Marketplace Realities 2018

Experience, preparation and cutting-edge analytics: your tool kit for a potentially tumultuous 2018

November 6, 2017

Joe Peiser, Head of Broking for Willis Towers Watson North America, on how to prepare for what could be ahead.

For years we in the insurance industry were saying, “Just wait for a mega loss or two and the long soft market will turn.” Then we began wondering if we were wrong. Maybe the fundamental economics of insurance would continue to attract capital and the steady rise in supply would continue to outstrip demand, and downward pressure on rates would persist indefinitely. Or maybe the mega losses wouldn’t be big enough. Maybe the insurance cycle was indeed a relic of the past.

Well, we’ve got some big ones now. While we come to grips with the scale of the ongoing humanitarian crisis, we in the industry can’t help but wonder if we might see some answers to those questions we’ve been asking for several years.

So far, however, Harvey, Irma and Maria have probably generated more questions than answers. Here is our top-10 list of questions that the industry is asking itself. While a few answers are emerging, we don’t expect substantial clarity much before year-end.

1. How big will the loss to the industry be?

The estimates for the total losses to the industry range dramatically. Some are lower than $50 billion while others top $200 billion. Despite this enormous variance, there seems to be a growing consensus that the total will exceed $100 billion. That’s a serious blow to the industry. It’s hard to imagine that such a blow will not impact rates.

2. Will property rates go up?

These are still early days, but yes, we expect rates to go up. For the insureds with losses and direct hurricane exposures, the losses could be steep. Others could see small increases.

The long soft market for commercial property insurance could be over, at least temporarily.

3. Will it extend and will it last — will the market turn?

This of course is the big-picture question of the moment and it’s impossible to say. The answer will likely depend on the answers that emerge to some of the questions that follow.

4. Will other lines be affected?

Unclear. Insurers booking heavy losses will likely be under pressure to make up the outflow and may look to do so in non-property premiums. Many industry observers have pointed out that the profitability of property insurance (even while rates have been declining, relatively modest catastrophic losses have meant profits for many) has masked loss deterioration in other lines of business. With that mask gone, some will seek increases in other lines. Competition may keep that in check, but we would not be surprised if the days of rate decreases are over — at least for a while.

5. Will insurers be able to pass along increases they may see from reinsurers?

The carriers will try. Reinsurers have seen rates tumble for an extended period and now face another blow. They could well be on the hook for a large portion of the losses that most expect will exceed $100 billion. This should certainly put the brakes on reinsurance price reductions and likely reverse them, leading to increases. Will the increases hold?

Unknown. But if they transpire as we expect, they will put insurers under further pressure to raise their own rates.

6. How will investors react?

Insurers will be hit, and in many cases hit hard, but for most we expect it will be what’s called an earnings event and not a balance sheet or capital event. The heavily regulated insurance industry has been reporting record policyholder surpluses for several years. These surpluses surpass $700 billion, and while $100 billion is a very noticeable chunk, it’s still a fraction. So the claims will be paid and insurers will live to underwrite another day.

As for investor reaction, the usual pattern has held so far: just after the storms hit, investors, fearing the worst, pull back and stock prices fall, but then quickly recover, and in anticipation of possible rate increases often push that recovery into positive territory. The long-term picture, however, may take on a different hue. Anyone who followed the forecasts for Hurricane Irma as it bore down on Florida will recall that at some points in the days before the actual landfall, a direct hit on the state’s most populous areas seemed possible, even likely. That could have yielded a catastrophe much worse than what we saw. Appreciation of the extent of the potential loss may over time have an impact on the way the industry is perceived, although we have seen little sign of it yet.

7. Will the influx of alternative capital be affected?

One of the key driving forces in our industry today is the influx of capital in various forms creating an increase in supply that has exceeded demand and kept prices down. The capital has flowed in as the global economy has remained in a low-interest environment, and major economies have experienced low, single-digit growth. The insurance industry has at least invited some glimpse of hope for growth. This terrifying windstorm season may give pause for the reasons outlined above. On the other hand, the prospect of rising rates may encourage fresh capital — capital unaffected by the 2017 hurricane season.

Here’s another possibility. If this triple disaster does not have a significant impact beyond a modest uptick in property rates for those with relevant exposures — if the recent pattern of resiliency that has sustained a soft market for upwards of a decade maintains — perhaps the insurance industry will lose some of its luster for the opposite reason. Instead of appearing riskier, it may appear flat and less appealing to capital in search of profit.

This is the kind of trend that takes time to develop and again is only conjecture. But food for thought.

8. Do we have our modeling act together?

Predicting losses before the damage can be fully assessed is never easy and estimates will vary, sometimes considerably. The range in loss estimates for Hurricane Maria, however, has been staggering. The low estimate from one modeler is higher than the high estimate from another. Further, these hurricanes broke records: for rainfall in the case of Harvey and intensity in the case of Irma (though that intensity had mercifully subsided somewhat by landfall). Just as the triple play of Katrina, Rita and Wilma sent the modelers back to the drawing board in 2005, this year’s trio will have an impact. Not to the extent that Hurricane Andrew changed the business in the 1990s, but still to a noteworthy degree, we expect.

9. Will some unflattering claim adjusting stories put a stain on the industry?

In the aftermath of a disaster, incredible effort is expended to get claims settled and let insurance do what it does — act as a foundation for recovery. The working of this machinery, remarkable as it is, is not usually newsworthy until something goes wrong. Hurricane losses are especially prone to disagreement given the necessity of sorting out the roles played by flood vs. wind in creating the losses as well as the definitions regarding each in the relevant insurance policies. Fair or not, the industry often suffers some bad PR when claim adjusting conflicts come to light. With a set of disasters this broad, at least some media attention of this kind seems inevitable and we’ll brace for it.

10. What should buyers do as 1/1 renewals approach?

The most basic and sound insurance advice, one that may sum up the entire industry, is simple: hope for the best, prepare for the worst. At the moment, in an era of seeming rising intensity in weather disasters and now contemplating what will likely go down as the worst hurricane season to date, we might rephrase it: prepare for the inevitable, hope for some respite. That’s a little stark. In fact, the insurance industry, when all is said and done, will almost certainly prove again to be a bulwark of resilience.

But the marketplace is going to react, and buyers need to be ready. By 1/1 renewals, insurers will have a clearer sense of the losses they face. They will have strategies for handling their internal business and external competition and no one should expect the status quo. Now is the time to catalog the positive differentiators of your risk so you can set yourself apart from the pack. Now is also the time to benefit from long-term relationships where perhaps you didn’t always seek the rock-bottom price. Anyone going to market should have a Plan B in place. And a Plan C. Buyers should also know their risk tolerances, so that if rates and retentions are spiking, you know where your ceiling is. Use the analytics now widely available to make these assessments rationally. The last thing you want to be is caught off guard.

Commercial insurance rate predictions for 2018

Chart: Commercial insurance rate predictions for 2018