Hard Market vs. Soft Market: The Insurance Industry’s Cycle and Why We’re Currently in a Hard Market

Posted in: Commercial Insurance

All industries experience cycles of expansion and contraction and this is particularly true of the insurance industry. Although no two cycles are exactly the same, insurance industry cycles typically last from two to ten years and incorporate a hard market and a soft market (phases marked by an expansion and a contraction of insurance availability). After experiencing a soft market for approximately eight years, due to a combination of factors, the market began to level off in 2011. By the end of 2012, the soft market had bottomed out and we are now facing a hard market.

What is a hard market vs. a soft market?

The characteristics of a soft market in the insurance industry include:

RM Prevent Claims

  • Lower insurance premiums
  • Broader coverage
  • Relaxed underwriting criteria, which means underwriting is easier
  • Increased capacity, which means insurance carriers write more policies and higher limits
  • Increased competition among insurance carriers.

Ultimately these rate reductions associated with a soft market affect the insurance carriers’ bottom line, as an insurer relies on a combination of insurance premiums and investment income to make a profit as a company.

On the other hand, the characteristics of a hard market include:

  • Higher insurance premiums
  • More stringent underwriting criteria, which means underwriting is more difficult
  • Reduced capacity, which means insurance carriers write less insurance policies
  • Less competition among insurance carriers.

Why are we currently facing a hard market?

A string of natural disasters and the residual effects of the economic downturn have been the main causes for this change in the insurance industry cycle from soft to hard market conditions.

  • Mother Nature: For insurance carriers, all of these significant natural disasters meant a large increase in claims. When losses are high due to natural disasters, carriers reserves are reduced, and insurance companies look to replenish reserves by increasing rates. Zurich-based reinsurance company Swiss Re, reported that insurers sustained $116 billion in losses from natural catastrophes and man-made disasters in 2011. Swiss Re Ltd. also reported that the total economic losses, both insured and uninsured, due to disasters reached an estimated $350 billion, making 2011 the year with the highest catastrophe-related economic losses in history. Germany’s Munich Re, one of the world’s leading reinsurers, rated 2011 as the worst year in history in terms of losses due to natural catastrophes worldwide. In the U.S. alone, we experienced numerous high-level tornadoes in the Southeast and Midwest, significant flooding on the East coast, a drought in the South and a massive winter blizzard and summer hailstorms in the Midwest. And in 2012, the trend has continued with the impact of Hurricane Sandy. Worldwide, one of the strongest earthquakes ever recorded shook Japan, a widespread drought struck East Africa, the worst flooding in 50 years occurred in Thailand and a major typhoon hit the Philippines.
    For insurance carriers, all of these significant natural disasters meant a large increase in claims. When losses are high due to natural disasters, carriers reserves are reduced, and insurance companies look to replenish reserves by increasing rates. Zurich-based reinsurance company Swiss Re, reported that insurers sustained $116 billion in losses from natural catastrophes and man-made disasters in 2011. Swiss Re Ltd. also reported that the total economic losses, both insured and uninsured, due to disasters reached an estimated $350 billion, making 2011 the year with the highest catastrophe-related economic losses in history.
  • Economic Downturn: During the insurance industry’s soft market when rates were extremely low, insurance carriers relied on their return on investments to make money. Whereas carriers used to shoot for and obtain double digit return on investments, now they are only seeing between three and five percent return. Carriers are no longer making the investment income they once had. As a way to counteract these investment losses, rates have begun to escalate.

In addition, there are two things that effect business insurance premiums – payroll and revenue. As companies began experiencing a decrease in revenue and consequently started to lay off employees, both their payroll and revenue decreased, which in turn meant a decrease in premium to the insurance carrier. This is another way in which the carrier is losing money due to the economic downturn.

What can we expect from insurance carriers during a hard market?

During a hard market, underwriting gets tougher and more stringent. With each year, underwriters are becoming more sophisticated, looking more closely at losses, safety records and financials. We are seeing insurance carriers dig deeper into a company’s financials than in the past. Most insurance underwriters today want a five to ten percent higher rate upon renewal, and some are requiring substantially more. Rates will vary from carrier to carrier and will depend on a business’s inherent risks, claims history and finances.

What does the future of this hard market look like?

We first saw the effects of the hard marked in the commercial industry. Commercial insurance prices in total rose by six percent during the second quarter of 2012 compared to the same prior year. But we are now seeing a hard market in the personal insurance market as well, especially with homeowner’s insurance.   As an industry, we expect rates to continue to increase in 2013 through the next two to three years.

What you can do in a hard market when you are seeing rates increase?

While you will most likely need to be prepared for some rate increases due to the insurance industry’s hard market, there are several things you can do to help minimize the impact of the more stringent underwriting criteria your company will face:

  • Because the market and underwriters are becoming more restrictive, it is imperative that a company’s management is involved with and committed to its safety programs.
  • Take a more active and strategic approach to managing your company’s risks and insurance claims.
  • Start your insurance renewal process earlier, both on a commercial and personal level.
  • Be even more cognizant of your company’s financials – most insurers are looking at whether bills are being paid on time and many insurers are using third party services to conduct credit scores.

For more information or questions on the insurance industry’s hard market, please contact me at craig@psafinancial.com.