Amid creating opportunities for companies and organisations to seek alternative ways to finance their risk, the hard market is set to continue
A hard insurance market is characterised by a high demand for insurance coverage and a reduced supply. Insurers impose strict underwriting standards and issue a limited number of policies.
Premiums are high and insurers are disinclined to negotiate terms.
Hard market conditions make captive insurance more attractive as a risk retention tool. However, people who have captives before the market hardens experience the benefits but at the same time, it drives more people to think about a captive for the future.
Industry experts have seen the market hardening over the last several years. Anne Marie Towle, global captive solutions leader at Hylant, suggests that the hard market will continue for some time.
The pressures in catastrophe driven areas of the world, and particularly the US, continue to wreak havoc with securing adequate capacity as required by insureds, according to Towle.
She says: “The concept now is to build your tower of risk with multiple carriers, as many carriers are limiting their capacity. The old days of utilising one or two carriers are pretty much nonexistent.”
“Some carriers have been writing business at a loss and not pricing the risk appropriately, in addition to historically low-interest rates, so now they are stressing the balance sheets,” Towle adds.
In agreement, Jason Stubbs, consulting actuary of Risk International, says there is a great deal of uncertainty around economic recovery from the pandemic, around the outcome of pandemic-related lawsuits, and around changes in society related to the pandemic.
Stubbs explains: “The combination of these risk factors creates a situation where insurance companies and private equity are not going to have a lot of confidence investing in insurance products without a higher-than-expected rate of return. As a result, insurance premiums will remain high.”
The ongoing COVID-19 pandemic stalled the world in early 2020. In order to protect national health, the majority of the countries have or still are in national lockdowns. Millions of workers were furloughed, mostly on a lower income than their regular paycheck. Other people were forced out of work resulting in unemployment rising and people not able to pay bills. With the pandemic affecting the current hard market, Towle suggests the world will continue to see outcomes from COVID-19 in healthcare for years to come, there will be a rolling effect to various lines of insurance.
She comments: “Carriers are still grappling with initial outcomes from COVID-19, and those outcomes have a dramatic impact on claims in workers compensation or general liability.”
The COVID-19 has created volatility, and with it comes uncertainty which will exasperate the hard market, Towle explains.
Also discussing the COVID-19 pandemic and the hard market, Nate Reznicek, head of US distribution, International Re, suggests that there is no telling how high rates may go and how long the cycle may last if the US market experiences a judgment similar to the ruling just passed by the UK Supreme Court and the natural catastrophe’s continue as they have over the past few years.
Reznicek explains that the recent decision by the UK Supreme Court is estimated to impact nearly half a million small business policyholders across nearly 60 insurers.
In January 2021, the UK Supreme Court handed down judgment in the COVID-19 business interruption insurance test case of the Financial Conduct Authority (FCA) v Arch and Other.
The FCA argued for policyholders that the ‘disease’ and ‘prevention of access’ clauses in the representative sample of 21 policy types provide cover in the circumstances of the coronavirus (COVID-19) pandemic and that the trigger for cover caused policyholders’ losses.
The judgment brings to an end legal arguments under 14 types of policy issued by six insurers, and a substantial number of similar policies in the wider market which will now lead to claims being successful.
Continuing, Reznicek explains: “Although the true value of the losses impacted by this decision may not be known for years (conservative estimates have it at approximately $2 billion) the precedent that has been set is even more uncertain.”
He notes that the US market is not isolated from this “landmark decision” and dozens of insurers involved have both US and international insurer books.
“Clarity of coverage intent will be key and I wouldn’t be surprised for the market to take a draconian stance on the wordings contained within both standard policy forms as well as a significant increase in exclusions,” he concludes.
A useful tool
The hard market shines a light on companies are yet to explore the benefits of a captive. Stubbs says he has already seen increased use for business interruption and extra expense.
Stubbs says: “I believe there is an opportunity for captives to address many other traditional commercial lines of coverage, from mergers and acquisitions to workers’ compensation to directors and officers and employment practices liability.”
Captives that have been in existence for some time have been able to provide their affiliated insureds with the option to increase retention, utilise premium holidays, and implement other creative means in which to mitigate the impact of the market, according to Reznicek.
Unfortunately for those that have not yet taken advantage of funding for future losses through a captive, Reznicek says they are a little behind.
He highlights: “I fully expect that captive interest to increase significantly for insureds with large auto liability schedules, property-heavy risks, as well as almost any trade with a need for excess liability.”
In a recent post, Jim Swanke, director, risk consulting at WTW, recently suggested that captives can provide relief through greater risk assumption.
Many captive owners maintain that they are better off paying substantial premium increases to their captive rather than to an insurer.
Swanke commented: “A captive can also help your organisation access additional risk transfer capacity from the reinsurance marketplace and fill risk transfer protection gaps or layers of coverage in towers where premium pricing is prohibitive.”
Elsewhere, Stubbs thinks a hard market could be a catalyst for the risk management function to better coordinate between commercial insurance and captive insurance, including opportunities to use a captive more aggressively for emerging risks.
In a hard market, captive owners have the opportunity to leverage their own surplus and utilise it in a manner which will be the most cost-effective to secure the type of coverage they need so they can protect their organisation.
Towle explains: “When you have a surplus, you have control of your destiny and don’t need to be at the whim and pricing of the commercial market. Captives can easily tap into the reinsurance capacity, to which organisations without a captive don’t have access.”
“Having your own captive provides you access to your data, which you own and control, thus aiding in the message to the markets and control of the overall pricing,” she notes.
The hard market has also highlighted captives for companies who haven’t considered using them yet.
Challenges
Although a hard market is favourable for captives, Reznicek highlights the biggest challenge will most certainly be carrier appetite.
Historically the adverse changes in the market have resulted in carriers restricting risk sharing appetite and even exiting the market entirely which Reznicek explains can increase the frustration level of both potential and existing captive owners as they look to evaluate options for the future.
He says: “For those insureds looking to enter the captive market for the first time they may also be surprised that the time it takes to implement a successful captive can often be considerably longer than what they have been exposed to with their standard market renewals in the past.”
With this in mind, Reznicek “strongly suggests that insureds that have strong balance sheets and historically positive loss performance to reach out to their brokers now to start the due diligence process in order to determine if a captive solution is a good fit for their business”.
