Has the property-casualty market cycle stopped its ferocious spin—for good?

A new market paradigm portends problems for independent insurance agencies. Although agents will be able to reassure clients that assuming losses aren’t off the charts, their budgets won’t likely strain under the weight of a substantial premium increase in future, the downside is that big agency paydays with hefty commission checks are likely gone forever.

“The amplitude of the cycle has definitely flattened, as has its fragmentation,” says Jerry Theodorou, vice president of insurance research at Conning. “In the past, pricing and coverages in virtually all lines of insurance rose and fell as one. Today, individual lines like medical malpractice, auto insurance or D&O march to their own drummers.”

Today, market dynamics suggest the cycle is starting to spin in a different direction: toward increasingly softer markets.

“All signs point to the peaks and valleys not being as high and low as they used to be,” says John Iten, director of North American insurance ratings at Standard & Poor’s. “Improved data analytics has provided insurers with a much firmer grasp on their underwriting profitability and pricing. This is having a mitigating effect on cyclical swings.”

In addition to more sophisticated data analytics for underwriting purposes, shallower cycles could result from a growing interest in absorbing insured risk among providers of alternative capital—both factors that have made barriers to entering the industry more porous. Data analytics is yielding a more refined view of wide-ranging risks compelling lower pricing, while nontraditional players are reducing the traditional market’s premium volume.

In this new competitive environment, insurers are struggling desperately to innovate, according to a survey of 280 insurance executives interviewed one on one by KPMG International. If carriers don’t respond effectively to these competitive challenges, the industry may diminish in size at an accelerating rate, another study by Conning asserts: “A smaller pie with the same number of players portends rising competition and declining margins for what remains of the traditional risk transfer product.”

The New Landscape

If Conning is right and the relevance of traditional insurance products dissolves, the amount of risk transferred to traditional insurers could decline as customers absorb more risk.

The first threat: the rise of alternative risk capital solutions like insurance-linked securities (ILS) and cat bonds. Providers of these nontraditional risk transfer products have enjoyed tremendous success in the p-c reinsurance market, driving price competition to the point of market dislocation. At present, the capacity of the ILS reinsurance market is estimated at $70 billion.

Now, pension funds, hedge funds and other investor groups backing the securities have interest in absorbing primary insurance risks, as well. Consider the risk capital Nephila Capital recently arranged for primary property insurance through wholesaler broker AmWINS. According to the Conning study, “certain insurance risks can be financed most efficiently through the capital markets, as losses can be spread over a much larger capital base that exists within the insurance industry.”

Other analysts believe these nontraditional sources of risk-bearing capital may seek primary insurance business in the future, assuming a decent return on equity. “We’ve seen more alternative capital flow into the industry, particularly on the reinsurance side, but this could trickle down into the primaries as business flows from front-end producers all the way to the capital providers,” says Andrew Colannino, vice president, p-c insurance ratings at A.M. Best Co. “Those lines could be blurring.”

Nontraditional competition is not confined to alternative risk capital providers. Other possible competitors include technology giants like Google, Amazon and Apple. While most analysts predict these companies will enter the industry as online distributors, over time they may be interested in absorbing some measure of insured risk—particularly from products like automobile, homeowners and small commercial insurance, which lend themselves more easily to commoditization.

“Their access to data and their unsurpassed analytics will be their selling point,” Colannino says. “The question is their willingness to set aside capital to take on the risk. If the return on equity is less than what they would expect from existing enterprises, they’ll sit on the sidelines.”

Robert Hartwig, president and chief economist at the Insurance Information Institute, also questions the interest of large technology companies in underwriting insurance. “Even if the barriers to market entry are diminishing, this doesn’t mean there is an economic case for Google or Apple doing it,” he says. “Unquestionably, the margins in the businesses in which they are presently involved are much higher than the margins in property-casualty insurance.”

But what if the companies’ data analytics indicates a steady and somewhat predictable flow of underwriting income? Dax Craig, CEO of Valen Analytics, which provides predictive analytics solutions to insurers, posits the development of a potential alliance between technology behemoths and alternative providers of risk capital. “A nexus will occur in which the data analytics and other technology assets of a Google or an Amazon drives the primary business, with the risks absorbed by the capital providers,” he explains.

The p-c industry’s sluggish rate of innovation renders it ineffective in competing against these threats. The KPMG study suggests some insurers may be ill-equipped to keep pace with the technological transformation surrounding them. Although 83% of respondents “overwhelmingly realize” the importance of innovation to their companies’ ability to generate competitive growth, 74% say they their organizations lack the internal core skills necessary for generating innovation.

Digitization, Disintermediation

As many traditional insurers struggle to invest in technology innovations, new market entrants are sharpening their knives. Nearly half (48%) of KPMG respondents say their organizations are already experiencing disruption from new, nimbler competitors.

A 2013 study of the impact of technology on more than 700 different professions does not bode well for many traditional insurance professions: On a scale where 100 defines the highest impact, insurance agents ranked 92, claims adjusters 98 and insurance underwriters 99.

“There is no doubt in my mind that digitalization will continue to create tremendous pressure for independent insurance agents,” says Tom Nodine, principal, U.S. insurance strategy group at KPMG. “Owning and operating an independent agency right now is a very tricky place to be.”

“Agencies and insurance carriers can no longer rely on what happened in the past, business-wise, to happen in the future,” agrees Anthony Diodato, group vice president of p-c insurance ratings at A.M. Best Co. “Profound changes are underway.”

Differentiation Opportunities

But amidst these dark clouds are a few silver linings. One is the fact that new risks [see sidebar] have emerged for all companies, promising new sources of premium income for insurers and, by extension, independent agents. “While corporations have become more sophisticated in their management and retention of many types of risk, they are at the same time seeking new coverages that only insurers can provide,” Hartwig points out.

“There’s a move towards specialization among carriers, looking to focus on particular risk transfer needs and not necessarily be ‘all things to all people,’” Craig says. “Data analytics will continue to give insurers the ability to specialize.”

Theodorou also sees increasing specialization ahead. “If what our study predicts comes to pass, then insurance companies will have to become more customer-focused by providing value-added services,” he explains. “Over time, this will differentiate insurers, which is a good thing for independent agents.”

Theodorou elaborates that agents will be able to select insurers for a customer based more on their specialized expertise, rather than the cheapest price. To do this, agents must shift from a product focus to a customer focus.

“They need the tools to better understand their clients’ risk profile,” Theodorou says. “They need to assist policyholders with value-added services. And to do that, they need to invest in data analytics.”

Many agencies are already awakening to this need. “Certainly, we are hearing more about it from the carriers’ perspective, but we’re also hearing that many agencies are investing in data analytics,” says Julie Herman, associate director of North American insurance ratings at Standard & Poor’s. “The more value you provide, the less chance you will be displaced.”

This value extends to agent interactions with both carriers and customers. “The best distribution of a product or a service is the one the purchaser wants, and this is definitely the case with insurance,” Diodato says. “Insurers and agents must do business how the customer wants to do business—in person, online, through an email or a text, whatever. Those that don’t risk losing even longtime customers.”

Nodine agrees: “The trump card for agents is that they’ve always owned the customer, but the smarter agents realize their ongoing viability rests on their ability to continue to own the customer.”

Russ Banham is a Pulitzer-nominated business journalist and author.