At a recent insurance event, Tim Grafton (pictured), former Insurance Council of New Zealand (ICNZ) CEO, presented his view of the challenges facing local brokers and underwriters in the softening market. He also pointed to the industry uncertainty around the degree and extent of the softening, and suggested strategies to deal with it.
Only about half the room raised hands. He then asked if they thought this soft market would continue for one or two years. Very few of those who raised their hands kept them up.
“But 47% said it was impossible to generalize, as there was so much variety in the market,” he said. “That might explain why not that many hands went up [here].”
However, few could dispute another premise.
“You all are operating in the same market,” said Grafton, addressing the brokers and underwriters at the event. “Much of what I've got to say applies to you.”
He said hard and soft markets require different strategies. However, Grafton said despite the “real risks” in both soft and hard markets, these tricky and changeable business environments have some constants that brokers and underwriters can count on.
“In a hard market, good prices feed healthy profits, which in turn can hide poor underwriting performance,” said Grafton. “In a soft market, the temptation to grow market share to meet targets can lead to poor underwriting decisions, which may lead to major losses later.”
He said insights about how to respond to a soft or hard market are gained by “understanding what the triggers are that make the cycle turn.” He said significant risks like climate and cyber events can reset soft markets and trigger the prices to start moving upwards.
“So if you are operating in a market with prices going south, be wary of significant risks that could change the landscape,” said Grafton. “The market stays in the state of more or less equilibrium until something extraordinary happens to change that estimate of future claims costs – that is when the market will turn.”
He said these extraordinary losses trigger a market readjustment through two mechanisms.
“First, premiums may rise to reflect a better understanding of the risk if this follows a major event, for example,” said Grafton. “Secondly, insurers and reinsurers reduce their own exposure by limiting the capacity of cover available to the market.”
He said there are several reasons for the softening of the market and that the brokers and underwriters present should be asking: how easy would it be for that to change?
He suggested that a significant climate event would be one way.
“There have been relatively few climate events locally, insurers have made healthy profits on the back of a benign claims period following very steep premium increases,” said Grafton.
There is also alternative capital in the insurance market. He suggested that this investment from pension and hedge funds could dry up if reinsurance rates drop.
The “sluggish” local economy is another concern.
“Clients you're dealing with are cutting and looking to cut costs which is putting [downward] pressure on rates,” said Grafton.
He said lower interest rates and increased competition have now brought some rates down but this softening has not been uniform.
“Residential property in higher risk areas has not seen eye watering, rate reductions and some customer discounts are even disappearing,” said Grafton.
However commercial lines have seen rate reductions of about 10% compared to last year, he said.
“The impact, though, is not across the board,” said Grafton. “Higher-risk seismic areas like Wellington are not seeing cuts of that order, but there is more capacity even in that market.”
He analysed the motor market.
“The weak economy has produced lower levels of commercial motor activity, fewer claims and improved loss ratios,” he said.
This has enabled well managed fleets with low loss rations to enjoy “very large rate cuts.”
However, Grafton said domestic motor is a different scenario.
“Domestic motor is a different story, reflecting increased parts costs and the complexity of late model vehicle repairs,” he said.
He suggested that there is little doubt that “we will experience deteriorating economic conditions globally” leading to rising insolvencies and its flow on consequences for insurers.
He said in this softer market, the conversation brokers are having with clients is very different to last year.
“Last year, agencies and brokers alike were very, very busy explaining to clients that the high rates were beyond their control,” said Grafton. “You wanted clients to understand that there was no scope for lower rates, and in some instances, you were lucky to be able to secure insurance capacity for them.”
Now the conversation has changed, he said, driven in part by clients suffering economic hits to their businesses. There are also the insurance offers they are getting from a broker’s competitors who can offer more capacity and lower prices.
He said prudent agencies – and their brokers – should operate according to “three key levers.”
“First, use data and modelling and your own expert judgment of the broader environment to inform your commercial position,” said Grafton. “Know your technical price and know your walk away price, which may be different, so you don't get into a spiral to the bottom.”
He said agencies should avoid over exposure to higher risks, particularly climate exposures or risks that are not well understood.
“The third lever is customer service,” said Grafton. “You need to show your customers the value you bring through hard and soft cycles - so price is not the sole basis of the relationship.”
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