In the fantastic book, The Secrets of Consulting by Gerald Weinberg, the author humorously describes common mistakes consultants make (and mistakes to which their clients should pay attention). One of his classic stories involves consultants and grocery stores. He calls it Rudy’s Rutabaga Rule. Seriously, you need to read any book that has a Rutabaga Rule!
The story goes like this: A grocery chain asks a consultant to help them improve profitability. The consultant identifies sales per square foot, a common metric in grocery and retail stores. The vegetable that has the least sales per square foot is the lowly rutabaga. The consultant advises the grocery chain to eliminate rutabagas and sell oranges in that same space. Awesome! The consultant increased sales by a tiny percentage. Now what? How many vegetables does a grocery chain eliminate before making itself useless? At what point does it become the orange store?
Insurance companies must be following the guidance of the same silly consultant. The data is strong they long ago began making themselves immaterial. Using 2019 as the most recent year for fully developed claims frequency, the industry incurred 101 million claims (43 million excluding auto physical damage). In 2009, the industry incurred 90 million claims (45 million excluding auto physical damage) (per A.M. Best’s Aggregates and Averages, 2023 edition). Auto physical damage coverages haven’t changed that much, but the other coverages have many more limitations.
How can it be that the economy grew by approximately 48% during this time while the number of non-auto physical damage claims decreased? I’ve been cautioned that the industry claim counts should not be trusted at face value (which seems to be a major issue that requires significant and immediate attention). But I’m taking this data at face value because it’s all the data I have, and I get it from a trusted source.
The answer may be that when deductibles are raised sky high, people turn in fewer claims. The answer may be that carriers are simply refusing to insure a larger percentage of the economy. More exclusions have definitely been added. Without question, more people are willing to self-insure, are being forced to self-insure, or have turned to alternative risk transfer.
In fact, the last estimate I saw was that more than 50% of all commercial premiums are in the alternative market. If carriers are excluding so much and increasing premiums (premium increases have generally exceeded GDP growth over the last 15 years), this may explain why they are not more profitable than they already have been. If premiums increase as if exclusions had not been added, profitability should increase (and it has with the last ten years being some of the most profitable years for carriers in history). But if the best accounts are moving to alternative markets, then the reduced coverage may not be an adequate offset for the adverse selection and with the traditional market writing less than 50% of commercial premiums, a good case can be made the traditional market is a market of adverse selection.
Additionally, study after study shows carriers are not insuring businesses or homes to full value, another example of not being fully relevant. Multiple studies, including Hub International (October 2023), Hiscox (2023), and several others, certainly do not suggest consumers are over insured.
Moreover, the Aon studies (2022) show the majority of our economy’s assets are intangible assets, and there is virtually 0% insurance coverage. When you put all this together, the industry is probably only insuring around 20% of the country’s business assets. That is a poor number and indicative of nearing obsolescence.
Carriers are not insuring property on a blanket basis because of the wildfire danger or the wind danger or the roofs or you name it. No one needs insurance companies that only insure part of a property, and often exclude the most important part of the property for the most important hazard. Insurance companies are trying to avoid all risk by only insuring the safest properties.
The problem is they all hired the same consultant so they’ll compete on price to write the safest properties to the point of making that market unprofitable too. How can I predict this with so much confidence? Because this is what insurance companies always do, without any exceptions in my 35 years’ experience analyzing insurance companies and the market. For some reason or possibly recency bias, their models do not adjust correctly relative to supply and demand. They project a profitability trajectory without consideration of intense competition for the “best” (as they define them) accounts.
Additionally, AI underwriting models are now determining what is not a good vegetable to be selling and those models are eliminating about everything but apples and oranges, maybe a kiwi here and there. One of the great opportunities carriers have for reducing expenses is eliminating underwriters, underwriting managers, and senior executives if a carrier is going to simply accept AI decisions. Although, I am positive that many senior executives think, and they’re likely correct, that their positions are safe even if their results stink, provided they can say they depended on The Model and no one holds them accountable for conscientiously thinking through the implications, including unintentional implications, of whatever the AI model is promoting.
The executives’ thought processes are identical to why people use to say, “I won’t get fired buying IBM computers.” They bought IBM computers even if those units were not the best for the situation and almost certainly, back in the day, not the cheapest. Many insurance companies are run by people paid to avoid mistakes even if it means failure for not identifying low risk opportunities.
No one needs an insurance company that does not provide the most important coverages. A significant consolidation of carriers is on the horizon. This could be bloody because so many carriers are useless. They don’t even insure well what they’re still willing to insure. And the skeletons in some carriers’ closets likely can fill a mansion.
As a test, look at a carrier’s results after they reduce coverages and increase rates. They should quickly become more profitable. Reduce exposures 10% and increase rates 10%, and profits should obviously follow. If profitability does not increase, fire the executives and actuaries because they’re obviously incompetent. They failed to reduce the most important exposures or increase rates enough or realize the obvious. The more expensive and restrictive a carrier becomes, the more they attract adverse selection and the quicker they succumb to Rudy’s Rutabaga Rule.
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