PHIL’S CORNER: Cycles in the Insurance Industry – Here’s How It Affects You (And Us, Too)
Phil’s Corner is a special column from OAMIC’s President & CEO Phil Fraim that is sent in our e-newsletter each month.
For nearly 40 years, OAMIC has been the only local provider of legal malpractice insurance that is based in the state of Oklahoma. We take great pride in our local roots and do our best to be your MVP – Most Valuable Partner.
Part of that MVP role includes having an open dialogue with our insureds about today’s insurance market, including how its volatility impacts both you as an insured and us as a carrier.
In order to adequately explain everything, let’s start with a few basics about how the insurance industry operates.
How Insurance Carriers Generate Income
Insurance carriers generate income from two sources – underwriting profit and investments. Underwriting profit is the difference between the total amount of premium collected and money we paid out in claims and general administrative expenses that same year. Investment income is, as you would guess, income generated from an assortment of stocks and bonds.
In the last 10+ years, OAMIC’s cost per claim has risen, and we’ve lacked an underwriting profit. During some of those years, interest rates remained higher, and we could make up for underwriting losses with our investments income. However, when interest rates are low, like now, it’s a tougher task. Still, our investment income gives us great stability and allows us to pay policyholder dividends even in years when we have underwriting losses.
Insurance carriers are also required to maintain adequate reserves, which are certified by a casualty actuary and examined by the state’s insurance department. One of those is an unearned premium reserve, so that in the unlikely event that every single one of our policyholders cancelled their policies on the same day, they could all be paid the unearned portion of their premiums. We also have loss reserves, which is an estimate of the cost to dispose all open claims. The loss reserve figure is an insurance company’s largest liability item.
Hard vs. Soft Market
The insurance industry, especially reinsurance, is truly a marketplace and, like all markets, there are cycles. For hundreds of years, the insurance industry has continually fluctuated between a hard and soft market, which is largely driven by supply and demand. In a hard insurance market, there is high demand for coverage. Insurers are more selective about whom they insure, coverage terms are more restrictive, and premiums are high. In a soft market, it’s just the opposite. Demand for coverage is low, insurers are less selective, and premiums are lower.
A soft market has existed since the mid-2000s, but we have seen the pendulum swing within the industry over the last couple of years. Many are questioning what these changes really mean. The increase in our reinsurance rates started slowly in 2018, gained momentum in 2019, and is continuing into 2020. We expect to see more of the same through 2021.
Loss Leader Pricing From National Competition
For legal malpractice specifically, a big part of the problem has been an increase in loss leader pricing strategies amongst big national carriers. From Investopedia, a loss leader “is a product or service that is offered at a price that is not profitable, but it is sold to attract new customers or to sell additional products and services to those customers.”
As an example, if a big national carrier provides you with a quote that is significantly less than ours, it’s likely a loss leader pricing strategy. Low rates are given to new insureds for a year or two, and then a sharp increase occurs to get your premium up to a level that allows the company to be profitable.
Homeowners insurance companies started this practice years ago. Large discounts were extended to “new customers” and then prices jumped upward by year three. Some people contend this is an unfair business practice; however, it is not illegal. Keep in mind that you will see a natural increase in price with any carrier in the step rating methodology within professional liability – until you hit the mature rate. However, loss leader process can be more drastic.
We know the loss costs of writing lawyers professional liability insurance in Oklahoma because we write the majority of the market. Substantially lower premiums are short-term, at best.
Your premiums will be more stable with OAMIC for a few reasons:
- We’re a direct writer; we don’t have to pay agents commissions from a portion of your premium.
- Our costs to defend claims and suits against you are more efficient because of our relationships within the Oklahoma legal community.
- Our overall operating expenses are much lower, partially because we’re a small local company and partially because we write only legal malpractice in Oklahoma.
Having irresponsible and inadequate pricing for too long can have a negative effect on a company, and the industry as a whole. As one big national competitor is currently scrambling to recover some of its losses, its D&O and E&O liability insurance rates – of which legal malpractice is a part – were up 42% on average at the end of Q3 2019 (via InsuranceInsider.com). Additionally, it is not uncommon for big national carriers to enter and exit a market (or region of the country) for periods of times if they experience significant losses or if they expect losses in the immediate future. This, obviously, leaves their insureds in a tough spot. However, the drive to enrich shareholders can create conflicts with the insureds’ best interests.
Rising Claim Costs
Another factor impacting insurance cost is the rising claim cost, known as increased severity. This is being experienced nationwide and at OAMIC. Legal malpractice is sometimes referred to as the “case within a case.” The plaintiff must prove that, but for the lawyer’s conduct, he or she would have succeeded in the underlying case. A plaintiff cannot recover damages in excess of what the damages were in the underlying case. Therefore, the more valuable the underlying case, the more expensive it will be to defend and settle the case.
The current average cost of a claim for a legal malpractice lawsuit in Oklahoma is approximately $70,000. However, in some areas of practice, this cost can increase dramatically. The limit of insurance coverage obtained should be carefully considered by an insured.
So, what does all of this mean?
As the market continues to harden, things will get tricky for those who use irresponsible pricing, especially if claims continue to grow in severity, complexity and cost. Our goal is to provide more stable, long-term pricing for our insureds.
If big national carriers do not achieve stellar results in a particular jurisdiction, they’re more likely to leave. That’s what happened in 1978, when what would become OAMIC first came into existence. National carriers had given little attention to this market. Frustrated, a group of Oklahoma Bar members banded together to start an insurance company in 1980 that would eventually become the preeminent writer of lawyers’ professional liability insurance in the state.
OAMIC has been here for 40 years – through all the natural ebbs and flows of the market cycle. We aren’t going anywhere. And, as a mutual company, we are owned by you – our members. This means that our responsibility lies with you, our policyholders, instead of corporate shareholders.
When we make decisions that impact pricing, we understand that it affects you. You may experience a slight increase in your premium for 2020. We want you to know we make these types of decisions only after actuarial rate studies, data analysis, and careful thought. Our Demotech Financial Stability Rating of A Double Prime, the highest rating available, means that “regardless of the severity of a general economic downturn or a deterioration in the insurance cycle, insurers earnings [this rating] possess unsurpassed financial stability.” This increase will further strengthen us and insulate us from the reinsurance market swings and volatility. It will also allow us to remain committed to providing the best coverage for everyone we insure.
If you have any questions about this, or would like to discuss further, please don’t hesitate to give us a call at 405-471-5380.