As we enjoy the first real days of spring sunshine, we can truly begin to put this winter behind us. March came in like a lion but it certainly didn’t leave like a lamb. The same might be said of pricing in the commercial insurance market, where CFOs like me, as well as risk managers, might have reasonably expected some softening after an abnormally risk-free 2013.
In fact, it appears that a number of factors are conspiring to counterbalance the positive results of 2013, results which led to an unexpectedly stable pricing market without dramatic changes. I see these factors coming from four different sources – the increased impact of new regulations relating to risk, some early reminders of natural-hazard risk norms from earthquakes in California, geopolitical uncertainty and a fragile global economy.
On the regulatory front, I see insurers coming to grips with the Own Risk and Solvency Assessment (ORSA). This self-assessment, which is being promoted by the International Association of Insurance Supervisors, will be required of all large- and medium-sized insurers by 2015.
An ORSA will require insurers to analyze all reasonably foreseeable and relevant material risks (such as underwriting, credit, market, operational and liquidity risks) that could affect an insurer’s ability to meet its obligations to its policyholders. Combined with the European Union’s Solvency II Directive, the ORSA is leading underwriters to take a more cautious approach in pricing because it requires them to disclose and report capital allocation by line of business.
The net effect for multi-line insurers is that every line of business has, as it were, to stand on its own feet rather than be protected by the total strength of the company’s capital. In combination, these two emerging regulations are creating a more conservative pricing environment and this trend is likely to continue.
Insurers Fear Uneasy Calm
The second influence on pricing, as we start the second quarter of 2014, is the recognition that 2013 was anomalous from a number of perspectives. As an unusually loss-free year, 2013 was relatively gentle in claims requirements. Earthquakes in California, as well as the mudslide in the Northwest, are reminders that a repeat of a calm 2013 is unlikely and insurers are pricing in expectation of a 2014 closer to the norm than its predecessor.
Also note that 2013 was a year of significant growth in capital market valuations. The Dow Jones Industrial Average ended the year over 16,000, for an annual increase of 26.5 percent, its best since 1995. The NASDAQ also had a record performance, closing the year up more than 38 percent, its best since 2009. This is a record that most economists feel is unlikely to be repeated. In fact, many commentators feel that a correction is due at some point this year.
This sentiment would probably have existed no matter what the economic picture looked like in 2014. The pessimism has certainly deepened in the light of the fragility of the economic recovery in the United States, continued difficulties in Europe and fresh concerns in China and Brazil.
Lack of confidence in the world economy has also not been mitigated by the current geopolitical environment. Even before the government transition in Ukraine that led to Russia’s occupation of Crimea, the civil war in Syria and continuing upheavals in the Middle East and Turkey have contributed to the perception of increased risk in the world economy.
Whether viewed through the lens of corporate earnings or market valuations, this darker economic picture has made underwriters even more conservative in their pricing decisions. This conservatism continues, of course, to parallel the caution that CFOs in general are exhibiting in their investments in capital expenditures across the board. Exuberance of any kind is hard to find.
Beware of Short-Term Premium Cuts
In light of this picture, there are three things that CFOs and other insurance buyers should keep in mind.
- CFOs should beware of any short term policy price reduction being offered by carriers. Not only are such reductions unlikely to be sustained, but they also may actually increase an organization’s overall cost of risk if losses end up being uncovered.
- It is also critical for CFOs to understand that, in these conditions, risk is dynamic and constantly evolving.
- Finally, CFOs should understand their insurance providers’ business model and the results the insurer anticipates. Transparency by insurers in this area is key so buyers can make well informed decisions.
For the insurance buyer, 2014 so far is proving to be less friendly and more challenging than might have been expected, with an interlocking series of forces counterbalancing what might otherwise have been a softening in the market. Given the likely persistence of these forces, it is hard to anticipate more friendly market conditions for the insurance buyer for the foreseeable future. We can enjoy the first green shoots of spring here in the United States. Unfortunately, it’s always winter somewhere.
Jeffrey A. Burchill has been FM Global’s CFO since 1999. He was the subject of a previous CFO interview on the insurer’s currency strategy.