There is an underlying second cause for rates to increase this year, independent of Covid. It has to do with reinsurance, a topic foreign to most people but one that affects the prices we ALL pay for every kind of insurance. It has to do with Reinsurance.
To understand reinsurance, let me give you an example of how insurance works. Say you pay $1000 a year to insurance a $50,000 car with a $50,000 liability limit. The insurance company could at any time have to pay $100,000 for a total-loss claim. Since you only paid them $1000 in premium, they have to write 99 more policies just like it to pay your claim. But now with 100 policies, their risk is $10 million. You can see it becomes exponential, so how do insurance companies manage the risk and why should I care?
Continuing the example, after ten years of writing 100 policies and incredible luck, the insurance company would have $1million in the bank but still be $9million short in the catastrophic scenario where they would have to pay all 100 policyholders at the same time. It would take one hundred years of no losses to collect enough premium to pay all of their risk; instead of waiting insurance companies get reinsurance.
Reinsurance companies are like insurance companies FOR the insurance companies. They agree to insure that excess risk (the $9million) and charge a premium to cover it. Often there are more than one reinsurance company involved and their coverage creates a "tower", a visual to explain how one reinsurance company may take the first $3million, another company takes the next $2million, and so on until the full $9million is reached.
In a world where catastrophes don’t happen, these reinsurance towers may never get used. Diversification of policyholders and infrequency of claims would allow the insurance company to operate simply by using the 99 to pay for the 1.
But we don’t live in a catastrophe-free world and reinsurance companies have been absolutely hammered recently. The total amount paid for loss events in the US has steadily increased over the last 30 years *. The average insured losses per year over the last decade is more than double what it was during the 1990s and up 40% from the 2000s (which is surprising considering that decade included the World Trade Centers and the US's costliest single event ever, Hurricane Katrina).
Catastrophic losses have been relatively modest and for context averaged around $17 billion per year for the four years prior to 2017; the second longest stretch of the last thirty years. The hurricane season of 2017 cost insurance companies over $100 billion, then another $50 billion in 2018 for Hurricane Florence, Michael and the California wildfires (which are quickly becoming as costly as hurricanes).
And it is important to remember that a lot of insurance companies and reinsurance companies are global. For a little context, this was recently written in the Insurance Journal, "Swiss Re suffered higher-than-expected natural catastrophe losses, notably from Dorian, Faxai, Hagibis, and the Australian bushfires, said S&P. In addition, the company saw prior-year adverse reserve developments related to Typhoon Jebi and the U.S. casualty lines, which hit both its reinsurance business and its primary unit, Corporate Solutions."**
The top two reinsurance companies over the last decade have been Munich Re and Swiss Re, which together control about 30% of the entire reinsurance market. This makes them highly influential in pricing for practically ALL lines of insurance. These two companies along with the reinsurance industry as a whole had back-to-back severe losses in 2017 and 2018, then two things happened in 2019.
First, many if not all of these companies raised rates in 2019 to make up for their losses. Second, Swiss Re decided to severely limit it's US market, which reduced supply and further drove up prices by forcing insurance companies to go elsewhere to "complete their tower" or limit their own capacities. This affects us in the coastal market because capacities have been limited or reached more quickly than usual, especially in commercial property insurance, which means the better priced options are no longer on the shelves.
This would typically be the end of the story, they would raise rates a little to make up their losses and then we all move on business as usual. Most of these companies are also heavy investors, so with a strong stock market (not only the NYSE but also the London and Tokyo markets) they may not need to raise rates at all. Their global scale spreads the risk thin so no one event can do too much damage to their financials and as a result, not too much damage to the price you pay for home insurance in little Santa Rosa Beach Florida.
This is what makes the pandemic so unique, it is a worst case scenario, a fully global event that could mean paying all policyholders at once.
2020 is different for many reasons, obvious to anyone who has lived through it. Elana Ashanti Jefferson recently wrote "P&C insurance is poised to lose between $15 billion and $30 billion due to pandemic-related claims… Lloyd's of London says that figure could be as high as $203 billion." *** As I mentioned in my previous article, just the chance of paying that much is enough to provoke insurance executives to raise rates in preparation.
On the low end, adding $15 billion to a standard year would be enough to cause concern, especially since insurance companies are still reeling from the largest single-year loss in history (2017) . But take into account the possibility of Covid related claims being the largest ever paid for a single year, more than 5 times the decade's yearly average and double 2017's number, and you can see why reinsurance companies have sounded the alarm.
There are several cases going through the courts now related to Business Interruption coverage that will tell how big the insured losses may be. So far it looks to be trending in favor of the insurance companies, many of which have specific wording in their policies related to infectious diseases. But the companies who don't have that wording have reason to be alarmed and the reinsurance companies that cover them may start jumping ship. As it continues through judicial rulings I expect rates to continue to rise until some finality can be estimated for its related losses.
* https://www.iii.org/fact-statistic/facts-statistics-us-catastrophes
** https://www.insurancejournal.com/news/international/2020/02/21/559014.htm
*** https://www.propertycasualty360.com/2020/07/06/industry-giants-2019s-top-100-insurance-companies/