Insurance is cyclical in nature, meaning that there are hard markets and there are soft markets. Insurance companies must make a profit, and hopefully earn investment income off of the premiums received. There may be years where there are fewer losses than other years, but companies must make enough money to not only cover the losses in the current year, but have enough money set aside in reserve to cover future losses. They use actuarial methods to try and predict future losses based on past experience but that does not always hold true. And in recent years, there have been a number of unprecedented catastrophic losses that have negatively affected the capital held in reserve by insurers and reinsurers. Thus, for many lines of business, we are currently in a hard market.
A hard market may also be referred to as market tightening. This is because the availability for insurance, usually a particular type of insurance, becomes more difficult to obtain and often may be more expensive. This typically happens in the commercial property and casualty markets, as a result of catastrophic losses, large jury verdicts, or other factors affecting the profitability of insurers and reinsurers.
In simple terms, the insurance industry takes in premiums to pay losses. A certain portion of their premiums typically go to reinsurers to offset catastrophic losses or to free up capital, and another portion gets set aside in reserve funds. Insurers invest the premiums they take in to make money off the investments. The amount set aside in reserve is determined by actuarial calculations that take into account previous loss history and earnings and actuaries use this to make predictions about losses and the rates necessary for the company to maintain a profit. The actuarial predictions are not just for the current year but usually for five or maybe even ten years out. If the insurer doesn't set aside enough funds in reserve, they get downgraded as to their financial stability by rating agencies such as A.M. Best and Standard & Poors. Therefore, it is important that insurers take in enough premium to not only cover the losses that happen in the current year, but also to have enough in reserve to cover unexpected catastrophic losses that were not accounted for in the actuarial predictions.
In a hard market, when policyholders start seeing their rates increase or higher deductibles be required, some policyholders may decide to self-insure their risks in order to keep premiums lower. By self-insurance, they may decide to not purchase insurance for some risks and simply go bare – meaning that the entity will pay for its own losses; or they may self-insure all or part of their deductible.
In a hard market, policyholders look for new ways to insure their risk. Groups of policyholders with similar exposures may create an insurance pool, where each member contributes the premiums and losses.
Another way entities insure their risk is through captive arrangements. In a hard market you are apt to see a lot more captives being formed. The continuing hard market and captive growth is the subject of this discussion.
Hard market conditions are expected to continue into 2021, with rate increases in almost every line, according to Willis Towers Watson (WTW) in its 2021 Insurance Marketplace Realities Report.
The most challenged lines will be property, umbrella, directors and officers (D&O), and fiduciary, followed closely by cyber insurance. Non-challenged properties are predicted to see increases of 15% to 25% in 2021, while umbrella increases will stagger from 30% for low-moderate hazard, to 150% for high hazard excess. All categories of D&O are expected to see double-digit increases in 2021, with some as high as 70%.
Cyber insurance rates are expected to increase by 10% to 30%, while general liability rates are expected to increase by 7.5% to 15%.
Workers compensation rate decreases are flattening, according to WTW, with a slight increase in response to high severity/excess losses. Unsurprisingly, workers compensation remains the casualty line with the most COVID-19 claim activity.
Some moderation in property rates is anticipated by mid-2021, following two cycles of rate increases by that point, per the report.
A bright spot on the horizon may be found in the following statement by Joe Peiser, global head of Broking at Willis Towers Watson: "However, our experience in this hard market is that there is a wide range of results; renewal results are not huddled around the mean. This means underwriters are underwriting, and there is the opportunity to differentiate your risk."
A "captive insurer" is generally defined as an insurance company that is wholly owned and controlled by its insureds. It's primary purpose is to insure the risks of its owners, and its insureds benefit from the captive insurer's underwriting profits. For more on captives, see Captive Insurance Companies.
Already, new captive insurance companies have been created amid the tightening conditions in the traditional market, and that growth trend is expected to continue in 2021.
State | No. of Captives(as of 10-1-20) | New Captive Licenses 2020 |
Vermont | 595 | 25 (5 more expected) |
North Carolina | 230 | 13 (8 pending applications) |
Tennessee | 207 | 13 (24 more expected) |
Hawaii | 238 | 11 (20 more expected) |
Nevada (protected cell captives) | 168 | 17 |
South Carolina | 172 | 6 |
Montana | 271 | 12 |
Utah | 393 | 12 (28 more expected) |
Missouri | 72 |
A recent survey by Marsh, LLC noted that Marsh formed a record number of new captives in the first seven months of 2020, with 76 new captives, a 200% increase compared to the same period last year.
With premium increases and commercial insurers cutting back on their limits, many organizations are expanding their captives, and those without captives are looking to get captive feasibility studies done, as reported by Jim Swanke, head of captive solutions North America for WTW In Minneapolis.