Navigating the New Market

In a rare historical moment, the hardening of Canada’s insurance market is happening at roughly the same time as a downward turn in Canada’s economic market. For risk managers, this raises the obvious question of what to do when they must cover more potential risk exposures at the same or lower price, when insurance prices are increasing and coverage availability is decreasing. The current conditions have some risk managers preparing to head into renewals and bracing themselves for what some are calling “the perfect storm.”

Statistics Canada reports that the country’s gross domestic product sank 3.4% in the fourth quarter of 2008 — the largest decline since the 1991 recession. As the current recession plods along, it appears no industry or market will make it through unscathed. Companies across all sectors are in the process of trimming operating costs in an effort to maximize efficiency.

At the same time, murmurs of a long-awaited hard market are transforming from rumours to actual signs of increased rates. This hard market will be different, though, in the sense that risk managers won’t necessarily see a severe spike in rates, industry experts are predicting. Instead, they are likely to witness an incremental increase in rates throughout 2009, which will undoubtedly affect renewals moving forward into 2010.

The much-anticipated revival of the hard market, whenever it happens (if it hasn’t happened already), is a sword dangling over the heads of the Canadian risk management community. As risk managers prepare to navigate their way through this financial storm, many have been told by their boardrooms to cut spending and increase the risk retained by the company. The end result is to increase the companies’ loss prevention efforts.

What decisions does this force a risk manager to make? In a climate that can best be described as uncertain, how do they determine which carriers will remain standing after this financial storm blows through? What other enterprise risks are created by the financial turmoil? What parts of their risk management programs should be contracted and which should expand?

Hard market seeping in

When exactly the hard market will be in full swing is still up for debate. Many industry experts suggest that, unlike the hard markets of 2001 and 2005 (ushered in by 9/11 and Hurricane Katrina, respectively), commercial insurance rates won’t necessarily spike. Instead, they will more likely creep higher in a gradual fashion, with certain lines showing signs of hardening sooner than others. In its January 2009 report, The Hard Market is Coming (But Don’t Hold Your Breath), Advisen Ltd. suggests the average rate levels for commercial insurance are expected to level off in 2009 Q2, and will begin to creep higher beginning in 2009 Q4 or 2010 Q1.

Advisen further predicts the deteriorating global economy could delay the hardening of the commercial insurance market until the end of the year. That’s because the deepening global recession might suppress the demand for insurance, thereby causing carriers to lower rates to keep their market share. But when that hard market does arrive, it might be more prolonged than in past cycles Advisen says.

In Marsh’s Insurance Market Report 2009, researchers found insurance market conditions were generally favourable in 2008. But as the year wore on, the rate of premium decreases slowed. Ultimately, they started to increase in notable lines, such as trade credit. “The signs of an impending hard market abound,” the report says. “Yet the financial crisis is making it difficult to see just how it will evolve and likely that it will look and feel different than previous hard markets once it arrives.”

In the report’s executive summary, Marsh CEO Brian Duperreault refers to the coming hard market as “an invisible hard market.” Because of the “countervailing winds of the financial storm, it may not look that way at first. It’s going to evolve differently than any hard market we’ve experienced in the past 50 years. And that represents a management challenge for the industry in 2009.”

Here in Canada, Paul Martin, president and COO of KRG Insurance Group, notes small business accounts are already experiencing slight increases, one sign of a changing market. “In the $1,000 to $10,000 package policies, we have actually seen a slight premium increase,” he notes. He suggests this could be explained by the fact that rates were “extremely low after the last soft market, and there has been a lot of emphasis put on small businesses insuring to value.”

Mid-market accounts, he continues, which are generally worth between $10,000 and a few hundred thousand dollars, have experienced a fair amount of stability over the past six months. Premiums in this class have been renewed as-is for most insureds, although there needs to be a rate increase in these lines, he adds.

And in larger, multi-national accounts, “I still see tremendous pressure to reduce premiums,” Martin says. “Because our economy is not developing a large amount of new opportunities, there’s an increased battle for supply. And it’s better to go after a larger account than it is to go after 10 smaller accounts, so I see a tremendous amount of pressure from competition to push rates down.”

Dan Beaudry, executive vice president and regional marketing officer at Willis Canada Inc., agrees with Martin that for the most part, commercial lines are relatively stable at the moment. He suggests, though, that on a case-by-case basis, rates are beginning to increase — particularly for those carriers with a poor loss experience or large catastrophe exposures. He notes the stress on rates in personal auto lines is now transcending into commercial auto lines. As well, Canada has seen a drop in capacity for financial institution business professional lines, including directors and officers and errors and omissions coverage.

Anticipation

Although the waters seem relatively calm on the rate front, risk managers say they do not expect it to last. “I think everybody is waiting to see what is happening in the market, what’s happening to others [during their renewals] and how others are faring out there,” says Inga Michaluk, director of risk management for the Minto Group in Ottawa. As of press time, Michaluk is in the midst of renewals and she expects to pay higher premiums across the board. “I do expect to see markets hardening but I do believe that the impact will be felt later in 2009.”

Nowell Seaman, manager of risk management and insurance at the University of Saskatchewan, shares this view. He says his January renewals went pretty smoothly, but he acknowledges that it won’t likely be the same in a year’s time. “I think we have to consider that in our budget planning for the coming year and have some anticipation that we’ll likely see some hardening,” he says. “At this point, I’m not anticipating a dramatic hardening or a dramatic loss in capacity. I hope that I’m right.”

As risk managers keep a close eye on rates, the financial crisis presents an entirely new set of uncertainties, says Joe Restoule, leader of risk management at Nova Chemicals and president of the Risk and Insurance Management Society. There are definitely struggling markets that tend to be very competitive in both pricing and terms, he says. “The reason why they’re being competitive is that they need to maintain their market share. The big thing for risk managers is that they must weigh the future of this [pricing competition] against the future of these markets. It creates a bit of a dilemma, because you’re being offered a great rate and competitive terms, but you know that some of these firms have had difficult financial times.”

The major quarterly losses and credit default swap exposures of three or four (re)insurers have dominated headlines over the past year, Restoule observes. But it’s difficult to tell which other (re) insurers may be “lurking in the dark” and not being completely upfront with finan cial woes, burying them deep in the jargon of quarterly reports. This creates an added challenge in solidifying a risk transfer program, he says.

Jump ship?

During these times of uncertainty, risk managers must exercise particular caution when deciding where to place their business. “We’re monitoring our insurers much more closely,” Seaman says. “My concern in this respect is the pressure that insurers will be under in the next 12 to 24 months due to the financial markets, the economy or other factors. To what degree do those factors precipitate a hard insurance market cycle or affect the viability of the insurers?”

It has to be a constant monitoring process, adds Restoule. This involves following the financial reporting in the trade press, rating agency reports or actions, conversations with brokers and in some cases direct conversations with carriers.

“If you don’t have a dialogue, and you don’t know what they [the insurers] are planning for the future, are you making the right decision?” he asks. “Do you have enough information? Typically in these one-on-ones, they will tell you about their road to recovery or their long-term vision.”

Linda Stojcevski, director of global risk management at Magna International, agrees the increased monitoring of carriers has become one the larger challenges that the current economic climate presents. “The biggest challenge is just making sure that our risk is spread and placed with markets that are financially strong,” she says. “The other step is making sure that we’re well diversified and that we’re not aggregating with any one market.”

Once a risk manager has considered the solvency of a carrier, he or she may want to consider the insurer’s strategy as well. “Speak with insurers who just do insurance, rather than those markets that do insurance but have other financial services activities — those are the things that have really weakened the balance sheet,” Restoule adds.

Risk managers admit to being fairly loyal to their insurers, but in tough times like these, every decision needs to be scrutinized, Michaluk says. “You like to stay with the insurers that have served you well, and obviously you are double-checking that their financial status is up to standard,” she says. “And if one or the other isn’t up to standard, then you have to go back and figure out what risk they are on and can you recommend that they stay on. The last thing you want to do is recommend a company that will be in trouble or gone by the end of the year.”

Pushing the panic button and jumping ship may create more issues than staying put though, says Terry Henderson, global risk manager at ShawCor Ltd. Certainly a risk manager needs to pay close attention and obtain as much knowledge as possible, but longevity and relationships still need to be taken into consideration. “It gives one pause to think, if this was a small carrier that wasn’t deeply intertwined into our business a decision to go or stay would be relatively easy,” Henderson says. “But the effects of just pushing the panic button can be very high for everyone and not necessarily appropriate behaviour.”

Large global insurers have networks with a global reach that bring value to multinational organizations, he continues. “We have been with all of our panel of insurers for a considerable amount of time. We have regular contact with them. They treat us fairly and we have negotiated in good faith for many years.”

The policy wordings and premium levels that have been negotiated over the years have value, he continues. “As long as the claims are going to get paid.”

Rising rates, rising deductibles and increased loss prevention

Once a risk manager completes his or her due diligence and feels confident their selected carriers will weather the economic downturn, they still need to maximize their risk transfer program. These days, chances are that this will be done on a tighter budget. Restoule says that he’s heard from many RIMS members that they’re receiving boardroom directives that the company “won’t pay more than last year.”

As budgets shrink and premium rates begin to creep skyward, it appears deductibles are also creeping upwards and companies are assuming more of the risk themselves. Beaudry says this will be interesting to watch in 2009. “Given the pressure put on the customer to reduce costs and a market that is leveling off, [companies] might be forced to make different buying decisions,” he says. “Some [options] might be higher deductibles, lower limits or the decision not to buy certain coverages that are considered nice-to-haves, but not need-to- haves.”

One example of a “nice-to-have” form of coverage is business interruption coverage, Restoule says. “Given the downturn in the economy, are you going to be producing a big net income?” he asks. “And if not, do you want to buy that coverage, or maybe do you just want to buy fixed or continuing expenses?”

These kinds of coverages may end up being a casualty of insurers exercising a much more stringent underwriting process, Beaudry adds. Underwriters are taking a second look at the “frills” afforded on a client-by-client basis, he says. “Certainly if there have been some losses in that particular extension of coverage, then you could see that potentially going away or potentially being re-underwritten. An example of that would be product defect or product recall coverages for specific industries where they are not commonly available.”

But after coming through the most recent hard market less than a decade ago, the risk transfer program is already as efficient as possible, with little to no coverage that could be considered nonessential, Seaman says. “If we have to make adjustments for budgetary reasons, we would consider increasing our retention levels before considering lowering our catastrophe limits.”

Decreasing coverage and higher deductibles will place pressure on the organization -specifically the risk management department -to ensure that loss prevention programs and claims handling departments are beefier than during soft market times. “Loss prevention is a big priority,” Michaluk says. “We need to try to avoid having claims to start off with, which will in the long run affect premiums.”

Internal education programs raise awareness and internal inspection programs help to ensure that situations do not evolve into claims, she continues. “Normally we’ll do a dozen inspections at random during the year. Now we say: ‘Let’s do the inspections sooner than later.'”

Should a loss occur, claims service becomes paramount: it is important to ensure claims do not evolve into pricey lawsuits, she adds.

Construction and capital projects certainly need to be managed, and Seaman says his workplace has focused on improving its capacity to prevent and respond to crises. “We’re taking it further than disaster response,” he says. “We’re doing everything we can to identify and prevent crises. Violence in the workplace is always a concern, but we’re looking at more counseling or services and a better threat assessment process.”

Even simple steps help, he said. This might include having a third party examine boiler and heating systems, or double-checking that the organization is carrying the right amount of insurance.

A complicated matter

It seems logical for companies to retain more risk in an effort to curb spending. But not everything is logical in this credit- depressed era.

For example, Restoule says he’s heard of companies increasing their risk transfer program during the financial crisis, so that they maintain access to much-needed capital.

Typically for large corporations that retain large portions of their own net risk, if there are losses, they access capital to pay for it because they can not afford to cover it from their existing cash flow. “You would go to your credit lines or your banks, but I don’t think that’s the case anymore,” Restoule says. “The banks are now insisting on solid risk transfer progra ms and these banks are completely risk-averse these days. There’s little flexibility with them in loan covenants. It’s a double-edged sword.”

In addition, the financial turmoil has created a new breed of enterprise risks across all sectors of the economy. For instance, the tightening of capital flow has resulted in a heightened regulatory risk, Seaman says. “Specifically, [the risk is associated with] the required contributions that we must make under regulatory requirements in order to make sure that the regulators can verify that we have adequate funding in defined benefit pension funds,” he says. “When the markets operate the way they do, you can end up having to make very significant contributions to bring those up to the appropriate regulatory level.”

In the short term, some organizations may elect to rely on operating contingency funds and controlling expenditures. Capital projects can be deferred, some equipment replacement can be safely deferred, unnecessary travel can be eliminated and vacant spots don’t have to be filled immediately. These measures “won’t save the world, but will help to reduce expenditures,” Seaman says.

Uncertainty about the length and depth of the recession has risk management departments on edge, Seaman says. He recommends having an integrated team at the company examining all possible actions that might mitigate the long-term impact of a number of different scenarios. “It’s not unlike business continuity,” he says. “What are the critical operations and what are the less critical that you can adjust? You would have to go there. You can’t cut out critical operations, so the question is how can you continue to deliver them and cut out expense?”

Setting yourself apart

Whatever measures are taken, be they streamlining expenditures or increasing loss prevention, they should be brought to the table come renewal time in order to secure the best possible coverage at a reasonable rate, Beaudry says. “Differentiate yourself from your peer group,” he says. “If your risk profile is better than your peer group, really emphasize that. There’s still an appetite for risk out there and there’s still capacity. Where insureds might fare better than others is when they differentiate themselves from their peer group in terms of having a better risk profile.”

Anything that allows an underwriter to become more comfortable with a risk will generate better results, he says.

“It’s a definite tight rope for risk managers, now more than ever,” Restoule says.

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“My concern is the pressure that insurers will be under in the next 12 to 24 months due to the financial markets, the economy or other factors. To what degree do those factors precipitate a hard insurance market cycle or affect the viability of the insurers?”

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“Given the pressure put on the customer to reduce costs and a market that is leveling off, [companies] might be forced to make different buying decisions. Some [options] might be higher deductibles, lower limits or the decision not to buy certain coverages that are considered nice-to-haves, but not need-to-haves.”

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“Given the downturn in the economy, are you going to be producing a big net income? And if not, do you want to buy that [business interruption] coverage, or maybe do you just want to buy [coverage for] fixed or continuing expenses?”