“In the current market, carriers are quoting significant price increases and walking away if insureds don’t agree.”
Pete Kranz, Beecher Carlson

I’ll go back about three years prior to the start of the hardening market. We had the first of three bad windstorm and wildfire years. Typically, insurance companies are well positioned to weather a bad year through release of redundant reserves and support from the capital markets, and that’s what we saw. However, a second tough year followed.

The markets still had some reserves they could release, and the capital markets offered some support. Then it happened. A third straight year of wind and fire. That was the tipping point which precipitated this most unique of hardening markets. I say unique because, by all accounts, this one would be very different in both how underwriters handle it and its impacts on the future of risk financing.

It started in the real estate world. Property and general liability premiums started to spike up, with frame habitational taking some of the biggest hits. Property and general liability were getting beaten up in other industries. It then expanded to other casualty lines. During 2020, we started to see umbrella and excess lines getting clobbered (some still are). Of late, it’s been cyber (with good reason in some cases) and even directors’ and officers’ liability.

But none of that explains why this hardening market is different.

Historically, when markets have looked for pricing increases on a renewal, they would give after push-back. A market prices a renewal for a 20 percent increase and the broker and client push back using whatever levers are available. Then the market gives, reducing to an 8 percent increase and everyone feels OK.

In the current market, carriers are quoting significant price increases and walking away if insureds don’t agree. They aren’t incentivised to fill their capacity. In one anecdote, the leader of a carrier asked his underwriters what their retention rate was. When they proudly proclaimed it was near 90 percent, the boss surprised them by saying it should be closer to 50 percent. The carrier needed to shed the loss business—the carrier side of the house has an intent focus on chasing rate, profitable business. This isn’t necessarily a bad thing, but it is having a significant impact on defining the future of risk financing.

At the same time insureds, with improvements in technology and data analysis tools, have been gaining more insight into their losses. This better positions them to mitigate risk, but also makes them more comfortable in taking it on. So, as markets have been coming in with significant premium increases, insureds were responding with increased retentions. The markets haven’t given equitable premium credits for the increased retentions, which has further strained the relationships between insurer and insured.

Insureds—in particular those on the leading edge, with the best understanding of their risk tolerance and appetite, as well as their data—started searching for ways to bypass the whims of the insurance markets. More insureds have interest in captives to support their financing of risk, especially through groups or multiline integrated aggregate structures. Essentially, they are looking at risk financing more holistically, rather than on a line-by-line basis.

The view of risk financing at the C-suite level is changing. Does it really matter if a company takes a $100,000 or a $500,000 deductible on workers’ compensation? Or rather, does it matter if total expected cost of risk is $25 million across their programmes, if they are exposed to $10 million of volatility, which the probabilities indicate will happen once every 20 years, saving $1 million of (previously) guaranteed cost premiums per year?

In the latter scenario, the probabilities indicate a premium savings of $19 million in 19 years and once every 20 years an additional $10 million of losses. That means a net saving of $9 million over 20 years.

Learning the right lessons

The interest in such multiline, integrated aggregate structures has been growing significantly over the past couple of years. However, reinsurers have been keen to demonstrate that coverage has tightened up due to the unknown exposures resulting from the pandemic. In addition, more recently they’ve been turning their sights to more monoline structures, thus leaving a gap in the marketplace where the market is wanting solutions.

In my opinion, this is a big mistake. The market reaction is primarily to large programme structures. Not all programmes are that large and the multiline, integrated aggregate solution can work for companies down into the middle market. The numbers aren’t as large, but that provides these markets with exactly what they are looking for—greater diversification in how they distribute their capacity.

If the reinsurance markets don’t start re-opening to integrated aggregate structures soon, other capital will fill the void and some of that capital might be unique. Some people start thinking about the insurance-linked securities markets, but that capital has clearly defined its desire for very short-tail, finite risk. We could see it deployed in structures for cat risks, but the rest of a typical company’s property and casualty portfolio doesn’t fit that model.

“The path forward exists even with the markets’ hesitancy.”

We have seen the traditional insurance markets not deploying all their capacity, so they could turn to re-deploying that capital either directly or through new reinsurance entities to the multiline integrated aggregate space. We could certainly see hedge funds injecting capital into the reinsurance marketplace to fund such structures.

However, I am more inclined to believe it will be large US and international organisations that have built themselves into industry juggernauts and are looking to invest more into risk as a business diversification being a more likely answer.

In the end, the current hardening market, precipitated by a greater frequency of wind and fire events, has pushed the traditional insurance markets into chasing premium increases. That has forced insureds to take an increasing level of risk, gaining the attention of the C-suite executives asking the questions:

  1. How do we become less dependent on the whims of the traditional insurance markets?
  2. How do we gain greater control, analytically and strategically over our risk financing?

The path forward exists even with the markets’ hesitancy. As suggested throughout history, the exact words evolving over time: “Necessity is the mother of invention”. Perhaps we should say necessity is the mother of innovation. The need exists and the capital exists—we just need them to get aligned by truly innovative thinkers.

Pete Kranz is captive practice leader at Beecher Carlson. He can be contacted at: pkranz@beechercarlson.com

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