The insurance industry marches to its own economic drum. Historically it has fluctuated between what are called hard and soft markets. A hard market is characterized by reduced capacity or surplus, stricter underwriting, reduced coverage, and increased prices. A soft market conversely has increased capacity, looser underwriting, broader coverage, and lower prices.
Every insurance underwriter we talk to these days wants 5 to 10 percent higher rate on renewal, and some lines of coverage or underwriters want or require substantially more. Unfortunately for the underwriters, and fortunately for those who buy insurance, the industry’s robust surplus is keeping rates on preferred accounts from increasing. If an underwriter increases prices too much, or at all, they will lose market share. It is a fine line and a classic balancing act.
Munich Reinsurance Company is estimating that 2011 will be the worst catastrophe year of all time. There was significant flooding in Australia, the earthquake in New Zealand and the tsunami and nuclear challenges in Japan. Domestically, it is estimated that the tornados that hit the South in April will total about $5 billion in insured losses. The recent hurricanes to hit the East Coast could equal that as well.
Although some people feel the insurance industry is one big disaster away from a hard market, it’s important to put these losses into perspective. Recognize that a $5 billion disaster is less than 1 percent of the industry’s surplus.
So what can design and construction professionals expect their rates to do in 2012? It really depends on their individual risk profile as well as which line of coverage they are considering. Here is our best estimate of what they can expect:
Property and casualty market — The market in general should be relatively flat, although property risks in wind-prone areas will see some increases as a result of the recent hurricanes and tornados. Capacity could also be an issue, so if you have a significant property portfolio in these areas, you will want to start working on your renewals sooner than normal. General Liability and Excess Liability are anticipated to be flat. Auto rates could actually come down. This has been one of the most profitable lines recently.
Professional liability — Professional Liability is all over the board. The poor economy has adversely affected some lines. Real estate attorneys, for example, are seeing increases, as are attorneys specializing in intellectual property. Law firms in general, as well as the accounting profession, should see stable renewals. Competition for architects and engineers is as intense as it ever has been. Seven to eight years ago, there were at most 10 companies competing for this business; today there are more than 40!
Many of these companies don’t have much experience in this line, so the only way they can compete is on price. It is anticipated that these “newbies” will not be around long, so it is prudent to evaluate a prospective insurer on factors besides price, such as its commitment and experience in the industry. The competition has already forced some of the experienced underwriters to withdraw. They are simply not willing to match the undisciplined pricing offered by the new entrants.
Directors and officers liability — While pricing on average has been stable, this line is seeing increased loss ratios. This is a reflection of the economy; when companies do poorly, there are more lawsuits against the directors and officers. Accounts are being underwritten more carefully, specifically companies heavily involved in merger and acquisition activity.
Employment practices liability — This line is experiencing price increases on average of 10 to 20 percent. As with directors and officers liability, the poor economy is causing an increase in lawsuit (claim) frequency and several companies have withdrawn from the market due to bad results.
Workers compensation — Nationally, conditions in the workers compensation marketplace continue to deteriorate. This is attributable to poor underwriting results, declining premiums due to decreased payrolls, an increase in claims frequency, and an uncertain regulatory environment in many states. The combined ratio (losses + expenses/premiums) increased five points in 2010 to 115, which is the highest it has been since 2001. Despite increased investment income, the line suffered a 1 percent pre-tax operating loss. The last time this happened was 2002.
In California, things are worse. Rates in California remain near an all-time low. The average insurer rate per $100 of payroll is $2.37. This is down 62 percent from the July 2003 rate of $6.29; however, accident year-combined ratios in 2010 replicated 2009 at 128 percent. Despite the poor results, the Workers Compensation Insurance Rating Bureau (the Bureau) is recommending an average rate decrease of 1.7 percent.
It is important to point out that the rates proposed by the Bureau are advisory only. Insurance companies are free to charge whatever they want. Interestingly, the Bureau’s proposed pure premium rate (the anticipated cost of losses and loss adjustment expenses) is actually slightly less than the industry average filed pure premium rates. The average Bureau “proposed” rate is $2.33 and the actual filed rate is $2.37.
It should also be noted that the industry average manual rate is $3.27. This includes the insurance companies’ overhead as well as losses and loss adjustment expenses. The actual industry average charged rate was $2.38. In other words, after all credits are factored into the manual rate, the actual rate charged is almost exactly the same as the pure premium rate. Is it any wonder the industry isn’t making money?
So what will happen to workers compensation rates in 2012? If you believe the Bureau, they will be flat. If you look at the combined ratios, however, you will conclude that they have to go up. This applies in both California and the balance of the country. We are already seeing some insurance companies withdraw from this line and we are seeing others increase rates, in some instances significantly. For budget purposes, assuming your experience modification remains unchanged, we would figure on a 100- to 15-percent increase.
To avoid surprises, it is prudent to project your experience modification seven months into your policy term (the losses and payrolls that comprise your modification must be filed within the sixth month after policy expiration). The sooner you know what your modification might be, the sooner you can plan for it. Your published modification is usually available 30 to 90 days prior to expiration. You should also check with your insurance company 90 days out to see if they have or intend to amend the base rates that apply to your policy and whether there are any other changes that will impact your program.
Surety — The surety bond market is nervous, to say the least, although 2011 should be a profitable year. The concern arises out of a continued stagnant construction market and razor-thin profit margins. Most surety experts feel that performance bond claims will increase in 2012 and 2013. Contractors are being closely underwritten and surety underwriters are looking for strong cash flow, realization of projected profits, and reasonable overhead as a percentage of volume. Debt loads, owner financing, and contract terms are also considerations.
Benefits — The double-digit increases continued for the first three quarters of 2011, but the fourth quarter presented the first single-digit increases we’ve seen in many years. Should this give us cause to celebrate?
The Patient Protection and Affordable Care Act, (PPACA), also known as “Healthcare Reform” or “Obama Care,” is ending its second year as law. A majority of the states, and numerous organizations and individual persons, have filed actions in federal court challenging the constitutionality of PPACA. As of September 2011, federal appellate courts are almost evenly divided on the constitutional issues raised in this litigation; at the district court level, three judges upheld the constitutionality of PPACA and three declared it unconstitutional in part. Several other challenges were dismissed on technical grounds such as jurisdiction and plaintiffs lacking standing. The Supreme Court may review the matter as early as the end of 2011.
While PPACA awaits a Supreme Court decision, the law regulation and implementation calendar continue to get pushed forward. We are watching this process very closely.
We are cautiously optimistic in our 2012 forecast. Medical insurance rates for both HMO and PPO plans will see single-digit increases in 2012. Health Savings Accounts (HSA) and Health Reimbursement Arrangements (HRA) have settled in at high single-digit/low double-digit increases. California has admitted a new insurance carrier, SeeChange, that is rolling out Health Incentive Arrangements (HIA). These plans incentivize employees to complete health risk assessments and biometric screenings in exchange for a richer benefit plan (less out of pocket).
Wellness plans and a focus on employee productivity, employee engagement, and absenteeism will lower the human capital cost and drive dollars to the bottom line. Employee education on insurance best practices continues to improve employee satisfaction and lessen the administrative burden.
Other employee benefits such as dental, group term life insurance, long-term disability, and vision insurance rank very high in importance in employee job selection and satisfaction.
The insurance marketplace will fluctuate depending on various factors including surplus, return on equity, and the economy in general, and there is nothing anyone can do about it. Businesses need to focus on what they can control: the frequency and severity of their claims and losses, which drive their insurance costs. Companies that allocate resources to effectively manage risk are going to be more profitable than those that don’t.
Jeff Cavignac, CPCU, ARM, RPLU, CRIS, is president and principal of Cavignac & Associates (www.cavignac.com), a commercial insurance brokerage firm providing a broad range of insurance and expertise to design and construction firms.