The "state of the market" has been a regular agenda item in any broker, insurer or risk manager meeting lately. In the last couple of years, pretty much every industry player has produced reports, articles, or papers to explain why the market has changed, to try to define how long this "hardness" would last and to advise risk managers and insurance buyers on how to react to the new situation.
All this, before one of the most dramatic and sudden changes of the modern world occurred: the COVID-19 pandemic—which has deeply impacted the economy worldwide, caused bankruptcies and changed our lives and behaviors, possibly for years to come. Oh, and it has also impacted insurers already scarred by two years of severe underwriting losses.
So, it's only natural for the insurance buying community to ask a very simple question:
How is the COVID-19 crisis going to affect these trends?
To understand what has been happening in the market and where it is going, a simple model that looks at the underlying drivers of market conditions can provide some explanation. Like any other market, the insurance market is based on demand, represented by insurance buyers, and supply, represented by insurers and other risk transfer vehicles; however, unlike traditional markets, there are two peculiar "wild cards" that play a major role in determining peaks and troughs—insured losses and the financial markets. Insured losses directly impact the profitability of insurers, financial markets play a key role, but indirectly, as insurers build their surpluses not only on their underwriting profit, but also on their return on the assets invested.
Since 2018, due to ongoing lack of profitability, all insurers have tightened their underwriting. The pre-COVID-19 market has been defined as a "disciplined market." All underwriters now direct more focus to the types and quality of risks they will write, on the accuracy of the value submissions they receive, on the capacity they are willing to provide, and on the terms and conditions they are willing to underwrite. Coverage restrictions are also being applied and fewer coverage extensions are available as insurers seek to return to “core” underwriting principles while also paying more attention to at-risk aggregation across multiple lines of coverage.
The pandemic crisis has enhanced this process by making it more difficult for insurers to assess insured assets and engineer risks, and some losses have been escalated by the inability of loss adjusters to reach the damaged premises in good time.
As the economy has been growing at a steady pace through the last 15 years, it hasn’t been unusual for insurers to accept a reduction in rate knowing that insured values were going up, therefore preserving the gross premium income. However, with larger values came larger exposures. Furthermore, companies operating in a growing economy tend to produce more, exceed equipment design loads, expand the intervals between maintenance outages, have streamlined supply chains and a smaller inventory. All these factors translated into larger losses than insurers expected, and larger losses than they received premium for.
As the pandemic certainly slowed down global growth, and while some specific businesses may have thrived, on average the insurance industry is seeing reduced values, especially the potential value of business interruption. From an insured perspective, by the time the COVID-19 crisis is over, virtually no part of the economy will be untouched. The entertainment, tourism, travel, technology, business and personal services sectors, as well as labor-intensive manufacturing, have experienced significant disruption. The stock market has also seen unprecedented volatility, while simultaneously interest rates have tumbled. For all industries, the recovery will take some time as experts determine how to proceed cautiously in reopening markets.
Much has been written about the large losses incurred in 2017-18 that led to poor underwriting results in the market. These losses were not only due to natural catastrophes (hurricanes, typhoons and earthquakes), but also non-cat hazards, in most cases due to the lack of risk improvement. Scott Ewing, SVP of AXA XL Risk Consulting, said that, "The soft market definitely does not drive good behavior and recommendation compliance." Additionally, the rise of new and emerging risks, such as cyber, or risks related to climate change, such as wildfires, have also had a significant impact on losses.
Since the start of the pandemic, Lloyd’s estimates that there has been US$203 billion in losses from insurance companies; US$107 billion in insured losses and $96 billion in reduced asset values. Some US$28 billion of the US$107 billion is expected to be paid out in 2020 across a wide range of policies, including event cancellation, property and travel. Further payouts are expected as the effects of COVID-19 continue to unfold, across classes such as directors’ and officers’ policies, professional indemnity and credit insurance. From a catastrophe standpoint, experts say they see conditions similar to 2005, when a record 28 storms hit the Atlantic—including Hurricane Katrina, which practically razed New Orleans and killed 1,800 people.
But what is happening to the more traditional, non-COVID related losses? On one side, during lockdown it is fair to say that plants that were not operating have delivered a lower level of operational claims to their insurers. However, this positive factor has been counteracted by claims generated by the "idling" of these facilities, for example due to vandalism or fires and flooding where there was neither early detection nor a response team ready to address them. Second, we are also now facing losses related to the re-start of the operations, especially with equipment that hasn't been properly secured or prepared for a prolonged shutdown period. Third, we are also seeing an uptick in cyber related claims due to the increased remote working environment, where hackers are exploiting the less secured domestic Wi-Fi access paths to companies' data. And last, the odd "black swans" continue to occur, as demonstrated by the Beirut explosion in August 2020.
There is also the question as to how well global companies will be able to prepare for the hurricane season, given that the COVID-19 restrictions could limit movement of people and goods more or less everywhere, further enhancing the negative effects of natural catastrophes on insureds losses.
Although all of the above factors are certainly making the process of buying commercial property insurance more difficult at the moment, buyers certainly shouldn’t give up hope of the process going smoothly. By taking several key actions to accurately assess the exposure of their organization, and most importantly by communicating early and continuously with brokers/the insurer directly, insurance buyers can gauge a more accurate prediction of the rates they will be offered for coverage. This can allow them to conduct the internal groundwork of informing budget holders, such as the CFO, of any increases and why they are occurring, ensuring that there are no surprises at the end of the buying process.