March 3, 2020
By John Merrigan, Deals Managing Director, PwC
Many business leaders may not spend much time thinking about insurance, but in recent months, premiums for most commercial policies — property, auto, general and excess liability, and officer and directors’ liability — have been climbing rapidly, leading to higher expenses and deductibles.
While there’s no sign that rising insurance costs are causing companies to rethink acquisitions, joint ventures or IPOs, they definitely add to the costs of such transactions. And that’s likely to continue this year and into the next as deal professionals find it more difficult to get insurers to shoulder the additional costs of poor insurance risk profiles.
Significant underwriting losses over the past few years have driven the increases, often without regard of a company’s risk profile or geographic location. A surge in hurricanes, floods, earthquakes, wildfires and other natural disasters followed a decade of historically low insurance premiums.
As a result, most insurers across certain lines of coverage have sought and are winning higher premium rates to make their underwriting activities profitable. Even companies with few or no recent claims are facing higher deductibles and premium rates — increases of 25% or more in some cases. Businesses with exposure to catastrophic weather events, such as hurricanes in Florida or earthquakes in California, are seeing an even bigger rise, as are companies in higher liability sectors such as the trucking industry.
More discipline in rates, higher losses from other policies
What’s surprising about this market correction is how effectively insurance companies have maintained their discipline in upholding the higher prices. In the past, when markets have tightened and premiums increased, higher pricing would be undercut by new competition. Today, however, insurers are showing few signs of breaking ranks on pricing, and few new entrants are underbidding the market. We may be seeing a situation among insurers similar to the airline industry, in which participants have largely maintained pricing discipline, resulting in a new standard of higher rates.
Shrinking capacity also can influence higher premium rates. Often insurers will rein in coverage if they’ve endured losses or a significant rise in claims. After the 9/11 terror attacks, for example, many insurers reduced their exposure to claims by reducing the underwriting capacity they offered. This time, however, insurance capacity continues to be available for most companies willing to pay for it. Higher premium rates and the resulting costs affected most US businesses that renewed policies in 2019, regardless of sector.
While insurance markets are always cyclical, this pricing pressure may be longer than average and may continue through 2020 and into 2021. Property rates for risks with catastrophic risk exposures could increase this year by 10% to 20%, according to Insurance Marketplace Realities 2020 by Willis Towers Watson, an international insurance brokerage and risk management firm. Companies with catastrophic risk exposures and losses may have rate increases from 15% to more than 35%, and non-catastrophic risk companies may face rate increases of 5% to 15%. The insurance firm Aon has reported average property rate increases in Q2 2019 of 14% over Q1 2019, and in Q2 2019, accounts with loss ratios over 100% faced rate increases.
The biggest increases came for companies that renewed policies in the latter half of the year. The cost of US commercial policies in general increased more than 10% in the fourth quarter of 2019, according to the latest pricing report by Marsh, an insurance broking and risk management firm. Property rates led the surge, rising more than 18%. We should note that Marsh averaged results across all industries and company sizes.
Aon reported in Q2 2019 that 70% of their property renewals had rate increases, and the fourth-quarter results may reflect even higher levels of companies hit by rate increases. Most companies have been touched by the higher rates, and some have been particularly hard hit. For example, those whose property insurance claims exceed their property insurance premiums have seen those premium rates increase by 75% or more. Even among companies with lower loss ratios, premium rates have increased by an average of 25% from 2018.
Insurers also have reported higher losses from other types of policies, such as directors’ and officers’ (D&O) insurance. As a result, we’re seeing increases across most private and public company policies. Premiums for private companies’ D&O insurance, for example, are expected to rise an average of 5% to 40%, according to Williams Towers Watson. For umbrella policies, WTW forecasts increases of 30% or more for high-hazard policies and 15% to 25% for low- to moderate hazard coverage. Excess liability rates are also rising, with high-hazard clients such as operators of large vehicle fleets experiencing increases of 25% or more, while low- to moderate-risk clients face increases of 15% or more.
The impact on deals and what companies can do
This hardened insurance market can directly impact buyers and sellers in mergers and acquisitions. In a recent carve-out transaction, the seller was spinning off a business with main locations in high-hazard zones – one on California’s San Andreas fault and another in a 100-year flood zone. The availability of property insurance for high-hazard risk, the cost of coverage and deductible levels were material deal considerations in the proposed transaction.
Stories like this may seem extreme, but they’re less rare. Both buyers and sellers should be aware of the insurance market and its potential deal implications. This includes asking questions such as:
- Have historical expenses been adjusted to reflect current premium rates and possibly higher levels of risk retention?
- Can a business carved out from a much larger parent stand alone in a commercially reasonable manner given the availability and cost of property insurance with locations in a high-hazard zone or with a poor loss history?
- Can a seller get ahead of potential buyer concerns by arranging with its insurers to insure the business separately?
Deal professionals don’t have the same opportunity as they did as recently as 2018 to inexpensively deal with poor insurance risk profiles by laying the risk off onto insurers. As a result, companies must be proactive in dealing with the insurance market.
For instance, it may not be realistic for a company to move operations from a high-wind zone if the company can demonstrate loss resiliency with tested business continuity and disaster recovery plans. Businesses may be able to mitigate the impact of the market correction by ensuring they have effective safety, risk control, business continuity, recovery and property loss control programs and empirical data to prove it.
While the cost increases experienced by companies with good loss records may be painful, effective risk management typically results in lower costs compared with those borne by companies with poor loss records. In other words, companies that can demonstrate commitment to risk management should fare better than those that can’t.
They may also be able to reduce insurance costs by evaluating their current risk levels against their premiums, validating that data and providing it to insurers. By sharing that information and meeting with underwriters, company officials can improve insurers’ understanding of the company and its risks, which may help mitigate rising costs.
All of this may not shield companies from premium increases, but it might make those increases more manageable. Even the best-run companies with the lowest histories of claims need to prepare, as higher insurance costs are likely to be a significant factor in deals for the foreseeable future.