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  • Writer's pictureChris Burand

Is the Hard Market Driven by Reinsurance?

I have my doubts.

Hard markets are driven by surplus issues, not profitability. A review of historical industry data shows that hard markets happen when surplus is an issue, and insurance companies can have surplus issues while still making plenty of money. This hard market is a prime example.

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According to data from A.M. Best, the U.S. property and casualty (P&C) carriers have had an average annual pretax operating profit of $47 billion over the last twenty years through 2022. Their profit in 2022 was $45 billion. When insurance companies "only" make $45 billion rather than their average of $47 billion, a hard market is not precipitated. Considering that approximately 1,000 P&C carriers exist (excluding all the subsidiaries and PUP companies), on average then, each carrier made $2 million, or 4%, less profit. If carriers cannot handle such a minor decrease from average, they should find better executives. This point is not just an opinion. The obviousness of the conclusion makes it a fact.

Reinsurance is not necessarily the issue either. Let's take a real example (with the numbers rounded for simplicity and to provide a little camouflage for a carrier). This example carrier is extremely successful.

Their premiums are $10 billion. They only reinsure 5% of their premiums. That is $500 million of reinsurance, not a small amount, but relative to their total premiums, it is a tiny sum. I don't know what they pay for their reinsurance, but it's less than 1% of their total premiums. I'll use 1%, which is an overestimate. That is a $100 million dollar expense. Let's say reinsurance rates increase 25%, a large increase. This means their reinsurance expense increases by $25 million. $25 million divided by $10 billion equals .0025 of their premiums. In other words, the 25% increase in reinsurance equals a .25 percent, one-quarter of one percent, increase in the carrier’s total expense ratio.

Is a crisis created when expenses increase by one quarter of one percent? If so, the carrier should probably be declared insolvent.

Now, if a carrier is reinsuring 40% and is already unprofitable and their reinsurance increases 25%, agents should be rolling their books ASAP.

Last year, the real issue was insurance companies lost approximately $90 billion in their investments. That loss is a direct deduction from their surplus. The losses, if my guess is correct, are probably much worse because some carriers miraculously saw their stock, bond, and that mysterious "other" category investment values increase. These carriers must have the best portfolio managers in the world (but if they were the best, they probably wouldn't be working anonymously for an insurance company). To be clear, I am not suggesting misdeeds, but accounting rules do permit a variety of options.

Making the $90 billion loss especially painful is that prices increased fast last year, as is typical in a hard market. When surplus decreases and premiums increase, leverage increases quickly and that is a problem. In the last two years, premiums increased approximately 18%. Surplus increased less than 6%. Additionally, one carrier out of the 1,000 owns between 20% and 24% of surplus. A lack of surplus is the issue, and the problem is severe for some carriers.

If you receive a notice from a carrier saying their problems are shared by most other carriers, such a notice might more accurately be interpreted as the carrier's problems are actually far more severe than most carriers' surplus issues. For example, one large carrier lost over 20% of their surplus last year.

Another reason to not believe reinsurance is the driver is that large reinsurers are spending billions to be primary insurers, whether they are backing captives, catastrophe bonds, or delegated underwriting authority organizations. If they were out of money, they would not be making these investments. Instead, they believe their return on investment is better there, even after accounting for reinsurance rate increases.

Reinsurance is a factor, especially with otherwise poorly run companies, but it is not driving the overall hard market. Incompetency revealed by slightly adverse conditions is probably the bigger driver. A lot of current talk is about AI, but I do not know if the industry needs AI more than simple competency. For example, one of the "reinsurance" issues is wildfire risk. I live in a wildfire zone. I took my homeowners policy to the market. The underwriter reviewed the application, protection class (10), and so forth. They went through the entire underwriting process including obtaining verification of whether wildfire risk management measures had been taken (my home has been certified by the state forestry department for taking such measures). Then the underwriter declared, "We can't write your home because you're in a wildfire zone." No kidding? You didn't figure that out by my address?

Additionally, simply red lining, and this is red lining, homes without consideration of their risk management/construction features is incompetence. It has nothing to do with reinsurance unless cheap reinsurance is a substitute for competency and carriers are unwilling to become competent underwriters. For example, an underwriter turned down a building due to hail risk. The building was concrete on all six sides. Or, the commercial development turned down for wildfire risk where other than an isolated tree in the parking lot island, there was no organic material for a long, long way. In fact, on one side, the closest organic material on land was likely in Japan.

Competency is not only reflected in individually stupid (blunt is appropriate) underwriting decisions. One carrier sent out a notice to agents that they are restricting writing, like other carriers, has achieved total growth of 0.6% since 2016. Their average annual net income is -$200 million over the last five years. If management cannot grow a company by more than a dime over six years and manages to lose $200 million annually, reinsurance is not the issue. Other than maybe reinsurers finally decided to charge losers more. I'm not sure how you can define this company any other way than a loser, they lose $200 million a year (on average). Again, this point is not just an opinion. The obviousness of the conclusion makes it a fact.

Reinsurance is not the primary driver of this hard market. The combination of the huge investment losses resulting in about a $90 billion decrease in surplus along with insurance carrier incompetency is what is driving this market. This combination is one awesome opportunity for carriers with smart leadership teams. This combination is one awesome opportunity for agents who think bigger than the next sale.


NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.

None of the materials in this article should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this article. Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations.

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