Risk Management

Insurance Outlook: Higher Prices by Year’s End

But if the global recession continues to spiral downward, many companies will try to slash their insurance bills by resorting to various forms of s...
David KatzJanuary 5, 2009

Following five years in the bargain basement, property-casualty insurance prices will start to rise again by the last quarter of 2009 or the first quarter of 2010 and stay high for an unusually long time, according to a new report that attempts to predict the commercial insurance pricing cycle in the upcoming year.

That’s assuming, however, that the financial crisis doesn’t get too much worse, thereby decreasing the demand by companies for insurance coverage. The report, issued last week by Advisen Ltd., an insurance research firm, lists another caveat: Insurance prices could turn sharply up if there are a couple of severe natural disasters.

Lacking those factors, CFOs should plan for higher premiums and less available insurance by the end of this year. “In years past, insurance companies recouped underwriting losses with investment income, but in 2008 the combination of underwriting losses and material investment losses means a five-year soft market is coming to an end,” said David Bradford, Advisen’s executive vice president and the author of the report. “The global recession may delay the return of hard market conditions by keeping demand for insurance down, but once the hard market sets in, it is likely to last longer than was the case in recent cycles.”

Average prices for commercial insurance are likely to glide into a “soft landing” by the second quarter of 2009 and will start to inch higher beginning in the fourth quarter of 2009 or the first quarter of 2010, according to the report. But a deepening in the recession could stall the return of high premiums and scanty by holding down the corporate demand for insurance.

If the recession continues to spiral downward, many companies will try to slash their insurance bills by resorting to various forms of self-insurance, increased use of captive insurance, and other kinds of alternative risk financing, Advisen predicts. Further, companies will try to switch to low-cost insurers, “even if it is necessary to loosen financial security criteria,” according to the report.

Even though those are typical corporate responses to “hard” insurance markets (high prices and hard-to-get insurance), “it is likely companies will resort to them even before the market turns as they are squeezed by a deteriorating economy,” Bradford writes. “All these factors will help prolong the current soft market.”

Nevertheless, the report notes, insurance prices follow the law of supply and demand. Between the fourth quarter of 2003 and the second quarter of 2008, the supply of insurance (the capital held by insurers to support the underwriting of insurance policies) surged, prodded by large profits and muscular investment returns. “The rapid accumulation of risk capital fueled competition, driving down rate levels, according to the report.

Then came the subprime collapse. “On the supply side of the equation, plummeting stock markets, frozen credit markets and, in some cases, investments in `toxic’ mortgage-backed assets, caused many insurers to post investment losses in the third quarter,” Advisen reports. The investment losses came on the heels of five years of price cutting, higher than average catastrophe losses, and the need to reserve $9.6 billion for claims stemming from the subprime meltdown, according to the firm’s estimate.

Assuming that corporations don’t drastically cut their insurance purchasing, that decrease in insurance supply should kick prices up by the end of the year, the report predicts. And in “the absence of major natural catastrophes, which could trigger skyrocketing premiums, the hard market will be more gradual, and also more prolonged, than has been the case in recent cycles,” it says.