Why is your Insurance Premium increasing? You better learn about a hard market.
If you have been following the news across Canada you have probably seen some information about insurance premiums increasing, and most notably for condominium buildings. There are other classes of property, such as automobiles and commercial businesses along with many other industries and segments. Some classes are being hit with rates increases worse than others but there is an increase ‘across the board’ and no class of risk (as insurance people like to say) is being spared. So why is your premium going up?
When a hard market hits, insurance companies react in all sorts of ways, but the result is the cost for insurance rises and the consumer pays the price. A hard market is typically defined by these traits: a lack of capacity (dollar amount) to insure classes of business, more expensive reinsurance costs (insurance companies also buy insurance), claims ratios where insurance companies are paying out more money to claims than they receive by premium, and insurance companies leaving the market as it relates to insuring certain classes of risks.
For the average homeowner, business owner or car owner that’s a lot of high-level information to explain why their insurance premiums are increasing. Let’s break it down one by one and then add some more information to explain why we are in a perfect storm for rate increases.
Lack of capacity
When this happens, insurance companies have insufficient funds to support insuring more property, whether it be homes, automobiles, condominiums, commercial buildings or other classes of risk. The result is that premiums increase to allow for the reserves of funds to grow again. What many insurance policy holders do not realize is that insurance companies are federally regulated to have a specific access to capital so they can pay claims.
An insurance policy is simply a conditional guarantee for an access to capital, and like the average policy holder, insurance companies purchase access to capital from reinsurance companies. Reinsurance companies support many insurance companies and provide capacity, but when more and more losses happen and the severity of losses increases, even the reinsurance companies must increase costs for their own reserves. The trickle-down effect is much like inflation, the consumer pays more.
One of the key metrics for insurance companies is the claims ratio. This means the connection between the dollar amount of premium written vs the dollar amount of claims paid. Anything over 100 is bad as it means there is more money being paid out compared to earned premiums. Also consider that an insurance company needs to pay people and cover all its expenses from those premium dollars.
Retreating from the market
When an insurance company loses some of its capacity and the reinsurance costs goes up while the claims rations increase, they often will tend to stop writing business in certain classes or regions. This is known as retreating from the market. The result is it leaves fewer companies writing business in a region or for a particular class of risk and the capacity of other insurers is tested and potentially strained. It also leaves less options for insureds to find coverage and the coverage they do find will almost certainly be more expensive.
To compound all these standard hard market traits there are other factors at play, most importantly technology. Insurance companies prefer to write profitable business meaning classes of business in regions that does not cost them money in losses. The development of data in the last fifteen years has allowed insurance companies, and reinsurers, to be far more precise in who and where those profitable classes of businesses are. In some situations, only the best risks receive options of insurance from many companies and less desirable risks will receive few, if any options of coverage.
The core principle of insurance is that the premiums of the many pay for the losses of the few, but that principle is being tested on many fronts. When losses cost more, happen with greater frequency and have less entities to absorb the losses the costs of insurance will inevitably increase. Combined with investment rules and regulations for insurance companies it is harder for insurance companies to find new opportunities to earn money without affecting premiums.
There is a reason the insurance industry calls this a ‘hard market’ and that’s because it is simply harder to place business, find affordable premium, reduce loss exposure and earn a profit. It’s not always easy to predict when a hard market will start and it’s even harder to predict when one will end and unfortunately this is the situation the industry and consumers are facing now and the foreseeable future.