Cover agents say hard market will be delayed—

… As industry repeats history once again

By Dennis H. Pillsbury

There's an old saw that says those who don't learn from history are doomed to repeat it. And, about once a decade or so, the insurance industry proves the truth of that statement as it greets a market turn with almost suicidal delight.

It's as if the industry lives on its own version of "Fantasy Island" where underwriters can compete for business with untenable loss ratios and "make it up in volume." Until finally, Tattoo hears the motors of doom and shouts: "The Pain, The Pain." Everyone's eyes move skyward, probably to avoid the red ink they would see if they looked down, and they begin the pre-hard-market ritual where "they run about and scream and shout" and do everything they can to increase "The Pain," until it reaches that crucial level where it is so severe that they are actually forced to pay attention to underwriting.

There's an old saw that says…Whoops, sorry, started to repeat myself. Guess I've been in the industry a little too long.

Anyway, we here at Rough Notes had been hearing rumblings, perhaps it was the aforementioned motors of doom, that the market was beginning to turn, so we surveyed our cover agents to determine what they were experiencing. And I guess we hit a nerve because more than 25% of the agents responded in less than a week. And that was during a holiday week.

More than 90% of the respondents said they had seen either no increases in commercial lines premium rates or small upward adjustments in the low single digits. And most agents said that, after discussions with their companies, they anticipated there would continue to be small or no increases in 2012. As one agent quipped: "They've gone from giving it away to moderately giving it away."

What, we don't have enough shoppers?

A significant minority of respondents (just over 30%) reported that the increases affected only current clients, while competition for new business continued apace. So the same companies that complain about the commoditization of the personal lines business, thanks to geckos, mayhem, good hands and so on, ad infinitum, ad nauseum, apparently are intent on creating shoppers of those commercial clients that have been loyal to them. The not-so-subtle message is: "If you stay with us, we'll raise your rates, but if you shop around, we'll write you for a lower rate."

As one agent observed: "This has the potential of creating a lot of account movement between carriers in 2012, which will push out any true firming to a later date." Another pointed out: "I find it both comical and frustrating that our industry does not heed the past, nor learn from history. It seems there will always be carriers willing to 'buy' clients on the cheap and perpetuate bad pricing strategies." And one agent expressed his frustration in even stronger terms: "I'm very concerned that we will be competing with one of our own companies that wants a rate increase on a renewal but will give another agent a cheap price to write it away from us!"

Yes, that's right, we are actually seeing cases where an insurance company will cut the price on business it already has because, apparently, its "smart" underwriting system isn't quite as sophisticated as we assumed and doesn't inform underwriters that: "Hey, you're already writing that business at a better rate!"

Aarghhh!!!

It's pretty clear that agents are starting to feel like Charlie Brown getting ready to yet again attempt to kick the football being held by Lucy Insurer. If Lucy only lives up to her promise, then the agent could kick the winning field goal. But "aarghhh!!!" At the last minute, Lucy Insurer pulls the ball away and you wind up flat on your back trying to explain to your raving fans why it happened.

Is it any wonder that more and more of the commercial insurance marketplace has opted to control its own destiny through one type of alternative risk transfer mechanism or another? One agent pointed out that 45% of his agency revenue now comes from the alternative market, and that will probably grow when underwriters for the traditional insurers start to tattoo clients with unjustified rate increases.

And which clients move first? The ones with the lowest loss ratios. So, slowly but inexorably, the traditional insurance industry becomes a residual market for those clients that have the greatest risk problems. That sure doesn't sound like a winning formula to me.

What's wrong with this picture?

Every agent who responded to the survey said he or she was explaining to clients that a change in the market was inevitable. Nearly all said they work with their clients to improve their loss profile so that, when the rate increases come, they won't affect their clients as severely as some others. And, they report that they are indeed remarketing the business to take advantage of competitive pricing. One agent noted that he had no choice but to do this. "A number of my clients have been with me for a long time and have seen this dance before. They know what will happen and have asked me to remarket their business. They understand that there is little premium (pardon the pun) on loyalty."

It would be an interesting exercise to see what the retention rate of insurance companies is. The agents who responded to the survey all have retention rates in the 90s, but I am willing to bet that that isn't the case for their insurance companies because of insane market cycles that necessitate shopping.

So companies get to write new business, with its higher acquisition costs, at cut-rate prices while pushing away its current clients. Does this make sense to anyone?

And the timing stinks

Several agents pointed out that the timing of even these small increases was problematic because of the poor economic conditions. "Businesses are suffering already with excess regulation and the poor economy," one agent noted. He added that a hard market could "make it difficult for some businesses to survive. 'Suboptimization' occurs when each part of a system does what is in its own self interest without regard to its impact on the system as a whole," he continued. "The end result is that the whole is less than the sum of its parts—not a good outcome.

"While it is obvious that rates must go up for the health of the insurance industry, let us be careful not to damage or destroy the customer base by going up too much or too quickly. We don't need to kill the goose that lays the golden eggs," he concluded.

Another agent noted that "just getting hit with a small rate increase in today's economy feels like hardening for many of our customers." And another comments: "While the market is firming, the economy has not leveled to where clients can absorb dramatic increases. Any hardening of the market for 2012 may look different from other hard markets for this reason."

Where do we go from here?

Unfortunately, we have moved from the days when underwriting was more of an art than a science. Underwriters looked at the quality of the person or business, not just the parameters of the risk. As one agent pointed out: "Technology allows the insurance companies to monitor every aspect of this equation, week by week, month by month."

But it does mean that the independent agent should be even more important in this environment because he or she does know the quality of the person and business and needs to find ways to overcome the tendency of insurers to rely solely on numbers. Somehow, we need to get the underwriters involved with the clients so they can't simply pass on rate increases without seeing the client's face.

"I appreciate more of a 'hometown' approach than the depersonalized predictive modeling approach," one agent noted. "Part of the sale is selling a client to the insurance company and predictive modeling takes away the ability in many cases to do this. How we differentiate ourselves is a lot about our ability to build relationships and work out problems for our customers. The approach of using algorithms to predict everything that might happen rather than looking at the quality of the client doesn't allow for this.

"The carriers don't go to church with our clients, they don't go to their children's sporting events. They don't get to know and understand that many of these people are better-than-average risks because of their beliefs and the level of care they exhibit with their families, their employees and their lives. And if they don't know that, then it is easier for them to pass down generic, depersonalized mandates that may indeed reflect the risk based on mathematical formulae but have almost nothing to do with the people purchasing the coverage."

And maybe that's why in recent conversations that I have had with agents, I have found that many of them are inviting the underwriters to social events with their clients. Is that the answer? Even if the underwriters do have empathy with the clients and understand their values, will that matter when stuff starts hitting the fan blades in earnest?

Get ready for a rough ride.