By David B. Dolnick
This article was completed in early May 2020. Changes related to the COVID-19 crisis and construction and insurance industries are still occurring; some data in this article may have changed by the time of publication.
In the world of surety, commercial insurance may not be a primary focus; and dealing with insurance-related issues may seem like either a distraction or a luxury that can, or perhaps even should, be set to the side. It’s natural in the face of uncertainty to stick to issues within our core competency and to relegate other matters to the back burner. The simple truth, however, is that many businesses in high risk or volatile sectors such as construction are facing many threats at the moment and a rapidly hardening insurance market is now prominent among them. In these unsettled times, you have an opportunity to strengthen your client relationships and to help your business partners survive and succeed. One way of augmenting your present services is to help your clients with tips and suggestions about the hard insurance market and help them address the rising costs of commercial insurance.
In this article we’ll take a brief look at prior market cycles for comparison, and we’ll try to make some educated estimates about where the insurance market appears to be heading. View this article for a list of pragmatic steps and tips for you and your client to help him or her meet those challenges. You can read these in any order you like, but some of the tips and ideas may make a little more sense if you put them into perspective with the observations and thoughts discussed here.
The insurance market today has little to no precedent for its current status, and thus its direction remains unclear. The hard market we are seeing now may well be fundamentally unlike any other that we’ve ever seen before. I use “may,” as the impacts on your client’s business may, at its core, look much like the problems we’ve faced in prior hard markets. At the street level of business, grand theories of causation are rarely the most important consideration. In addition, the massive disruptions brought on by the COVID-19 pandemic are causing intense and deep changes over an astonishingly short a period of time. The full impacts of the pandemic on both surety and insurance markets will not be known for months or, even in some cases, years down the road, and will likely be the subject of much debate and uncertainty as they unfold.
Overview of Insurance Markets
Insurance markets move in cycles. Over the last century, “hard” markets (with higher rates and restricted availability) have typically been relatively brief, lasting anywhere from 18 months to three years. Those have been followed by “soft” markets (with lower rates and a broader availability), which have, until recently, lasted between three and five years before the cycle repeated. That cycle changed in 1984, and the hard market that ended in 1987 was followed by a much longer soft market than had been seen, one lasting a bit more than twelve years. The next hard market cycle (2000–2003) was in turn followed by a soft market lasting sixteen years, ending in mid-to-late 2019. By the first quarter of 2020, most insurance rates were rising, some steeply; and underwriting criteria were again being tightened across most of the remaining (but not all) lines of coverage.
The differences between today’s insurance market and its history are not limited to the length of the cycle. Insurance carrier net earnings, net income, and policyholder surplus all remained strong through the latest soft market, as did combined loss ratios for most lines. That pattern is not typical of previous soft markets and could imply that this hard market will also be different. In most previous hard market cycles, the multiple lines of commercial insurance tended to all move generally in sync with each other; the industry as a whole tended to harden at about the same time, or within a few months of some triggering event or events. The present hardening cycle of the market has been steep for a few lines, very gradual for others, and remains soft for a few core lines of coverage some six to eight months into the shift. All of these mark a very different pattern when compared to history. While those patterns may change or not as the hardening deepens, the shifts do signal the potential for a very different kind of hard market than any we’ve seen before. The insurance industry is shifting as we watch.
Further complications are being introduced by the COVID-19 pandemic and the likely recession it will trigger. Many, if not most, states will mandate some form of workers’ compensation coverage for medical personnel and first responders exposed to the pandemic; and the potential extension of that mandate to other essential employees is not out of the question. Five states at the time of this writing are considering or debating bills that would, if enacted, seek to retroactively force carriers to provide business interruption coverage for COVID-19 impacts. Most of those policies specifically excluded such payments by endorsement or other means. Any legislation of that nature will almost certainly be challenged in the courts, but an insurance industry forced to retroactively cover COVID-19 business interruptions would become highly unstable at a minimum (one recent estimate puts the potential business interruption costs in the U.S. alone at somewhere between $220 and $380 billion a month).1 As a comparison, the entire U.S. insurance industry’s surplus mid-year 2019 was $802.2 billion, meaning that all available surplus would exhaust in two to four months, risking the stability of the industry.2
The deep losses in market capital and investment income that carriers have experienced in the 2020 stock market declines related to the COVID-19 pandemic have also put enormous pressure on carriers and will likely lead to some rate increases on their own. Almost all insurance requires carriers to hold a minimum level of capital (known as admitted surplus) backing the transaction. The ratio of written premiums to that admitted surplus varies among the states and, to some extent, by line of coverage; but a loss of upwards of 20% of that admitted surplus in the value of investment portfolios will put pressure on carriers to reduce their writings to maintain the proper ratios. Hardening underwriting practices is a technique commonly used to make those kinds of corrections. Another method of correction is to inject further capital into the surplus, but many sources of that capital may not be willing to deploy it in a risky industry like insurance. Those impacts will play out in the middle half of 2020 or later in the year and are also likely to have an impact as reinsurance treaties for early 2021 begin negotiations in roughly September or October.
Where Rates Are Today—Property and Casualty Lines
Many but not all commercial insurance lines are seeing significant rate increases. Some are sharp (20% or more), while others are more gradual. Auto liability, umbrella/excess liability and some property coverages (especially those located areas with catastrophe exposure) are reaching or exceeding 30% versus 2019 rates. The rise of sexual harassment litigation has caused the cost of directors & officers coverage to rise. Companies that lag or make significant missteps in their COVID-19 responses could see stock prices drop, leading to potentially significant D&O litigation and even steeper increases in coming months. Other lines (specifically, commercial general liability) are also seeing rising prices and tighter underwriting requirements, but less evenly and with more room for individual account negotiations. As is always the case in hardening markets, larger accounts will have greater negotiating ability, leaving small and middle market insureds to bear a larger portion of the increases.
Workers’ compensation rates continue to remain either stable or to show slight declines, in contrast to other sectors discussed above; but the ultimate impact of COVID-19 on those rates is an open question at present. Employment in the health care sector is about 12% of the workforce,3 and any change to that large a segment of our employed population will certainly have a ripple effect on the overall rate and cost profile of that coverage. Several commentators are of the opinion that workers’ compensation rates have been too low for some time now, reducing underwriting options for carriers and pointing to higher rates in the very near future. Medical costs continue to rise at rates far above those reflected in general inflation, a factor that impacts both workers’ compensation and the health insurance sectors of the industry.
A deeper analysis of the causes behind these changes is beyond the scope of this article, but principally the causes include continuing adverse development of losses in primary and excess lines of coverage, rising reinsurance costs, changes to risk-based capital allocations, and regulatory shifts. Some lines, such as commercial automobile liability, have historically been underpriced; and as investment earnings have fallen, greater pressure is put on underwriting to produce a net operating profit for the carriers.
Employee medical and individual health insurance programs will be dramatically impacted by COVID-19. While fundamentally a different market from commercial property and casualty lines or surety, the enormous scope of COVID-19 costs on a global scale are likely to have an impact, and some significant fall-out to the P&C insurance sector is inevitable. Having said that, most major health insurance companies, and several rating organizations, believe those costs are within the ability of the industry to absorb. While the losses from COVID-19 will be extremely painful on many levels, at this writing it does not appear that the health and medical insurance sectors are in any long-term danger. The likely impact bleeding over into the commercial P&C areas are at the reinsurance level, where many of the major international reinsurance carriers have some significant exposure to both sectors. Health insurance rates will continue to rise and probably accelerate their long-term trend of increases approaching or entering double-digit levels.
For a series of tips and steps that might be of help to you and your clients, see the web exclusive SBQ article at www.suretybondquarterly.org that includes the quick tips for bond producers and their clients.
- “P/C Insurers Put a Price Tag on Uncovered Coronavirus Business Interruption Losses,” Insurance Journal, March 30, 2020.
- “2019 Commentary on the First Half Financial Results,” Insurance Information Institute, October 10, 2019.
- “Health Care Employment as a Percent of Total Employment,” Kaiser Family Foundation, May 2018.
Find Out More
For more information, access this NASBP Virtual Seminar: Business Interruption Coverage Under COVID-19. Access more NASBP Virtual Seminars at https://learn.nasbp.org. Access free NASBP Podcasts on this topic at https://letsgetsurety.org/episodes.
David B. Dolnick is the founder and President of Dolnick Risk Advisors. He has more than 40 years of comprehensive experience in commercial insurance, construction risk management, occupational safety & health, and loss prevention. Dolnick works with developers and owners, general contractors, construction management firms, and trade contractors across many sectors of the industry. He has in-depth and direct hands-on knowledge of workers’ compensation and casualty insurance, claims and litigation management, and of occupational safety and health programs. He can be reached at [email protected] or 619.569.2280.