In a season of unprecedented change and hyperbolic rhetoric, we want to sound a word of caution and suggest the U.S. property/casualty insurance industry think critically about the possible adverse consequences of a headlong rush to impose steep rate increases to cover anticipated loss exposures.
While raising rates might be how the industry has responded to uncertainty in the past, there are a number of reasons why doing so now might be ill-advised: First, the industry risks alienating its customers and inviting more regulatory scrutiny if it pursues onerous rate increases before the full scope of 2020 exposures are known. Second, the past several years have seen a rise in technologies to capture and analyze more precise data, improve efficiencies and develop products, all offering insurers an opportunity to innovate how they manage risk—if they successfully integrate those in their operations. Third, many insurers routinely posting combined ratios in excess of 100% need to first put their house in order and look at their expense structure and underwriting performance before seeking blanket relief by raising rates that do not address underlying problems.
The drivers behind today’s sharply harder rates are a combination of capital markets uncertainty, assumptions about prospective insurance exposures to COVID-19 losses, assumptions about insurance regulatory positions, natural catastrophe forecasts and, last but not least, reliance on historical experience. Based on discussions with regulators, reinsurers, primary insurers and new entrants to the industry, the sharp rate filings now in the pipeline began with reinsurers, followed by primary carriers. The greatest hardening of rates is occurring in commercial lines, especially for small business, as well as in homeowners, general liability and workers compensation.
Filing rate increases based on market or capital uncertainty has historically been an accepted industry practice, managed on a state-by-state basis. However, given the beneficial impacts of COVID-19 stay-at-home orders and business closures on routine insurance expenses, including claims volume, should these filings for extreme rate increases be approved, as if business as usual? We think not.
Back in 2019, the signs of a firming property/casualty insurance market were apparent, due to rising primary, reinsurance and retrocessional rates after years of losses from catastrophic weather and wildfires plus continued low investment yields. Throw in a little 2020 volatility from COVID-19 and social unrest, and the market has grown even harder across both personal (except auto) and commercial lines.
We acknowledge there are valid reasons why incremental rate increases may be needed, but not at the across-the-board and exponential levels we are seeing. We frequently hear of premium increases in the mid- to high double digits, and in many cases the increases are measured in multiples. We have spoken with insureds being quoted premium increases as high as 400%, with most increases falling in the 50% to 200% range.
Among the problems with a business-as-usual approach is uncertainty about the future. In particular, there is uncertainty about the relevancy of historic data sets to actual loss exposures in a rapidly changing risk environment, such as we are experiencing now.
One consequence of these extreme rate increases could be a policyholder backlash. At what point do higher prices cause economic harm to policyholders, driving them to limit or abandon because it is not affordable? Or drive commercial policyholders to captives and other alternative risk financing options? Or drive them to seek relief from insurance regulators—perhaps even federal regulators? What would those consumer and regulatory reactions mean for the future health of the insurance industry?
If we accept that the world shifted on a societal scale within a six-month period, should we not expect that insurers also change how they operate?
While many insurers in recent years have experimented with innovation, unfortunately they appear slow to fully incorporate real-time data and analytics technologies into their operations. These tools, the focus of much innovation activity in recent years, could help to better understand evolving risks and improve loss forecasting capabilities, as well as the ability to mitigate loss frequency and severity.
See also: COVID-19 Highlights Gaps, Opportunities
One of the promises of insurtech is that it would enable insurers to apply the right data sets to the right circumstance to more accurately underwrite a risk—and perhaps identify opportunities to prevent certain losses altogether. As it turns out, the impact of insurtech on incumbent insurers has not yet resulted in a simplification of the supply chain, a reduction in costs, an acceleration of growth or a more accurate predictive view of the future. Rather, the sophistication of actuarial calculations and the application of technologies used to perform historic functions with greater precision have increased the complexity and deepened specialization within the existing supply chain. Silos within organizations are deeper and more restrictive, all of which create challenges to working innovative solutions through an organization, achieving new insights and efficiencies.
Any argument for extreme rate increases should also ask questions about the validity and relevance of the insurance industry’s historic benchmark of profitability: the combined ratio. A ratio below 100% indicates a company is making an underwriting profit, while a ratio above 100% means that it is paying out more money in claims that it is receiving from premiums.
Fundamentally, why would a regulator approve a rate increase for an insurer with a combined ratio well above 100%? Wouldn’t this be a misplaced reward for bad management? That may sound harsh, and some may accuse us of being uninformed or naïve, but think about it: What other industry routinely allows businesses to operate at a loss? And now, when investment returns are assuredly lower and no longer offer cover for losses, insurers turning to policyholders to make up the difference seem to ignore fundamental problems.
The COVID-19 pandemic and resulting restrictions has caused enough of a shift in how everyone lives and works that it’s fair to raise fundamental questions about the role of the insurance industry in reacting to and recovering from this shift and in defining how emerging risks are appropriately managed. Simply raising rates cannot be the industry’s only response. Let’s examine some questions that the situation raises.
First, from an economic perspective:
- Could a significant increase in premiums for nearly all non-auto insurance products hurt a national economic recovery or, worse, compound the current financial challenges consumers face?
- Will rate increases combined with the traditional U.S. insurance industry practice of operating with a combined ratio above 100% contribute to small business closures and job losses?
- What happens if a number of people don’t/can’t procure the coverage they need due to prohibitive costs, and a hurricane or flood or other disaster comes along? What happens if businesses cannot afford the new premiums and drop coverage, and a loss occurs for which they don’t have coverage? Or what if a business needs to cut jobs or other operating costs to stay in business and pay premiums?
From an operational perspective within an insurer:
- Do remote working environments provide a greater opportunity to break down silos and create cross-functional working groups to capture key learning from our recent/current operating experiences? For example, one regulatory leader described multiple working groups within his organization that also highlight an issue that may be occurring within insurance companies. Two small teams were focused on solvency, while others worked on other operational questions. However, none of these working teams was asked to look at operational practices as they affect the combined ratio. The regulatory leader did agree with our hypothesis that, given the complexities of insurance and chaos of a COVID-19 “new normal,” the combined ratio is a solid “ground zero” number to use as the foundation for rate filing analysis.
- What have carriers learned from operating through the past six months regarding full-time equivalent (FTE) count, efficiency gains, elimination of red tape, gains from new processes and procedures? Consider the savings alone from elimination of routine business travel, from conferences to Ritz-Carlton client lunches, being shut down for months, if not longer.
- Have loss ratios worsened to such an extent that double-digit (or triple-digit) rate increases are necessary? Do these rate filings reflect a sort of day of reckoning for ratings agencies that also believe the present and future must be extensions of the past? Are current economic realities forcing insurers to reckon a loss of investment returns they have relied on to cover underpriced coverage?
- The most recent sigma research report from Swiss Re seems to recognize the danger of unrestrained premium increases in the short term, without taking a longer view. The Swiss Re report noted that there will be challenges to industry profitability in 2020, but the industry’s capital position should be strong enough to handle COVID-19 shocks. Between non-life rates that were already showing signs of firming, and an anticipated increase in demand for risk protection amid heightened risk awareness, industry premiums should rebound in 2021. In other words, don’t overreact. (Swiss Re subsequently announced a $1.1 billion loss for the first half of 2020, after claims and reserves related to COVID-19 of $2.5 billion.)
From a regulatory perspective:
- Are insurance regulators the most appropriate body to challenge the basis for combined ratios that exceed 100% before approving carrier rate filings?
- In the event of a public outcry for federal legislators to “fix” a broken insurance system, questions will focus on the oversight applied by the dtate regulatory system. Were premium increases necessary and warranted for the protection of the customer and resiliency of the insurer?
- Has the role of the insurance regulator changed with respect to prioritizing the viability of insurers, protecting consumers, contributing to state budgets?
- Will the election cycle increase the natural tendency to expand a federal solution within the construct of the Federal Insurance Office (FIO) created under Dodd Frank with expanded powers to respond to the market? The long-term effect of this would be to essentially turn insurance into a federally regulated public utility – with all of the bad and very little good that would come from that scenario.
See also: COVID: How Carriers Can Recover
Innovation thrives on uncertainty, and has always been the engine that drives the most growth. The same will be true now. Whether innovation produces efficiencies that reduce combined ratios or generates new sources of revenue, innovation is the better and more sustainable course. Many insurers seem content to rely on rate increases as their strategy for resiliency through these uncertain times. Be assured, based on several advisory engagements from the past six months, others in insurance-related sectors have acted upon and are developing new models, accelerating pace and devoting resources toward their goal. Circumstances that are perceived as chaotic and threatening by any majority of incumbents are also perceived as “once-in-a-lifetime” opportunities to change business-as-usual by those who will lead in the future.
Our purpose is to urge the insurance industry to ask hard questions and examine the potential consequences of the various strategy responses to these uncertain times. To us, there are essentially two paths. There is that path of sharp rate increases and business as usual, with potentially dire results. The other path encourages innovation, a nimble look into the future and a commitment to leadership.
How do you think it will all work out? Let us know.