Why Are My Insurance Rates Going Up?

Harvey Zook

Many who started their businesses in the past 15 years may be asking themselves why insurance premiums suddenly are rising, when just one year ago, premiums were declining. More seasoned managers, however, may remember that 15 years ago, they paid higher premiums — even higher than they are being asked to pay now.

Historically, insurance costs and availability are known to cycle over an approximately decade-long curve. Many things can affect this cycle, including natural disasters (i.e., causing higher losses for insurance companies) and changes in the investment markets. In times of strong competition, insurance companies actually may underwrite at a loss.

One way to determine the health of an insurance company is to look at its “combined ratio,” which compares money going out for losses to money coming in from insurance premiums. A combined ratio of .80 means profitability; a combined ratio of 1.12 means losses ($1.12 going out for every $1 coming in).

During periods of strong competition, such as we experienced from the late ’80s through the ’90s, the majority of insurance companies had combined ratios greater than 1.00. This is because they tended to lower underwriting standards to go after more business, which led to greater losses. Insurance companies are able to sustain under-pricing of their product by relying on investment income to not only cover losses, but also to profit.

In recent years, some observers have declared the insurance cycle a thing of the past. But the property and casualty insurance business has proven this wrong; it prices its product before it knows its costs or claims. As long as this is the case, insurance premiums always will be cyclical, although the length of the cycle may vary.

Three primary factors drive the cycle: cash flows, reserves and stock prices.

Going Down?

During the first 10 years or so of the most recent commercial insurance price wars, rates and costs declined at the same pace because of savings from tort reform and other cost-reductions. Then, about two years ago, while rates continued to decline, additional cost-reductions no longer were forthcoming. Increasing paid losses and shrinking premiums put a squeeze on cash flow. And cash flow for the industry is believed to have turned negative in 1999, to the extent that it was not sufficient to cover stockholder dividends.

A negative cash position in the insurance business is, to put it mildly, not an enviable situation. An insurance company can quickly raise cash by selling investments. But when a business sells under pressure, it doesn't get the best prices.

A company also can raise cash by cutting insurance premium rates to gain market share, but this digs the hole even deeper. Consequently, the insurance industry now is beginning to take the responsible action needed to reverse hemorrhaging cash flow — by raising rates to fix the underlying problem.

As profits wane due to escalating losses, insurance companies sometimes will not own-up to the need to put up loss reserves because that would squeeze earnings even more. Many insurers actually have been releasing reserves to shore-up earnings. This shrinks reserves to the point that insurance companies' loss reserves are deficient.

Many reports have been published noting that the property and casualty industry is over-capitalized. This is true, but part of the reason for over-capitalization is that the industry is short on reserves. Estimates by independent observers say the industry is anywhere from $25 billion to $45 billion under-reserved. The higher number translates into 13 percent of statutory surplus. So much for excess capital.

The final blow is the steep decline in the stock market price of property and casualty companies' shares. As the net worth of the industry's leaders' share holdings decreased, the intrinsic value of their stock options evaporated. It's a good thing that equity-based compensation systems force executives to walk in the shoes of shareholders.

Faced with fleeting affluence, insurance executives have drawn the proper conclusion: They need to focus less on revenue growth and more on profitability; less on market share and more on the need for prudent underwriting and adequate rates.

With the combination of dried-up cash flows, inadequate reserves and deeply discounted share prices, you can bet there will be return to higher prices in the insurance cycle.

So, understanding that insurance companies now are in the phase of their cycle in which they increase rates on the risks they select to recover from their losses, how can you present your business in its best light?

The information an insurance company needs is divided into several areas:

The most important factor to present to an insurance company is loss information. This is because the insurance company awards discounts for good loss experience. The fewer the losses, the better the discount.

Loss Information

Every good insurance agent will give a client an insurance company-generated listing of your firm's losses for one year. Do not immediately place this information in the circular file as more garbage from the insurance company. Keep the listing because it is an important document that could save you thousands of dollars in premiums.

Insurance companies will want to review at least four or five years' worth of loss information to assess your account. Consequently, you should request a copy of this information annually, as some losses from prior years may not be closed. Amounts shown for open claims are the insurance company's estimates (reserves) of how much they will pay. Circumstances can change, causing a claim's value to fluctuate as it matures and reaches settlement. The effects of these changes are reflected in your updated loss runs.

If a claim is listed as “open,” you should ask your agent to provide the final settlement figure. Remember that loss reserves are estimates and are likely to change. In lieu of a final settlement figure, your agent can keep you posted about the status of the claim.

Financial Information

Financial information is often overlooked, but remember that an insurance company operates like a banker. The insurer must underwrite the financial risk of the insured, as well as the insured's physical assets. Consequently, the insurance company will need a copy of your financial statement for the most recent fiscal year. This financial document will tell the insurance company about the financial health of your company.

Underwriters want your business to be profitable. There may be circumstances that cause you to post a loss one year. If this is the case, two or more years of financial statements will show the insurance company that the year of the loss was a fluke.

The financial statement also can be a tool for the underwriter to aid in designing an insurance program to suit your needs. For example, it may be beneficial to you and the insurance carrier if you share in the risk in the form of a deductible. Sharing the risk lowers your premium, and the carrier can take comfort in knowing that the insured has a stake in controlling claims to keep costs down. The financial statement will help the carrier decide what, if any, deductible may be appropriate for each situation.

Asset Information

Asset information includes all of your company's real and personal property items. The insurer needs a complete description of each item, with items broken out by class (buildings listed together, computers listed together, vehicles listed together, etc.) Every schedule should include the values of the insured items. Be certain that the values are current.

It will help the insurance company (and you) if you include the new cost for all items, such as automobiles, trucks, and trailers. This will guide the insurance company in valuing them. Also include any specialized equipment costs in the total.

Driver Information

Every time you request a quote on fleet insurance, the insurance company requires the name, date of birth and drivers license number of each of your drivers. This might seem like needless paperwork, but the information provides the insurance carrier with a picture of your overall fleet. If you have “bad” drivers, then your fleet will not be a good insurance risk and will result in higher premiums.

Bad drivers will manifest themselves in many ways. Your accident rate will be higher than average; your operating costs will be higher than average; and you will suffer higher than average vehicle downtime. This is costly for both the insurance company and you.

The definition of a bad driver varies, depending on the employer or the insurance company. From the employer's viewpoint, a bad driver does not cover routes efficiently, does not take care of the vehicle or has no respect for authority.

The insurance company views a bad driver as someone who has risky behavior and accidents. The insurer's definition takes into account information provided from studies of why drivers have accidents and the common characteristics of drivers who have accidents. A bad driver is one who gets a lot of speeding tickets, has accidents, is inexperienced or is an aggressive driver.

The two definitions of a bad driver may seem at odds, but they actually coincide. An aggressive driver generates complaints and a bad reputation for your business. Eventually, this driver will probably have a serious accident.

Tickets are evidence that your driver speeds. But more important than the ticket is why the ticket was issued. Was it issued for going 65 miles per hour (mph) in a 55-mph zone? Or was it issued for going 55 mph in a 35-mph zone? The second is worse than the first because a lower speed limit indicates more traffic and crowded conditions. An accident in this area usually will cause more damage than one on the open highway.

Your business loses in two ways from an accident. Your fleet insurance premiums probably will rise to reflect the payment of a claim. Additionally, if your driver is hurt, you lose his services and your workers' compensation policy experience takes a hit. This could increase premiums. And the rise in premiums on either policy will remain with you for at least three years if they are experience-rated (policy pricing based on your company's experience).

Aggressive behavior is the last characteristic an insurance underwriter will look for in a driver. An aggressive driver is especially a problem because his accidents usually are more serious, and often the driver has limited driving experience. Many insurance companies will not insure a commercial driver who is younger than 25 or who has less than three years of commercial driving experience.

Rules for Hiring Drivers

Keeping these problems in mind, hire drivers thoughtfully, as taking precautions can save money on your premiums.

For example:

Above all, recognizing that there is an insurance cycle can help manage your business. When rates are falling, you can appreciate the savings. And knowing that premiums eventually will rise again can be a reminder to continue taking care of business; be proactive on safety; communicate with employees; and document your efforts on loss control.

Following these few simple rules, you can help keep your insurance premiums in check.

Harvey Zook is the program manager for the Environmental Industry Association's Insurance Programs at Americana Financial, Camp Hill, Pa. View website www.brokernetusa.com for more information. To view additional articles about insurance, visit Waste Age's website: www.wasteage.com.