Insurance Market: What to Expect in 2010

By Jeffrey W. Cavignac

By this time, most companies have firmed up their budgets for 2010.  A key budget item is insurance.
Regardless of what direction the insurance industry is headed, each company will be affected not only by the type of business it is in, but also by its individual risk profile. Based on past history and current critical indicators, below are some educated guesses that will help you better estimate insurance costs for 2010.
The Market in General
The industry is characterized by fluctuations between what are commonly known as “hard markets” and “soft markets.”  When the industry is suffering and surplus is declining, rates typically go up, availability goes down, and coverage is restricted. This is characteristic of a “hard market”.  When the industry is thriving, competition returns – rates go down, availability increases, and coverage is expanded.  The market is soft.
Insurers currently are in an awkward position.  While the recent rebound in the investment markets has helped offset underwriting losses, surplus has still decreased.  Profitability has plummeted.  Regardless, capacity is still adequate so they can afford to remain competitive in order to retain their market share.  At some point, poor underwriting results will drive down profitability so far that rates will have to go up; we just don’t know when.
We predict that the preferred market for property, liability, auto and umbrella coverages will be relatively flat in 2010.  The only segment of this market that will not be particularly competitive are accounts with 20 percent or more of their total insured values exposed to coastal windstorms.  Tougher classes of business or accounts with adverse loss experience are more difficult to predict.
Similar things can be said about the professional liability marketplace.  Architects, engineers, accountants, attorneys, and other professionals with decent loss histories and risk profiles should do fairly well in 2010.  Although there will not be dramatic rate reductions, pricing should remain relatively constant.
Workers Compensation
The workers compensation market nationwide is relatively stable and has not changed significantly in the last year. There are some concerns, however.  Medical claims costs continue to rise, and low investment returns make it difficult for insurers to overcome their underwriting losses.
California is a different story altogether, since it  operates as an “open rating” state.  The Workers Compensation Insurance Rating Bureau (WCIRB or “Bureau”) recommends pure loss costs for each of the numerous classifications.  These are reviewed by the Insurance Commissioner, who comes up with his or her own rate recommendations.  Regardless of what the Bureau or the Commissioner recommend, insurance companies are basically free to choose whatever rates they want.  Having said that, the industry as a whole generally follows the rate recommendations provided.
Since July of 2003, rates on average have dropped nearly 64 percent (Exhibit B). This is attributable to increased profitability due to workers compensation reform, which had a positive impact on underlying costs.  The opportunity for increased profits dramatically increased the competitiveness in this line.
Unfortunately, rates probably went down too far.  If you look at Exhibit C, you will see that the combined ratio, which peaked at 185 percent in 1999, actually came down as low as 54 percent in 2005.  Since then it has more than doubled to 111 percent in 2008, and doesn’t look like it will be any better.
In January of 2009, the Bureau recommended an average increase of 16 percent.  This was countered by the Commissioner, who only recommended five percent.  Although each company selected its own rates, average rates per $100 of payroll still declined slightly ($2.35 to $2.33).
July of 2009 was a different story.  The Bureau recommended a whopping 23.7 percent increase.  This had to do with increased medical costs as well as a reversal of some of the reforms that drove costs down in 2004 and 2005.

Steve Poizner, the Commissioner, refused to provide his thoughts in a timely manner. Poizner said he didn’t have enough information, and he recommended no change in rates.  Recognize that most of the companies that were going to file rate changes had already done so and Poizner’s tardy reply really had little impact on the rates filed.
The industry faces further challenges due to exposure base (payroll) decreases.  As payrolls and rates have both come down, total written premiums have dropped dramatically, from $23.5 billion in 2004 to $10.7 billion in 2008.  For the first six months of 2009, total written premiums dropped 18 percent to $4.5 billion.
Claim costs continue to rise.  The average cost of an “indemnity” claim (a lost time injury) in 2008 was $57,000 — a 48 percent increase over the average cost of an indemnity claim in 2005.
Average rates increased 10-15 percent last year and, in all likelihood, will go up again this year.  Recognize, however, that California employers are still in a substantially better position than they were five years ago.  Even if base rates increase 20 percent, when you factor this on top of the 64 percent rate decrease, average rates are still down over 56 percent from where they were in the second half of 2003.
Please realize we have been talking about “average” rates.  “Net” rates are also affected by experience modifications, premium discounts and schedule credits.  The premium you ultimately pay for workers compensation is impacted by all of these.
In addition, rate changes vary by classification; many will go up, and some may come down.  If you renewed in the second half of 2009, on average you saw 10-15 percent increases.  If you renew in the first six months of 2010, you might see 15-20 percent increases.  The best way to estimate your workers compensation cost is to project your experience modification and discuss your specific account with your insurance broker and underwriter.
Surety
The year 2008 was an exceptionally good year for the surety industry.  Although written premiums dropped in 2009 and the frequency of contractor defaults trended up, 2009 is expected to be a profitable year as well.  This year could be another story.
Despite this fact, with many contractors burning off their backlogs and the evaporation of residential and commercial work, sureties are getting the jitters.  Public works are just about all that are available to bid on today.  The municipal sector is fiercely competitive, with very thin margins if any at all.  Where several years ago five contractors would bid a project, today there may be 20 or more bidders.  Oftentimes the low bidder is wondering what he may have left out.
Many contractors have been trying to break into the Federal market.  Federal work is plentiful, but has become increasingly restrictive to selective types of programs, such as small business, 8(a), HUB Zone, SDVOSB, etc.
Needless to say, contractor defaults will increase in 2010.  Despite these concerns, no major changes have occurred in rate or capacity.  However, surety companies are starting to underwrite more conservatively, with their key focuses on liquidity, interest-bearing debt, availability of credit, and overall risk management.
Employee Benefits
Southern California health insurance rates in 2008 had an average increase of 12 percent for HMOs and 15 percent for PPOs.  The year 2009 saw rate increases of 10-13 percent in HMOs, 14-17 percent in PPOs, and 18-22 percent in qualified Health Savings Accounts (HSAs).
The primary drivers of the overall cost increase for standard HMOs and PPOs are the aging work force, increased costs of pharmaceutical drugs, new medical technology, and the renegotiation of provider contracts (doctors, hospitals, laboratories and other medical facilities).  HSA plans entered the market in 2003 with a flurry of interest from those looking to lower premiums and save pre-tax money.  HSA plans have seen higher than expected utilization, which has caused rate increases higher than those in PPO plans.  Consumerism was one of the driving ideas behind the design of HSA plans with the idea that an insured person in a high deductible plan would shop for the best prices before receiving care.  But many employers use premium savings to help fund employee deductibles, which allows employees to receive first dollar coverage without having to shop for lower prices.

The original hope for lower utilization and price shopping has not been realized and HSA rates are expected to rise by 20 percent in 2010.  Actuaries do believe that by the end of 2010 or by the beginning of 2011 they will have a handle on HSA pricing, and future increases will be comparable to PPO plans.
Two-thousand-nine was a very interesting political year for the health insurance industry, with President Obama pushing for a comprehensive national health care program. The Senate Finance Committee passed the Baucus Bill (named after its proponent, Senator Max Baucus (D) Montana) in mid October, clearing the initial hurdle toward health care reform.
Conclusion
The insurance market will transition and costs will eventually go up.  This is already happening in workers compensation.  Although there are things you can do to prepare for and survive in a hard market, your “cost of risk” really needs to be looked at in a long-term perspective.  In fact, insurance is just one of the elements in your cost of risk – for many companies, it is less than half the total.  Other costs include: 1) your time spent analyzing and managing risk; 2) money spent on uncovered losses or deductibles; and 3) your time and your employees’ time spent dealing with losses.
Whether or not the insurance industry is in a hard or soft market cycle, well-run companies will always be looking for ways to effectively manage their risk.  Risk management is not a seasonal or cyclical exercise; rather, it needs to be a vital part of your company.  By lowering your frequency and severity of losses, you can lower premiums in the long run.
Jeff Cavignac is president and principal of Cavignac & Associates, a leading commercial insurance brokerage firm providing a broad range of insurance and expertise to design and construction firms, law firms, real estate-related entities, manufacturing companies and the general business community. The firm employs a staff of 40 at its office headquarters located at 450 B Street, Suite 1800, San Diego, California 92101.  More information about the company can be found on the web at www.cavignac.com.