Behind the Shift in Pricing

As insurers engage in the autumnal policy renewal season, next year’s property-casualty insurance market conditions clearly look to be an extension of current conditions, in a word—stable.

But, masking this comfortable term is the growing realization that unique forces are in play that may bode historic changes ahead in marketplace conditions.

These forces so powerful that the prospect exists at some time in future for insurers to actuarially underwrite lines of business to the individual organization level, relying much less on the industry’s traditional risk-spreading philosophy to offset losses in one line with winnings in another.

What are these forces? The answer is technology. The increasing use of advanced analytics by carriers offers the means to make better predictions of potential loss frequency and severity. As these tools improve, risks can be priced closer to the bone, while also paring costs on the expense side of operations.

Down the line, this clearer insight into an insurance applicant’s potential financial exposures will guide insurers to make more informed decisions about risk selection. These decisions will combine to reduce the carriers’ overall loss costs. Assuming a growing economy, the lower losses will compel lower prices, extending the current bargain bonanza for buyers—the generally soft market conditions that have prevailed for several years running.

The increasingly important role played by technology in the industry’s future cannot be discounted. All roads are leading toward a day when data analytics will be as integral to market conditions as a major catastrophe or a double-digit interest rate hike. But, this is jumping ahead. Let’s first look at the current and near-term property-casualty insurance market.

2016 Outlook

So what’s ahead? Look for a repeat of this year—even with the industry consolidating. In other words, what is stable today will remain stable, with nominal premium increases and decreases depending on the line of business. 

Of course, there are always outliers—the unexpected catastrophe, latent liability disaster or new litigation trend that can arise tomorrow, suck up capital and harden the market.

“In no way is the industry’s cycle disappearing,” says Gerard Vecchio, director of insurance research at Conning.

Still, he hedged his opinion. “But, due to technology and the ability to underwrite individual risks,” Vecchio says, “I don’t see a return to extreme pricing increases and decreases.”

Awash in Capital

Several factors are conspiring to maintain the current stable market outlook—good news for buyers, less so for brokers and agents who make money from the commissions on premiums. The factors include rather sluggish economic growth, with little in the way of new exposures and incipient interest in relatively new insurance products absorbing cyber and intellectual property risks.

Investment income also remains lethargic, although one keeps hearing interest rates will rise—slowly, someday, surely. At the same time, property catastrophe losses have been extremely low for two and one-half years running; reinsurance is cheap and plentiful, given a massive influx of alternative capital; and operating efficiencies are at their all-time-best (reason: technology). 

Add it all up and the industry has money to spare, flattening the resolve to boot pricing upwards. “There is still a tremendous amount of capital in the industry, which increases competition and keeps pricing flat,” Vecchio says. “More competitive pressures lay ahead, which explains why we are seeing these transformative M&A deals.”

He’s referring to the industry’s abrupt consolidation over the past year, the first significant M&A activity since the late-1990s. Much of the dealmaking has been confined to reinsurers and middle market and smaller specialty insurers, with the giant ACE-Chubb deal the eye-popping exception.

Why are carriers suddenly in a marrying mood? “A substantial increase in M&A would decrease overall industry surplus, possibly translating into harder pricing,” explains Tracy Dolin-Benguigui, director of financial services ratings, at Standard and Poor’s. Apparently, just the lift insurers are looking for.

More deals are expected in 2016, although the jury remains out on whether there will be additional transaction of the ACE-Chubb variety. “The actual number of mega-deals that could possibly occur in the U.S. is limited,” says Robert Hartwig, chief economist and president of the Insurance Information Institute. Translation: not likely.

“If I were advising my customers about the 2016 renewals,” Hartwig says, “I’d say to expect a very competitive market insofar as coverage terms, conditions and price, despite slightly fewer options due to the industry’s consolidation.”

Good News for Buyers

Brokers are reading the same tea leaves as the analysts. “In my long career, I have never seen such a disciplined market,” says J. Patrick Gallagher, Jr., chairman, CEO and president of Arthur J. Gallagher & Co.

Gallagher came into the business in 1974, at a time when such practices as cash flow underwriting were in vogue (and remained so for decades thereafter). Here’s how the practice worked: When sales figures were high, insurers would take these returns and invest them to pay losses down the road. A smart idea, unless the investments failed to produce as expected and losses were higher than anticipated.

The risky concept has faded, due in large part to insurers’ advanced analytical tools, not to mention times like the present (i.e., meager investment opportunities).

“The industry is making money the old-fashioned way—underwriting,” Gallagher says. “And the reason the market is softening is because the industry is making a ton of money.”

Others agree. “There’s a healthy amount of capital on both the insurance and reinsurance sides of the industry, causing very stable pricing,” says Paul Kim, co-chief broking officer at Aon Risk Solutions U.S. “The same factors influencing the marketplace are causing the consolidation of the insurance and reinsurance markets, although we have yet to see any indications that a significant amount of capacity will be withdrawn from the supply side.

Without that, prices will remain stable into 2016.”

Albert “Skip” Counselman, chairman and CEO of Riggs, Counselman, Michaels & Downes, echoes this refrain. “It’s a fiercely competitive industry and that’s really good news for clients. They’re enjoying every minute of it.”

With regard to the impact that lower premiums have on brokerage fees and commissions, Counselman conveyed pragmatism with a dash of optimism. “Now that the recession is drawing to a close across the rest of the country, the exposure base isn’t falling as precipitously as it was in the 2007-2013 period, when payrolls and receipts were less and economic activity was stagnant. Companies that did not go out of business then hung in there, albeit with less business. We’ve gotten through all of that now. Things are stabilizing—even with no premiums going up, and no commissions going up either.”

Some brokers suggest that overall property-casualty pricing will decline further in 2016, despite the industry’s ongoing consolidation.

“We’re in a downward slide in the rating cycle,” says Tony Campisi, president and CEO of Glatfelter Insurance Group.

He explained that insurance carriers are increasingly pressured by dismal investment income returns. Assuming the Federal Reserve sends a signal to increase rates, the likelihood is for the incline to be of the quarter of a percentage point variety. “With the favorable catastrophe and non-catastrophe loss environment, and nothing dramatic expected along the lines of loss cost inflation, there’s really no driving force to shift the rate cycle back in a positive direction, other than a massive catastrophe or economic upheaval of some sort,” Campisi says.

Such a mega-disaster was predicted in June by The New Yorker magazine. An article titled, “The Really Big One,” stated that a massive earthquake followed by a giant tsunami will destroy a sizable portion of the Pacific Northwest—sooner than later. “We are now 315 years into a two-hundred-and-forty-three-year cycle (for this earthquake to strike),” the article’s author ominously warned.

Even a more modest earthquake or another couple Hurricane Katrina’s would kick the industry’s rusty cycle back into gear. Spread across carriers, the losses from such mega-disasters would shrink the industry’s war chest, encouraging insurers to increase prices.

Until then, absent major losses the industry will continue to hoard capital. Where to deploy it, other than invest in M&A transactions, is the problem. With investment income potential dim, cash flow underwriting is not an alternative. It’s tough for one carrier to raise prices and expect every other carrier to follow suit. Flush with cash, some carrier will seize the opportunity to take market share with discounted premiums.

Cyber Insurance

Perhaps the good news is that no one expects prices to ratchet down fast like in some prior market cycles, when a knee-jerk decline was not uncommon.

“I just don’t see the kinds of destructive double-digit declines or inclines on the horizon,” Campisi says. “We’ll be looking at tighter arcs in the swing of the cycle.”

“This is a fully functioning marketplace,” agrees Christopher Lang, US placement leader at Marsh. “It’s very robust, with lots of competition and plenty of capacity to explore underinsured areas like cyber, promising new growth opportunities. There’s a lot of movement right now in the marketplace to position buyers with broader cyber coverages, addressing both the privacy and security risks.”

Lang makes a good point, but such improvements are just now filtering into the market, meaning that it will be awhile before any new business trickles down to improve carrier premium income and brokerage commission. This also assumes eager buyer interest, of which there has been only modest interest to date.

Nevertheless, there does seem to be a greater resolve among carriers to become more diversified in different lines and segments. “We’re seeing substantial diversification of underwriting appetite,” says Ryan Wilkerson, president and CEO of Haas & Wilkerson Insurance. “If one line gets hit hard, the other lines will help make up the shortfall.”

This diversification also is evident in market pricing. “If it’s a new piece of business, the underwriters are pretty aggressive, fighting for it and adding to the market conditions,” Wilkerson says. “If it’s renewal business, they try to hold the line or maybe get a bit of rate. In general, it’s a really competitive marketplace, with much of this stability driven by data analytics.”

Those Forces Again

As Wilkerson alludes, advanced analytics is the newest gear spinning the industry’s cycle, one that will become more influential as the cost of technology drops and the algorithms powering Big Data become mightier.

“As more insurers develop the means to afford predictive modeling, it will have a substantial impact on the underwriting side in terms of risk selection,” says Vecchio from Conning. “It will also begin to play a more important role in claims management. Claims that have certain characteristics will be flagged as more likely than others to cost more. This will compel insurers to put their most experienced claims adjusters on these claims to minimize their financial impact.”

Technology tools also will continue to assist insurers to become more efficient operationally, identifying bloated expenses and squeezing them out to obtain greater economies of scale. Of course, this just adds to the capital hoard keeping pricing flat.

As the cost of technology comes down, their functionality will increase—the theory behind the prescient Moore’s Law. Assuming truly extraordinary predictive capabilities—not to be discounted in an era that is concept proofing driverless cars and drone deliveries of diapers—the possibility exists that a single insurance carrier can move the market one way or the other.

Don’t believe it? “A company the size of Berkshire Hathaway, Travelers or The Hartford has a relatively small market share overall; consequently, their ability to change overall pricing conditions in the market isn’t yet possible,” Vecchio acknowledges. “But at some point in future—maybe in a particular class of business—I do think they can acquire this ability, assuming truly best-in-class data analytics.”

Even veteran industry watcher Hartwig agrees that technology is the new kid on the block, one with very big muscles. “You can look at the 1990s and see the same range-bound dynamics that we have in place today—a large accumulation of capital, price discounting to grow market share, and intensifying M&A activity,” he says. “Past often is prologue. Except what is different this time around is major commercial carriers beginning to leverage increasingly advanced predictive modeling tools.”

Hartwig projected that the use of Big Data will generate questions as to why one insurance company suddenly brings rates to the market in a direction that is radically different from its competitors. “Why is it their prices are so much less?” he explains. “Is it their loss experience or something their advanced analytics is telling them? It’s just one more check on the market.”

In other words, another force to be reckoned with.