INSURANCE MARKET BAROMETER: FOURTH QUARTER 2023

As we prepare to enter 2024, here is a look at a few key indicators to explore the state of insurance markets. We’ll also examine key events that have impacted markets recently.

THE VESTTOO FRAUD

Over the course of the summer, financial fraud was uncovered in the reinsurance industry, which has created immediate concerns for certain insurers and market concerns about how this event could have ever happened. The company responsible for this market misconduct is the Israeli fintech firm, Vesttoo. Their vision is (was) to connect aspiring “capital-light” entrepreneurs with the global capital markets to compete with the traditional reinsurance industry.

Unfortunately, in this case, it appears that the capital support portion was backed up by $4 billion of fraudulent letters of credit (LOC). In essence, the carriers who thought they were just “fronting” the policies, were, in actuality, taking on the risk.

The parties that were most impacted are the “fronting carriers” who were left exposed, as it is their paper now missing the capital support expected behind it, and the managing general agents (MGAs) responsible for underwriting and distribution. A fronting carrier is an insurance company that issues a policy and cedes all or the majority of the risk to a reinsurer. The state of Florida defines a fronting company as:

A “fronting company” is an authorized insurer which by reinsurance or otherwise generally transfers more than 50 percent to one unauthorized insurer which does not meet the requirements of s. 624.610(3)(a), (b), or (c), or more than 75 percent to two or more unauthorized insurers which do not meet the requirements of s. 624.610(3)(a), (b), or (c), of the entire risk of loss on all of the insurance written by it in this state, or on one or more lines of insurance, on all of the business produced through one or more agents or agencies, or on all of the business from a designated geographical territory, without obtaining the prior approval of the office.1

Unlike traditional “balance sheet” authorized reinsurers, which provide security to downstream insurance partners based on the liquidity and consistency of their balance sheets, Vesttoo focused on an alternative area of capital support known as insurance linked securities (ILS). ILSs provide an alternative capital to enter the insurance market and have risen in popularity in accordance with the fronting carriers that rely on them for support. These markets are considered “unauthorized insurers.” These ILS providers for Vesttoo put up letters of credit, $4 billion of which were not worth the paper they were written on.
The Vesttoo event is being billed as “Unicover 2.0.” Many will not have the grey hair to remember these events in the 1990s and the aftershocks provided to the general insurance marketplace, especially to my old friends at Reliance National. It was the first time I heard the term “cash-flow suffocation.”

Unicover sold a tremendous amount of reinsurance support to workers’ compensation carriers and MGAs, such as Reliance, who acted as a fronting carrier. It was a consortium of life insurance carriers (i.e. CIGNA, Lincoln) who had surplus to deploy and so they formed a reinsurance MGA called Unicover. On paper, they never took any risk on most transactions and should have never lost a dime. Fronting carriers cede all or most of the risk to other supporters (cedants) of a given transaction, and this was the traditional position of Reliance. They would be paid a fee to, in essence, take no risk (usually 5-6% of premium), but instead provide others the ability to trade with their paper.  The support provided was also not traditional, but instead, occupational accident insurance (unauthorized like ILS), which was endorsed to act like workers’ compensation and was better understood by the life insurers that supported the positions.  Or so they thought.

When the losses started rolling in and the reinsurers saw they had been duped on the positions they took, they litigated instead of paying claims. Whether they were right or not, this delay in funding for loss to Reliance quickly rendered the company insolvent.  While on paper they were making great money and had an “A-” rating, the amount charged to front the policies was a fraction of the money needed to pay all the claims out in time. The 5-6% collected for the fronting fee was nowhere close to the 60-70% typically expected in losses.

IMPACT TO MARKET

“Asset-light entities are delivering for brokers and insureds, developing new products for some of the most challenging exposures in today’s market, including cyber risks and property perils impacted by climate change,” said William Pitt, director, insurance research, Conning, in a statement about the report. “At a time when data analytics are increasingly pivotal, these agile entities can often move faster than traditional carriers, identifying and developing attractive niche markets and offering speedier submission turnarounds.”2

Being a regular attendee at “Target Markets,” an association convention supporting the MGA sector and the insurers that support it, it is obvious how quickly the “fronting” sector has grown in the last five years. According to AM Best, “direct premium written on an aggregated groupwide basis by AM Best-rated fronting carriers increased 43% on a year-over-year basis to $10.6 billion in 2022. Fronting companies in the surplus lines/specialty commercial marketplace, particularly hybrid fronting companies, are also growing in number.”3

A good portion of the support for this explosive growth has been fueled by alternative capacity such as ILS. With the cost of money up and now capacity shrinking based on this event, I expect there to be a reduction in new entrants to the fronting carrier space and potentially a consolidation of some of the existing ones. The downstream impact will be a flight to quality in the market, especially in casualty lines, towards financial strength and stability. Increased scrutiny of the ILS model and proper collateralization of these alternative capital transactions will impact overall market capacity, especially in lines such as workers’ compensation, EPLI, and cyber, where it is most deployed. Hopefully regulators will recognize the importance of maintaining these alternative vehicles while providing a better regulatory framework to ensure that it will never happen again.

2024 OUTLOOK

Our friends at MarketScout see an overall 5% increase in the sector with Richard Kerr, its CEO, providing the following commentary: “While the composite rate held steady in the second quarter, there was some movement in various lines of insurance. Property, business interruption, general liability and umbrella/excess rates increased, while most other coverage classifications softened a bit.”

RATE MOVEMENT BY LINE OF INSURANCE

While the composite index is only moderately up, certain lines of insurance such as property are increasing dramatically, and others such as workers’ compensation continue to soften. It should be noted that the below data on workers’ compensation occurred prior to recent dramatic rate reductions expected to take place either October 1, 2023, or January 1, 2024.

The inflation rate and the Consumer Price Index are two core drivers of insurance rates. As the price of goods increases due to inflation, such as the cost to build, there is more value to insure and replace, and thus higher premiums to be charged. It appears that the Federal Reserve’s raising of interest rates has neutralized the rates achieved during the pandemic.

In sum, here are my takeaways going into the fourth quarter of 2023:

• Property is a disaster everywhere; expect sharp increases at best.
• Workers’ compensation rate decreases across the nation are approaching double-digits, with an expected range of 8-10%.
• Cyber liability is coming in with some increase, but generally flat.
• EPLI is still a problem in California and becoming more so in New York and Florida, per our underwriters. Expect continued push to increase retentions in these areas, for higher wage earners and certain industry sectors.
• If you are of the size, consider a captive. Interest rates justify their consideration.

REFERENCES

1. http://www.leg.state.fl.us/statutes/index.cfm?App_mode=Display_Statute&Search_String=&URL=0600-0699/0624/Sections/0624.404.html
2. https://www.carriermanagement.com/news/2023/09/10/252968.htm
3. https://news.ambest.com/newscontent.aspx?refnum=250463&altsrc=175