How Insurance Carriers Can Survive Hard CAT Property Markets
There’s no denying it — challenging times are coming for CAT property markets. Truthfully, they’re already here.
As I type this article, Hurricane Ian (category 4) is hours away from a direct hit on Florida’s west coast. Numerous wildfires are also actively burning throughout the U.S., including the Mosquito Fire in California, which has encompassed over 76,000 acres. In 2021, wildfires burned more than two and half million acres in California alone and experts now believe the wildfire season is extended due to climate change. Every day brings new headlines about catastrophic events that will have major impacts on the insurance industry.
Domestically, climate change is creeping into all facets of life, and in the global arena, outcomes don’t look much better. Globally, insured losses from natural catastrophes reached $130 billion last year — 18% higher than 2020.
But it’s not just environmental shifts that are plaguing insurers, seemingly ever-increasing inflation has also taken center stage. Coupled with nuclear verdicts and the downgrades of several insurance carriers, insurance experts anticipate a further hardening of the CAT property market, especially in the excess layers.
These factors will impact property insurance renewals from top to bottom — but there are ways to prepare for the changing and more challenging markets ahead.
A Closer Look at Hard CAT Property Markets
A hard CAT property market occurs when available insurance capacity and appetite contract at the same time, causing pricing for risks to rise.
In their simplest form, hardening trends follow the law of supply and demand. In a hard market cycle, carriers are generally more selective in choosing which risks to cover and charge an “adequate” rate for those risks. This leads to an increase in rate for complex property policies on a like-for-like coverage basis. As the gap between supply and demand increases, terms and conditions tend to become less favorable for insureds and the availability of insurance limits decreases. This ultimately leaves little to no market for more challenging insurance risks.
In a hard market, all areas of property insurance are impacted. However, the current hardening cycle is particularly devastating for catastrophe exposed properties. This includes properties facing traditional threats like named windstorms, floods and earthquake exposed risks, as well as nontraditional hazards like severe convective storms and wildfires.
Navigating Vicious Hard CAT Market Cycles
We’ve seen cycles of hardening CAT property markets with similar negative impacts before. However, this current hard CAT property cycle is different.
In previous cycles, major disasters, like Hurricanes Andrew and Katrina, led to a reduction in market capitalization, exacerbating the hardening trend. But for the most part, today’s carriers are well capitalized to mitigate catastrophic events. The reduction in appetite among insurers for CAT exposed risks is mostly a method to reduce balance sheet volatility brought on by more nebulous market factors. This includes unmodeled losses such as:
- An increase in extreme environmental events resulting from global warming;
- Ongoing poor economic conditions; and
- Claim fraud resulting in development uncertainty.
Unmodeled losses are tougher to insure against as their impacts are harder to quantify. Despite inherent complexities, these unique market conditions also mean that with intervention it is possible to soften — and ideally avoid — challenges.
Here are three steps to get started.
Leverage Diverse Information Sources
The information insurers have at their disposal is a major difference between previous cycles of hardening CAT property markets and the current insurance environment. Thanks to advancements in technology, insurers are better positioned to assess complex risks and optimize policies for clients.
Through advanced data analytics, for example, a carrier can aggregate information about a potential policy (like weather conditions and demographic information). Third-party data offers more granular insight into the potential pros and cons of a given policy, making it easier for insurers to work with insureds around otherwise contentious proposals. Risk assessment and management are streamlined through technology solutions.
Explore New Coverage Options — Parametric Risk
Naturally, insurers hope to safeguard their books of business in response to the increased frequency and severity of losses among insureds. We’ve seen carriers increase deductibles while also negotiating down insurance limits in an effort to protect their bottom lines.
But new coverage options reduce the need for such restrictive measures. Consider parametric risk contracts. With this model, insurers only pay out to insureds when a certain threshold of damage is surpassed. In this case, a loss event — let’s say an earthquake — would need to reach a specified magnitude on the Richter scale before the policy kicks in.
Parametric risk contracts can also be situated as part of a larger scale property risk program. This staggered insurance approach allows property markets to structure coverage more appropriately based on risk potential. Additionally, this extra layer of coverage counters insurers offering policies with reduced limits.
Select the Right Broker
Within hardening CAT property markets, it’s expected that insurers and insureds will experience disagreements. Selecting a broker with the depth, experience, resources and expertise to help navigate these challenging times is crucial.
In the end, a hard market cycle is just that: a cycle.
In time, carriers will feel rates and terms are adequate enough to begin generating profit on more traditional insurance policies. When that happens, insurers will start to compete for market share, resulting in a softening cycle for CAT property markets. After all, insurance carriers are in the business of underwriting risk for a premium.
Insurers can also take action to ease the pain of hard markets while they’re still active. Just because there’s a rise in catastrophic events doesn’t mean the way insurers and insureds react to them has to be a catastrophe.
Now is the time to develop a thoughtful strategy for dealing with the tough times — and hardening CAT property markets — ahead.