Where Are Liability Insurance Rates Going?

By Roy Felipe



Where are liability insurance rates going? In a word, up. And while there are ways for you to keep your premiums down as you manage your company's risk, let's explore how we got here before we figure out what to do about it.

Over the last three years, insurance costs for commercial general liability, workers' compensation and commercial auto have gone down, in succession, 15%, 12% and 10%. These numbers are industry-wide and may not accurately reflect your specific experience. But on average, it means if you paid $10,000 for your insurance program in 2006, this year it cost you about $6,700 - pretty cool if you are an insurance buyer.



A 'Soft Market'

As it turns out, even in the face of eroding premiums, the last few years have been pretty good for insurance companies, too. How is that? Property and Casualty (liability) insurance companies maintain huge reserve funds to pay for catastrophes or times where they just have to pay more than expected in claims. Investment return on these reserves has allowed these insurance companies to continue to be very profitable while cutting their prices. In fact, as an industry, they have been paying more in claims and expenses than they collected in premiums.

Why would they do that? Market share. Yes, it's the old joke about losing money on every transaction but making it up in volume, except in this case, it works because on average, a business stays with the same insurance company for seven years. So, you cut prices in the hopes of gaining customers with the intention of being able to keep most of them, even when the prices go back up.

But what has happened to your investments has happened to those of the insurance companies, too. No longer able to turn a profit by using investment returns, they are going to be forced to increase premiums until they are higher than expenses.

As businesses continue to shrink, so do their payrolls and sales. When these numbers are used to calculate premiums, the premiums will shrink as well. This gives insurance companies yet another reason to raise rates.

It gets better (or worse, depending on where you stand in these transactions). You may have noticed certain insurance companies in the news recently. Some are in trouble and some are consolidating. This creates upward pressure on rates by lowering the capacity of the industry. Fewer companies competing means less incentive, and in the case of a weakened company, ability to cut costs.

When rates are falling and there is high capacity, it is known as a "soft market." We have been in a soft market for almost five years now. That is actually a pretty short cycle, since they can run 10 years or more. Based on the renewal premiums forecast for the next few months, it's possible that this soft market may be over and rates will turn sharply to a "hard market" with higher premiums and fewer insurance sources available. The "flat market," when rates are stable, may be so short we don't even notice it.



Small Claims Can Have Big Repercussions

One risk management strategy you could adopt is to stop thinking of insurance premiums as an investment. If you are the type of business owner who files a lot of small claims because "that's why I have insurance," you may find yourself wishing for the good old days when you actually had insurance.

Here's why. Severity follows frequency. There are two ways to trend insurance claims. One is frequency - the actual number of individual claims - and the other is severity - the total dollar amount paid out. Insurance actuaries have found that a number of small claims over time predicts a whopper of a claim down the line. They don't use the term "whopper," but you get the idea.

Think of a restaurant kitchen with several slip-and-fall workers' compensation claims. It could be a slippery floor; it could be careless employees; it could be pressure to move quickly. In any event, if the behavior or the environment doesn't change, there is a slip-and-fall coming with a long-term disability and a huge payout. It may seem like bad luck, but over time, it happens over and over again. Severity follows frequency.

Insurance companies know this, and in a hard market, they will be less inclined to keep you as you move ever closer to the severe claim that is sure to come. Remember that they are now paying much closer attention to claims. Change the behavior or the situation, and don't keep turning in nuisance claims. They are keeping score. It's what they do.



Buckle Up

Insurance is an annual expense you incur to protect your business against catastrophic financial loss. It is not an investment on which you should expect returns. This is especially true now.

Raise your deductible to almost painful levels. Remember that you aren't going to be making those small claims anymore, so at least get a better premium. Before you do, ask your agent if there are enough savings to warrant it. Saving $100 by increasing your deductible to $1,000 may not make sense after all, but do explore the option.

You also can get some competitive bids on your insurance program. A word of caution here: If you are paying $500 for an office policy, don't expect agents to break down your door for your business. It very likely could be that you are paying the minimum premium, and there isn't much anybody can do. That being said, give each agent the exact same information, and make sure that the company is highly rated.

Make sure you are insuring to value. If you have a BOP (business owners policy), the premium is pretty much derived by the amount of business personal property or contents. Most businesses have no idea how much they own. Try to get a good number on the replacement cost (new, not depreciated) of your business property.

The hard market is coming. It is counterintuitive, given that every other business is slashing prices, but now you can see how it happens. Buckle your seatbelt (always a good idea), and take a closer look at your operations and your insurance program.



Roy Felipe, CIC, CRM, is commercial account manager for McCabe Insurance Associates Inc. in Columbia. He can be reached at 410-992-5550 or roy@mccabeins.com.