02 Aug 2018
How to prepare your business for a hard insurance market
By Claire Gomo, Fred Hawke
A hard insurance market is marked by higher premiums, narrow policy wordings, wide exclusions, more stringent underwriting criteria, and lower policy limits, so you should try to lock in terms now.
There are a number of practical steps that you can take now to ensure your business is prepared for the hardening insurance market.
What is a soft insurance market and when will it harden?
The nature of insurance is cyclical, characterised by fluctuating availability of underwriting capital for the various classes of risk, according to their loss experience and profitability.
Briefly, as claims experience in an underwriting class deteriorates, reinsurers withdraw support and focus their capacity upon more profitable lines. Scarcer capacity causes rates to rise in the affected lines, along with more rigorous indemnity underwriting, which restores them eventually to profitability. The other classes, meanwhile, have become less profitable, because of the cheaper capacity and sloppy underwriting which it promoted, and so harden in their turn. This is the so-called "hard/soft insurance market cycle".
The Australian insurance market has been soft for some time, however there are strong signs that it is beginning to harden, especially in the Directors' & Officers' sphere. A soft market is characterised by:
- easily available insurance;
- low premiums;
- expansive policy wordings;
- narrow exclusions; and
- increased capacity for higher policy limits.
In a soft market, insurers may be willing to provide certain extensions free of charge and we have even seen some insurers throw in additional policies, such as cyber insurance, at no extra cost.
Conversely, a hard insurance market is marked by:
- higher premiums;
- narrow policy wordings;
- wide exclusions;
- more stringent underwriting criteria; and
- lower policy limits.
Here are some practical steps which your business can take in order to prepare for the shifting market.
Option 1: Develop a good relationship with your insurance broker
During a hard market, higher risk businesses can find it increasingly difficult to obtain suitable policy wordings and adequate capacity. Additionally, you may find that insurers take an unnecessarily adversarial approach to insurance claims. Insurance brokers have long-term relationships with underwriters, often covering several insurance cycles, and are in a much better position to bargain on your behalf. Having a good relationship with a broker that truly understands the needs of your business can help mitigate some of these difficulties when the going gets tough.
Option 2: Prepare the business for increased insurance costs
As the market has been soft for so long, many executives and insurance managers may not be used to procuring insurance in a hard market or psychologically prepared for cost increases. Once coverage narrows and premiums increase dramatically come renewal time, it may come as a shock to those who are unaware of the cyclical nature of insurance. Preparing businesses early for this eventuality, and ensuring appropriate provisioning for increased premiums, can reduce internal angst and friction when the market shifts.
Option 3: Sell your risk
Prior to policy renewal each year, many senior executives from Australia's largest corporations visit the offices of their insurers in order to answer questions about the business and, in particular, its risk profile. This provides insurers with comfort about the policies they are writing and the businesses they are insuring, which helps in increasing coverage and reducing premiums. In a hardening market when insurers are increasingly restrictive, this may be a worthwhile exercise for SMEs and other businesses. Your insurance broker will be able to discuss this option with you further.
Option 4: Lock in
While the market is soft, it is a good idea to shop around and try and find the best, widest suite of insurance policies at a reasonable price. It is also a good time to obtain new types of insurance policies which your business may not have previously had, such as cyber insurance. Then, if possible, negotiate to lock in renewals in advance on as favourable terms as possible, whether by multiple year contracts or guaranteed minimum terms. Again, a competent insurance broker can help with this process.
Option 5: Set up a captive insurer
Care and feeding of captives (that is to say, insurance companies that are wholly owned subsidiaries of their policyholders) is a topic in itself. They do, however, offer significant advantages in the economic management of insurable risk, especially to corporate groups with strong consolidated balance sheets, that are able to accommodate substantial risk retention and only need access to the reinsurance markets at catastrophic loss level. They also provide an efficient mechanism for loss allocation at business unit level, contributing to good risk management. Specialist brokers and insurance lawyers can advise you on the management and regulatory issues associated with captives, and the most favourable jurisdiction in which to establish one.
Adopting some or all of these options now, while the market is favourable, will go a long way to preparing your business for the changing insurance landscape.