede their peak exposures.
“Lately,” he said, “we have seen a decrease in spread [price] for the same level of risk for CAT bonds, providing sponsors cost relief when compared to the traditional property catastrophe reinsurance market.”
Advantages and Drawbacks
Among the advantages such products offered insurers are multi-year coverage and minimal credit risk versus the traditional reinsurance market, he said. They also provide another dimension to diversify and manage catastrophe risk.
“The main drawback for some of these instruments, for example, CAT bonds and ILWs, is the lack of reinstate features when compared to the traditional reinsurance program. (Reinstate implies the restoration of the reinsurance limit of an excess property treaty to its full amount after payment by the reinsurer of a loss as a result of an occurrence).
“Another criticism for the use of these instruments,” he said, “is whether investors’ participation will continue in case of property catastrophe insurance market disruption as result of a huge catastrophe event or if we start seeing a continuous increase in returns for other fixed income instruments.”
According to Attoh-Okine, if a major hurricane or other natural disaster triggers one of the CAT bonds, the sponsor of the bond will be reimbursed for the loss amount up to the amount of the CAT bond. In such a case, investors will lose part or all of the principal amount and the corresponding interest proceeds.
The A.M. Best report concluded that the increasing usage of CAT bonds and similar instruments add to recent improvements in the modeling of peak risk exposures, but also “adds another dimension to diversifying and managing catastrophe risk.”
In addition, the report said, other areas that might benefit from the use of various capital market instruments to transfer insurance risk include terrorism risk exposure; assigned risk non-property plans facing inadequate pricing/capacity issues, (e.g., workers’ compensation, auto, accident/health, etc.; and the National Flood Insurance Program, which provides flood insurance to approximately 5.5 million U.S. properties with total insured values exceeding $1 trillion, and growing.
Preparing for and Navigating the Claims Process
All of a sudden – it happens. The huge explosion in the plant. The executive scandal that leads the evening news. The discovery that one of your company’s leading products has led to multiple consumer deaths due to a previously undiscovered fault in its design. Your business and its reputation, along with your own, are on the line. You had hoped this day would never come, but it’s time to file a major claim.
Is your company ready? Do you know – for certain – how you would proceed, both internally with your own employees, and externally, with your insurance provider? What data will you need to provide, and how quickly can you pull it together? Do you know – and understand – the exacting wording of your policy? Are you sure you are covered for this type of incident? And even if you are a multinational with a global policy, how old is it, and is your coverage in concert with any recent changes in the laws of the country and local jurisdiction in which the incident occurred?
As should be clear from these few questions, if you organization is hit with a major event and you need to make a claim, just knowing that you are current with your premium payments is not enough. Preparation before the event ever occurs, strong relationships with your insurance team, and a thorough understanding of what needs to happen throughout the claims process are all essential to reaching a satisfactory claim settlement quickly, so that a long business disruption and further damage are avoided.
Get Ready before Disaster Strikes
The Boy Scout motto, “Be prepared,” applies equally well to organizations that may suddenly be faced with the need to navigate the complexities of the claim process – especially for large claims following a major crisis. Crises are by nature emotional events. Taking the following steps ahead of time, before disaster strikes, will help avoid the sense of paralysis and tunnel vision that often follows in their wake.
Open up a dialogue with your insurer – today.
For risk managers and others who will be called upon to interface with your insurer in the event of a crisis, establishing open and honest lines of communication now will save trouble and time in the claims process. Regular communication with your insurance team and keeping them up to date on recent developments in your organization, business and manufacturing processes, etc., will provide them with a better understanding of your risk profile and make it easier to explain what has happened, and why, in the event you ever have to file. It will also help in the process of updating and refining the wording in existing policies to reflect important changes that may impact a future claim.
Conduct pre-loss workshops to stress-test your readiness to handle a major loss.
Firefighters conduct frequent drills to ensure their teams know what to do when confronted with different types of emergencies. Commercial airline pilots do the same. Your organization should be no different. Thinking through potential loss scenarios and conducting workshops around them will help you identify where the gaps are – in personnel, reporting structures, contact lists, data maintenance, etc., before a real crisis occurs. If at all possible, you should include your insurance team and broker (if you have one) in these workshops. This will not only help cement important relationships, but it will also serve to further educate them about your organization and on what you will need from them in a crisis; and vice versa. The value to your organization can be significant, because your risk management team will not be starting from zero when you have to make a claim. Knowing what to do first, whom to call at your insurer, what data they will need to begin the claims process, etc. – all of this will save time and help get you on the road to a settlement much more quickly.
Know what your policy covers, before you need it.
This advice may sound obvious, but experience has shown that all too often, companies are not aware, in detail, of what their policies cover and don’t cover. As Noona Barlow, AIG head of financial lines claims Europe has noted, particularly in the case of small to mid-size organizations, “it is amazing how often directors and risk managers don’t actually know what their policy covers them for.” This can have dire consequences. In the case of D & O insurance, for example, even a “global” policy many not cover all situations, because in some countries, companies are not allowed to indemnify their directors. Obviously, these kinds of facts are important to know before rather than after an incident occurs. So it is important to have an insurer with both a broad and deep understanding of local laws and regulations wherever you have exposure, in addition to an understanding of the technical details of working through the claims process.
Make sure your data management policies are in order.
Successful risk management depends on having consistent, high-quality data on all of your risk-sensitive operations (manufacturing, procurement, shipping, etc.), so that you can quantify where the greatest risks sit in the organization and take steps to reduce them. Good data, complemented by strong analytics, will also help you to identify potential problems before they occur. It will also help you to maximize the effectiveness of your insurance purchasing decisions. Frequent, detailed conversations with your insurer will help you to identify any areas where additional data might be needed in the event of a crisis.
No one ever wants to find themselves in the midst of a crisis. But if and when such an event does strike, if you have taken the steps above you will be much better positioned to work through the claims process – and reach an effective resolution – as quickly and as smoothly as possible.
For more information, please visit the AIG Knowledge and Insights Center.