Insurance industry economics provide some perspective on where insurance rates are going in 2019.
By Jeff Cavignac, CPCU, RPLU, ARM, MLIS; Jase Hamilton, CPCU, AFSB; and Patrick Casinelli, RHU, REBC, CHRS
Insurance is not a unique concept. Although the sharing of risk has been going on for thousands of years, “modern” insurance only traces its roots back about 300 years. That is, if you consider a bunch of boat owners sitting around a coffee shop (Lloyds) agreeing to share the cost if one of their boats went down as the beginning of modern insurance.
Insurance, however, is a unique product. Businesses pay a lot of money — sometimes hundreds of thousands or millions of dollars — for something they hope they never use. If they use it, the cost will go up; and if they use it a lot, they may not be able to get it. And if they can’t get it, in most cases, they can’t stay in business.
While some forms of insurance are either required by law (workers compensation and auto liability, for example) or mandated by contract, other coverages are purchased because it makes financial sense to transfer the risk of a significant exposure to an insurance company in exchange for a relatively modest premium. (Note the use of the term “modest”; some people think any money spent on insurance is too much.) Regardless of whether insurance is mandated by law or contract or simply purchased because it makes sense, the cost of insurance is a major expense for most businesses.
Insurance is only one component of the cost of risk (sometimes less than half), and the cost of risk can be one of a company’s largest expenses, sometimes exceeding 5 percent of total income. Because of this, managing risk effectively and budgeting for the cost of risk are critical to both short- and long-term success.
Table 1: Insurance industry economics, 2008-2018
Economics of the insurance industry
Insurance companies, like any other for-profit enterprise, are in business to make money for their shareholders. Insurance companies make money in one of two ways: underwriting profits and investment income.
An underwriting profit is achieved when losses plus all expenses are less than premiums. Dividing the former by the latter equals the combined ratio. A combined ratio of less than 100 percent means there is an underwriting profit, and a combined ratio of more than 100 percent means there is an underwriting loss. The industry has generated an underwriting profit in only three out of the last 10 years (see Table 1). The average of all 10 years in Table 1 equals 101.5 percent. Most insurance company executives will tell you they would like to see their combined ratio under 95 percent and, ideally, at 92.5 percent or lower. So, if most insurance companies are losing money on underwriting, how can they actually make money?
Insurance companies collect premiums and set aside reserves to pay future claims. These funds, known as surplus, generate investment income. In 2017, the industry lost 3.7 percent on underwriting (2017 was a terrible year for property-driven catastrophic losses) but earned an overall return of 5 percent. The difference is attributable to investments. During periods of substantial investment returns, insurance companies are willing to tolerate inferior underwriting results because they make it up on investments.
Since the insurance industry’s surplus is currently at an all-time high, prices should go down since supply is up. On the other hand, insurance company returns have been mediocre, so they need to increase rates to improve those returns. Rates have been relatively flat during the last three years (see Figure 1), so efforts to increase premiums do not appear to be working. While most underwriters are seeking single-digit increases where they can get it, rates are still predicted to be flat and some lines will see minor decreases.
Property, general liability, auto, and umbrella (aka allied lines) — As expected, preferred property risks are receiving the largest decreases, but even challenging accounts benefit from somewhat relaxed underwriting and increased competition. While property rates in general should be flat, two notable exceptions are property in high-risk locations, such as the Southeast (2017 was one of the worst years ever for insured catastrophes) and risk of residential wood frames, both completed and under construction.
General liability is also stable and 2019 should bring flat renewal pricing, with preferred accounts seeing single-digit decreases. Not surprisingly, the companies that have the best risk management programs and positive loss histories are experiencing the most favorable renewals.
On the other hand, automobile rates are going up across the country. This is caused by increased frequency due to distracted driving, as well as severity. Poor profitability in this line is increasing the average premiums anywhere from 5 percent to 25 percent. Differences among insurers is also greater in this line, which means this coverage is being shopped more frequently than other lines. Increased focus on fleet safety is critical to managing auto insurance premiums.
Excess liability (umbrella) remains reasonably competitive. Pricing is usually based on underlying policies, so excess liability pricing will increase if the underlying auto premiums increase.
Professional and pollution liability insurance — These lines remain competitive and there are a number of new players looking for business. Coverage and risk control services, however, differ dramatically, as does the quality of the claims teams for each insurance company. While price is important, the best value in this line is rarely the least expensive.
Executive risk — which includes directors and officers liability, employment practices, and fiduciary liability — remains stable, but is being carefully underwritten. This coverage also varies significantly by industry. Adverse loss experience or poor internal controls will also impact pricing. As much or more than most exposures, these areas lend themselves to being proactively managed. It is also important to understand the coverage you are purchasing, as every policy is unique and coverage differences can be significant.
Cyber coverage continues to be the fastest growing insurance product, yet it is still under purchased. Every business has cyber risk. Managing these exposures goes beyond having data backups. Cyber extortion and social engineering (aka cyber deceit), among other types of crimes, continue to grow. Every business owner should consider this coverage. The application process, even if you don’t buy the insurance, will serve as a self-audit for your exposures and alert you to areas that can be improved.
Workers compensation rates continue to improve across the country, as well as in California. Rates in California reached an all-time high in 2003, when the “average charged rate per $100 of payroll” was $6.29. Rates dropped nearly 67 percent to $2.10 in 2009. Unfortunately, this was well under what was needed for profitability and combined ratios inflated to 130 percent in the same year (see Figure 2).
From 2009 to June 2014, average charged rates increased 41 percent to $2.97 — still less than half of the $6.10 charged in 2003. This increased pricing generated an underwriting profit in 2012, the first time since 2007. As this line turned profitable, more insurance companies became interested in writing workers compensation and, since 2014, rates have dropped approximately 20 percent. Although the combined ratio is creeping up, workers compensation rates are still anticipated to drop 5 to 10 percent. Note that this can differ, in some cases dramatically, by classification. In addition, there are other factors such as your experience modification and schedule credits, which will directly affect net rate.
The current insurance marketplace is relatively stable. While profits haven’t been great, they have been decent, and the industry’s surplus is keeping pricing competitive. Most businesses will be able to negotiate flat rates, and some preferred risks with solid risk management programs and favorable loss histories will be able to negotiate rate reductions.
Insurance premiums, however, need to be kept in perspective. They are only one component in the total cost of risk. OSHA estimated, among others, that the indirect cost of risk actually exceeds premiums paid. This includes money spent managing risk, training employees to be safe, dealing with claims, funding uncovered claims, and a number of other costs.
While it is important to understand the economics of the insurance industry and how this can affect your costs, 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 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 that cost. An effective risk management program, coupled with a proactive insurance brokerage firm 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.
Surety bonding: The peak of the cycle
As we close on 2018, the construction and surety industry remain in fairly good shape. For most contractors, backlogs are as strong as they have been in over a decade, margins are returning to pre-recession highs, and work is abundant. For surety companies, profits are at an all-time high, loss margins remain low, and demand for bonding — along with total spending in the building industry — continues to grow across the nation.
According to the U.S. Census Bureau, total construction spending in 2017 was $1.24 trillion and is expected to grow to more than $1.35 trillion in 2018. Along with construction spending, the surety industries historic results have continued to improve. Since 2012, the direct written premium for the industry has grown from $5 billion to more than $6.2 billion at the end of 2017 — an increase of more than 23 percent. And the industry does not appear to be slowing down any time soon, with projected direct written premiums of more than $6.5 billion in 2018.
The continued results and positive forecast for both underwriters and contractors have many wondering when the market is going to reach its boiling point and how to prepare for the inevitable decline. Rather than speculate, surety underwriters are depending even more on their clients and agents to proactively manage their operations and associated risks to grow in an expanding economy. Best-in-class contractors are using the market’s positive growth and outlook to focus on what they do best and intelligently grow their backlogs, rather than over extending themselves by taking on work far outside their abilities and capacity. As growth continues, three main questions continue to be at the top of all contractors’ and underwriters’ minds — labor shortage, material costs, and fiscal policy.
Health insurance outlook
The Affordable Care Act (ACA) is still the law, but the individual mandate ends in 2019, which means that individuals will no longer have to carry medical insurance or prove that they have coverage. We are not sure how this will affect employer group plans, but it may have a negative impact on rates if the pool of insureds sees higher claims and less premiums.
One of the last provisions of the ACA law is the Cadillac Tax, which may or may not be implemented in 2020. The Cadillac Tax is intended to help fund benefits to the uninsured. Employers were supposed to begin paying a 40 percent tax on costs of health plans that were above $10,200 per individual and $27,500 for family coverage.
Throughout 2018, rates remained flat with only minor increases. The ACA allowed teenage rate bands to change (0-14, 15, 16, 17, 18, 19, and 20), which resulted in higher increases for employees with dependents on the group plan.
For 2019, we expect low single-digit rate increases and minimal plan changes. Rates for all small employers (2 to 99 eligible employees) will be based on the employee and their dependents’ individual ages, plan design, and company location. For example, a family of five will pay for each family member based on each individual’s age and the plan they select. Some younger employees or families with one child may realize lower premiums.
We forecast additional plan changes in 2019 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. The ACA guidelines gave a percentage requirement for each tier: 90 percent = Platinum, 80 percent = Gold, 70 percent = Silver, and 60 percent = Bronze. As costs increase, the value of the percentage changes and therefore the plan benefits change.
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 and the benefits will change. This will always be a moving target until the values are fixed or the law is changed.
For insurance carriers to be competitive in 2019, we 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 very few choices 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 organizations hire and retain the best employees.
Trust Plans, or Association Plans, are being formed for industry-specific companies so they can ban together to lower their cost. Captives, self-funding, and partially self-funded plans continue to be popular and could be a viable option for companies with more than 50 employees. Additional ways to reduce cost include buying a Bronze level plan and supplementing it with cancer, hospital, accident, and critical illness plans.
The construction market is cyclical in nature, and it’s impossible that the current upswing will last forever. Yet, in spite of the market experiencing the longest expansion in history, there remains little to suggest the end is near. The last year (2018) continued to yield good growth in construction despite a weakening labor pool, increasing material costs, and uncertainty surrounding fiscal policy.
As these factors continue to burden the construction industry in 2019, contractors must continue to hold the line and not only maintain the profits they’ve worked so hard to get back, but also retain those profits, take advantage of the low interest rates, reduce debt, liquidate surplus equipment, and build cash reserves to guarantee future sustainability and success, both professionally and personally.
What does risk really cost a company?
For many companies, the cost of risk is one of their largest expenses, but you won’t find it on their income statement. The cost of risk includes factors such as:
- time spent analyzing risk;
- money spent on risk control, including salaries for safety, human resources, 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;
- time spent dealing with losses;
- productivity costs due to time lost by injured workers and the cost of training new workers; and
- the cost of insurance (less than 50 percent of the cost of risk in many cases).
Jeff Cavignac, CPCU, RPLU, ARM, MLIS, is president and principal of Cavignac & Associates (www.cavignac.com); and Jase Hamilton, CPCU, AFSB, and Patrick Casinelli, RHU, REBC, CHRS, are principals. Cavignac & Associates, a San Diego-based risk management and commercial insurance brokerage firm, provides 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.