Contents
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US Surety — Quarterly DPW
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passenger rail network, including the construction
of new rail corridors and transit lines in
underserved areas. The IIJA also calls for broadband
internet access to expand to rural areas and sizable
investments to protect against droughts, floods and
other weather-related challenges.
Public Construction Expenditures Finally
Poised to Supplement Growth in Private
Outlays
Over the past decade, private-sector projects
have dominated total construction spending; public
construction spending has averaged about $300
billion annually, mostly at the state or local level.
Private-sector spending averaged approximately
$810 billion from 2010-2020, reaching a peak of
$1.1 trillion in 2020. The influx of over $500 billion
in new IIJA-related federal spending, spread over
several years, will bring a significant increase in
public-sector spending to supplement the growing
annual expenditures on private construction
projects, boosting overall construction spending.
Inflationary pressure is becoming a greater
concern and will likely be a driving force behind
total dollars spent on construction projects.
Construction costs for labor and materials have
been rising at a pace not seen in 30 years. New
construction projects generated under the IIJA
may be more expensive than similar projects
undertaken even a year earlier.
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After the financial
crisis of 2008, surety
premium continued
to drop until 2012.
Beginning with
2013, annual surety
premiums rose
steadily until the
pandemic hit the
United States in
2020. The decline
in 2020, however,
was muted—down
less than 1%.
Surety premium
growth tends
to follow trends
in construction
spending. Annual
expenditures on construction projects have
risen since 2012, driving commensurate growth
for surety premiums. Through the first half of
2021, surety DPW was up by 4.7% over the same
period in 2020, after falling modestly during the
second half of 2020. Once the IIJA takes effect,
the projected increase in spending on public
construction projects could significantly boost total
construction spending, likely adding to projected
surety premium down the road.
However, projects might not proceed as quickly
as hoped, especially as inflation leads to significant
cost overruns. On Dec. 2, Congress averted a
government shutdown by passing a stopgap bill to
extend government funding through Feb. 18, 2022;
the bill was signed into law by President Joe Biden
on Dec. 3. Any government shutdown thereafter
would halt infrastructure projects. Supply chain
disruptions also could lead to project delays or, in
extreme cases, contractor bankruptcies. Additionally,
new COVID variants may lead to re-imposed travel
restrictions and internal lockdowns.
Labor pressures exist as well. The workforce is
aging and fewer younger workers are taking jobs
in construction. New vaccine mandates could lead
to more workers staying home. Contractors may
find hiring and retaining employees more difficult.
These factors could delay expected construction
growth so the impact of the IIJA may be muted
over the near term.
BR
Surety
($ millions)
Insurance: Financial Protection
I
From Risks
Insurers protect people against loss and risk, both of which play a large part
in everybody’s lives.
nsurance protects against the financial risks that
are present at all stages of people’s lives and
businesses. Insurers protect against loss—of a
car, a house, even a life—and pay the policyholder
or designee a benefit in the event of that loss.
Those who suffer the loss present a claim and
request payment under the insurance coverage
terms, which are outlined in a policy. Insurers
typically cannot replace the item lost but can
provide financial compensation to address the
economic hardship caused by a loss.
All aspects of life include exposure to risk.
Individuals and businesses are presented with a
choice: accept the consequences of a possible loss,
or seek insurance coverage in the event of a loss,
reducing the exposure to risk. Those who don’t
procure insurance coverage are responsible for
the full loss. Those who obtain coverage succeed
in “transferring the risk” to another organization,
typically an insurance company.
Purchasing insurance is the most common risk
transfer mechanism for the majority of people and
organizations. The money paid from the insured
is known as the premium. In return, the insurer
agrees to pay a designated benefit in the event of
the agreed-upon loss.
By the Numbers
Insurance takes advantage of concepts known
as risk pooling and the law of large numbers. Many
policyholders pay a relatively small amount in
premiums to protect themselves against a possible
larger loss. When a sufficient number of insureds
make that same choice, the funds available to
pay claims increase and the chances of any single
person or group exhausting the available funds
grow smaller.
In risk pooling, insurers can accept a diverse
and large number of risks, so long as many people
participate in the insurance process, and the
insured risks are individually unpredictable and
infrequent. Although an insurer may accept risks
from a large number of people, only a small portion
of those are likely to suffer an insured financial
loss during the period of insurance coverage. Risk
pooling allows insurers to pay claims to the few
from the funds of the many.
EDITOR’S NOTE: This
article is an excerpt from
the 2021 edition of
Best’s
Guide to Understanding
the Insurance Industry.
The guide is an easy-to-
follow introduction to the
insurance industry for
students, new employees,
prospects and those who
would like to learn more
about the industry. It is
available on Amazon.
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Guide to Understanding
50
What insurers sell is protection against
economic loss. These losses are outlined in
contracts or documents known as insurance
policies. Insurers that cover life and health usually
do not cover property or liability, which is the
domain of property/casualty insurers.
Life and health insurers cover three general
areas:
Protection against premature death.
Protection against poor health or unexpected
medical costs.
Protection against outliving one’s financial
resources.
Nonlife insurers, known as the property/casualty
sector in the United States and Canada, in general
offer two basic forms of coverage:
Property insurance provides protection against
most risks to tangible property occurring as the
result of collision, fire, flood, earthquake, theft
or other perils.
Casualty, or liability, insurance is broader than
property and is often coverage of an individual
or organization for negligent acts or omissions.
A well-known form of casualty insurance, auto
liability coverage, protects drivers in the event they
are found to be at fault in an accident.
A driver found to be at fault may be responsible
for medical expenses, repairs and restitution to
other people involved in the incident.
How Insurers Make Money
Insurance companies primarily make money in
two ways: from investments and by generating an
underwriting profit—that is, collecting premium
that exceeds insured losses and related expenses.
It all begins with underwriting. Insurers,
whether life or nonlife, must assess the risk and
gauge the likelihood of claims and the value of
those claims.
Insurance companies invest assets that are set
aside to pay claims brought by policyholders. The
interval between the time the insurer receives the
premium and the time a claim against that policy is
made is known as the “float.”
If an insurer has predominantly short-term
obligations, asset portfolios should be relatively
liquid in nature (i.e., publicly traded bonds,
commercial paper and cash).
If the needs are long term, a portfolio
containing fixed-income securities, such as bonds
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and mortgage loans, may also include preferred
and common stocks, real estate and a variety of
alternative asset classes.
Life insurers also establish separate accounts
for nonguaranteed insurance products, such as
variable life insurance or annuities, which provide
for investment decisions by policyholders.
Property/casualty insurers traditionally have
been more conservative with the asset side of their
balance sheets, primarily due to the high levels of
risk on the liability side. For example, catastrophe
losses can wipe out years of accumulated
premiums in some lines.
In the end, the insurer builds up a diversified
portfolio of financial assets that will eventually
be used to pay off any future claims brought by
policyholders.
The global recession of the previous decade
hurt nearly all aspects of the insurance industry, as
many companies experienced declining revenues
and investment losses. Companies that were
trading riskier instruments such as credit default
swaps suffered most severely.
Few winners emerged. However, the mutual
insurance sector managed to remain somewhat
unscathed by the downturn. Meanwhile, a chronic
low interest rate environment limited the ability
of life and other insurers to benefit from fixed
investments such as bonds. That may be changing,
depending on economic conditions that could spur
higher inflation.
The Economics of Insurance
More than 2,603 single property/casualty
companies and 752 single life/health insurance
companies are included in AM Best’s files for
the United States and Canada. AM Best’s global
database includes information on more than
10,812 insurance companies worldwide. Insurers
pay claims in property, liability, life, health, annuity,
reinsurance and other forms of coverage. In the
United States alone, the broader insurance industry
provides employment to 2.8 million people.
Insurance organizations play a vital role in
the U.S. and other economies. They protect
individuals and businesses from financial loss.
Money they receive as premiums is invested in the
economy. Protection from financial loss provides
a sense of security to individuals and businesses,
which are freer to pursue business and personal
Guide to Understanding
opportunities with less worry about financial
devastation. Businesses can afford to purchase real
estate and equipment, to hire more employees and
fund travel and expansion.
Premiums collected from insureds, often
known as policyholders, are invested by insurance
organizations until they are paid out. Investor
Warren Buffett has famously championed the value
of “float”—funds held by insurance companies
until they must be paid—as an important source
of investment capital. However, insurers must be
cautious and risk-averse with the majority of their
investments, both to satisfy regulators’ demands
and to be able at any moment to pay claims.
Insurance companies are large holders of
bonds, particularly those issued by corporations
and similar sources. They invest small portions
of their available funds in stocks. Life insurers
have traditionally played larger roles in real
estate investments, although a portion of those
investments has shifted from direct ownership
of commercial properties to more liquid
investments in real estate investment trusts and
the like. Insurers have also funded mortgages for
commercial borrowers and developers, who in
turn use the money to build commercial centers,
shopping centers, apartments, warehouses and
houses.
The insurance industry is part of the larger
financial services industry, which includes
banks, brokerages, mutual funds, credit unions,
trust companies, pension funds and similar
organizations. Traditional barriers between
industries have disappeared in part. Mutual
funds can be sold by insurance companies and
banks. Equities brokers handle cash management
accounts. Banks have become active sellers of
life insurance and annuities and other insurance
products. Insurers themselves have developed
products that include savings, protection and
investment elements.
How Insurance Is Sold
Insurance is sold through a variety of channels,
including face to face by insurance agents and
brokers, over the internet, through the mail,
by phone, in workplace programs and through
associations and affinity groups.
Insurance agents generally represent the
insurance company. Insurance brokers usually
represent the insured client but can sometimes act
as an insurance agent.
The insurance agent (or producer) can be a key
component in the underwriting process by taking
the role of intermediary.
Unlike the underwriter, the agent is positioned
to meet with the applicant, ask pertinent questions
and gauge responses. Information gathered
from the interview may become the basis the
underwriter uses in decision making. As a benefit
to the consumer, many agents—called independent
agents—represent several insurance companies,
and may have a better view of each company’s risk-
selection threshold.
A “captive” or “tied” agent works primarily with
a single insurer or a group of insurers, and may
receive business leads or some sort of special
preference for having that relationship. The insurer
often offers benefits, such as health coverage,
marketing support and training to the captive
agent.
Generally speaking, insurance companies
with a captive agent force also may see better
policyholder retention. For starters, independent
agents are less likely to follow policyholders
from one state to another when they move; many
independent agents are not licensed in multiple
states. Larger insurance organizations may have the
resources to track and follow an insured, and they
may alert a new agent in the area to where the
policyholder has moved.
In addition to agents, the following channels are
used to get the business of insurance done:
Brokers:
These producers do not necessarily work
for an insurance company. Instead, the broker will
place policies for clients with the carrier offering
the most appropriate rate and coverage terms. The
broker is rewarded by the carrier, often at a rate that
differs than that paid to the carrier’s agents.
Managing General Agents:
These individuals or
organizations are granted the authority by an
insurer to perform a wide array of functions that
can include placing business and issuing policies.
Agents are paid commissions based on the value
and type of products they sell. Some insurers pay
brokers additional compensation based on how the
business performs.
Direct Sales:
Direct selling of insurance to
consumers through mail, internet or telephone
solicitations has exploded in recent years. Insurance
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companies can bypass commissions by removing the
agent from the transaction, although marketing and
other associated costs can offset the savings.
Investment:
Increasingly, online relationships are facilitated
by traffic aggregators—basically an alternative term
for price-comparison sites. The aggregator service
links the consumer to the insurer. Aggregator
companies receive a commission from product
providers when a policy is sold. They also may
charge a fee based on any click-through to those
providers.
The aggregator service can present challenges:
The site encourages consumers to select insurance
policies based almost exclusively on price, and
direct sales are a threat to the independent agent.
Important Functions of Insurance
Organizations
Insurers look to investment
managers to make sure they have the funds
available to pay claims in a timely manner, match
expected losses with investments that mature or
become available at appropriate times and help
generate income that will contribute to profits.
Investment professionals handling insurance
assets have an additional complication: Insurers
are prohibited by state regulators from investing
too heavily in riskier, more volatile instruments.
For that reason most insurers are heavily weighted
in bonds and similar instruments, and less heavily
invested in stocks.
Insurance Density – Annual Per Capita Insurance Premiums (2020)
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Guide to Understanding
Actuarial:
Insurance is based on probability and
statistics. Actuaries are skilled in both areas and use
their training to help insurers set rates, develop and
price policies and coverage, determine reserves for
anticipated claims and develop new products that
provide coverage at a profit. Actuaries must pass
extensive exams to earn their formal designations.
Actuaries play influential roles in all sectors of
insurance, including property/casualty, life, health
and reinsurance. The role of actuaries grows as
noninsurance industries—such as hedge funds, risk
modelers and capital markets participants—become
involved in developing risk products and programs.
Underwriting:
At the heart of insurance is the
art and science of assuming risk. Underwriters
use a combination of data gathering and analysis,
interviewing and professional knowledge to
evaluate whether a given risk meets the insurer’s
standards for prudent evaluation. Their job is to
evaluate whether given risks can be covered and,
if so, under what terms. Underwriting departments
often have the authority to accept or reject
risks. Perhaps the most significant responsibility
of underwriters is to determine premium that
recognizes the likelihood of a claim and enables
the insurer to earn a profit. Some of the process
has been automated, such as when auto and
homeowners insurers access information like
driving and property records. Applicants for life
insurance and some forms of health coverage may
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be asked to obtain medical evaluations.
Claims:
Sometimes called the actual “product”
that insurance companies deliver, claims
departments usually operate in two areas: at the
offices of the insurer and in the field through
claims adjusters. Claims are requests for payment
based on losses believed by the policyholder to
be covered under an insurance policy. Claims
personnel evaluate the request and determine the
amount of loss the insurer should pay. Requests for
claims payment can come directly to insurers or
be handled by agents and brokers working directly
with the insured. Claims adjusters can work
directly for an insurer or operate as independent
businesses that can work for multiple insurers.
Claims adjusters often have designated levels of
authority to settle claims. Adjusters serve as claims
investigators and sometimes conduct elaborate
investigations in the event of suspected fraudulent
claims.
Insurance Entities
Ownership of traditional insurance companies
generally comes in two structures, mutual and
stock, although insuring entities may take a number
of other forms, including reciprocal exchanges and
risk retention groups. Mutual insurers are owned
by and run for the benefit of their policyholders.
Relative to insurance companies with shareholder
ownership, mutual insurers have less access to
the capital markets to raise money. Many mutual
insurance companies have been formed by
people or businesses with a common need, such
as farmers. Mutuals pay a return of premium or
“policyholder dividend” back to the policyholder
if the company has strong financial results and a
lower-than-expected level of claims. Policyholders
also have the ability to vote on company leadership
and have a say in certain corporate governance
issues.
Reciprocal insurance companies resemble
mutual companies. Whereas a mutual insurance
company is incorporated, the reciprocal company
is run by a management company, referred to as an
attorney-in-fact.
Many mutuals were able to grow during the
credit crunch of the late 2000s. Their growth
is limited, however, because capital has to be
generated internally, as there are no shares to sell.
Some top former mutual insurance companies,
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including Metropolitan Life and Prudential, have
demutualized to become shareholder-owned
public companies. Typically, demutualization is
done to raise capital or expand operations. Other
companies, including Pacific Life and Liberty
Mutual, took an intermediate step and became part
of a mutual holding company structure.
A holding company structure, employed
primarily in the United States, provides easier
access to the capital markets, whereby shares can
be sold to help raise capital. The holding company
owns a significant amount, if not all, of another
company’s or other companies’ common stock.
Many insurance companies are part of a holding
company structure, with the publicly traded parent
company owning stock of the subsidiary or the
controlled insurance company or companies.
Captive insurance companies are formed to
insure the risks of their parent group or groups,
and sometimes will insure risks of the group’s
customers. Captive insurers have become more
high profile in recent years after many U.S. states
and some international jurisdictions adopted
legislation and rules encouraging captives to locate
in their domiciles.
A risk retention group is a liability insurance
company owned by its policyholders. Membership
is limited to people in the same business or activity,
which exposes them to similar liability risks. The
purpose is to assume and spread liability exposure
to group members and to provide an alternative
risk financing mechanism for liability. These entities
are formed under the Liability Risk Retention Act
of 1986.
Structural differences between stock and mutual
insurance companies affect business decisions.
Stock companies have to answer to owners and
policyholders, so if management’s investment
strategies are carried out with shareholder
expectations in mind—seizing opportunities for
growth and profit—they may be acting at the
expense of policyholders. Mutuals, on the other
hand, are owned by the policyholders, so the focus
likely will be on affordability and dividends.
Observers have struggled to make meaningful
comparisons of profitability generated by public
and mutual companies. One thing is certain,
however: No particular organizational structure
is a cure-all for poorly conceived or executed
strategies.
BR
Guide to Understanding
Minor adjustments
can have a
major impact
Assess P/C insurers’ capitalization levels across risk categories and
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Model – P/C, US
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