Businesses will need
to prepare for major changes in insurance availability
and pricing. We expect that most, if not all, insurance
companies will be increasing premiums during the coming
year, as well as restricting certain classes of business
or certain types of coverage. These are industry wide
changes, and not restricted to any one particular insurance
company or any one particular geographic region.
While the events of September 11th most definitely
had an effect on insurance availability and pricing,
there were changes taking place even before this event.
Our economy was changing and the insurance industry
was already experiencing an economic downturn.
Insurance companies rely on investment income to make
a profit, since premium alone is typically not adequate
to pay claims. Investment income is used in calculating
the rates necessary to meet claims obligations. Since
the late 1980s, too much capital in the insurance industry
resulted in what is known as a “soft market”,
as evidenced by highly competitive pricing for commercial
insurance policies. By the mid 1990s, outstanding performance
in the investment market created even more competition
for premium dollars among insurance companies, driving
the premiums down to even lower levels. After twelve
years of “soft market” conditions, in 2001
the industry began to show signs of strain and there
seemed to be pockets of activity within the marketplace
that indicated that a change in the cycle might be near.
As the investment market began to change, resulting
in a lower rate of return for investors, insurance companies
were beginning to increase rates and be more selective
in the types of risks they were willing to underwrite.
This condition is termed a “hard market”.
Insurance companies also purchase their own type of
insurance, called reinsurance, which allows them to
insure large risks and to spread the risk on smaller
accounts. Reinsurance costs to insurance companies were
already rising prior to September 11th, resulting in
increased premiums passed on to consumers. The World
Trade Center catastrophe is the largest insurance claim
event in history, with estimated claims totaling in
excess of $40 billion. This event sent shock waves through
the entire insurance industry, including the reinsurance
market, and hastily sped up what was already happening
in terms of rising prices. While all legitimate World
Trade Center claims are expected to be paid by the insurance
industry, the financial consequences of this event are
Starting in 2002, reinsurance companies have sharply
increased their costs to insurance companies, and are
refusing in certain cases to provide coverage at all
on certain perils, such as terrorism. All of this is
eventually passed on in some form to the insurance company’s
customers, across all lines of coverage. It’s
a simple matter of supply and demand, in this case the
demand surpassing the supply.