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Explanation of the Current Insurance Market
By John Schreiner
Prior to the September 11, 2001, Terrorist Attacks on the World Trade
Center and the Pentagon, the insurance market was adjusting rates upward.
Several forces were at work creating this upward rate adjustment.
(1) Interest income from investment on loss reserves and surplus was negligible due to the low interest rates and poor returns of the financial markets. This forces rates to increase to cover 100% of the expected loss rather than 95%.
(2) Social inflation has continued to increase the cost of claims and the cost to defend liability claims, i.e. medical costs are up; cost to repair property losses are up; legal expense rates are up; labor cost is up.
This means severity of all claims is higher than in past years.
(3) Frequency of claims has increased slightly. Employment Practice, Americans with Disability Act, Directors and Officers liability and Automobile are examples with increased frequency of claims.
(4) Catastrophe claims, which were below average in the mid-1990's have seen consecutive years of worse than average experience, which adds pressure to increase reinsurance rates.
(5) Mold claims are the new unexpected and not intended to be insured claim type which the industry has not contemplated in rate or loss reserve. This was causing rate increases for both property and liability coverages.
(6) Market conditions of the late 1990's did not permit insurance companies to increase rates even though these loss conditions were evident. This created a longer period of underwriting loss, which further deteriorated the surplus and financial strength of the industry.
The terrorist attacks of September 11, 2001 have added a significant new factor, which dramatically worsens the insurance market.
(7) The insured losses are estimated at $50 billion to $80 billion.
(8) A large component of the losses are property losses, which require payment in a relatively short time frame. This means many insurance companies have immediate cash needs.
(9) The surplus and capacity (the amount of available insurance) in the insurance industry has been significantly reduced. The information available to our office suggests that there may have been a loss of 15% to 25% of the market surplus as a result of the attacks. The capacity loss may be even greater. Insurance companies are able to accept a smaller limit of liability than was previously their maximum limit of liability.
(10) Reinsurance Recovery (payment of claim liability from the Reinsurance Company to the Insurance Company, which issued the insurance policy) is an issue. To the extent an insurance company is unable to collect these claim payments from a reinsurer, there is an unexpected financial hardship for the insurance company. It is expected that some reinsurance companies will not be able to pay their claim liabilities. This could cause insurance company insolvency. As a result, insurance companies will switch their reinsurance to fewer more financially solid reinsurers, where-ever possible. Reinsurance solvency is more important than lower reinsurance rates.
(11) The loss of asset value in the financial markets has also reduced insurance company surplus to the extent that insurance companies were invested in equities. This was further reduced as a result of the slow down of business and loss of earnings stemming from the attacks of September 11, 2001.
The loss of capacity creates a condition where demand, which is fairly constant, exceeds supply, which can fluctuate and is now well below demand. The result is that all rates and minimum premiums will increase. Coverage terms will be more restrictive. The financially strong insurance and reinsurance companies will be in the driver's seat because they are the companies in demand.
In short, the cost of capacity has increased significantly and every insurance policy will be impacted in some way.
Looking ahead, it will take a few profitable underwriting years for the
insurance industry to correct these conditions and permit the market to
return to a "buyers" market.
last updated: October 16, 2001
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Diversified Risk Insurance Brokers
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