Commercial insurance costs have been accelerating this year. Renewal rates rose more than 4% in the second quarter and past 5% in the third, according to a report by IVANS Insurance Services. In some sectors, insurance rates rose as high as 7%–20%, and experts predict this trend will continue into 2022. 

What does this mean for startup founders—and how could this impact your business insurance renewal this year? Here we explore the forces driving these increases and what startups should expect moving forward.

Why do insurance costs increase as your company grows?

As a business expands, so does its risk. Unfortunately for startups, litigation and class-action lawsuits are on the rise. That’s why as startups raise more money, they are at higher risk of getting sued. Insurance underwriters review several aspects when it comes to your company’s insurance premium pricing, and one of them is your business rating.

Business insurance policies have a rate that directly correlates with a company’s revenue, number of employees, and assets or capital raised. Essentially, your risk curve steepens as you hire more employees, sign bigger customer contracts, and have larger term-sheets, because there is a higher likelihood that you’ll face lawsuits.

Let’s look at a fictional example of a client in 2020, renewing their business insurance policy in 2021. This client has a Directors & Officers policy with Vouch, and the primary “rating basis” (i.e., exposure base) in this case is the company’s total capital raised and/or assets. So, with D&O insurance, the measure of risk is total assets or capital raised; in the case of EPL insurance, it would be employee count, etc. Put simply, a rating basis (exposure base) is a proxy for how you measure risk in an insurance policy.

Back to our example! In 2020, the client raised a Series A, putting their total capital raised at 15 million dollars. During 2021, that same client raised a Series B, putting their total capital raised at 50 million dollars. What equation do we use to derive your insurance premium? Here is an important part of how we calculate it: Insurance premium = Insurance rate x Rating basis. So in this example, as the client raised more capital, this increased their rating basis, which in turn increased their insurance premium. (This is not the be all, end all. There are other factors that will affect your insurance premium as well, such as where your company is headquartered, your company classification, and your company profile.)

Does that mean every time you hire more employees or raise a round, your premium is going up? Not necessarily. Thankfully, the bigger your company gets, the more experience it has to draw from. Your startup may face higher insurance premiums as you grow; however, having seasoned board members or performing more compliance or cyber security measures can also improve your premium pricing. So at a certain point, costs level off. But on balance: the bigger the company, the bigger the risk.

Why are my insurance premiums up if my coverages and limits are staying the same? Are there any other areas where startups can expect increased rates? 

If your limits and coverages are the same, and your renewal price has gone up, other factors have contributed to your rise in costs. For example, if your startup has 200 more people and you’ve increased your revenue by 3x, your increase in sales and employees have increased your risk exposure. So, while you are paying for the same coverage, your overall risks to lawsuits are much higher.

The pandemic is also creating increased claims for management liability policies like fiduciary, directors & officers (D&O), and employment practices liability (EPL) insurance. Workers’ compensation claims are also on the rise as people allege they contracted the coronavirus on the job. In particular, this has affected healthcare, frontline, and essential workers, as well as commercial drivers.

Statutes about communicable disease vary, but at least 19 states allow employees with COVID to file workers’ compensation if they potentially got exposed in a physical workplace. That can be a significant benefit for employees; however, from an insurance perspective, it does place additional stress on the policy limits, especially given the complications of long COVID.

The pandemic lockdowns forced the closure of many courts, which temporarily took pressure off liability lines. But experts still predict rate hikes for casualty risks.

How do claims and loss history affect premiums?

Data shows that past claims do lead to an increased risk for additional claims. So your final premium is likely to be higher. But insurers give consideration to the type and size of the claim, as well as the line of business. For example, a small property claim won’t have the same impact as a large E&O claim.

The nature of the catalyst factors into all this too. For example, a $750,000 claim from a “shock loss”—like a large water leak in a building—doesn’t reflect poorly on a company. It’s not indicative of a lack of management oversight. Something terrible and uncontrollable just happened. But on the flip side, a $10,000 claim could stem from gross oversight that could happen repeatedly, so it raises a red flag.

There’s a saying in insurance that “frequency breeds severity.” A bunch of small claims can be a really good indication that—as we say about earthquakes—the big one is coming!

Which is all to say: a heavy loss on your record isn’t necessarily a bad thing. It all depends on the type of event and also your response.

What steps should companies take to mitigate rate increases after a big claim?

As with many things, how you stick the landing matters a lot. Insurers look favorably on companies that work with them, taking claims as wake-up calls. So if the worst happens, audit the events leading up to the claim. Look for holes in processes and then fill them.

How does a clean loss history typically affect rates?

Cyber, E&O, and D&O losses can create scrutiny and possibly increase premiums. However, in lines of business like workers’ compensation and property insurance, losses aren’t necessarily a bad thing if they’re well-controlled and not severe in nature (i.e., high claim amounts).

Why did cyber insurance prices spike this year?

Cyber coverage has experienced an explosive growth in claims. Every quarter the insurance industry is setting records for ransomware. Insurers have seen a boom in the number of claims, but also in their average costs, which have risen more than 400% between 2019 and 2021 in the U.S.

A report by Cybersecurity Ventures estimates that costs from these crimes will reach $20 billion globally in 2021—57 times more than in 2015. As the industry adjusts, premiums are rising. The average hike was 32% between June 2020 and June 2021.

Cybercrime insurance has traditionally been underpriced as it’s relatively new. That means the industry has been on a learning curve while it gathers historic loss data. As patterns start to emerge more clearly, we’re also seeing higher claims being paid out. So there’s a market correction happening with premiums.

Startups carrying this coverage should engage all levels of leadership to increase cyber security culture and defenses. Insurers are often requiring standard controls be in place now before they offer new coverage or renewals. Work with an insurer that truly understands your unique risks and how to mitigate them. And get out in front of your renewal! If there have been significant changes to your business, receiving a cyber and/or errors and omissions (E&O) quote may take longer to process than usual. Insurance underwriters may need more time to make adjustments to your quote so that you are properly insured.

It’s not just business insurance costs that are rising; auto coverage costs have been rising too. Why?

The disrupted supply chain has boosted the price of parts and repairs. Additionally, parts tend to be way more intricate in newer vehicles, which have elaborate sensors and require more labor—and more sophisticated labor—to fix. So a minor repair bill, like for a fender bender, could now escalate from a few hundred dollars into a four-figure hit.

This coverage also has been underpriced for the last decade. Insurance companies are trying to find the right balance between raising premiums while not throwing markets completely into chaos because of overly steep increases. So for 2021, insurance providers saw an average 4.3% hike in the third quarter, down from 4.5% over the summer.

What role do catastrophic losses play in rising insurance costs?

Major disasters—including cyclones, earthquakes, hurricanes, and wildfires—have been increasing over the past several years, according to the Catastrophe Loss Index. The World Meteorological Organization tracks this pattern back even further, showing that climate change has increased disasters fivefold over the last 50 years. (The silver lining: deaths have decreased threefold, thanks to improved early warnings and disaster management.)

Historically, catastrophic coverage has been underpriced. So expect to see premiums go up. If that doesn’t happen, the worst-case scenario would be entire insurance companies pulling out of the market. And lack of choice is bad for consumers for a whole slew of reasons, including higher-than-normal premiums, less than ideal terms, and lack of coverage innovation. Competition can help drive down costs, while increasing quality, including broader coverage and prompter servicing of claims. Insurers may also offer trainings and loss-prevention services as a bonus.

What can we expect moving forward?

Worldwide, insurance prices have increased for the 15th consecutive quarter, according to Marsh’s Global Insurance Market Index. Some of this is due to loss, the pandemic, and the underwriting cycle. But we’re also seeing signs the market continues to harden, where some insurers increase rates and pull back from “tougher” types of businesses. Startups and companies in the VC-tech and innovation space may have already experienced this with other insurers. The upside? Vouch specializes in this space.