Commercial insurance rates – up or down?

Surveys by Insurance Times asking senior managers at brokerages about their expectations for commercial lines insurance rates always provide a range of responses. For example, the 2009/10 Broker Service Survey produced no consensus to the question “When do you expect commercial lines rates to harden?” (click on the image 'Graph 1' for the full figures).

But results of a second Insurance Times survey circulated amongst brokers in February 2010, a little over six months after the Broker Service Survey, provided a more consensual view; rates in 2010 will remain about the same as 2009 (see graph 2 for the figures).

Which survey was right? Probably elements of both; predicting rate movements is not easy in intensely competitive insurance markets.

Why is it so difficult to predict rate movements?

Markets are comprised of many different insurance classes, each influenced by a range of factors that determine the capacity in the market. Each class of business is impacted differently by any number of political, economic, environmental, social, legal or fiscal factors, some predictable, some less so. For example, the April 2010 Lockton Market Update noted that fee income in the professional indemnity (PI) market has dipped in the present challenging economic environment, while claims frequency has increased, leaving the market facing mounting losses.

Losses should indicate that a rate rise is fairly imminent. But the PI market is currently considered to be soft with decreased demand as the recession increases market capacity. Rates, therefore, will likely remain about the same.

Business strategy

As individual insurers underwrite a mixture of insurance classes with dissimilar proportions of their books assigned to particular insurance classes, losses in the PI market will hit different insurers to a greater or lesser extent. Competition between insurers means that when the market is soft (has a lot of capacity) individual insurers may find it difficult to raise rates for a particular class without losing business.

Insurers can make losses on one class and rely on others to take the strain - for a while. It is a judgment call based on business strategy for the insurance class and the business as a whole.

If the strategy is to improve return on assets (ROA) or return on risk-adjusted assets, the insurer will probably set rates to reflect the underlying risk in an attempt to deliver a good underwriting performance. However, the insurer could adopt a disruptive strategy, choosing to go for market share by keeping rates low. There are good reasons for doing this, such as the ability to cross-sell other products.

Delivering market share

Reserves can be used to help deliver a market share strategy. Reserves from previous years can be released to offset underwriting losses in the current year, helping the insurer to maintain current rates. Optimistic reserving in the current year can play a role too; insurers may set aside less than a final claim with the true result of the underwriting year not known for several years.

This is especially true in the case of PI claims which can be complex and take time to resolve; seasoned underwriters advise that the true result of the underwriting year will not be known for about seven years by which time a host of factors may have changed the overall shape of the business.

Alternatively (or as well as) the insurer can adopt an aggressive claims strategy seeking to pay out less from reserves set aside for claims, or take longer to make payments to better manage those reserves. Another option, although generally not one that is adopted as it is deemed too risky, is to move reserves between classes. Insurers are not legally bound to ring fence reserves within the class for which they were first set aside.

Without deep market knowledge of individual insurance classes, and the role played by individual insurers, it is difficult to predict rate movements. However, many brokers and other market analysts are well placed to deliver this insight as a result of their efforts to track rates and monitor overall market capacity.

Where can I find more information about rates?

Lockton Market Update: www.locktonmarketupdate.com