Climate change is pushing insureds to the E&S market
Global warming will demand accurate data sharing among MGAs, carriers and reinsurers.
If you live, well, almost anywhere within the continental United States, you felt the extreme heat of this past summer. Just one single seven-day heat wave from July 18-24 set more than 350 high-temperature records and more than 709 records for the warmest overnight low temperature, according to NOAA’s National Center for Environmental Information.
This scorcher of a summer — which extended all the way throughout Europe — served as the latest reminder of a harsh reality evolving over the course of the past few years: Climate change and its impacts are here. This is not just a future threat; it’s a present reality. As global warming reshapes our weather patterns, it also promises to forever change the way insurance agents, brokers and underwriters do business.
One of the most interesting recent developments is how the overall effects of climate change are impacting excess & surplus (E&S) lines. In 2021, the surplus market grew direct premium by 25% to a record $82 billion, according to an AM Best Market Segment Report. In its analysis, AM Best wrote that one of the reasons for the record growth was an uptick in unique exposures.
As climate change keeps creating more frequent and severe storms, and the E&S market surges, the downstream effects will impact MGAs, carriers and reinsurers directly. Why this change is happening, the opportunities and risks it creates, and how the industry can evolve to meet this emerging new reality are among the most paramount concerns of much of the insurance industry today.
A future filled with ‘1 in 20’ risks
Rewind to the early 2000s and you’ll see a nearly completely different world when it comes to weather patterns. Twenty years ago, when the insurance industry considered the issue of climate change, the focus was on hurricanes. Even within that short time span, 100-year floods were only an issue … well, about every 100 years. Consequently, insurance leaders tended to pay attention to named storms. Back then, it was likely that mid-level managers at a large carrier might experience one or two of these “one in 20” risks over a 10-year tenure in that role. Some might never have contemplated ever seeing a 100-year flood event at any point in their insurance career.
Two decades later, the definition of climate-related disasters is expanding almost as quickly as nat cat claims mount. Those same mid-level managers today will likely deal with as many as one or two “one in 20” events each and every year for a 10-year period. With Hurricane Harvey in 2017, Houston experienced its third 500-year flood in three consecutive years.
While climate change might have seemed like just a theory a few short years ago, data doesn’t lie. Reams of data prove the extraordinary impact of climate change on both our planet and our industry. A report from Capgemini and Efma revealed that insured losses from natural catastrophes have increased 250% over the last 30 years, with perils such as wildfires and storms fueling the remarkable growth. What’s more concerning, when the report authors asked 270 senior industry executives if they felt their companies were prepared to adequately handle the impact of climate change, only 8% said yes.
Whether you’re ready or not, the effects of climate change will keep mounting. Over just the last two years, we’ve seen devastating flooding in Germany and Japan and out-of-control wildfires spreading in California and Australia. Lloyd’s of London reported the average number of wildfires grew 30% over the past 15 years, while Swiss Re data shows losses for secondary perils, such as floods and wildfires, nearly doubled over the past 10 years.
Just as troubling as the damage, these types of severe weather events leave in their wake the fact that few tools exist to accurately model and predict these new types of storms. For example, Winter Storm Uri in Texas in 2021 — a completely unmodeled event — left more than 4.5 million homes and businesses in Texas without power and caused an estimated $18 billion in claims.
What does the future hold? More of the same, unfortunately. Swiss Re forecasts a 30%-63% rise in insured losses for all types of natural catastrophes in advanced markets by 2040.
A quick migration to the E&S market
The rapid increase in climate-fueled disasters is driving a shift of homeowners and commercial property policies away from the admitted market and toward the E&S market. And California is leading the charge.
As the number of home insurance claims skyrocket, leading to a sharp uptick in non-renewals, some of the largest carriers — including American International Group, Inc., Chubb Ltd., Liberty Mutual, Nationwide and State Farm — have reduced or eliminated conventional home coverage in the Golden State.
This reduction of capacity in the admitted market is leaving the E&S market to pick up the slack. The amount of direct homeowners’ premiums in California by E&S filers has almost tripled in the last three years, rising from $85.1 million in 2018 to $235 million in 2021, according to an S&P Global Market Intelligence analysis of regulatory statements submitted to the National Association of Insurance Commissioners.
The underlying reason for this migration is pricing. In particular, it is due to an inability to properly model the type of weather-related risks we’re seeing today. In traditional modeling, insurers would look at historical weather data in order to derive what future outcomes would look like, then they’d essentially put a band around it and price the package. But as the frequency and types of storms have increased over the last few years — bringing varying outcomes — that band has grown. In short, the speed of climate change is simply outpacing the speed of the industry to model and adapt.
Each time that band has widened, it has increased the cost of capacity. This then creates price increases for insureds in the attritional and admitted market. A great example of this is in Florida, where homeowners’ premiums have risen by 55% in just the last three years alone, according to Insurify data.
The problem then gets amplified further as homeowners’ policies move from the admitted market to the E&S market. Large carriers have broad and diversified books of business, and therefore are built to absorb some of the risk. While the MGA market is more targeted and tailors coverage to the individual insured, the risks remain as great or greater than in the admitted market creating increases in the cost of capacity, which directly translates into higher premiums for the insured.
So, the unfortunate consequence is, no matter where the risk lives, it is property owners who are paying the price with no end in sight.
Where the opportunities lie
The unfortunate reality is there is little carriers, reinsurers or MGAs can do to stop or reverse the effects of climate change. However, our industry can start taking immediate steps to better understand the impact of climate change and then take action to improve pricing models and reduce the risk for insureds.
For starters, agents and brokers must acknowledge what’s happening. We can’t ignore climate change’s impacts. We must face facts by trusting our data and insights. We then must adopt a mindset where we can move faster than in the past, because the reality is we have far less time to react to our changing circumstances than we did just 5 or 10 years ago.
To fully comprehend the challenges our industry faces and then act upon them, carriers, reinsurers and MGAs must insist on accurate and transparent data that can help them identify the root cause for why their loss ratios are increasing. Was it an insured problem? A credit problem? An exposure problem? It can be impossible to know for certain until you run the data.
The next step is to share that data with all members of the insurance ecosystem. This, in my opinion, has gone from a nice-to-have to a need-to-have. I believe what’s needed today is almost weekly data synchronization among carriers, reinsurers and MGAs. This kind of comprehensive data sharing will give entities within our industry the information they need to help improve underwriting, reduce risk, and ultimately provide more affordable rates for insureds despite the climate-change-fueled pressures we all face.
As homeowners and commercial property policies continue their migration from the admitted market to the E&S market, MGAs will naturally want to write some of that business. Compared to large carriers, MGAs are more inclined to leverage their capacity to incentivize the behavior of individual insureds, creating opportunities on a one-to-one basis with insureds in ways carriers cannot. Relying on variable and alternative datasets versus claims history alone, MGAs can incorporate their insights into their pricing. Combined with an MGA’s faster proclivity for technology tool adoption and ability to build in risk mitigation incentives, MGAs have an opportunity to develop a successful book of business in areas where the admitted market has chosen to exit based on claims history.
The best way for MGAs to do this is to better understand the evolving risks. And the best way to do that is to leverage their relationships with carriers and their capacity providers so they can see, using a range of data, where the best opportunities lie. It is also through this data that MGAs moving into homeowners and/or commercial property insurance can better ensure they’re getting quality business and not just less desirable leftovers from the admitted market.
One of the key goals for MGAs is to build a solid relationship with carriers that will help them quickly zoom in and scoop up a certain amount of risk or endorse a policy midterm. In this ideal relationship, MGAs have more operational freedom to write good business. Getting there starts with building a foundation of trust, and that trust can only be built by providing communication and transparency with your data. While some MGAs may be reluctant to share their data with carriers, it’s table stakes for carriers that are dealing with an uphill battle against climate change. At the same time, data should never be shared with carriers without the MGA’s explicit consent.
When it comes to risk management in a climate-change-impacted world, carriers and MGAs will face different challenges. While large carriers are better positioned to absorb risk overall due to their diversified books of business, MGAs may be better positioned to incentivize homeowners to implement risk-mitigation strategies or cherry pick risk through better analytics.
While large carriers have many different priorities, most MGAs focus on one particular product. This allows them to offer their insureds more attractive rate cuts based on how well they protect their property or the MGA’s idiosyncratic insights into their markets. We’ve already seen some MGAs put successful strategies into place by doing things like pushing text messages to insureds to warn them of upcoming winter storms, for example, and reminding them to turn on the heat. Ultimately, however, it is still up to the insured to take these recommended risk mitigation steps — such as adding hurricane straps to their roofs — so they can get the best price in the MGA market.
Facing an uncertain future
In the next decade, as natural catastrophes continue to increase, the MGA market will change significantly, shaking out the underperformers. Those that emerge the strongest will be the MGAs who can build trustworthy relationships with carriers, position themselves to take advantage of market dislocations, and share and use data to better model risk and improve underwriting.
Three new imperatives for insurers, MGAs and reinsurers
If you tuned into any newscast over the past three months, it’s a good bet you heard the words climate change. After an active spring tornado season and a summer filled with both sweltering heat waves and wildfires that threatened iconic structures like the ancient Sequoia trees near Yosemite State Park, it’s clear the challenges associated with climate change will impact our country — and the insurance industry — for years to come.
While it’s true that carriers, reinsurers and MGAs can’t do much to stop or reverse the effects of climate change, they can take immediate action to help improve underwriting, reduce risks and curb the skyrocketing cost of homeowners’ policies for insureds. Three smart steps to take include:
1. Admit it’s happening.
Agents and brokers can no longer act like teenagers trying to sneak out of their parents’ houses to go to a party. Insurers must acknowledge the impact climate change is having on our industry and stop doing business-as-usual. That means committing to finding new ways to model severe storms. The traditional method of evaluating future risk based on past storm patterns is no longer valid. It’s up to us to find more up-to-date methods that can help underwriters do their job better.
2. Learn why your loss ratios are increasing.
Yes, it’s because of climate change. But is it an insured problem? A credit problem? An exposure problem? The more advanced analytics you have at your fingertips, the deeper of a dive you can do to identify the true cause and start taking steps to reduce your loss ratios.
3. Build trustworthy relationships through data sharing.
The migration of homeowners’ policies from the admitted market to the E&S market creates encouraging opportunities for MGAs and reinsurers. The best way to evaluate and act on those opportunities is to better understand the market so you can leverage your relationships with carriers and capacity providers. Doing so starts with building a foundation of trust by sharing accurate, reliable and dependable data with carriers. While some MGAs may be reluctant to do so, sharing data with carriers will help them better evaluate their potential opportunities and risks — but MGAs should only share the types of data for which they’ve given a carrier their explicit consent.
John Horneff is CEO and founder of Noldor, a startup that delivers turnkey API information to MGAs. He has a successful startup track record in the fintech and insurtech industries, and his background includes two private exits and two organizations that were unicorns. He can be reached at john@noldor.com. For more information on Noldor, please visit www.noldor.com.
Opinions expressed here are the author’s own.
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