The last couple of years have seen the first true hard market since the 1980’s. We had a few minor events in the ‘90’s and the 2001-2002 “hard” market was simply fortuitous timing for some carriers to cover up the losses they had been hiding in their insufficient reserves. For example, if you review the subsequent reserve changes, you’ll see that reserve deficiencies in specific lines were far larger than initially and, for all practicality, publicly recognized.
This long history means a vast majority of insurance people have never experienced a true hard market. It used to be, in days gone by, that a hard market would occur about once every seven years so the industry always had institutional knowledge. One of the problems with long periods of good times is that knowledge of how to deal with hard times is lost.
Here is some advice and warnings for people who have never experienced a true hard market until now.
Hard markets punish incompetent carriers. High quality carriers should thrive in a hard market eating up market share as if they hadn’t been able to write a policy in the last ten years and now they need to make up for their draught. In soft markets, undisciplined carriers can and do sell price. Disciplined carriers historically would “rest” during soft markets saving their capital for the hard market. It is quite similar to how private equity describes having “dry powder.” Disciplined insurance companies have lots of dry powder and high-quality dry powder, i.e., surplus to spend in a hard market.
The markets agents need in a hard market are the disciplined carriers who have saved their powder. While not always true (I’d argue there are a handful of very significant exceptions), a good, quick indication of high quality from this perspective is a carrier with an A+ A.M. Best rating. A huge difference exists between an A+ rating and an A- rating.
While sometimes, a high-quality carrier does not always act as if they have any more capacity than their weak competitors, they have the capacity and it’s just a matter of convincing them to use it.
The weak companies, regardless of their rating, will be limiting their writings much more severely because they do not have the surplus to support their premiums. They can either reduce their premiums or increase their surplus. They can increase their surplus by selling more stock, selling parts of the company, borrowing money, or buying more reinsurance.
Sometimes strong companies in a hard market sell more stock because they see a great opportunity. But more often it is weak companies selling stock because they need more capital. If you see carriers selling parts of the company, that is quite often an indication of an issue. And while many will argue that when you see an insurance company borrowing money, they are really simply being ingenious financiers, I will argue they are so ingenious they have worked themselves into such a bind that they have no options left but to borrow against their futures. A strong company makes money on its surplus through investments. A company that borrows for its surplus pays interest.
How does surplus work? Carriers must have $X of surplus for every $Y of premium. The ratio varies by type of business, growth rate (faster growth generally requires more surplus, but not always depending on how a carrier is managing its reserves), and quality of surplus. A company that runs out of operational surplus may have no means by which to grow and in fact, may have to “shrink to their surplus.”
I mentioned borrowing. Many carrier and agency people do not know that some companies borrow their surplus. As one carrier executive said upon learning that some of his competitors have borrowed their surplus, “That should be illegal!” I won’t go that far but when the collateral for these loans is the surplus pledged to future claims, as most of these loans are designed, some caution is required. Historically, if a carrier holding these loans went sour, regulators have ruled that the lenders were losers, and the money must remain in the company with which to pay claims. One headline 20 years ago read something to the effect of, “The department of insurance ruled we cannot repay our lenders, so we’ll be defaulting, but the good news is that we now have more surplus for our policyholders.” True story.
From a policyholder basis, regulator basis, and rating company basis, these loans are not that risky. From a lender’s perspective, these loans carry extra risk. For agents though, a company that must borrow money is constrained in what it can do and how much it can grow, because it has these large interest payments, a deficit of not having as much of an investment portfolio, and eventually the repayment of these loans.
If you see high turnover of employees, that is another warning sign of instability. Something is going wrong that quality employees do not see they have a future. And obviously when you see downgrades, or even a downgrade warning, that is a sign. The rating companies in my opinion do not downgrade a carrier without a lot of time, consideration, discussion with the carrier beforehand (any carrier “surprised” by a downgrade is lying or living in fantasy land), and likely triple checking all their numbers. Pay attention to these events. A slight downgrade may not make much difference in some cases but usually this means a carrier’s ability to grow responsibly is limited.
A hard market is also a time for quality to shine because it is easier to explain to clients why cheap insurance is not always the best choice because cheap insurance is often correlated with some of the carriers reducing/restricting writings. It is a time to prove your worth in solving your clients’ problems.
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.