The insurance industry is cyclical in nature, and business owners should pay attention because the insurance cycle directly impacts their insurance premiums.

Insurance companies make money in one of two ways: underwriting profits or investment income. An underwriting profit is achieved when losses plus all expenses are less than premiums. When the former is divided by the latter, the outcome is the combined ratio. A combined ratio of less than 100 percent means there is an underwriting profit, and a combined ratio exceeding 100 percent means there is an underwriting loss.

In the eight years ending in 2012, the industry generated an underwriting profit twice. However, 2013 and 2014 both generated an underwriting profit. This is primarily attributable to lower losses in general, but catastrophic losses in particular have been light for both those years. While an underwriting profit is better than an underwriting loss, most insurance company executives would like to see their combined ratio under 95 percent and ideally 92.5 percent or lower (only achieved once in the last 10 years).

Insurance companies collect premiums and set aside reserves to pay future claims. These funds, known as “surplus,” generate investment income. During periods of substantial investment returns, insurance companies are willing to tolerate inferior underwriting returns because they make it up on investments. In 2014, the industry earned a 3 percent underwriting profit, and the overall return on average net worth equaled 8.4 percent. The difference (5.4 percent) is attributable to investments.

The Importance of Surplus
Surplus is a critical economic driver for the insurance industry. Surplus 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 be safely written given a certain amount of surplus. If the ratio of premium to surplus gets too high, the insurance company’s credit rating could ultimately impair the firm’s ability to operate.

This is why the insurance industry is supply driven. Demand for insurance stays relatively constant. Sure, it may ebb and flow depending on the economy; however, these swings are relatively modest. If surplus goes down, insurance companies must write less insurance, and this causes rates to go up. Similarly, if surplus goes up, rates tend to go down. The industry’s surplus has increased nearly 50 percent in the last six years and is currently at an all-time high.

Finally, it’s important to realize that the insurance industry competes with every other industry for capital. To attract investment dollars, the insurance industry has to demonstrate an acceptable return on equity. Most investors want to earn at least 10 percent. Historically, the insurance industry has averaged just shy of that; however, the five years from 2008 to 2012 generated meager returns, and results have only improved during the last two years.

In terms of insurance pricing, rates dropped about 40 percent from 2004 to 2011. When prices went down, combined ratios and profits began to deteriorate. Rates started to increase and average rates have gone up about 15 percent since 2011. Still, they remain 30 percent below what was charged in 2004, and the rate increases have begun to taper off.

Today, underwriters want more rate increases, but the high surplus is keeping the industry competitive. Although rates on average have increased about 1 percent through July 2015, that should change by 2016, with a modest rate decrease anticipated. In short, the industry is flat. However, this will differ by account and policy type. Preferred risks in desirable industries with profitable loss histories may see rate decreases of 5 percent to 10 percent or more, while challenging accounts in high hazard classes with poor loss records can still see substantial rate increases.

Allied Lines and Workers’ Compensation
Allied lines refers to general lines of insurance that most companies need to purchase. This includes general liability, property, inland marine, auto, workers’ compensation and umbrella coverages. In general, for a company with average risk in a decent class, rates should be flat.

Workers’ compensation is trending positively after six years of rate increases. In California, the average rate charged per $100 of payroll peaked in 2003 at 6.29. The reason for the higher rates is attributable to the lousy underwriting results from 1999 to 2002. As rates went up, results improved and, from 2003 to 2009, rates fell off 67 percent to an average of $2.10.

While this was good news for insurance buyers, it was bad for the insurance industry, and rates started back up to combat the poor combined ratios. Since then, rates have increased more than 40 percent, but it is important to remember that they are still less than half of what they were in 2003. While rates continued to increase modestly through 2014 and 2015, it is anticipated that rates will be flat in 2016. Remember, this is an average. Each of the more than 250 classifications is affected by the experience of that class. Some will go down fairly substantially, but others (e.g., Class Code 5606, Contractors Executive Supervisors) could go up.

Executive Risk
Executive Risk refers to directors and officers liability, employment practices liability and fiduciary coverage. This also can include crime, kidnap and ransom, and cyber. Executive risk is more volatile than the allied lines. In addition, the last economic downturn is affecting current pricing. The poor results experienced by many businesses and the layoffs and reductions in force have increased loss ratios. Insurance companies tend to be reactive in their pricing, and these poor results are now manifesting themselves in higher premiums.

While it is difficult to provide an average rate increase (10 percent to 25 percent is not uncommon), it is also misleading. Every account is different and individually underwritten. Start these renewals early and go into detail on why the firm is a good risk and should be credited accordingly.

Professional Liability
In general, professional liability lines are flat like the industry at large, but once again this can vary by profession, specialty and account. Architects and engineers currently have more options than ever. A firm could probably obtain 50 quotes on a preferred risk, but the devil is in the details. Every one of these policies is different and coverages can vary greatly.

In addition, the claims handling and risk control services offered vary. Some insurers simply offer a policy (often a mediocre one) with a subbed out (i.e., third-party administrator) claims department. Others provide broad coverage, in-house specialized claims expertise and sophisticated risk management. Accountants, attorneys and other professionals also have a wide range of suitors, but similar to the design profession, coverage, claims and risk control are all over the board. This underscores the importance of dealing with a specialized broker who knows the differences in coverage and the pros and cons of each insurance company.

Health Insurance
Medical insurance costs in 2015 increased between 20 percent and 40 percent due to the changes in the Affordable Care Act (ACA). The early renewal strategy in 2013 helped employers delay the effects of the law, and grandmothering helped in 2014. The 2015 medical renewals for companies with two to 50 employees realized all the impacts of the law.  

Rates are currently determined by employees and their dependents’ individual ages, plan design and location of the company. A family of five will pay for each family member based on each individual’s age and the plan selected. Some younger employees or families with one child may have lower premiums. All of the small group plans have changed to conform with the law, and most have higher deductibles and copays; therefore, employees will have to pay more when they use services.

The provider networks are changing and offering fewer choices for doctors and medical groups. The industry calls them “skinny networks.” Often the price looks good, but employees will have very few choices for doctors. Be sure to run a disruption
report to compare current providers to those associated with the programs being considered. 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.

2016 is the year insurance carriers will try to figure out how to survive after implementing all of the ACA requirements. Rates will continue to increase as the plan’s taxes and fees continue to rise. Employers should budget a 10 percent to 15 percent increase, and depending on plan change options, rates could settle in at 5 percent to 10 percent.

Dental, life, vision, disability and worksite products
continue to remain extremely popular benefits for employees.

Bottom Line
It is a pretty good time to be an insurance buyer (with the exception of health insurance). The industry has abundant surplus and decent results. Most businesses will be able to negotiate flat rates, and some businesses may even see rate reductions. However, insurance premiums need to be kept in perspective. They are only one component in the cost of risk. Time spent managing risk, training employees to be safe, dealing with claims, funding uncovered claims and a number of other costs all factor in as well. For many large companies, insurance premiums can be less than half the total cost of risk.

While it’s important to understand the economics of the insurance industry, there is nothing a business can do to positively affect it. 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 control program and a partnership with the right broker who can thoughtfully present a company’s program to the insurance marketplace is the key to lowering costs. 


Surety: Do More With Less
A slow and steady improvement in the surety industry in recent years has been mirrored in the U.S. economy and other related financial markets. In the not-so-distant aftermath of the economic meltdown of 2008 and now the poor performance of the stock market in 2015, the surety outlook for 2016 will remain positive, but will be significantly challenged by factors that influence the construction and commercial business markets.

Astute contractors have not abandoned the lessons learned in the recent post-recession recovery. Construction firms today are leaner and meaner with a focus on bottom-line results. An overall acceptable profit margin for efforts expended is mandatory. However, owners’ expectations are still in a buyers’ market mode, interest rates are artificially low, fuel and materials prices are cheap, technology applications are improving and there is a painfully large worker shortage. Going forward, successful firms will cautiously continue to grow their operations with an eye on doing more with less. 


Jeff Cavignac, James Schabarum and Patrick Casinelli are principals of San Diego-based Cavignac & Associates. For more information, visit cavignac.com.