Insurance Market Cycles and Surety Reinsurance: How Do They Impact a Contractor’s Surety Line?

Insurance markets tend to run in cycles of ‘hard markets’ and ‘soft markets’. Simply stated, a ‘hard market’ exists when underwriting terms and conditions favor the insurance provider and a ‘soft market’ exists when underwriting terms and conditions favor the insurance purchaser. These hard and soft market cycles can last years and can change slowly or quickly depending on a number of issues. One thing that is certain: the cycles always occur.
When a given insurance market is ‘hard’ and capacity is tight, the following takes place: prices increase, underwriting rules become more conservative, and losses moderate. Eventually, new capacity enters the market. As excess capacity grows and becomes overabundant, a ‘soft’ develops with the following characteristics: prices will decrease, underwriting will become more liberal, losses will increase and the market begins to harden; launching a new cycle.
Like all other insurance markets, the surety reinsurance market runs in cycles. In fact, the hard/soft status of the surety reinsurance market affects the hard/soft status of the overall surety market. To understand the impact of surety reinsurance on a given contractor’s surety line, one must first examine and understand reinsurance in general. A quick definition of reinsurance is, simply, insurance purchased by and for the benefit of insurance companies.
Through the purchase of reinsurance, an insurance company cedes some of its overall exposure and transfers some of its risk to the reinsurer. Thus, reinsurance serves to protect the ceding insurer from exceptionally large, unanticipated losses. Reinsurance also helps insurers diversify their books of business, it enables insurers to provide increased capacity, and it ‘smoothes out’ underwriting results.
Surety reinsurance is one form of reinsurance that is purchased by sureties to back a given surety company’s surety results. It is usually purchased in one of two forms:
>Facultative – surety reinsurance written on a per risk basis, or
>Treaty – automatic protection for an entire class of business/covers the portfolio. Reinsurance is further broken down into the two following classes:
>Pro Rata – here, the reinsurer assumes a portion, or pro rata, share of each loss, and,
>Excess of Loss – the reinsurer assumes losses only over a mutually agreeable dollar threshold.
When a contractor’s supplier/subcontractor increases rates for their product/service, contractors will ‘pass through’ to an owner, the increased costs placed on them by the suppliers and/or subcontractors. Similarly, the surety industry will ‘pass through’ to contractors the increased rates, the more stringent underwriting criteria, and the many exclusions/restrictions placed on them by the surety reinsurers.
As you review the terms and conditions of your surety line with your agent/broker, keep in mind that the terms are, at least in part, reflective of the surety reinsurance marketplace. Insurance cycles are dynamic and in a constant state of flux. As surety results improve/decline...new surety reinsurance capacity will emerge/contract, terms and conditions will be relaxed/strengthened and these conditions will be passed on to the surety markets who, in turn, will pass them on to the contractors…and the cycle will continue....
Timothy J. Hutton, AFSB, CPCU
mobile (703) 220 - 7771
timothyjhutton@gmail.com

*What does the Blog title mean?!

Many hold that modern commercial insurance started in the mid 1600's at Edward Lloyd's coffee shop which was a popular meeting place for local merchants and shippers. To insure a shipment and earn a premium, a wealthy merchant would 'write' their name 'under' the description of the vessel/voyage posted on the wall of Mr. Lloyd's coffee shop. For a premium, the shippers were able to transfer risk to these 'underwriters' and make their voyages feasible ventures. This process of transferring risk continues today with insurance carriers 'underwriting' various risk transfer offers from brokers and their clients.