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

Craig English • Jan 29th, 2013

All industries experience cycles of expansion and contraction and similarly, the insurance industry is cyclical in nature. Although no two cycles are the same, insurance industry cycles typically last from two to ten years and are comprised of a hard market and a soft market. After experiencing a soft market in the insurance industry for approximately eight years, due to a combination of factors, the market began to change, firming up in 2011. By the end of 2012, the soft market had started to bottom 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:

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

Ultimately these rate reductions associated with a soft market affect the insurance carriers’ bottom line, as a carrier relies on a combination of insurance premiums and investments to make money 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;
  • And 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.

  • Mother Nature: 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 Ltd., 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 until the cycle turns back to a soft market:

  • Because the market and underwriters are becoming more restrictive it is imperative that as a company you are more involved with your safety programs.
  • Take a more active, strategic approach to managing your company’s risks and claim activity.
  • 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 carriers are using third party companies to conduct credit scores.

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

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About the Author: Craig English, Sr., senior vice president and director of Property & Casualty Insurance, oversees PSA’s property and casualty insurance division, including commercial lines, personal lines and professional liability. He joined PSA in 1981 as partner, serving as the dedicated leader spearheading the development and growth of the firm’s Property & Casualty Division. Previous to his role at PSA, he worked for INA as a commercial lines underwriter as well as an underwriting manager for a local brokerage and as an agent for Provident Mutual.

  • Bob

    I respect the intelligence of this article, but I don’t believe we are truly in a hard market, although certainly firmed very much so over the past 18 months. I get what the article is establishing in terms of hard vs. soft, but right now, at least within my scope, capacity has not left — which is the sign of a true hard market. There’s capacity to insure most risks. If John Doe won’t quote a new risk, or he is seeking a substantial increase at renewal, his agent can place it elsewhere without a major problem.

    • Craig

      Thank you for your comments Bob. While I agree that there is still some capacity, overall the marketplace is limited as carriers are becoming more and more stringent with underwriting as compared to a soft market. There are different levels of severity, and while the current market hasn’t quite reached the same level as we’ve seen in previous hard markets,heightened underwriting scrutiny and premium increases all add up to what most are calling a hard market. On a state-by-state basis,certain areas of insurance such as workers’ compensation and property are being more heavily affected than others.

  • Supercure

    Great! Just what I neeeded. I am a translator and the terms hard / soft are bandied around all the time, but their meaning encompasses a number of variables, so it makes it fairly difficult to translate accurately.

    This explanation is crystal clear and precise, probably a great reminder even for insurance professionals. Thanks for posting this.

    • Craig

      Thank you for your comment!

  • Shirley

    Would you know what is happening in the medical professional liability insurance market? Hard? Soft?

    • Craig

      Great question Shirley and thank you for your comment. Right
      now we’re still in a relatively soft market in the professional liability insurance industry. In 2008, there was a sharp rise in frequency of claims and also a rise in the cost to defend each claim, which temporarily hardened the market. Recently there has been a slow increase of claims frequency. Maryland is a unique state in that there are not a lot of malpractice carriers compared to other states and a lot has to do with Medical Mutual, which was formed by the state in 1975. Medical Mutual
      writes the majority of business in the state of Maryland.

  • Amy

    Hi Craig,
    Thank you for your article, it is very informative. I work in Personal Lines Insurance and we are interested to find out about classes of business which are less affected by ‘hard’ and ‘soft’ cycles. Would you know what these are?
    Thanks,
    Amy