7 August 2019Accounting & tax analysis

How to dodge a commercial rate hike

Following big losses in 2017 and 2018, the wider insurance markets have started to experience hardening rates. In North America, many key lines of businesses ranging from property-catastrophe, to directors & officers (D&O), to workers’ compensation have enjoyed steep rate increases in some instances.

According to Willis Towers Watson’s Q1 Commercial Lines Insurance Pricing Survey, prices for commercial auto, commercial property, excess/umbrella liability and D&O have all been increasing steadily and again there were increases in the first quarter of 2019.

The survey compared prices charged on policies underwritten during the first quarter of 2019 to those charged for the same coverage during the same quarter in 2018. The aggregate commercial price change reported by carriers was close to 2 percent for all four quarters of 2018, and came in just above 2 percent in the first quarter of 2019.

Data for four standard lines indicated material price increases in the first quarter: commercial auto, commercial property, excess/umbrella liability, and D&O liability. Price changes for most lines were similar to or slightly above those reported in the fourth quarter of 2018.

These findings are supported by the Council of Insurance Agents & Brokers’ (CIAB) Commercial Property/Casualty Market Report Q1 2019, which suggested commercial pricing by account size increased an average of 3.5 percent in Q1 2019, compared to a 2.4 percent increase in Q4 2018 and 1.6 percent in Q3 2018. This trend began in Q4 2017, with average rates increasing moderately, indicating firming market conditions across all sizes of accounts.

Commercial auto continued to experience the largest premium price increase at 8.8 percent, compared to 7.0 percent in Q4 2018. Furthermore, commercial property saw the largest increase relative to its Q4 2018 increase, from a 2.9 percent increase in Q4 2018 to a 5.9 percent increase in Q1 2019.

Some of this is being driven by hikes in reinsurance pricing. Following disappointing pricing increases in 2018 and early 2019, despite the heavy losses borne by that market in the preceding two years, during this year’s April and June renewals, reinsurers saw property catastrophe rate increases in the 15 to 25 percent range on loss-affected accounts, according to a report published by S&P Global Ratings.

S&P characterised the current global reinsurance pricing environment as a hardening market rather than a hard one in a report titled For Global Reinsurers, 2019 Pricing’s Green Shoots Look Promising.

Yet it seems that, for captives, there are still much better deals to be had in the reinsurance sector. Many more captives owners, it seems, are reacting to hardening rates on the primary side by reassessing the amount of risk their captive takes on—and some are looking to tap the reinsurance markets directly.

Dodging rate hikes
The onset of this hardening market has prompted many companies to explore ways of leveraging their captive to help avoid, or at least offset, some of the rate increases, according to Jason Flaxbeard, executive managing director, captive management and consulting, Beecher Carlson.

Flaxbeard says that, helped by advisers, more are leveraging analytics to get a more holistic sense of their overall risk exposure and then establish how they can better use their captive to manage that risk.

“People have been used to 15 years of a soft market; now, we are seeing rate increases across many lines of business including property, D&O, and workers’ compensation,” he says. “People are wondering how to deal with that and one natural conclusion is to self-insure more, to use their captive.

“Analytics is being used to establish the optimal risk structure for companies—it is a different way of cutting the cloth. If companies are buying monoline insurance coverage, a different policy for different risks, they forget that these risks are usually not correlated.

“You might be able to use a captive to cover this in a different way and offset rate increases on those specific lines.”

Flaxbeard adds that although the use of analytics is nothing new, it has had a new lease of life in the past three or four years, while hardening rates have led to a spike in inquiries about its potential. It combines a number of forms of analysis including actuarial, catastrophe risk models and stochastic models to generate an integrated overall risk profile for firms, he explains.

“This process can give risk managers the tools to work with CFOs to establish a new structure for transferring risk in a more efficient manner. It can be a way to insulate yourself against a hard market,” he says.

Avoiding unbudgeted costs
John English, CEO, captive and insurance management at Aon, agrees that he is seeing large companies look to better leverage their captives to avoid “unbudgeted” rate hikes on their traditional insurance programmes, with some using captives to work with reinsurers directly to get better deals.

English says that he is seeing many of the clients he is speaking to looking to navigate the hardening market by using their captives in very specific ways.

Many companies, he says, even with loss-free portfolios, are being hit with rate increases of 10 percent or more on property business; companies that have suffered losses are seeing increases of more than 30 percent in some cases. On top of this, nat cat business is proving problematic for many clients with retentions increasing and the risk appetite of carriers changing.

“This is an unbudgeted cost for many clients and they are looking to their captives to help navigate what is going on,” he says.
Some firms, he adds, are looking to mitigate increased retentions being imposed by their insurers by using their captives to place a cross-class aggregate cover directly into the reinsurance market. “The net effect is a lower retention by accessing reinsurers directly,” he says.

Others are stripping the natural catastrophe element of their property programme out and placing it separately into the reinsurance market via their captives. English has seen one client in North America do this using a parametric trigger. “Seeing a corporate go directly to the reinsurance sector and use a trigger like that is pretty interesting,” he says.

Finally, he says, some financial institutions that are grappling with a spike in rates and restrictions on coverage for professional indemnity and crime, are looking to use facultative reinsurance on an opportunistic basis. “They are using it tactically,” he says, “but all these are examples of using a captive more efficiently.”

Oceana Yates, senior vice president at Quest Management Services, agrees that this is a big trend at the moment. She says that with the hardening of the commercial insurance market for many lines of business, captives are being used more either for increasing retentions or for new lines that were traditionally placed in the commercial market when it was softer.

“We are seeing this increase in interest from all industry sectors,” says Yates. “I’m seeing this particularly in medical malpractice and auto lines at the moment in the US, but the brokers are saying the market is hardening throughout the property and casualty lines.”

Yates also notes that there is an increasing use of captives for different lines, for example medical stop loss, environmental exposures and cyber, and there is also a big push for digital asset business and insurtech.

Paying too much for collateral arrangements?
Captives could be saving themselves money on collateral arrangements, according to Robert Quinn, vice president, global capital markets institutional client services at Wilmington Trust.

He claims that many captives are still paying over the odds for their collateral arrangements due to inertia when it comes to exploring the use of captive collateral trusts instead of letters of credit (LoCs). While more captives are starting to use the option, many captive owners and captive managers neglect the idea, often due to myths that do not stand up to scrutiny, he says.

Quinn has worked in this sector, helping captives and other risk vehicles, for trusts for some 20 years. He estimates that 20 years ago, only around 5 percent of captives used trusts; now, he estimates, that is closer to 35 percent. But it has been a long road and that still leaves 65 percent of captives paying too much, he claims.

“When I started in this business in 1999, not many people knew what a trust was. I was at one of two banks that spoke specifically to collateral. There were many myths around their costs and how long it took to establish a trust account.

“A lot has changed since then and there many more providers now, but the myths remain and the inertia is still in place in the market when it comes to changing things,” he says.

Quinn states that for a captive with $10 million of collateral requirement, a LoC will cost between 50 and 75 basis points, which equates to around $50,000 to $75,000. Plus, it then needs to cash-collateralise the LoC. In contrast, a trust can simply be used as a vehicle for the same cash and only an arrangement fee will be required, of around $5,000.

He also notes that, whereas most LoCs need to be renewed every one to three years, trusts will continue until both parties agree to unwind them.

“The perception has been that trusts are much more difficult to establish, but that is not true,” he says. “Most fronting carriers are now very familiar with their legal requirements and it is far easier than a LoC to form. Once we have all the necessary documents from a client, it generally takes no more than two days.”

Quinn adds that in the aftermath of the financial crisis there was a spike in the use of trusts as credit was harder to get and the cost of LoCs soared. Take-up rates have normalised again now, he says.

“LoCs have more flexible investment criteria, allowing users to make a more substantial investment return. While this is true in some cases, most captives are relatively conservative in their investment tolerance and this difference is nil for the average captive as a result,” he concludes.