The hard market: Challenges and opportunities
Observations of the hard market across APAC and globally
After a prolonged softening phase with inadequate pricing levels, commercial insurance rates have been increasing since 2018 across most market segments and regions, including APAC. This is driven largely by two key factors; heavier than expected insurance losses, and a persistent low interest environment.
In Asia Pacific, severity in insurance losses has emerged not only due to large natural catastrophes but also a multitude of so-called secondary perils events like floods, bushfires and hailstorms. This is compounded by claims inflation driving pressure on earnings. On the other hand, increased loss of investment income has arisen due to the persistent low interest rate environment.
The COVID-19 pandemic has added to and accelerated this hardening market trend. Apart from the uncertain economic outlook, the COVID-19 induced recession is also leading to budget constraints in many industries. Consequently, many corporations have less discretionary spending available for insurance than they did in the past.
This already very difficult business environment now coincides with a tightening insurance market. This is a driver of the rate increases that we observe, but also capacity constraints and limitations in the scope of cover provided.
We are also seeing a continuing shift in the corporate world from asset-heavy to asset-light, which companies deriving more of their revenue from intangible assets. A shift that the insurance sector is only very slowly addressing.
Greatest impact of the hard market
Over the past 12-18 months we have seen several insurance markets exiting or severely reducing their appetite for certain classes of business and exposures. This has been prevalent in liability with US exposures, D&O and some property exposures, like bushfire or flood.
What challenges do customers face in a hard market?
Many companies were taken by surprise by the severity and extent of the Covid-19 impact on their businesses and industry, which has led to corporate risk managers becoming more risk alert and risk aware - a lot of companies are going through their risk registers to see if there are any other exposures that they did not have on their radar.
In this situation of a hardening insurance market compounded by the impact of Covid-19, customers are increasingly turning to the Alternative Risk Transfer (ART) markets looking for alternatives to their traditional insurance programs based on three broad criteria:
- Solutions that fill the protection gap left by traditional insurance programs: This is particularly for NatCat capacity that is becoming scarce, but also cover for pure financial losses generally excluded from traditional insurance (eg. NDBI exposures).
- Solutions that allow for long term budgeting and give certainty of price and capacity.
- Solutions that offer customers the ability to retain more risk and optimize their self-insured retentions. In the current environment with less budget available and rising insurance prices, risk transfer might not always be the most efficient solution.
The upside and opportunities available
With the hard market, insureds can look to leverage various tools and instruments available. While some of these tools are newly developed, others are making a comeback in terms increased prominence or having adopted a different form.
One type of insurance that is gaining very strong momentum, and clearly moving from exotic into mainstream are parametric or index-based solutions. These parametric structures have proven to be very powerful instruments to fill the gaps of conventional programs and cater to the intangible exposures of businesses.
To address the price volatility and uncertainty in the current market environment, a rather simple solution could be multi-year and cross-class contracts providing budget certainty over the longer term. Such structured programs are an efficient way to pool capacity over time, and often include profit-sharing elements which gives the insured the opportunity to benefit from the upside.
As you would expect, the hard market forces corporations to rethink their retention strategies and is often a catalyst for new captive formations or an increase utilization of dormant captives. And we are seeing a clear trend in this direction with an increased number of requests for captive solutions. This can be on the fronting side where companies are looking for an insurer's expertise and capabilities to issue and administer local policies. Demand for captive protection is also on the rise: with the increased retentions comes increased volatility, and many captives are looking for tailormade risk transfer solutions that cap their overall exposure, protecting them against an unexpected frequency of extreme events depleting their capital.
For corporations that do not have a captive but still feel the most efficient way forward is to retain more risk in-house, a "virtual captives" could be considered. These are fairly simple insurance contracts designed to emulate the benefits and mechanics of a captive without going through the process of an actual captive formation. Essentially these are contractual agreements allowing customers to pre- or post-fund part of their losses and thereby optimize their self-insured retentions.
With a range of instruments available to address the hardening market, this is an opportunity for corporates to manage their risks and navigate this volatile market environment to enhance the resilience of their business operations.