As commercial property owners renew their insurance programs in 2017, they’ll be pleasantly surprised to see their property premiums continue to decrease. Those owners can thank favorable meteorological and financial conditions for their good fortune.
Florida hasn’t been hit by a major hurricane in more than a decade. Hurricane Matthew skirted much of Florida’s coast, ultimately wreaking damage and disruption in Jacksonville, but overall, had a relatively small impact on the state and the insurance industry as a whole. Insurers have enjoyed the good weather, which has attracted more competitors to the state at the primary and reinsurance levels, while better technology and predictive modeling have driven property catastrophe (CAT) coverage closer to a commodity, making it difficult for existing carriers to firm up rates, let alone drive increases.
Weathering the Storm
Even if we were to experience major storms in 2017, the effects of any jolt would be contained. As carriers begin the new year with significant surplus in their coffers and the January treaty renewals wrapping up, initial reports point to another year of declining reinsurance costs. For carriers, the cost of capital has declined materially for years and their ability to strike a better deal has cascaded down to property insurance buyers.
Alternative capital, which for some time has disrupted the reinsurance industry, has in recent years become available directly to property insurance buyers through regulated carriers and products. These new capital sources offer cost advantages over their more senior competitors, as they aren’t building robust internal distribution salesforces, regional offices or policy execution infrastructure, as was the traditional model for the existing carriers with legacy infrastructure.
Real estate owners and managers seeking to decrease their insurance operating expenses will best leverage these conditions by finding an insurance broker that specializes in commercial real estate properties. These niche brokers communicate daily with the wholesalers and hot managing general agent (MGA) programs to gain access to products and capacity provided by emerging capital sources.
With the right help, owners can find new, private companies that: 1.) aren’t burdened by legacy claims, 2.) are aggressive about growing market share, 3.) have a higher risk tolerance than publicly traded companies and 4.) have investors waiting in line to park their cash in the industry.
The market was very different a decade ago when we had very few dominant players competing on a primary basis for catastrophic exposed risks, commonly referred to as “wind coverage” in Florida. The number of companies with an appetite for wind coverage has doubled today. And for larger CAT-exposed property portfolios, as many as 40 carriers will compete for an excess layer of risk in a shared tower program.
Coverage from Reinsurers
Reinsurance carriers, which backstop the primary market, have a similar predicament. Insurance carriers turn to reinsurance markets to transfer some of their exposure in the same way property owners do. Solid performance and years of historically low interest rates have steered capital into reinsurance firms, where returns are stable. During the past several years, capital has poured into the reinsurance space, where investors are seeking higher yields than that available on treasuries and similar investments. Other factors, such as trends toward greater retentions, more accurate modeling, new regulations, industry consolidation and technology, have all compounded to challenge the market’s desire for rate stabilization.
In a market long on cash and short on claims, the capacity of reinsurers has grown, while the amount of reinsurance purchased by primary carriers — due to their own surpluses — has reduced. Further compounding the already competitive environment, mechanisms now exist which allow the capital markets to more easily enter the markets quickly. Consistent with some opinions that the current conditions are the “new norm,” it’s possible that when a hint of rate increase is felt, it will be quickly undercut by new entrants, looking to capture market share and willing to put their capital to work, for less. This trend will continue, likely until a market surprise of sorts, making people think twice about investing in the industry.
On the Horizon
What could cloud these conditions? One possibility would be a storm or series of storms that prove worse than predicted, resulting in industry total losses that exceed projections from forecasted catastrophe models. For instance, reinsurers would remain calm if claims reached into the hundreds of millions of dollars, so long as the total loss fell within an acceptable range from what was modeled. Again, the capacity exists to absorb great losses, and in this case, the fundamental underwriting and exposure modeling would be shown to be sound. However, the market could be buffeted by a storm that caused $100 million in damage when just $30 million was expected.
This scenario could cause some doubt or lack of confidence in the way catastrophes are modeled and lead carriers to question whether exposures are adequately priced. Higher interest rates, which have been expected from the Federal Reserve for some time, could slow the rate at which capital flows to the reinsurance markets, which long-term could have an effect on industry surplus. However, in the short-term, incremental interest rate increases would have little impact on the property insurance rates proposed in owners’ upcoming renewals.
The question today is what to do with the savings. Should a property owner or manager send the savings to the bottom line? Or should they maintain the premium figure and tweak sublimits and deductibles?
The answer depends in large part on the insured’s risk profile and capital position. How much does an owner or manager want to pay out of pocket? Higher sublimits and lower deductibles will lessen cash demands should a property sustain even minor damage. And if a major hurricane hits, owners and managers can rest easier knowing that the cash demands will be tempered by better coverage.
— By Tom Kersting, president of Insurance Services for Franklin Street. Tom can be reached at [email protected].