Businesses will need to prepare for major changes in insurance availability and pricing. We expect that most, if not all, insurance companies will be increasing premiums during the coming year, as well as restricting certain classes of business or certain types of coverage. These are industry wide changes, and not restricted to any one particular insurance company or any one particular geographic region.

While the events of September 11th most definitely had an effect on insurance availability and pricing, there were changes taking place even before this event. Our economy was changing and the insurance industry was already experiencing an economic downturn.

Insurance companies rely on investment income to make a profit, since premium alone is typically not adequate to pay claims. Investment income is used in calculating the rates necessary to meet claims obligations. Since the late 1980s, too much capital in the insurance industry resulted in what is known as a “soft market”, as evidenced by highly competitive pricing for commercial insurance policies. By the mid 1990s, outstanding performance in the investment market created even more competition for premium dollars among insurance companies, driving the premiums down to even lower levels. After twelve years of “soft market” conditions, in 2001 the industry began to show signs of strain and there seemed to be pockets of activity within the marketplace that indicated that a change in the cycle might be near. As the investment market began to change, resulting in a lower rate of return for investors, insurance companies were beginning to increase rates and be more selective in the types of risks they were willing to underwrite. This condition is termed a “hard market”.

Insurance companies also purchase their own type of insurance, called reinsurance, which allows them to insure large risks and to spread the risk on smaller accounts. Reinsurance costs to insurance companies were already rising prior to September 11th, resulting in increased premiums passed on to consumers. The World Trade Center catastrophe is the largest insurance claim event in history, with estimated claims totaling in excess of $40 billion. This event sent shock waves through the entire insurance industry, including the reinsurance market, and hastily sped up what was already happening in terms of rising prices. While all legitimate World Trade Center claims are expected to be paid by the insurance industry, the financial consequences of this event are enormous.

Starting in 2002, reinsurance companies have sharply increased their costs to insurance companies, and are refusing in certain cases to provide coverage at all on certain perils, such as terrorism. All of this is eventually passed on in some form to the insurance company’s customers, across all lines of coverage. It’s a simple matter of supply and demand, in this case the demand surpassing the supply.