Know what to expect with property and casualty insurance, workers' compensation, sureties and employee healthcare benefits.


I began working in the insurance business in 1980 as an underwriter trainee for an indemnity company. I was told that an “underwriter” evaluated a prospective insured’s exposure to loss and determined an appropriate premium for that account. What I quickly realized, however, was that the insurance industry was in the middle of a raging soft market. Instead of intelligently selecting the right price for new and renewal business, the thought process was more like, “How low can we go on price?”

Now, we are again in the middle of a soft market, and this is characterized by excess capacity in the insurance industry. “Capacity,” or what is referred to as “policy holders’ surplus,” is basically the insurance companies’ current reserves to pay future claims as well as their other capital. The more surplus a company has, the more premiums it can write. If more insurance companies write more premiums, competition ramps up.

I remember learning in college that when supply goes up and demand stays the same, prices go down. This, essentially, is what happens in a soft market. In an effort to write more premiums, insurance companies slash prices, write accounts they might not usually pursue and provide the types of coverage and terms that otherwise would be unavailable.

As insurance companies compete feverishly, results deteriorate and loss ratios go up. The “combined ratio” equals losses paid out and expenses incurred divided by premiums. If the combined ratio is less than 100 percent, an insurance company is making an underwriting profit. If it is above 100 percent, it is losing underwriting money.

Historically, the insurance industry’s combined ratio has been about 100 percent. The industry can survive at this level because it also makes money on investments. During periods of substantial investment returns, insurance companies will even accept modest (and sometimes not so modest) underwriting losses because they can make it up on their investments. The problem is that during a prolonged soft market, prices get bid too low, the rate of return deteriorates, and at some point, the industry must raise prices, restrict its underwriting appetite and reevaluate the types of coverage offered.

Table 1 reflects the insurance industry’s critical financial indicators for the last 10 years. The year 2001 was the worst in the industry’s history. The combined ratio was 115 percent, surplus was depleted, and the industry actually lost money for the first time ever. The industry reacted. Prices went up, combined ratios improved and surplus took off. By 2004, rates had started decreasing. Table 2 shows that on average, commercial rates have dropped 38 percent since then. Workers’ compensation in California dropped a lot further.

The industry continued to improve in 2005 and 2006. The year 2006 was probably the best the insurance industry ever had. The combined ratio dipped to 92.4 percent, surplus continued to grow, and return on surplus hit 12.7 percent, the highest in recorded history. As surplus grew, however, competition became fierce. Prices continued to go down, insurance companies entered lines of business they did not understand, losses started piling up, and combined ratios began rising. Although 2007 returned a solid 10.9 percent, many reasons having to do with the number of natural disasters, 2008 was terrible, returning a meager 0.1 percent. Although 2009 was a little better, returning 4.7 percent, it was still way under what investors wanted.

For the first six months of 2010, results have actually improved, with return on average policyholders’ surplus increasing from 2.6 percent to 6.3 percent; this was despite the fact that the combined ratio actually increased from 100.8 percent to 101.7 percent. This is reflective of a better investment climate. It is, however, still far below the 13.9 percent long-term investment average of the Fortune 500 companies and the 9.4 percent average annualized first-half rate of return for the insurance industry (based on data going back to 1986).

So where are we today? And what can you expect for the remainder of 2011?

Property and Casualty

Rates have dropped significantly since 2004. Most underwriters will tell you today that they want to hold rates on their preferred business rather than lower prices, and they would ideally like five to 10 points of relief. Unfortunately for them, there is still too much surplus in the market and too many competitors. Preferred accounts, therefore, can expect flat rates through 2011 and conceivably modest discounts. More challenging accounts, either because of what they do or their loss history, may not be as fortunate. Regardless of whether or not you are a preferred account, it is prudent to start the renewal process early and lock down terms well in advance of your renewal, if possible.

An exception to what otherwise should be a decent year to renew insurance programs is executive risk, also known as directors and officers liability insurance (D&O) and employment practices liability (EPL), among other coverages. Not surprisingly, D&O and EPL have had adverse loss experience in the recent poor economy, driving costs up in these lines.

Workers’ Compensation

Nationally, workers’ compensation has been relatively stable. Although results vary by state, in general—outside of California—there should not be any huge surprises. Regardless, if you have most of your payroll in a state other than California, you should look into the results for that state to budget appropriately.
In California, rates will go up. California operates as an “open rating” state. The Workers’ Compensation Insurance Rating Bureau (WCIRB or the “Bureau”) recommends pure loss costs for each of the numerous classifications. These are reviewed by the insurance commissioner who comes up with his or her own rate recommendations. Regardless of what the Bureau or the Commissioner recommend, insurance companies are free to choose whatever rates they want. Most insurance companies, while not in lockstep with the recommendations, will generally follow fairly close to the recommended rates.

Earlier last year, it was rumored that the Bureau would recommend a 30 percent rate increase effective January 1, 2011. It actually came in at 27.6 percent. The commissioner believed there was not enough credibility to The Bureau’s data, and he recommended that rates stay the same. Although some insurance companies have chosen not to increase rates, many have. In addition, there were some changes to the experience modification formula, which are also impacting California employers. Based on both these factors, it is prudent to find out early if your insurer has chosen to take a rate increase and also what your new experience modification will be.


The latest figures from BizMiner, a provider of industry financial analysis and market research, confirm the effects of the economic trend on contractors. Of the 1,424,124 companies operating in 2007, only 969,937 were still in business in December 2009, representing a 31.9 percent failure rate. The failure rate for startups was even higher at 37.9 percent.

Following significant losses earlier in the decade, the surety industry “returned to the basics” of sound underwriting, exposure management and project analysis. These actions stabilized capacity by restoring profitability and preserving the capital necessary for sureties to stand the test of time. Moreover, the excellent results posted by the surety industry in 2005 to 2008 positioned surety companies to ride out the current economic downturn.

With the residential slowdown in 2008, the late 2009 slowdown in non-residential construction and now the shrinking backlogs, sureties do not expect to see growth return until at least late 2011, despite The Recovery Act. Anticipating the completion of public works projects and continuing limited public funding for new projects, we expect the construction market to remain competitive. The very best contractors should have no trouble obtaining bonds. However, marginal contractors will have difficulty. Contractors need to tighten their operations to emerge through the difficult economic conditions.

Sureties are looking more closely at onerous contract terms and conditions such as consequential damages, delay damages, hold-harmless obligations, efficiency guarantees and extended maintenance and warrantee requirements. Contractors may experience changes in their bonding programs due to more disciplined underwriting factors.

Small contractors may encounter challenges in meeting the more demanding underwriting requirements. Several surety companies have developed programs for emerging contractors, while other companies specialize in the small contractor market. The U.S. Small Business Administration Surety Bond Guarantee Programs may become a popular option for those unable to obtain bonds by traditional means. New and emerging contractors will need to provide well thought-out business plans, more frequent CPA-prepared financial statements and high-quality information about their company more often and in a more timely manner than in the past.
Construction is cyclical, and contractors should prepare for the pent-up demand that will build during a recession. While contractors must retrench during these lean times, they also need to protect their core resources and be ready to bid work when the economy rebounds. The surety is a critical partner through good times and bad and can help owners and contractors manage the changing economic climate.

Employee Healthcare Benefits

Employee healthcare costs continue to rise. Medical costs are going up, and healthcare reform has not appeared to help. The intent of the Patient Protection and Affordable Care Act, (PPACA) also known as “Obamacare,” is expected to improve the healthcare system for all Americans. The extent of the impact to employees and employers has not yet been realized.

What has been realized, well before 2014, is the impact the medical carriers have placed on premium rates to cover the new regulations set forth by the PPACA, such as adult child coverage for all children under the age of 26, the removal of the lifetime maximum, no co-pay or co-insurance associated with annual preventive visits and no pre-existing conditions or limitations for children under the age of 19. The medical carriers, along with their actuaries, have decided these benefits have a greater risk and must be addressed by increasing renewal premiums by as much as 7 percent. It is anticipated that small (50 or less) to medium (50 to 500) employers will see 15 to 25 percent rate increases in 2011.

Health Maintenance Organization (HMO) rates are expected to increase at a higher percentage than Preferred Provider Organizations (PPOs) in 2011, mostly due to contract renegotiations with providers. To offset this, HMOs will increase co-pays and pass more of the cost to the end user. The High Deductible Health Plans (HDHP) saw very large increases in 2009 and appeared to settle at the PPO medical trend percentage increase of 15 to 20 percent in 2010.

Employers continue to look for any way to moderate the magnitude of the inevitable renewal rate increase. Health Reimbursement Arrangements (HRAs), Health Savings Accounts (HSAs), HMO deductible plans and employer contribution changes are being considered to help offset increases.

The Long-Term Perspective

The insurance market will transition, and costs will eventually go up. This is already happening in workers’ compensation. While you can do some things to prepare for and survive in a hard market, your “cost of risk” must be examined from a long-term perspective. In fact, insurance is just one of the elements in your cost of risk—for many companies, it is less than half the total. Other costs include:

  • Your time spent analyzing and managing risk
  • Money spent on uncovered losses or deductibles
  • Your time and your employees’ time spent dealing with losses

Whether or not the insurance industry is in a hard or soft market cycle, well-run companies will always look for ways to effectively manage their risk. Risk management is not a seasonal or “one and done” exercise. Rather, it needs to be a vital part of your company. By lowering the frequency and severity of the losses that drive your premiums, you can lower those premiums in the long run.

Note: This article was written from a general perspective. Our prognostications are based on assumptions that could change. In order to more accurately estimate your insurance costs, you should discuss your specific situation with your insurance broker and underwriters.

Table 1. The Insurance Industry's Critical Financial Indicators
Description 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Net Written Premium $327.18 $369.1 $403.8 $421.1 $425.9 $443.8 $440.8 $434.9 $418.9 $212.5
Combined Ration 115.9 107.3 100.1 98.1 100.9 92.4 95.5 105.0 101.0 101.7
Investment Income $37.1 $37.2 $38.7 $39.6 $49.7 $52.3 $55.1 $55.5 $47.0 $23.6
Operating Income <$13.8> $5.3 $33.7 $44.1 $45.1 $84,6 $73.4 $30.6 $44.7 $19.2
Policyholders' Surplus $289.6 $285.2 $347.0 $391.4 $425.8 $447.1 $517.9 $457.3 $511.5 $530.5
Return on Average Net Worth <1.2%> 2.2% 8.9% 9.4% 9.6% 12.7% 10.9% 0.1% 4.7% 3.1%

*First Half Dollars in Billions

Table 2. Comercial Rate Changes
Month/Year Amount of Change Cumulative Change
August 2004 4% 1.00
August 2005 <6%> 0.94
August 2006 <y%> 0.67
August 2007 <14%> 0.75
August 2008 <10%> 0.68
August 2009 <5%> 0.64
August 2010 <4%> 0.62


Evaluating New Insurance Companies

You should also be wary of new insurance competitors entering the market.  An insurance company can only establish market share in four ways:

  1. They can provide broader coverage.  This is difficult to do in today’s soft market.
  2. They can provide better claims handling.  Not many new entrants can afford to invest in a claims department.
  3. They can provide better loss control and education.  Once again, not many new entrants are willing to invest in this area.
  4. They can provide a lower price.

Not surprisingly, most new companies opt for option four.  Unfortunately, these “newbies” do not have the actuarial data that experienced insurance companies have, and the likelihood of them surviving long term is doubtful. This can leave insureds without an insurance company just when they need it the most—during a claim. It is tempting to save some money in the short term and take the low dollar alternative. However, insurance is like many things in life—you get what you pay for.


Online Resource

Surety Bond Programs
Visit to learn more about the U.S. Small Business Administration Surety Bond Guarantee Programs. Here you will find information regarding the small business eligibility requirements, bond guarantee applications and bond guarantee fees. Locate bonding agencies by state, and access prior approval surety companies or preferred surety bond companies.

Construction Business Owner, March 2011