GRAND RAPIDS — The commercial insurance industry has been in a “soft market” for at least two years now, especially in the Midwest, which translates into lower insurance costs for business. And the forecast from the experts is — probably more of the same.
“Rates are declining, and that’s to the advantage of our clients,” said John Durkin, area chairman of Arthur J. Gallagher & Co. in Grand Rapids.
Gallagher, which is headquartered in Chicago, is the fourth largest insurance brokerage in the world.
“We’ve been in a soft market for the last two years, anyway. This is probably our third year,” he said.
Jim Dawdy of Universal Insurance Services agreed.
“We are in what we call a ‘soft market,'” he said. “The insurance underwriting community has had two years in a row now of record profits, and record combined loss ratios,” said Dawdy, commercial lines program manager at UIS.
Randy Amyuni, vice president of the risk management practice at The Campbell Group, a major West Michigan insurance agency, said the insurance rates for business in Michigan have been dropping anywhere from 10 to 20 percent, annualized.
Insurance rates are driven — in part, anyway — by ratios.
“Loss ratio” is the total amount a carrier takes in, in premiums, minus the total amount it pays out in claims. A loss ratio of approximately 60 percent is considered the ideal in the industry. However, “combined ratio” is the term usually used in figuring an insurance company’s profitability. Combined ratios take into account all the company’s expenses.
Insurance companies invest the premiums they take in, and when the stock market is booming, an insurance company can still be profitable even when its loss ratios are relatively high — sometimes even exceeding 100 percent.
When insurance carriers are enjoying high profits, they can afford to lower rates in order to be more competitive and hopefully increase their business. That’s a “soft market.”
According to the Chartered Property Casualty Underwriters Society, hard and soft markets are “part of the legendary ‘insurance market cycle,’ and are a function of supply and demand.”
Dawdy said he would guess that the low rates for commercial lines could last “a couple more years, if history is any indicator.”
“Anytime a combined ratio is at 100 percent or below, it’s an indicator the market will be more stable, because there is profit,” he said. He noted that in the first quarter of this year, the combined ratios percentage was in the low 90s, which, he said, “is why you are seeing the rate continue to fall.”
It also indicates the insurance companies are still enjoying record profits, he added.
Amyuni said the insurance market has probably been soft since the beginning of 2004 and will continue “as long as we have minimal amounts of catastrophic loss” in the United States.
“Right now, there is no changing market in sight,” he said.
“Like everything, the (insurance) business tends to be somewhat cyclical,” Durkin said. “Premiums go down; eventually, they have to come back up.
“What could change (premium rates) is a really tough hurricane season that could tag a lot of carriers,” added Durkin. “Any disaster could have an impact — but it would take more than one hurricane or event to really impact the market.”
While hurricanes and terrorism can temporarily impact rates, all three experts agree that terror attacks and hurricanes are probably less of a factor driving insurance market price than the general public would assume. They all agree that there was some insurance industry overreaction to the events of 9/11 and 2005.
Durkin said there was “a severe overreaction” in the insurance market when the hurricanes blasted the southeastern United States in 2005. As a result, rates went up on the East Coast and down in the Midwest, safely distant from the hurricane zones.
Dawdy noted that the 2005 hurricanes were originally predicted to cost the insurance industry $40 billion in claims. But insurance companies are legally required to maintain a policyholder surplus to cover a surge in claims above normal — and the $40 billion “was less than 10 percent of policyholder surplus,” said Dawdy.
Amyuni called 2005 an “amazing year” in terms of the profitability of the insurance industry. “Insurers were going to have a record year,” he said — and they still did. There were some “hiccups” from the hurricanes, but not to the extent thought, he said, and the result was “a little blip in the property (insurance) market.”
Insurance rates jumped after the World Trade Center attack, but Durkin said the insurance market at that time “was poised for a bit of a hardening anyway,” adding that the catalyst was 9/11.
“Every business got hit with big increases after the 9/11 event, because the actual loss amount was still unknown,” explained Dawdy. The big insurance carriers were afraid there would be more attacks in the United States as devastating as the death and destruction at the World Trade Center, so the industry adopted a bunker mentality of anticipating and preparing for the worst, by raising premiums to cover claims that they feared were coming in the future. Of course, there have been no significant terror attacks in the United States since then.
Amyuni noted that when 9/11 happened, “we were in the upturn, price wise, of the market already.” When the attack occurred, the carriers had a “knee jerk” reaction and raised rates.
“There probably was some fear in the re-insurance industry that more attacks were coming,” he said. “That lasted for about two years, maybe a year and a half; then we started to see rates going down.”
Insurance carriers share risks worldwide by buying re-insurance. “Re-insurance” companies actually insure insurance companies against large claims: One of the largest re-insurance companies is a Swiss firm.
The insurance industry tends to play “follow the leader” when it comes to rates.
Amyuni said when the market is soft, a shift toward a hard market can begin when there are major losses along with changes in the investment environment. Then, he said, “One carrier will seem to start to set a trend (of higher rates), and the rest play follow the leader.” Typically, he added, the trend is started by “one of the big boys” such as AIG or Travelers.
“Eventually, everyone does follow in line, and then you have a hard market,” he said.
Dawdy said that some businesses are inclined to make mistakes in risk management when the insurance market is fluctuating. For example, falling rates may lead a corporate manager to decide the company can now afford coverage with a lower deductible.
Deductibles — which the insurance industry calls “risk retention” — and coverage amounts should be carefully calculated for a long-term context.
“Long-term risk management philosophy says, as time progresses I should increase risk retention (i.e. deductibles) rather than decrease — but this is the kind of market that gets people in the trap of violating their risk management philosophy,” said Dawdy.
Or, a manager might decide to increase coverage because rates are lower, or decrease coverage because the rates are rising.
Dawdy said if a business decided it needed $1 million in coverage and the next year decided to increase or decrease that amount, “I would ask what changed” at the company. Insurance price fluctuations are “not how you should be making decisions,” said Dawdy.