For many engineering companies, insurance is one of their largest costs. When you add up premiums for Professional Liability, Property & Casualty, Workers’ Compensation, Employee Benefits, Life Insurance and other lines of coverage, it can often total 5% of revenues or more. The type of work you do, your risk management practices and your loss experience materially affect what you pay for insurance. These are factors over which you have control. The financial condition of the insurance industry also directly impacts what you pay and this is something over which you cannot control but should be aware of.
Insurance companies are in business to accept risk in exchange for premiums. Like any other business, they want to make money and earn a fair return for their shareholders. Absent a decent return, they will not be able to attract additional capital and the insurance industry thrives on capital or surplus. Insurance companies can make money in two ways underwriting profit and investment returns.
An underwriting profit is earned when losses plus expenses divided by premiums is less than 100%. This factor is called a combined ratio. If an insurance company has a combined ratio of 98%, it means they are making a 2% underwriting profit. If the ratio is 105%, it means they are losing 5%. Insurance companies also earn money investing the policyholders’ surplus and cash reserves they have set aside to pay future claims. It is not uncommon for an insurance company to have an underwriting loss, but to make up for it with their investment income (especially when interest rates are high).
Total Return or Return on Equity (ROE) is one of the industry’s key metrics. From 2008 to 2012, the industry’s “Return on Average Net Worth” was poor, less than 5% in each year. This was attributable to a lousy combined ratio and a low level of investment return (the majority of an insurance company’s portfolio is invested in debt obligations; they can only invest about 20% in equities). Note that the industry needs a return of 10% or more to attract capital. 2013 was a different story. Unlike 2012, which was a bad “cat” year (losses from catastrophes…remember Hurricane Sandy?), 2013 was a light “cat” year and the results reflected that (ROE was 10%). 2014 is shaping up to be a decent year as well. At the same time, the industry is in solid shape when it comes to surplus. An insurance company’s surplus determines how much business they can write. When insurance companies are flush with surplus the industry becomes more competitive. So where is the industry today and what can you expect in 2015?
Underwriters are looking for rate increases. They realize that the decent ROEs in 2013 and 14 were attributable to light “cat” years and they know that those are the exception. On the other hand, the industry is adequately capitalized and competition for preferred accounts remains fierce. While every account is individually underwritten and priced, there are some general observations we can make.
Renewal pricing on most lines of coverage required by engineering firms should remain flat in 2015. This includes Professional Liability, General Liability, Property, Auto and Excess coverages. If you are in a high hazard specialty or if you have adverse loss experience the story could be different and it is recommended you approach the market early to avoid any surprises.