The Hard Market of 2019

Posted On November 14, 2019

Written by John Zehr

The general insurance market goes through cycles that are known as “soft markets” and “hard markets”. I tend to think of it as a comparison to the water levels in the Great Lakes, interest rates in the general economy or investment performance in the stocks and bonds equity markets and the global price of oil. Somehow, I also think these comparatives are somehow linked.

In the insurance soft markets, insurance companies tend to have a large appetite for accepting risk and preferred or lower than otherwise rates. In hard markets, insurance companies tend to have a far lesser appetite than a soft market for accepting risk and there is a trend to higher rates.

For many years there was a general observation and understanding that the Great Lakes cycled from their low levels to peak levels every 7 years. This was supported by the US Corps of Engineers in either their published tables or predictions. Interesting, in my earlier years as an insurance broker (I have been at Zehr Insurance Brokers for 40 years), we tended to swing from soft to hard markets around every 5 – 7 years also. Where soft markets were extended, as claims costs increased for insurance companies and profitability was eroded, such losses were offset with well performing investment portfolios, thus it was less important to have strict underwriting practices. If they lost money paying claims, they made it up with investments. Back in the mid to late 1980’s, it was common to see 18% interest rates. Imagine the return on investment you could make on a GIC that had no equity risk and paid you that much. I remember purchasing a 1981 Buick Regal and I financed it at 14.2% with General Motors Acceptance Corporation (GMAC) and thought I had a good deal. At today’s interest rates, it is hard to imagine society even coping with those interest rates – but it could happen again. There are trends and swings in all the markets.

The price of oil is a market indicator in that I have observed when the price of oil is high, the equity markets do well. Today, oil is nowhere near it’s peak and yet our equity markets are high as ever – what is going on there? But in the insurance company investment portfolios today, investment returns are at record lows. Interest and bond rates that were high, even 10 year instruments have cycled into current rates – you do well to get 2% on a GIC, and stocks that are held have often been purchase at current high values – thus the opportunity to divest and realize gains is minimized. Investment income is not contributing much to underwriting losses the insurance industry is seeing. Insurance must be priced for the pure risk, not less than pure risk plus investment income – there isn’t much there.

I will add a contributing factor to my comparison of lake levels. Is it changing weather patterns that have caused the lake levels to have recently peaked? So much for the 7 year cycle as 3 years ago Lake Huron was down to around the 1966 levels and this year it peaked to what the prior peak had been in 1986 – a swing of several feet in only 3 years. Today the 100 year storm seems to be coming almost every year in some fashion or another. Insured weather events are slicing profits from the insurance industry like never before.

My observations of the past soft market saw around a 12 year soft cycle, which turned rather abruptly last year in 2018. 2017 was laying the foundation for the soft market turning hard as there had been a general trend of insurance company’s financial performance deterioration since 2015. At Zehr Insurance, our insurance carriers did well for 2013, 2014 and 2015. 2016, 2017, and 2018 brought significant declines in underwriting profitability and increased costs to operate businesses. Insurance companies operating ratios commonly exceeded 100%. How long could anyone run a business if they were paying out $115 for every $100 they took in? There are financial solvency governance regulations which are intended to protect the policy holder public and such operating ratios are simply not sustainable for very long.

How long could anyone run a business if they were paying out $115 for every $100 they took in?

The last 12 years of soft market

During the last 12 year soft market, I saw insurance companies offer increased insured perils, broader coverage extensions that made one insurance company’s products more attractive than the others, many necessary coverage features which traditionally were charged for just thrown in for free, and new competition in some market sectors that traditionally were much more stable than others, also joining the competition band wagon in an effort to gain market share.

At a time when investment returns were deteriorating, Canada and the globe had been directly affected by increased severe insured weather events, and we were in the bottom of the soft market, we also experience political interference in the free market influences that in the past tended to keep the 7 year cycle in check. In 2015 the Ontario Government ordered a 15% automobile insurance rate rollback that was to be achieved over 2 years. This was at a time when we were seeing run-away costs arising out of both bodily injuries and an increased frequency of total losses on cars themselves as cars became more sophisticated and expensive to repair.

The ordered rate rollback was imposed on the insurance market without realizing the mounting losses and without any automobile insurance product reform that might have saved the industry some costs. This is on the backs of the heavily legislated pricing models where the Financial Services Commission of Ontario carried a mechanism whereby all rates and rules must be approved. Companies may not just make underwriting and pricing changes as they did in the free market when I started in the business. It is a very cumbersome environment.

Insurance companies were losing money on automobile insurance.
For a while, insurance companies were losing money on automobile insurance and to balance the books they were charging more for the home insurance that may have gone with it. But this was not a sustainable pricing or operating model as in came the increased frequency of severe weather events. What once saw an average flooded basement of a home claims cost to be around $5,000 had ballooned to an average of $35,000 in a very short period of time.
Today, the larger national insurance companies have maneuvered their creativity to rate by peril and to utilize what is known as individualized rating. That is to say that no longer did the industry really follow the traditional definition of what insurance is, that is “the losses of the few shared amount the many”. Rather, today the large national companies have developed rating models which have rather successfully segregated those customers who either have demonstrated or are predicted to have no or less claims costs than the others. In turn, those customers who fell outside of the new “target customer” rating models were displaced into the market. Those insurers who had not invested in these sophisticated underwriting models saw a huge influx of new business from customers who had been identified somewhere else as likely to not be profitable – not at the filed rates as they were anyway. In the past 2 years these conditions have led to many barriers being put up as insurers try to not bring these clients into their folds, which in effect is a loss of market. Some insurers withdrew, even left Canada. Those conditions caused even more tough measures, thus exacerbating the formulating hard market.
Earlier in this article I made mention of some traditional lines that tended to not have such market swings. That was the farm insurance market – serviced generally by local farm mutual insurance companies. But the last soft market lasted so long, even the farm sector gave way to softening underwriting requirements, sloppy loss control, expanded products, features and included perils, and reduced rates. For years a typical barn rate was $.50/$100 of insured value. So on a $100,000 barn, the insurance premium was $500. Barn rates even increased to $.52 for a while. I used to say, where else could you insure a no fire hydrant unprotected huge 80 year old frame barn for fifty cents? Everything was carefully scheduled and a premium charged for it – barn, livestock, farm machinery, produce, loss of income for business interruption and farm liability lines. The soft market drove them to provide policies which simply grouped all the sub lines together to write them on a “blanket” basis, so one single limit and likely the business interruption line just thrown in with a no stated limit, but rather by the ‘actual loss sustained” and a “profits form at that – more desirable than the lesser “earnings” form, all for a blanket rate I’ve seen as low as $.16! As these rates went down, the replacement costs for construction of buildings and farm machinery went up, and the general market was displacing less desirable customers into the realms of the mutuals because they don’t have the individualized rating models – thus those new customers were bringing their higher than average claims experience with them. This underwriting and pricing model is not sustainable. Further, many of those older barns were now burning or blowing down if not due to their age and condition, for other reasons.

In the last hard market prior to it going soft 12 years ago, in commercial lines I saw insurance companies commanding significate rate increases. The challenge then was to get the customer’s insured “lines or capacity needs” placed in the market. So if an insurance company required a 25 – 30% increase in rate but they offered renewal terms, I went to most customers and recommended they accept those terms. Insurance companies were not anxious to undercut each other as the generality of the market was to get rates up and the balance sheets fixed. In some ways, the hard market today is worse. I have had several customers who have enjoyed stable business insurance for many years who were simply let go by their insurance company because the insurer decided that “the risk no longer met their target class of business”. Imagine – you’ve been with XYZ company for 20 years and you have had no claims – none. We are offered an “experience letter” from the insurer with a notice of non-renewal. The letter says who the customer is, how long they have been insured, no claims – great client. It doesn’t make any sense. Believe me, the customer would far rather had me bring them a rate increase rather than sorry I can’t get that for you anymore from “your company” and we’ll have to go to the hard market with your business as a new customer. In comes the 30% premium increase if they are lucky.

Better-off with a rate increase as-is, rather than starting off as a new customer in the hard market at a 30% premium increase, minimum.

The current hard market is not over as insurance company’s operating ratios in many cases are still over 100% and the recovery to adequate rates in automobile insurance has been a very long road. I foresee a continuation of these conditions through 2020 but at least hope many of the tough underwriting measures and market displacements will be behind us. I say that with the “utmost of good faith”, another underlying principal of the insurance industry which seems to have been lost along with the “sharing of the losses of the few among many”.
I am positive the future will look better and the insurance industry can then repeat it’s patterns of softening up, followed by try and increase market share only to find they are bleeding red ink and invoke the reactions we see that make the markets swing from soft to hard to soft again. The last soft market was a very long one and the reaction has been equally harsh this time. This is where the independent insurance brokers at Zehr are working very hard every day to serve their customers to navigate through all the complicated barriers that the underwriters have put up.

Many of our new employees at Zehr have never experienced a hard market before but they will be better competent brokers at the end of it because they serviced their customers and everyone got through it. Personally I always liked a hard market because my years of experience could be called upon to get through the challenging situations. I have less chance of a new broker beating me on price when they have not had a chance to gain experience that no often is required to best serve our customers. I’ve been able to pass my experiences onto others when conditions are at their worst.

A continuing volatile and cumbersome environment.

The lake levels, investment markets, the price of oil and the insurance business will all continue to trend up, down, soft and hard, even in the midst of increase governmental regulation, for the foreseeable future. I’m sure of that.

Thanks for reading.

John Zehr

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