Property/casualty (P/C) insurance and group benefits industry is changing faster than ever. Many factors are the parents of such change. In part one of this two part series, I will focus on the more traditional aspects and effects on agencies — the old-fashioned pricing cycle.
In the “old” days, only about 10 years ago, the P/C industry would go through hard and soft market cycles. Typically, companies would underprice or excessively relax their underwriting standards to grow more quickly. Insurance company executives were always confident and assuring that this time, they were pricing correctly. However, each time they were not pricing or underwriting correctly. Their mistake or excessive confidence would lead to a hard market, where prices increased 10 percent to 50 percent upon renewal overall, and coverages became difficult to obtain. In the most infamous hard market, the mid-’80s, some liability coverages were not realistically obtainable.
Companies had to turn the market hard to make up for their underpricing sins, incompetency or both. Warren Buffet summed up the situation extremely well when he wrote in Berkshire Hathaway’s annual report, “In 1999, a number of insurers announced reserve adjustments that made a mockery of the ‘earnings’ that investors had relied on earlier when making their buy-and-sell decisions.”
Some companies did not play this game and became known as “hard market” companies. These were companies that agents could count on when a difficult hard market arrived. They would not play the pricing game in a soft market; they suffered in the soft market. Agencies then had to have soft market and hard market companies.
Soft and Hard Agencies
Agencies could often be divided into hard and soft market agencies, too. Soft market agencies sold price. They grew more quickly in soft markets because they could always find a cheaper price. Sometimes prices dropped so fast they could cause clients to move midterm. In hard markets, they suffered. They had absolutely nothing to offer clients. Hard market agencies grew in tough times because they held onto their existing accounts, but at much higher rates. They also gained accounts because they had the companies that would write in a hard market (hard markets are historically correlated with higher number of insolvencies and downgrades). They generally also made much more contingency money because hard market agencies tended to be better upfront underwriters.
The cycle more or less evened out. Companies and agencies were fairly clear about their place in the market cycle. Some did not make it through the extremes of either part of the cycle and that was, frankly, just an accepted reality.
The P/C market has been in a soft market for 13 years, longer than any soft market going back to 1900. Net premiums written (NPW) growth has not exceeded 4.4 percent once in that time. Looking forward, growth is not likely to accelerate. Growth is likely to decrease further. This long and deep soft market has far-reaching effects.
First, hard market agencies have had to transform or sell, because hard market agencies were based on the cycle turning roughly at least every seven years. A hard market would last three or four years, generating enough growth to see them through the next seven years. In a long soft market, they fell too far behind which may be a factor in them selling (and an important reason so many buyers’ true, especially alpha, organic growth rates, completely stagnate after the deal and after the earn-outs end).
The second nail in hard market agencies’ coffins is how these hard market agencies were generally better underwriters. Between waiting for the large bump, a hard market gave to their revenues and often much higher contingencies earned. Hard market agencies did not work hard selling. They were more reactive, waiting for customers to find them or waiting for the right time (a hard market) to make a sale. Quite often, hard market agencies had no sales culture, whereas soft market agencies did, sometimes to the extreme where the producers were incompetent or even unethical. Few agencies historically were truly in the middle, which was a quiet point of frustration for carriers.
Burand is an insurance agency and industry consultant, author and analyst. This article is based on his most recent 50-page whitepaper, State of the P&C Insurance Industry 2017, his “must-read” annual report with his forecast for the industry and independent agents. The special report is available from Insurance Journal’s Research and Trends division.
A soft market is created by adequate to excess surplus and profitability. A hard market requires lack of profit and, most importantly, a dangerous decline in surplus. Both factors will almost definitely create a really hard market. A dangerous decline in surplus is actually more important than a lack of profitability. In today’s markets, carriers in total have made a large profit each year, every year since 2002. Their average profit the past 20 years is $37 billion on both a pretax and net income basis.
Why do carriers need to raise rates and create a hard market when they are making $37 billion each year?
Because surplus is more important than profits relative to the market turning hard, industry surplus hit an all-time high in 2016. Using A.M. Best data and 1996 as the base, surplus is now approximately 2.7 times what it was in 1996. Surplus has increased by approximately 172 percent during this time, while premiums have only increased approximately 97 percent. With so much surplus, and so much profit, the probability of the market remaining soft, even getting more soft, is far higher than the probability of it turning hard.
Hard market agencies may not have a place in this industry. Making their situation worse, carriers still need growth, especially if they are stock companies.
Hard market agencies grew with rates historically or through client duress (clients came to them when their soft market agency could not find a carrier in a hard market). They did not typically proactively go out and find new clients. In a perpetual soft market, proactively finding new clients is a must. Many hard market agencies do not have the tools to make this happen. If an agency cannot generate organic growth, it probably will not survive.
Another environmental factor pushing the extinction of hard market agencies is the invention and use of predictive modeling, and the development of quality behavioral underwriting/pricing models. These models “promise” more exact pricing based on a data set. Much of that data used to be provided by the agency. This was upfront underwriting, gained by being on premise and knowing the consumer. In theory, the predictive models obviate the data and vetting an agency would provide.
What does this mean to agencies?
Companies do not need agencies doing upfront underwriting, assuming they are using sophisticated modeling software. Agents are frustrated by the emphasis companies are placing in contingencies on growth, and what they see as a de-emphasis on upfront underwriting, or loss ratios. Hard market agencies often earned high contingencies because their upfront underwriting was good. Companies do not necessarily value that model today and it’s a paradigm change for those agencies.
Technology is devaluing upfront underwriting and changing the nature and frequency of claims. With the promise of automotive technology to decrease claims enough to reduce auto premiums by 20 percent, the potential for water leak sensors to eliminate non-cat water damage claims, plus new employee safety technology, companies may find themselves making money even with their bad management. The issue is, when claims decrease, premiums eventually decrease, and therefore, companies need growth.
The industry has been through the longest soft market in history and barring a catastrophe or black swan event, this soft market is likely to remain for the foreseeable future. Agencies and companies that can generate organic growth, not purchased growth, have the best opportunity at outsized success.
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