Insurance is one of the largest costs for many companies. When premiums for property and casualty, workers’ compensation, employee benefits, life insurance and other lines of coverage are added up, it can often total 5 percent of revenues or more. It is critical to understand not only how to manage these costs, but also how to forecast costs for the next fiscal year.

Read on for some perspective on where the insurance industry stands today and how the current financial situation and underwriting objectives will affect businesses in 2015.  

Insurance Company Economics

Insurance companies are in business to accept risk in exchange for premiums. Like any other business, they want to make money and earn a fair return for their shareholders. Absent a decent return, they will not be able to attract additional capital, and the insurance industry thrives on capital or surplus.

Insurance companies make money in two ways: underwriting and investments. An underwriting profit is earned when losses plus expenses divided by premiums is less than 100 percent. This factor is called a combined ratio. If an insurance company has a combined ratio of 98 percent, it is making a 2 percent underwriting profit. If the ratio is 105 percent, it is losing 5 percent.

Insurance companies also earn money investing policyholders’ surplus and cash reserves they have set aside to pay future claims. It is not uncommon for an insurance company to make up for an underwriting loss with its investment income (especially when interest rates are high).

From 2008 to 2012, the industry’s return on average net worth was poor. This was attributable to a lousy combined ratio and a low level of investment return. (The majority of an insurance company’s portfolio is invested in debt obligations; it can only invest about 20 percent in equities.)

The industry needs to attract capital (surplus) to continue to grow. Ideally, in order to do that, insurers need to earn 10 percent or more. When returns deteriorate like they did from 2008 to 2012, underwriters try to get more rate (increase premiums).

2013 was a different story. Unlike 2012, which was a bad year for losses from catastrophes (e.g., Hurricane Sandy), 2013 was a light “cat” year, and the combined ratio reflects that.

Underwriters realize that 2013 was somewhat of an aberration. They still feel they need about 5 percent rate increases on preferred accounts; however, they are not pushing the price increases as hard as they were at this time last year.

So what should companies expect to see in 2015?  

Allied Lines

Allied lines of coverage include property, general liability, auto and umbrella. Property and casualty rates have increased nearly 15 percent since 2011; however, they are still more than 30 percent lower than in 2004. While most underwriters want an additional five points of rate or more, the positive results of 2013 are moderating those rate increases. On average, preferred accounts should be able to negotiate close to flat rate renewals and possibly even minor rate decreases.  

Professional Liability

The market for architects, engineers, lawyers, CPAs and other professionals (e.g., errors and omissions insurance) remains competitive, with a large number of companies competing for preferred accounts. Recognize that coverage, risk management and claims handling differ greatly among insurance companies. While a company may be able to save money by going with a “bare bones” insurer, it is not recommended.

Like the allied lines, preferred professional liability risks should be able to negotiate renewal terms plus or minus 5 percent from expiring rates. For firms operating in a higher risk profession (e.g., geotechnical engineering or attorneys specializing in class action cases), or with adverse loss experience, the market is much narrower. In this case, negotiate terms early and market the program if necessary.  

Executive Risk

Executive risk includes directors and officers (D&O) liability, employment practices liability insurance (EPLI) and fiduciary liability. The last economic downturn resulted in many companies going out of business or generating poor results, which led to downsizing and layoffs. This increased the number of claims covered by D&O and EPLI policies, and the results suffered accordingly.

Underwriting tends to be reactive as opposed to proactive, and the adverse loss experience is driving rates for these lines higher. On average, expect D&O to increase 5 percent to 10 percent and EPLI to rise 10 percent to 25 percent or more. Fiduciary liability should be flat to plus 5 percent.  

Workers’ Compensation

The good news is that workers’ compensation results in California have improved significantly since 2011. This is largely due to average rate increases of about 35 percent since 2009.

It also should be pointed out that average charged rates are still 50 percent lower than they were in 2003. The combined ratio has improved from the mid-140s experienced in 2009, 2010 and 2011 to a projected 113 for 2013.

Of course, the bad news is that the combined ratio is 113, which means the industry still needs some additional rate to return to profitability. 

While the Workers’ Compensation Insurance Rating Bureau has yet to publish its recommended loss costs, it is estimated to be in the 7 percent to 8 percent range. Most insurance companies have filed for or announced similar rate increases.

While every insurer will publish its own rates, on average rates in California should increase 5 percent to 10 percent. National results have been marginally better, but each state will vary.  

Positive Risk Profile

The insurance industry is in a better financial position today than it was a year ago mainly due to the positive results in 2013 and the early positive predictions for 2014.

While the health of the insurance market will directly affect what companies pay for insurance, a much more important element is their risk profile. When underwriters consider an account, they will evaluate overall operations, HR practices, safety culture and safety practices, as well as loss history.

A positive risk profile will result in substantially better pricing than a negative one. This underscores the importance of proactively managing the cost of risk. While construction businesses can’t control the insurance marketplace, they can control their own risk profile.

Jeff Cavignac is president and principal of San Diego-based Cavignac & Associates. Patrick Casinelli and Jim Schabarum are principals of the firm. For more information, visit www.cavignac.com.