The Property Insurance Industry is showing signs of softening, but is it ready for it yet?

The first signs of the insurance market softening are starting to appear as the property market finds insureds are not willing to pay large premiums for terrorism coverage.

As a direct consequence of insureds declining to purchase coverage, many insureds are left to ask what other exposures do they have to warrant such drastic increases over last year's renewal?

Many clients are arguing that their exposures other than terrorism have remained fairly constant so why should they be assessed a double-digit premium surcharge if their most significant exposure has been removed.

And hence the property insurance industry finds itself in a quandary, a quandary largely brought on by the industry for asking the US government to bail them out of future terrorist attacks before thinking through the implications of asking for this assistance.

The terrorism bill requires that insurers specifically and separately quantify how much they want to charge for terrorism coverage.

They must do this to give clients, in most states, the option not to purchase terrorism coverage if they do not like the price.

The problem with separating the price of terrorism from the rest of the premium is that it immediately creates a premium charge based on underwriting data for that year and a terrorism premium. Without the buffer of terrorism as an explanation for needing to increase premiums, insurers have few explanations to offer to their clients as to why their premiums need to be increased.

Unless an underwriter is brave enough to admit that for the last 13 years, he has been underpricing his client's account to keep his business, there is very little reason for him to charge large premium increases.

One plausible explanation an underwriter can offer is the short fall of the investment market which has reduced underwriting income because despite the fact that they are getting the same amount of premium they were getting the year before, they are not getting the same return on investments as they did the year before.

However, a client could argue it was not his fault that his underwriter assessed his risk and came up with a premium that was not enough to cover his exposure and therefore, that there is no way he should be charged double digit increases when his exposures have not changed.

The property industry is always the first industry to be affected by the swings in the market because its exposures are based on the physical make up of a company.

Therefore, unless a client has had several losses, completed some major capital expenditures or has acquired other facilities, the risk does not change much from year to year and hence the reason it becomes difficult to argue that pricing should fluctuate much from year to year.

Many underwriters were rubbing their hands with glee at the prospect of surcharging accounts for being in high profile areas or being high profile clients because it gave them ample reasons to surcharge accounts and increase the premium income. That short window of opportunity has abruptly closed as a result of the passage of the terrorism bill leaving many property insurers to worry about being able to generate enough premium income to make their books profitable.

Renaissance Re, on the other hand, recently announced record profits for the year. Many are questioning how they could do this.

The principle underwriting philosophy of Renaissance Re is that when the market is soft and the premiums are not where they feel comfortable to underwrite, they decline to participate on programmes.

Therefore, their book of business shrinks in a soft market and grows in a hard market because they are not concerned about growth in a soft market. However, when the market comes back up to a level where they feel comfortable with the pricing, they step back into the picture.

Renaissance Re does not have the pricing issues of a majority of the market because they don't play the market.

So what does this mean for the rest of the property industry? It means that before it has had the opportunity to bring its rates up to where they were after Hurricane Andrew, they will have to start either settling for renewing accounts at the premium levels they were the year before, or they will have to start giving reductions on accounts.

Why reductions? Because those clients who had terrorism coverage thrown into the total premium calculation the year before may be looking for reductions on their programmes when they elect not to purchase terrorism insurance this time around.

Another quandary the property market finds itself in along with other lines of business is that the only clients purchasing terrorism coverage are those clients that most need it.

This is not a good sign for property underwriters because the highest risk clients are adversely selecting them against.

This in turn means they are not writing enough of a cross section of accounts to spread the terrorism risk between those that present high risk and those that do not.

It also means the property industry is not generating enough premium to pay for the large terrorist attack when it comes.

When property insurers are forced to reduce their premiums, they must seek volume to make up for the lack of premium income.

When they seek volume, it increases the supply of property insurance available which often outstrips the demand and before they know it, these insurers will be in a soft market well before they are ready for it.

And every report says, the industry is still far from being whole and cannot afford to begin reducing premiums yet.

The property insurers are in a quandary, one they must work out before it is too late

Cathy Duffy is a Chartered Property Casualty Underwriter (CPCU) and is now a freelance writer. She is a former executive of Zurich Global Energy and has 15 years experience in the insurance industry. She writes on insurance issues in The Royal Gazette every Monday. Feedback crduffy@cwbda.bm