This hard market may come back to haunt underwriters

Only a few years ago, there was considerable debate about whether the insurance market would ever harden again. After almost a decade of relatively soft conditions, some predicted that the historically cyclical industry had finally learned its lessons, as evidenced by a strong and growing balance sheet, stable pricing, abundant capacity, and terms and conditions expanding to provide broader coverage.

Of course, there were signs that all was not perfect. Climate change was clearly increasing both the frequency and severity of natural catastrophes and there were pockets of the market, including property and umbrella, that were known to be underpriced. The overall picture, though, was pretty good for carriers, clients, agents and brokers.

Then, the notoriously cyclical industry returned to its natural state of flux. Midway through 2019, things began to change significantly, and by early 2020, what had been a hardening market took a turn for the worse. Much worse — at least for insurance buyers.

The COVID-19 pandemic, unprecedented wildfires and other natural catastrophes, combined with record-low interest rates and jackpot verdicts created a narrative, legitimate or not, on which insurers based their case for substantial price increases, reductions in capacity and more restrictive terms and conditions. Nothing is set in stone, but most agree that these trends are expected to continue through at least the first half of 2021, and maybe into 2022.

For an industry as mature as the insurance business, there is nothing mature or reasonable about underwriters’ recent treatment of their customers. When given the opportunity to increase pricing, restrict coverage terms and better control their capacity, carriers have taken a frenzied rather than measured approach. This is particularly disappointing when you consider the financial challenges that many insurance buyers have faced over the past year during the pandemic. When clients needed insurers most, sadly, many insurers looked the other way.

Agents and brokers, most of whom are on commissions, have been complicit in carriers’ recent behavior. Look at many of the comments made by the publicly-traded brokers to analysts during the recent earning releases: Their underlying message is, “We are confident that the significant rate increases will offset the reduction in exposure, so we’ll be okay.” Not quite what you’d expect from a group that purports to be their clients’ “trusted advisors.”

As with previous insurance cycles, things will eventually calm down and buyers, especially those with attractive risk profiles, will once again have options. Carriers will conveniently forget what they’ve done to their clients over the past two to three years and ask out loud, “Where’s the loyalty?”

The insurance market is and will always be cyclical, but many things can be done to keep the cycles from being as extreme as they have been. One of the most obvious solutions is for commissions to be removed from all insurance transactions. Commissions represent a misalignment of interests that can and should be fixed. Behind paid losses, commissions are carriers’ largest expense. Removing them would add a whole new layer of much-needed transparency and integrity to the business. Sadly, insurers haven’t had the courage to end the commission game for fear that agents and brokers will move business to other insurers who are still willing to “pay to play.”

Clients deserve not only transparency but objectivity as well. Charging fees in lieu of commissions for the services agents and brokers provide is the only way that intermediaries can become the truly trusted advisors they want and need to be.

If you believe in the power of markets to knock out unnecessary frictional costs, and if the fates of other financial service industries where there were inherent conflicts of interests are any guide, the insurance commission business will experience a slow and painful demise. But that doesn’t have to happen. There is a better way.

Charlie Wilmerding (cwilmerding@altuspartners.com) is the founder and CEO of Altus Partners. He started Altus in 1997 with the purpose of changing the way that property and casualty insurance is bought and managed. These opinions are his own.

Also by this contributor: Consolidation, commissions and the rise of independent brokers