Insurance Conundrum: Premiums and Losses Rising
November 2019 (click to download)
In an environment characterised by low interest rates, macroeconomic concerns and a flat yield curve, insurance stocks have been a relatively attractive industry for investors in the financials sector. More specifically, various commercial insurance stocks have reported accelerating rate increases as some of the largest players in the market have been withdrawing from certain lines of business. This bullish narrative about rising premiums was disrupted recently by a few industry participants calling out rising losses necessitating building reserves, more than offsetting the benefit of higher premiums.
Several causes of rising losses have been called out. Commercial auto insurance has been a particularly problematic line of business for insurers as new ride-sharing business models, without the decades of loss experience of other businesses, have proven harder to reserve for and have become prime targets for personal injury lawyers. Other insurers have noted rising social inflation. Social inflation is an increase in insurance losses driven by higher jury awards, more liberal treatment of claims by workers’ compensation boards, legislated rises in compensation benefit levels, new concepts of tort and negligence, the growing trend of third-party litigation funding, the availability and analysis of attorney data and tactics, changing views of social responsibility coupled with the erosion of trust in corporate America, the increased use of legal advertising and the rise in populist sentiment. Some juries see their role in determining damages as increasingly needing to punish corporate malfeasance in addition to compensating the injured. Whatever the cause, frequency and severity are rising and putting upward pressure on loss ratios across the industry (Exhibit 1).
One way for investors to participate in the rising premium environment, without taking the risk of rising loss ratios, is with insurance brokers. Insurance brokers are paid as a percentage of premiums placed and, therefore, benefit as rates increase, but without taking on the underwriting risk that carriers assume.
*“Social Inflation in the US: What Is It and Why Is It a Concern?” PartnerRe Social Inflation in the US What Is It and Why Is It a Concern Comments, 26 November 2010, https://partnerre.com/opinions_research/social-inflation-in-the-u-s-what-is-itand-whyis-it-a-concern/; “Five Thoughts on Social Inflation.” Five Thoughts on Social InTation | Captive.com, 30 October 2019, www.captive.com/news/2019/10/30/five-thoughts-on-social-inflation.
Source: Michael Buck of Driehaus Capital Management LLC.
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