By Jeff Cavignac, James P. Schabarum, Jase Hamilton, and Patrick Casinelli
Insurance is a unique product— the classic intangible. You have to have it for various reasons, and the right insurance can provide your business with critical protection while opening up opportunities that wouldn’t exist otherwise.
Most people view insurance as a necessary evil. After all, you might pay hundreds of thousands of dollars for a product you hope you don’t need. If you use it, it will cost more when it renews, and if you use it a lot the additional cost can seriously affect a company’s profitability.
Insurance is also complex. Most construction firm owners don’t want to be experts, but they need to understand insurance well enough to be able to effectively manage it for their company. Our own clients rely on us to evaluate their exposures to loss, develop risk management strategies to lower the frequency and severity of their claims, and to negotiate appropriate coverage placed with the right insurance company at the lowest realistic cost.
It is also important to put insurance in perspective. As we know it, our economy could not survive without it. The financial guarantee it provides (along with surety) is the safety net that allows money to be lent, contracts to be awarded, and assets and liabilities to be protected.
Insurance can be expensive. For some businesses, it can be their highest expense after compensation. This number could double or more if you factor in the other costs of risk, such as:
- Your time spent analyzing risk
- Money spent on Risk Control, including salaries for Human Resources, Safety and Claims Management
- The cost of educating employees on safe practices
- The cost of complying with all the various laws imposed by OSHA, the Department of Labor and other governmental organizations
- Money spent paying uncovered losses or funding deductibles
- Your time and your employees’ time spent dealing with losses
- Productivity costs due to time lost by injured workers and the cost of training new workers
- The cost of insurance (less than 50 percent of the Cost of Risk, in many cases)
Our job as an insurance broker is to help our clients manage these costs. Insurance premiums are based on a number of factors, including the type of business, loss experience, and safety practices. Any business will have a number of different exposures and require a number of different policies to provide the appropriate protection. In addition to these factors, the amount a company pays for insurance is also impacted by the insurance marketplace.
Insurance is a supply-driven business. While demand stays relatively consistent (it will ebb and flow with the general economy), surplus can go up and down. Loosely defined, surplus is how much liquid capital the industry has in their coffers and includes money that is set aside to pay future claims as well as any additional capital held by the insurance company.
Specific ratios determine how much premium can safely be written given a certain amount of surplus. If the ratio of premium to surplus gets too high, the insurance company’s credit rating (as quantified by the A. M. Best Company and other rating agencies) could ultimately impair the insurance company’s ability to operate. If surplus goes down, insurance companies must write less insurance, which causes rates to go up. Similarly, if surplus goes up, rates tend to go down. The industry’s surplus has grown significantly since 2011 (See Table 1) and this has resulted in flat and, in some cases, decreasing rates over that same period. 2018 resulted in the first decrease in surplus (albeit modest) in some time and this concerns many in the industry.
The other factor you have to look at is Return on Average Net Worth. The insurance industry needs to attract capital, and it competes with every other business to do so. If you look at Table 1, you will note that, over the last five years, returns have ranged from 5 to 8.4 percent and averaged 7.2 percent. These types of returns don’t excite investors and the industry would ideally like to see their return at 10 percent or higher. While the industry has been trying to increase rates for the past several years, the robust surplus numbers have kept the market competitive enough to basically keep rates in line. That is slowly changing. Rates are starting to trend up.
So, if you are budgeting your insurance costs in 2020, what can you expect?
Property Insurance – Property underwriters have experienced several poor years in a row due to a number of factors, with the main one being catastrophe-type claims. Because of this, the insurance companies are carefully underwriting existing and new business. In general, preferred risks can expect rate increases of 5-10 percent in 2020. Any property that is even close to a brush area, however, can see dramatic rate increases. The 2018 California wildfires hammered property insurers (over 30,000 homes destroyed) and this is affecting pricing for both personal and commercial lines. It is also driving rates up in the Builders Risk segment, especially for frame construction.
General Liability Insurance – General Liability results have deteriorated as well, and underwriters are looking carefully at the risks they insure. They are also seeking rate increases. While some businesses will see flat renewal pricing, most will see rate increases of 5 percent or more.
Auto Insurance – Auto rates continue to increase. It is not uncommon to see prices go up 10-20 percent or more, and this is not the first year this has happened. This is driven by both an increase in frequency and severity of claims. Frequency is attributable to distracted driving. The number of rear-end accidents has doubled in the last five years. Severity is being adversely impacted by the cost to fix a modern vehicle (cameras and sensors are expensive) and the increased cost of medical bills for those injured in accidents. Five years ago, it was not uncommon to see average repair costs for a private passenger vehicle or pickup truck of about $1,000. Today, the average can be $1,800, $2,000 or higher. To obtain the most favorable rates, underwriters like to see a five-year loss ratio of 25 percent or less in addition to well-written Fleet Safety Programs that are being effectively implemented.
Excess Liability – Excess Liability pricing is based on the premiums of the underlying policies over which it provides coverage. While the percentage rate of the primary cost is staying consistent, Excess Liability pricing has increased, just as auto premiums have. We should point out that anyone working for a gas and electric company in California should be forewarned. One such company is now requiring that any contractor who wants to work on its projects carry $50M in general liability limits. The excess market for this exposure has all but disappeared, and arranging this coverage is outrageously expensive.
Executive Risk including Directors & Officers, Employment Practices and Fiduciary Liability – Experience in these lines has deteriorated and it is not uncommon to see increases of 5 percent to 15 percent or more. Underwriters are also looking to increase deductibles on Employment Practices Liability. It is getting more difficult to obtain defense coverage for Wage & Hour claims (indemnity damages have never been covered for Wage & Hour lawsuits).
Cyber Insurance – Cyber Insurance covers both first- and third-party damages. Most policies have numerous coverage parts, and every Cyber policy is different. While the current cost is fairly modest, we have seen claims on the rise. Because the marketplace is still competitive, we only expect modest increases this year; but if the loss trends continue, prices will have to go up. Note that every business, no matter how small, needs Cyber Insurance nowadays.
Professional Liability – We are seeing some of the opportunistic insurance companies that jumped into the Professional Liability marketplace starting to exit. Regardless, this line of coverage remains competitive and preferred design professionals, attorneys, accountants and other professionals can expect flat to modest rate increases. Recognize that every Professional Liability policy is different as are the companies that offer the coverage. Even more so than most commercial insurance lines of coverage, Professional Liability is not a commodity. It is critical that you understand the coverage you are buying, as well as the claims-handling abilities and risk control services that are offered by the insurance company and your broker.
Workers Compensation – Rates across the country continue to trend down for Workers Compensation, especially in California. Table 2 indicates that the average rates charged in California have dropped over 30 percent in the last five years and a whopping 66 percent since 2003. It is anticipated that rates will continue to drop in 2020. Assuming a consistent Experience Modification, most of our clients can budget flat to minus 10 percent.
We expect to see insurance prices in general increase 5-10 percent, with the exception of Workers Compensation. Insurance premiums, however, need to be kept in perspective. They are only one component in the cost of risk. As mentioned above and illustrated in the sidebar, insurance is often 50 percent or less of the total cost of risk.
Surety Outlook 2020: Capitalizing on your Capacity
As 2019 comes to a close, the overall economy remains positive and continues to grow. Though at a slower pace than experienced in 2018 and early 2019, 2020 should continue to show slow to moderate growth as the forecasts of many economists shift gears to a more cautious outlook.
Although continued optimism may be declining for some, the surety and construction industry remains very fruitful. The Surety industry is reporting another record year in direct premium written and overall capacity, and the availably of credit is at an all-time high. Contractors’ backlogs are strong and profit margins appear to show signs of not only stabilization, but also slight increases in some trades.
In 2018, The Surety and Fidelity Association of America (SFAA) reported overall direct premium written of $6.6 billion, up from $6.2 billion in 2017. The SFAA anticipates similar growth results for 2019 and likely 2020, with relatively low losses across the board.
Parallel with the Surety industry’s results, non-residential public construction spending remains up nearly 6.4 percent from this time a year ago. With an election year on the horizon, and increasing infrastructure needs, non-residential spending should continue to grow in 2020.
The availability of credit is in abundance for both small (under $10 million), medium ($10 – $100 million) and large ($100 – $250 million) size contractors. Because of the appearance of an endless surplus of work, many contractors are pushing their aggregate programs and continuing to show healthy backlogs going into 2020. The excessive amount of credit in the small-to-large markets has led many surety companies to soften their underwriting guidelines in an effort to obtain additional market share. This has been great for the surety consumer but will likely have a detrimental long-term impact on inevitable future surety industry loss results.
Another interesting trend in 2019 is resurgence of Subcontractor Default Insurance (SDI) in the market. SDI is an alternate product to bonding and, over the past 5-10 years, has experienced sizeable losses due to poor management of aggregate exposures. However, recent guideline changes and market conditions have given SDI new life, and this has attracted a number of new players to the SDI marketplace.
Although margins are good and backlogs are increasing, contractors are still facing a wide range of challenges similar to that we’ve seen over the past few years, including labor shortages, rising material costs and the uncertainty of fiscal and government policy.
Even with the small-to-large markets having such strong results in 2018, not all is smooth sailing, notably in the megaproject arena (greater than $250M) where the Surety industry has experienced sizable losses and we’ve seen some significant contractor failures. These large losses may be isolated but, once fully realized, could have a significant impact on the overall construction and Surety industries. This will eventually lead to a correction in these markets.
This begs the question, “Are you prepared for the next downturn?”
It’s easy for business owners to fall victim to the trap of maintaining the status quo, especially during times of prosperity. Most contractors simply lack the focus or do not see the value in assessing their operational procedures and committing to improving on them until forced by a market shift or project failure.
However, “Best in Class” business owners understand that now, during prosperous times, is the right time to perform an internal audit of their company’s capacities to capitalize on opportunities and guarantee both short- and long-term success. An operational audit should focus on improving deficiencies and strengthening efficiency in standard operating procedures, internal controls and the successful execution of your overall business plan.
If you wait for the market to dictate your actions, you will not only miss valuable opportunities, but you may find yourself in a distressed position when the next recession occurs. Here are a few areas that all contractors should be focusing on:
1. Human Resources / Risk Control – How a company attracts, trains and retains great people has a dramatic impact on its success. Consider including a Growth and Development Advisor (GDA) on your management team to drive a strategic approach and attack the ongoing labor challenges that have plagued the construction industry. Building a best-in-class culture and onboarding process will pay dividends many times over.
2. Project Controls – Adopting and integrating advanced communication and technology into all phases of your business will have a significant impact on morale, productivity and overall profitability. Rapid developments in artificial intelligence (AI), robotics and industry specific automation and data management tools are creating competitive advantages for early adaptors. From estimating and material and equipment procurement to subcontract management and project execution, the opportunities are endless for improving efficiencies.
3. Financial Controls – Much like project controls, updating your accounting software to ensure your business is utilizing the right accounting system is a crucial component to driving your success. The process should begin with evaluating the market options and discussing your company’s needs with your accounting team and trusted advisors. Whether it’s a fully integrated or standalone product, regularly updating your accounting system and controls will produce more efficiency and, as a result, increase bottom-line success.
4. Contract Procurement and Management – Understanding and knowing the best procurement methods for your company and project team are critical in today’s contracting environment. Those firms that don’t properly manage the risks associated with hybrid delivery models — including P3, IPD, CM/GC, MP, DBB and even some DB (Design/Build) obligations with erroneous efficiency guarantees — could find themselves in a vicious financial trap with unsophisticated owners, design professionals and/or subcontractors.
5. Succession/Continuity – Succession planning is a topic most owners avoid. For many, it signifies the culmination of your life’s work and it’s easier to ignore and put it off until it’s absolutely necessary. However, failing to effectively develop a detailed plan can have grave consequences, not only for your company but for business owners and their families. Work with your advisors to develop a well thought-out and comprehensive succession plan. The process may take years, but if done right, it can ensure the continued success and legacy of your business for you and your loved ones.
6. Pay-Off Debt – To manage swelling backlogs, some contractors have been increasingly dependent on their bank lines of credit or other debt facilities to help bolster cashflow. The challenge this presents is that, once the economy enters the next recession and companies experience reduced revenue and backlogs, contractors might find it increasingly difficult to service outstanding debt obligations. To ease this potential burden, business owners should now look to proactively service debt loads when unearned profits in backlogs are strong.
In lieu of significant labor shortages, rising material costs and uncertain political policies, both domestic and international signs indicate that 2020 will be another profitable year for the Surety industry. Direct premium written and construction revenues should be up, contractor failures should remain relatively low, margins should continue to rise, and, for most, backlogs should remain strong.
While there is an overall positive forecast for next year, there are some contractors who are experiencing growing pains and having a difficult time managing increased backlogs. But those that are thriving in the current market should not neglect the importance of taking the time to reflect on their strengths and focus on improvements for short- and long-term success.
Health Insurance Outlook for 2020
The Affordable Care Act (ACA) has two parts that will affect the small group (2-99 employees) in 2020:
- HIT = Health Insurer Tax, which began in 2014 with ACA, is a tax of roughly 2 percent that health insurers must pay to the federal government and which must be built into the rates. Congress suspended HIT for 2017 and for 2019, but HIT is back again for 2020. So this means that rates for policy periods in any months during 2020 need to be relatively higher than 2019 due to the need to include HIT.
RADV stands for Risk Adjustment Data Validation, and is the process that CMS (Centers for Medicare & Medical Services) uses to ensure the accuracy and integrity of risk adjustment data (diagnosis codes, etc.) that are used to determine the risk adjustment transfer payments: i.e. the amount of money a carrier receives due to having members with worse risk and the amount of money a carrier pays out due to having healthier members.
The Cadillac Tax, which was intended to help fund benefits to the uninsured, is still on the table. Most do not think this will be implemented until after the 2020 election. If the Cadillac Tax goes through, a 40 percent tax on the cost of health plans where the premium is above $10,200 per individual and $27,500 for family coverage will be added.
Throughout 2019, we saw minimal increases mostly due to age and plan changes. Blue Shield handed out the largest increases, which were due to the HIT and RADV mentioned above.
Each of us will be one year older in 2020, which means our rates will automatically increase. For 2020, we expect low single-digit rate increases and minimal plan changes. Rates for all “small” employers (2-99 eligible employees) will be based on the employee and their dependents’ individual ages, plan design and location of the company. For example, a family of five will pay for each family member based on each individual’s age and the plan they select.
We forecast additional plan changes in 2020 that will remain compliant with ACA guidelines. All of the major insurance companies have determined that, in order to stay in compliance with the ACA’s metallic tier guidelines, they must change plan benefits every year. Using the Platinum Plan as an example, if the actuarial value of a plan this year was $1,000, then the Platinum Plan has to cover 90 percent ($900) and pass 10 percent ($100) to the plan member. In the second year, if the actuarial value goes up to $1,100, 10 percent ($110) can be passed to the plan member. This will always be a moving target until the values are fixed or the law is changed.
For insurance carriers to be competitive in 2020, they will continue to see plans that offer Skinny Network choices, which offer a smaller number of providers. Skinny Network plans might offer an attractive price, but employees will have a limited choice of doctors. Be sure to run a report to compare current providers to those associated with any programs you are considering. Insurance carriers continue to seek greater discounts from hospitals, medical groups and doctors and are offering patient exclusivity in return. Some insurance carriers will allow Skinny Networks to be offered side-by-side with full networks, with the price and contribution being set by the employer to favor one or the other.
Employee satisfaction increases with choice of medical plans and networks, so the more choices offered, the better the employees feel about their benefits package. Also, ancillary (Dental, Life, Disability and Vision) and supplemental (Accident, Cancer, Hospital, etc.) benefits have shown to greatly improve employee satisfaction, which will help your organization hire and retain the best employees.
Captives, self-funding and partially self-funded plans continue to be popular and could be a viable option for companies with over 50 employees. Additional ways to reduce costs include buying a Bronze Level Plan and supplementing it with Cancer, Hospital, Accident and Critical Illness plans.
While it is important that you have a basic understanding of the economics of the insurance industry and how this can affect your business, there is nothing you can do about it. The market is the market. What you can control is how your company manages risk. Risk management is “market agnostic.” It needs to be front and center all the time.
In the long run, the only way to reduce the cost of risk is to reduce the frequency and severity of claims that drive the cost. An effective risk management program coupled with a proactive risk management-oriented insurance brokerage and the right insurance company is the key to lowering your total cost of risk. Investment in risk management will produce great returns and directly impact your bottom line.
Jeff Cavignac, CPCU, RPLU, ARM, James P. Schabarum II, CPCU, AFSB, and Patrick Casinelli, RHU, REBC, CHRS, are Principals and Jase Hamilton, CPCU, AFSB, is a Surety Account Executive for Cavignac & Associates, a leading risk management and commercial insurance brokerage firm providing a broad range of insurance and expertise to design and construction firms, as well as to law firms, real estate-related entities, manufacturing companies and the general business community. The firm employs a staff of 55-plus people at offices located at 450 B Street, Suite 1800, San Diego, Calif., 92101. More information about the company can be found on the Web at www.cavignac.com.