Tough to Navigate

Bob Fee sells insurance not far from the salt mines and grain elevators of a peaceful-sounding place called Hutchinson, Kan. But he and Fee Insurance Group are front-and-center of a trend starting to shake things in the commercial property market.

“I have an account with a lot of property exposures in Houston. Property rates didn’t go up horribly for them this time, but they went up for the first time in years, and that’s significant,” says the vice president of this 23-employee, three-location agency. “Underwriters I’ve talked with say recent storms are causing insurers to rethink their ratings in storm-prone areas—and those areas are now a big chunk of the U.S.”

The Double Edge
Welcome, at long last, to the Hardening Market. It’s a place where commercial property rates that were flat or falling since 2005 are finally starting to reflect the risks they’re intended to pay for.

Firming markets are usually festive places for agents and brokers, who look to the accompanying premium increases to balance deficits caused by rate falls of the preceding soft market. But few glasses can be heard clinking this time around. Instead, agents are almost as concerned about rate hikes in some lines as they were about fall-offs in others a few years back. “As agents, we need a hard market to balance our businesses, and we’ve been hoping for one for some time,” says Fee. “But this one is coming at a bad time. Some of our customers are still in difficult spots economically.”

August Felker, CEO of The Murphy Insurance Group, a 50-plus-employee agency with seven locations in and near Madison, Wis., agrees. “Usually a hard market accompanies a good economy,” says Felker. “It’s unusual to see it in a still-tough economy, and I think it will be a challenge, both for carriers to press rates and for our clients to pay them.”

Felker’s agency works with a number of regional insurers in the Midwest, and he says some property coverage renewals are coming in 2% to 10% higher than last year. “These are mainly customers with high property exposures who had hail damage,” he says. “I think a lot of carriers had a tough 2011 with losses. They’re looking at their exposures and starting to adjust premiums, because they’re too low for the risks.”

Felker also has an eye on workers’ compensation coverage, noting that it’s “another market having a tough time making money” due to sky-rocketing loss ratios. But his main focus thus far is habitational risk. “We have clients with apartment buildings, and they’re seeing substantial increases,” he says. “Anyone who has significant property exposure will see increases.”

Mounting Concern
The first market tickler occurred in February 2011 when Risk Management Solutions, Inc. (RMS) released a new version of its U.S. hurricane model. RMS is one of the leading catastrophic risk-modeling company in the world, and it takes more than a stiff wind to convince the firm to alter its products. In fact, RMS claims to revise its risk models only when incorporation of new data and/or new technology is expected to increase their accuracy.

In the case of Version 11, RMS had both. The new model “contains 10 times more onshore and offshore wind observation data than the last hazard update in 2003,” said company spokesperson Carolyn Krehel. Advancements in computing power also allowed RMS to run thousands of storm simulations to generate a new risk model of a hurricane’s behavior over land. Together, Krehel said, the two new models can calculate hurricane risk more accurately than ever. Not surprisingly, the risk scenarios they generate are scarier and more expensive than ever, too.

As a result of the model changes, RMS predicts wind-risk increases for all hurricane states on an industry-wide basis. Portfolios with non-coastal exposures and commercial or industrial businesses will likely show the largest increases, RMS said in a statement, since changes in loss results in the market portfolios analyzed jumped between 20% and 100%. “However, there are extreme cases above and below this,” RMS qualified. “Concentrated portfolios will see changes outside of the typical range, including some decreases.”

By November 2011, most property insurers had digested the implications of RMS Version 11 and were running their exposures against the new model. That month, for the first time since February 2005, commercial lines rates inched up across the board, ending the soft market. Commercial property, business-owner policies (BOPs) and workers’ compensation coverage all experienced 2% rate increases, according to MarketScout, the Dallas-based electronic insurance exchange. Business interruption, general liability, commercial auto and employment practices liability rates also rose by 1%.

A month later, the National Oceanic and Atmospheric Administration (NOAA) released additional relevant data. The federal agency reported that a dozen weather-related disasters in 2011 each caused more than $1 billion in property damage. The $52 billion in aggregate losses didn’t approach the $145 billion in losses (in today’s dollars) exacted in 2005 by Hurricane Katrina. But as NOAA observed, the 2011 disasters set a new record for the “greatest frequency of severe weather with costly losses” in more than 30 years.

Preparing Customers
The question now is how to best manage rising rates as they hit insureds. “I’ve found the only thing worse than delivering bad news is delivering it at the last minute,” says Sparling. He also believes agents should discuss the changing market with clients immediately to avoid an underwriting logjam. “The first thing [customers] often do when they get a whiff of a rate increase is ask you to market their business,” Sparling says. “Then underwriters start receiving hundreds of submissions a day, causing delays with quotes and more delays with competing quotes.” Make contact with selected wholesalers now, Sparling counsels, so you’ll be ahead of the crowd a few months down the road.

Tim Cunningham thinks the overall market hardening will occur gradually. “I think we’re at an inflection point,” says the president of OPTIS Partners, LLC, an agency financial consulting firm based in Chicago. Cunningham sees “pockets of activity” in which rate audits are coming in with additional premium instead of returning premium. He’s also hearing of underwriters holding firm on pricing that a year ago might have renewed at a 10% reduction. “If there are problems or issues with an account, companies are starting to ask for more rate or they may even refuse renewal,” he adds. But as of mid-December, rising rates had not dramatically impacted businesses in OPTIS’s sphere of influence.

Even so, Cunningham and OPTIS Partner Dan Menzer have suggestions. First, warn clients and begin working with those for whom rate increases may be problematic. “Good agents and brokers communicate regularly with their clients, and you need to condition them to expect increases,” says Menzer. Rate surveys suggest that commercial accounts of less than $25,000 in premium may be most vulnerable, he adds, while medium accounts (those with $25,000 to $100,000 in premium) are experiencing smaller rate increases and large accounts are still flat or experiencing small rate decreases.

Preparing Your Agency
Menzer also suggests that agency principals consider the impact to the value of their agencies. “Does an upswing in market pricing mean we’ve finally reached a stopping point of decline in agency value? Maybe,” says Menzer. “The value impact depends on what agency principals do with the new revenue they’ll earn through increased premium,” he says. “Will they pay it out to producers, will they invest to improve their balance sheet, or will they take it as owner compensation?”

“If you look at agencies that thrived or even minimally survived bad times, you’ll find most had rainy-day funds,” says Cunningham. The savings were used to retain talent, and then to rebuild when the economy improved. “We’re hoping more agencies will find a way to retain a portion of new revenues this time,” says Cunningham. “Whether that’s 2%, 5% or 15%, there will be newfound revenue if the market continues the way it has started—and smart agencies will continue to set some of it aside.”

Menzer has another idea as well: conversion to fee arrangements. “If you’re charging clients a fee, you have to defend your worth every year,” says Menzer. “You might give up some revenue during the hard market, but when the soft market arrives, you’ll fare better. It’s something some agents are doing since soft markets tend to last much longer than hard markets.”

Clint Harris has other suggestions. Harris is an analyst at Conning Research in Hartford, Conn., which issues regular economic forecasts for the property-casualty industry. “Agencies, like insurers, have to invest in technology and intellectual capital,” he says. “To maintain those investments, perhaps agencies should ask their carriers for more support. Could they partner more to leverage service capabilities? Could they further increase automation capabilities, the way we’re seeing more automation in BOPs?”

Harris says Conning sees growth in automation portals built by agencies and supported by carriers. “They reduce some of the frictional costs of providing information and risk management,” he says. “Perhaps there are other opportunities for partnership as well.”

A united front is usually stronger, after all—and in today’s extreme weather, agents need all the strength they can muster.

Hodges (hodgeswrites@gmail.com) is an IA senior contributing writer.

A Changing Hurricane Model
J.C. Sparling, executive vice president of Preferred Concepts LLC, a New York City-based program administrator and wholesale brokerage, puts Risk Management Solutions’ Version 11 of its U.S. hurricane model in perspective: “Reinsurance costs will go up in response to the new RMS model,” he says, “and poor historical results for 2011, combined with too much rate give-back by insurers over the last six years, will mean combined [loss] ratios of 101 to as much as 105 for 2011. So carriers will want to get those numbers back under 100.”

No doubt they will. And if Sparling is right, insurers and reinsurers may soon have another new tool to help them adjust rates. “You could argue that RMS will release a newer version still of its hurricane model,” he says, “because Hurricane Irene hit nine states in 2011 and caused damage all the way to Vermont.” Add Irene’s statistics to the model, “and I can clearly understand if a Version 12 or 13 comes out soon,” Sparling says.

—S.H.