By Altus Partners
After more than fifteen years of favorable or “soft” conditions for commercial insurance buyers, the market showed signs of firming in early 2018. Even before considering the impact of COVID-19, we expected this trend to continue through at least 2020. Carriers and most brokers are applauding the rate increases because of the positive impact on their financial results. Insurance buyers should be aware of the reasons behind the trend.
Over the past 18 months, insurers have spoken frequently about how “social inflation” has hurt their bottom lines. They characterize social inflation as an increase in the frequency of large jury awards or “nuclear verdicts” resulting in significant insurance payouts. Their theory is that millennials now account for a larger percentage of jury members, and they see awards to plaintiffs as a form of social justice. As a result, many businesses have experienced double-digit rate increases for their umbrella liability coverage and other lines of insurance during the last two renewal cycles.
While the insurance industry’s explanation may be plausible, the messaging has been mostly anecdotal with limited statistics to support it. Legal experts and watchdog groups have not identified a change in the U.S. litigation environment that aligns with the upward movement in insurance rates. Interestingly, social inflation is being used to explain the “current normal,” yet Warren Buffet referenced the term in a letter to investors over 40 years ago.
The same can be said for insurers’ concerns about their investments. Insurers rightly allocate most of their capital to fixed income vehicles to limit investment risk and focus on insurance risk. They say that low interest rates are hurting their return on capital, which is squeezing their margins. This is true, but treasury rates have been historically low since the financial crisis hit in 2008.
Social inflation and low interest rates do not tell the full story of why the market turned in 2018, and many other factors need to be considered. With $800 billion of surplus, the insurance industry has never been better capitalized––but competition, low investment returns and an uptick in catastrophe-related property losses are affecting insurers. Climate change, pandemics and other existential threats will continue to challenge the insurance industry going forward. Therefore, underwriters will need to increase rates on certain risks, and insurance buyers with preferred risk profiles must position themselves to avoid being unfairly subjected to broad market trends.
Time will tell how long this hard market will last, especially with so many unknowns around COVID-19. Insurance buyers looking to offset rising rates should consider higher deductibles and retentions, reassess their excess and umbrella limits, consolidate coverages with fewer insurers to leverage relationships, and seek out fee-based brokers for insurance transactions.