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In recent years, there have been a number of unprecedented catastrophic losses that have negatively affected the capital held in reserve by insurers and reinsurers, creating a hard market for many lines of business. (Photo: gopixa/Shutterstock)

According to Willis Towers Watson’s 2021 Insurance Marketplace Realities Report, hard market conditions are expected to continue into 2021, with rate increases in almost every line.

The most affected lines will be property, umbrella, directors and officers (D&O), and fiduciary, followed closely by cyber insurance. Non-challenged properties are predicted to see increases of 15% to 25% in 2021, while umbrella increases will stagger from 30% for low-moderate hazard to 150% for high hazard excess. All categories of D&O are expected to see double-digit increases in 2021, with some as high as 70%.

Cyber insurance rates are expected to increase by 10% to 30%, while general liability rates are expected to increase by 7.5% to 15%.

Workers’ compensation rate decreases are flattening, according to Willis, with a slight increase in response to high severity/excess losses. Unsurprisingly, workers’ compensation remains the casualty line with the most COVID-19 claim activity.

Some moderation in property rates is anticipated by mid-2021, following two cycles of rate increases by that point, per the report.

A bright spot on the horizon may be found in the following statement by Joe Peiser, global head of broking at Willis Towers Watson: “However, our experience in this hard market is that there is a wide range of results; renewal results are not huddled around the mean. This means underwriters are underwriting, and there is the opportunity to differentiate your risk.”

What makes a hard market?

A hard market may also be referred to as market tightening. This is because insurance availability, usually of a particular line, becomes more difficult to obtain and often may be more expensive. This typically happens in the commercial property and casualty markets as a result of catastrophic losses, large jury verdicts, or other factors affecting the profitability of insurers and reinsurers.

In simple terms, the insurance industry takes in premiums to pay losses. A certain portion of their premiums typically go to reinsurers to offset catastrophic losses or to free up capital, and another portion gets set aside in reserve funds. Insurers invest the premiums they take in to make money off the investments. The amount set aside in reserve is determined by actuarial calculations that consider previous loss history and earnings, and actuaries use this to make predictions about losses and the rates necessary for the company to maintain a profit.

The actuarial predictions are not just for the current year but usually for five or maybe ten years. If the insurer doesn’t set aside enough reserve funds, they get downgraded as to their financial stability by rating agencies such as A.M. Best and Standard & Poors. Therefore, insurers must take in enough premium to cover the losses that happen in the current year and have enough in reserve to cover unexpected catastrophic losses that were not accounted for in the actuarial predictions.

When policyholders start seeing their rates increase or with higher deductibles required in a hard market, some policyholders may decide to self-insure their risks to keep premiums lower. By self-insurance, they may decide not to purchase insurance for some risks and simply go bare — meaning that the entity will pay for its own losses; or they may self-insure all or part of their deductible.

In a hard market, policyholders look for new ways to insure their risk. Groups of policyholders with similar exposures may create an insurance pool, where each member contributes to the premiums and losses.

Another way entities insure their risk is through captive arrangements. In a hard market, you are apt to see a lot more captives being formed. The continuing hard market and captive growth is the subject of this discussion.

The role of captives

A “captive insurer” is generally defined as an insurance company wholly-owned and controlled by its insureds. Its primary purpose is to insure its owners’ risks, and its insureds benefit from the captive insurer’s underwriting profits.

A recent survey by Marsh noted that the firm formed a record number of new captives in the first seven months of 2020, with 76 new captives, a 200% increase compared to the same period last year.

With premium increases and commercial insurers cutting back on their limits, many organizations are expanding their captives. Those without captives are looking to get captive feasibility studies done, as reported by Jim Swanke, head of captive solutions, North America for Willis in Minneapolis.