Death. Taxes. Insurance cycles. For the past half-century in the commercial property-casualty marketplace, that trio could be counted on.
Hard and soft insurance markets have been ingrained in the memory of so many customers, agents, brokers and insurance analysts for so long that it’s hard to imagine a p-c market without them. But several industry executives believe the era of the cycle may be coming to an end, if it hasn’t already.
A major macro trend in the property-casualty marketplace is underwriting discipline, says J. Patrick Gallagher, chairman, president and CEO of Arthur J. Gallagher & Co.
“For years, analysts on the sell side and buy side have been trying to figure out when the next hard market is,” Gallagher says. “They’re used to looking for it, but for the past four years or so the p-c market has operated in a disciplined manner.”
Cyclicality has been a hallmark of the insurance industry in modern times, but it wasn’t always that way. “Look at p-c premium growth from 1900 to 1960,” Gallagher says. “It grew with the economy in a linear way. Then, in 1960, premiums go through the roof. What the hell happened?”
What happened, according to Gallagher, was the marketplace went from being property driven to being casualty driven. “In the ’60s we began to see medical malpractice liability, general liability and increased costs of tort,” Gallagher says, and that shift was reflected in premium growth. “The massive cycles started in the ’60s, ’70s, ’80s. By the ’90s, insurance companies started going broke left and right—The Home, Reliance, Kemper—big names that all went away because there was no discipline in the market.” Cycles of hard and soft markets continued even after that, though. The 9/11 terrorist attacks ushered in a typical hard market, and organic growth jumped. In 2002, another typical soft market emerged and lasted until Hurricane Katrina hit the Gulf Coast in 2005, when insurance prices firmed. A reprieve from catastrophe losses in 2007 and 2008 led to a reduction in rates, and pricing in the overall p-c market has remained relatively stable ever since.
“The muscle memory of Wall Street is that we must be heading for a hard market,” Gallagher says. “But there has been a fundamental change in our industry, a seminal change in the p-c world: underwriting discipline because there’s no investment income,” Gallagher says.
From insurance carriers’ perspective, there is more focus today on creating value in their portfolios for customers and investors.
“This market is not capacity-driven. It’s more of an economic-driven cycle where carriers felt they needed to get rate improvement,” says Jack Roche, executive vice president of Hanover Insurance Group.
“It’s the first test for a lot of what people have been forecasting about our industry: Will business start to drive toward less extreme underwriting cycles and exercise more underwriting discipline?” Roche says. “One of the biggest things that has happened is we as an industry have migrated into a different type of market cycle. That has implications going forward for agents and brokers.”
“In the market I’m dealing with today, property is softening, and it should,” he says. “The market has been funded well, and the customer deserves a break. Another fundamental difference in our market is that disciplined underwriting gives brokers an opportunity for growth in a way we haven’t seen before because the bottom hasn’t fallen out of the market. In this environment, loss costs are inflating, tort costs are inflating, so it’s not unreasonable for carriers to ask for 3% or 4% increases. That’s a professional way to approach customers, unlike how the market has behaved in the past.”
In Gallagher’s view, cycles of hard and soft markets actually make the broker’s job tougher.
“The problem with a hard market is we’ve teed up clients in the soft market that insurance is cheap, then we yank the rug out from under them,” he says. “That’s tough to explain, as a broker. But a key point about our industry is, when we have losses, we pay them. We don’t need bailouts typically, and that’s something we as agents, brokers and carriers should be rightfully proud of.”
Roche says the current marketplace is “more challenging” for companies that have relied too much on market cycles for their growth. The current market, he says “places more emphasis on major trends under way, which ultimately is about creating a better value proposition for the end consumer.”
Reinsurance traditionally has been a prime mover for pricing and capacity changes, so primary carriers are monitoring the reinsurance market, says Greg Hendrick, CEO of the global insurance operations of XL Group.
“We are watching closely a highly competitive reinsurance marketplace,” Hendrick says. “A broad swath of the reinsurance market is priced lower than it was 12 months ago in short-tail lines. We’re watching to see how it may or may not impact insurance pricing in 2015.
“During 2014 we’ve seen flat to 3% or 4% rate increases. A fairly stable pricing environment has persisted in a narrow band of rates.”
XL, along with other p-c carriers, is keeping a close eye on three main topics:
- Renewal of the Terrorism Risk Insurance Act. “Uncertainty around the renewal of TRIA keeps us up at night,” Hendrick says. “In the absence of a backstop for terrorism risk, it will require a shift in how we do business. We always need to shepherd capital and respond to our customers’ risks.”
- Pricing environment. “We’re watchful about where rates are going in primary insurance,” Hendrick says. “If the market can maintain rates at zero to 2%, that will be OK. But if average rates go down, that will be a problem.”
- The economy. “Continued slow recovery in the economy doesn’t trigger much exposure growth, so we’re watching that,” Hendrick says. “The more things there are to insure, the better our growth prospects become.”
“Overall, it’s hard to predict what’s going to happen to pricing for the industry into the future,” Roche says. “An event or two could change that.”
Three years ago, property rates led the firming in the market, he says. “Now that’s being replaced with auto and workers comp,” Roche says. As carriers are paying less for property catastrophe reinsurance now, he says, they have started to factor the lower cost into their pricing. “It’s a fundamental shift in the cost structure,” Roche says.
In a fluctuating reinsurance industry, casualty trends are down.
“And we don’t know how sustainable they are,” Roche says. “We don’t know what next year will bring in terms of exposures and events that could change that.”
Market data from Marsh suggests that rates for U.S. property and casualty risks are declining slightly overall.
“Insurer profitability in 2013, few major losses over 18 months and increased capacity and competition have helped keep U.S. property rates decreasing on average,” Marsh reported in its quarterly market briefing in mid-2014. The average level of increase in U.S. casualty rates “is gradually diminishing, and competition in this sector looks to be slowly driving a softening in pricing,” according to the report.
Buyers’ interest in certain lines appears to be growing. Marsh notes inquiries are rising for cyber risk insurance as well as specialty coverage for drones. XL is also seeing more interest in cyber risk.
These days, Hendrick says, customer inquiries fall into three broad topics:
- Cyber risk. High-profile hackings have made cyber risk a major concern, Hendrick says. “As an industry, we’ve developed good solutions for data breach and regulatory compliance,” he says.
- Supply chain. Business interruption, a likely result of a cyber attack, remains a major consideration for customers everywhere, Hendrick says.
- Political risk and political violence. “The world is a less stable place,” he says. “There’s a lot of conflict around the world.”
Carriers’ appetites for certain risks have tended to oscillate, which has contributed to cycles in the past. Supply and demand for coverage is another contributing factor, but these days industry observers see stability in both capacity and demand.
“We see stable supply and demand for insurance, so there appears to be no meaningful reduction in capacity in most of the marketplace,” Hendrick says.
In medium-tail lines, such as aviation, there has been loss activity around the world, which might affect capacity, he says. In long-tail lines, such as excess casualty and professional liability, Hendrick says, “a steady stream of smaller players has emerged.”
Carriers are benefiting from modeling and pricing segmentation, which is causing some big differences in rates from line to line, Roche says.
“Pricing sophistication is a double-edged sword,” he cautions. “It does help bring a better price to the customer, but as we’re seeing in small-commercial today you can go too far too fast. It’s a balancing act and doesn’t replace fundamental underwriting.”
As an example, five or six years ago commercial auto was a highly profitable line of business for carriers. “Now they can’t get rid of it fast enough,” Roche says. “What does that tell you about how companies look into their portfolio and into the future? People are making bigger mistakes faster. Pricing differentiation is as wide as it’s ever been, and it’s a very dynamic time.”
Hendrick agrees. Short-tail lines, such as property, tend to respond more quickly to price changes because they have “a quicker feedback loop,” he says. “A lack of catastrophe activity in North America, and a read-through from reinsurance pricing, means that as carriers pay less for reinsurance in those lines, they tend to reduce pricing for customers faster.”
Conversely, longer-tail lines, such as casualty, take longer to see loss development. Therefore, rate changes in those lines tend to take more time.
Regardless of whatever ebb and flow may occur among competitors and in capacity, Hendrick says, XL’s risk appetite is not changing. “Our job is to be in the group of leading insurers,” he says. “There will always be competition in the large commercial space. Carriers willing to transact in primary layers increasingly need to be able to issue globally compliant policies, and that’s where we have an advantage.”
The Hanover believes that value for the commercial p-c customer starts with “distinctive and relevant products for the small to midsize account, written by local, empowered underwriters with authority and knowledge about those communities,” Roche says. The Hanover defines insurance products not only as coverage but as service. “Technology and data advances are allowing us to serve smaller commercial customers in a more creative, thorough way,” Roche says. “There are so many innovations going on in the service side—those can be equally compelling as the latest coverages.”
More agents and brokers are consolidating, Roche says.
“We believed that agents were going to increasingly need markets that would help them create value,” he says, “and part of that value is working with the appropriate carriers.”
Why the discipline?
Carriers have been preaching the need for disciplined underwriting for decades, yet cycles persisted in the past. So what’s different now? Pat Gallagher believes it’s due to several factors, and all of them appear to be around for the long term.
“We have solid leadership at companies, with better information at their fingertips than they’ve ever had,” Gallagher says. In the past, he says, a gap existed between perception and reality in rates and underwriting trends. “For the first time in my career, when an insurance company CEO tells me something is happening at the street level, he or she is right,” he says.
Why the change? “One is underwriters write by account. As Jay Fishman of Travelers says, ‘There is no market,’” Gallagher says. “Underwriting is done at the account level, and if an account should have a rate decrease, it gets it.
Likewise, if an account should get an increase, it does.”
Another change, Gallagher says, is in the expectations of company leaders. “There’s no yield, so you better do your underwriting right,” Gallagher says. “The level of understanding and the speed with which they get information on their book has never been higher.”
Despite these big changes, Gallagher says, the market remains competitive. “It’s not a perfect market,” he says. “Companies are still competing to win accounts. Account by account, it’s a street fight. But by and large, across their books, carriers are continuing to show discipline.”