I am surprised at the continuing trend of new carriers entering the medical professional liability (MPL) insurance marketplace. Most industry pundits believe that the marketplace is suffering from a prolonged “soft market” business cycle. I agree with them. It doesn’t make sense to have more competition in a marketplace already full of it. So, I’ve been wondering… are we just watching the next ‘boom-to-bust’ change in the market cycle?
Market Cycle Theory
I’ve been studying the Austrian Business Cycle Theory (ABCT). I know, it’s a weird thing to do in my spare time! However, studying business cycle theories helps me to understand why the economy at large functions the way that it does. Of course, I can’t help but wonder if it will also allow me to predict the future of the MPL insurance market!
Michael Pollaro describes the ABCT like this: “once an economy is subjected to a bout of monetary inflation, whether that be via direct central bank money creation or via money (and credit) creation by the fractional reserve banking system, an unsustainable, artificial economic boom is born, whereby malinvestments (bubbles if you like) are created that sooner or later must be liquidated. And whether that bust takes the form of a hyperinflationary bust or a deflationary bust, bust we will get. The form the bust takes will depend on the course of the inflation. If the central bank/banking system pursues an inflationary course, by throwing continual and importantly ever larger doses of money (and credit) into the economy, the bust will take the form of a hyperinflationary bust – a collapse in the value of the currency and with that a breakdown of the entire economy. If instead the central bank/banking system ends its money creation activities or even moderates that increase in a material way, the bust will take the form of a deflationary bust – a healthy liquidation of the malinvestments made during the boom and with that a commensurate fall in the prices of those same malinvestments.”
The ABCT isn’t the only business cycle theory to consider, but it’s the one that makes the most sense to me.
So, what does this mean to those of us who earn a living in the medical professional liability (MPL) industry? Well, I’m no economist, but the symbiosis between banking and insurance is obvious. Therefore, it’s logical that the actions of the current fractional-reserve banking system necessarily impacts the insurance industry at a macro level.
Here are the key industry topics where I can observe the ABCT reflecting on the state of the MPL insurance market:
New Capital
“New capital” simply means new investments or investors in a market. Most pundits agree that the MPL market reached a “hard market” peak back in 2001-2004. During that time, the market welcomed new capital in the form of new carrier appetite with open arms. However, after many years of watching the MPL market cycle shift from hard to soft, continued new capital investments are now viewed with much suspicion.
When we look at new capital investments in our industry through the lens of the ABCT, we look at such investment with some caution. If these newest investments are, in whole or in part, derived by an unhealthy expansion of banking credit, then how much new capital is too much? Or, when does new capital become malinvestment into the medical liability industry?
Rising Prices in Specific Market Segments
As a highly-focused specialty wholesale broker, my job is to carefully monitor the various segments of the medical PL industry. During my years in this industry, I’ve noticed that each significant shift in the business cycle is preceded by often lesser-noticeable behavior in the smaller segments of the industry. By my past observations, the whole of the market is seen to shift only after enough smaller segments lead the charge on increasing rates. So, are rate increases (price inflation) observable in our industry now? I believe we are just starting to see signs of this in smaller segments now.
For example, here are two segments that I’m watching very closely:
These are smaller segments of the medical professional liability industry that are noticeably struggling to make a profit while other segments seem to be rolling along without complaint. But, I suggest that these are small signs of a larger business cycle shift in the making.
Low Interest Rates
This article contains a simple chart of the Federal Funds Rate history from 2000-2013. Notice the drop and flat-line effect since 2008. We know that the Federal Reserve’s Quantitative Easing (QE) policies began that year with the intention of maintaining near-zero federal rates. Although certain QE policies formally ended in 2014, the Fed is currently unclear about their intentions of raising the Federal Funds Rate in the future.
Towers Watson conducted a survey of property/casualty CFOs in 2012, which stated: “CFOs with P&C insurers are facing current investment challenges, which are inherent to their dual requirements of ensuring that their companies withstand today’s adverse market conditions while still meeting the expectations of rating agencies and regulators. The responses from our survey illustrate that capital appreciation and investment income aren’t sufficiently contributing to P&C insurance company returns levels needed to adequately please their investors.” The results of the survey also noted, “Over the next three years, all respondents expect low interest rates to be their companies’ biggest challenge. Paradoxically, half of the CFOs expect the risk of rapidly rising rates will also be their biggest challenge.”
This shows that a prolonged period of low interest rates contributed to the volatility we see in today’s market. So, when considering the ABCT, the new threat of rising interest rates implies that the end of the boom cycle is near. Now, the question is what kind of bust cycle will occur?
Conclusion
R.J. Balcarek, an economist and casualty actuary, wrote this essay in the late 1960’s. In it he stated, “…capital movement from one industry to another obviously is a long process. It begins when the investors become suspicious that they may have made a mistake in investing their capital in a given industry. Their first step is to stop providing fresh capital and hope that things will take a turn for the better. After it becomes crystal clear that there is not going to be an improvement, they begin to investigate the possibilities of withdrawing this capital with as little loss as possible.”
If we consider Balcarek’s observation along with the ABCT, then we understand that rising interest rates could help to correct any malinvestment that crept into the MPL market during the boom cycle. That’s the optimistic view anyway!
I believe the ABCT helps us to see that today’s MPL market cycle is nothing new or totally unpredictable. No, I don’t have a crystal ball and I don’t claim to know exactly what will happen next in our market. But, it seems obvious that carriers will struggle with the next central banking interest rate change. If the ABCT is accurate, the inevitable bust that ensues could be disastrous or corrective, but neither will likely be seen as favorable to insureds who have enjoyed low rates for some time now.
Feel free to contact me with your own thoughts, predictions or comments.