The insurance market fluctuates between soft and hard cycles over time. During a hard market, it becomes more difficult and expensive to obtain insurance coverage. But what exactly causes the market to shift into a hard phase? There are several key factors that can create conditions for a hard insurance market.
Overview of Insurance Market Cycles
The insurance industry tends to move in underwriting cycles that swing between “soft” and “hard” market conditions. These cycles typically occur over periods of 5 to 10 years.
A soft market is characterized by:
- Low premium rates
- Relaxed underwriting standards
- Broad coverage
- Lots of capacity – insurers readily write more policies
In contrast, a hard market features:
- Increasing premium rates
- Restrictive underwriting
- Narrowed coverage
- Reduced capacity – insurers scale back writings
The cyclical nature of the insurance market is well documented throughout recent decades. After a prolonged soft market, we are currently in a hardening phase that began in 2017-2018.
Understanding the key factors that create hard and soft markets can help you navigate these cycles as an insurance buyer.
Why Does the Market Shift to Hard?
There are three primary drivers that cause the insurance market to turn hard:
1. Reduced Insurer Profitability
Insurance companies make profits from two main sources:
- Underwriting income from premiums
- Investment income on reserves and surplus
During a long soft market, insurer profitability becomes strained.
To attract business when competition is high, insurers charge reduced premium rates. But claims may not decline at the same pace, pressuring underwriting profits.
Prolonged low interest rates also limit investment returns on the funds insurers hold in reserves. This dual impact on underwriting and investment income squeezes overall insurer profitability.
To repair their financial results, insurers shift to a hard market stance. This allows them to raise rates and become more selective with risks to restore profitable underwriting.
2. Increased Claim Losses
When insurers experience an unexpected rise in claims, it can prompt a move to a hard market.
Higher catastrophe losses from hurricanes, floods, or wildfires are a prime example. When natural disasters spike beyond projections, insurers take a financial hit.
Another factor is rising claims frequency and severity trends across liability lines like commercial auto and general liability. This too increases insurer loss ratios and puts pressure on profits.
To offset the impact, insurers respond by hardening rates and tightening underwriting.
3. Reduced Capacity
The insurance market relies on adequate risk capital to maintain capacity.
Capacity refers to the amount of insurance coverage insurers are willing to underwrite based on their capital levels.
During a prolonged soft market, surplus capital gets depleted through lower investment returns and higher losses. Some insurers may exit unprofitable lines altogether.
This capital crunch reduces insurers’ ability to write new coverages, contributing to a hard market as availability tightens.
Examples of Past Hard Markets
Looking at examples from past hard markets can illustrate what drives cycles to turn.
1980s Hard Market
The early 1980s brought a severe hard market, with commercial insurance rates spiking over 100% in some cases.
The primary driver was a capital capacity crunch. During a long soft market in the 1970s, insurer surplus got depleted and interest rates fell. Capacity shrunk just as liability and health insurance losses mounted.
By 1986, U.S. insurer capacity was down by 15%, leading to dramatic rate increases and coverage restrictions.
2001-2003 Hard Market
After a soft second half of the 1990s, the market hardened again in 2001.
Several factors were at play:
- Catastrophe losses jumped after the 9/11 attacks and a series of natural disasters
- New accounting rules forced insurers to strengthen reserves
- Weak stock market hampered investment income
By 2002, commercial insurance rates were up 20% or more across many lines. But after peaking in 2003, the market softened again.
Current Hard Market
Today’s hard market emerged in 2017-2018 on the back of multiple influences:
- Underwriting losses in commercial auto, general liability, and other lines
- Reduced investment income with low interest rates
- Increased catastrophe claims
- Loss of surplus capital over a prolonged soft market
Commercial insurance renewal rates have risen 20% or more since 2018. Underwriting has tightened significantly in the hardening environment.
The Impact of a Hard Insurance Market
Hard markets create challenges for insurance buyers as coverage becomes more restrictive and expensive. Here are some typical effects:
- Higher premiums – Renewal rate increases outpace inflation in a hard market. Affordability can become an issue for some insureds.
- Lower limits – Insurers may only offer reduced coverage limits compared to expiring policies.
- Less capacity – Certain high-risk accounts may get declined as insurers cut back writings.
- Restrictive terms – Policies can feature larger retentions, exclusions, and limitations.
- Coverage gaps – Some desirable coverages may get excluded where available previously.
- More scrutiny – Underwriters dig deeper into risks and financials during renewal underwriting.
These changes underscore the importance of working with an experienced broker during hard markets. Skilled risk advisors can help negotiate the best options amid the restrictions.
When Do Hard Markets Typically Ease?
Hard markets eventually subside when conditions improve for insurers. This allows capacity to reopen and competition to increase again.
But predicting the timing of the next soft market is difficult. Hard conditions often persist longer than initial expectations.
Key factors that can contribute to easing a hard market include:
Improved underwriting margins – Rate increases outpace loss trends, restoring profitability.
Higher investment returns – Rising interest rates allow insurers to rebuild capital through investments.
Increased capital – New capital infusions from investors expand capacity.
Lower claims – A return to normal catastrophe loss levels and/or lower claims frequency.
Stable reinsurance – Adequate and affordable reinsurance relieves pressure on primary insurers.
However, some lines may remain hard while conditions improve in other segments. The cycles are rarely uniform across all coverages.
Navigating Insurance Market Cycles
The insurance marketplace is always changing, and hard markets bring challenges. But by understanding what drives cycles, you can make smart insurance decisions for your organization.
Here are some tips to navigate hard and soft conditions:
Discuss upcoming renewal strategy with your broker early – don’t wait until the last minute.
Make any program changes proactively before your renewal rather than reacting.
If reducing premiums, weigh potential savings vs. retaining adequate limits.
Be flexible and open to considering alternative insurers/programs where advantageous.
Manage exposures even when insurance is readily available to control costs over the long-term.
Emphasize risk control and safety with staff to help prevent losses.
Report any positive changes in your risk profile to underwriters.
Consider higher retentions to reduce reliance on the insurance market.
Staying informed on market conditions allows you to plan ahead and make smart insurance decisions for your organization, even during turbulent times. With an experienced broker guiding you through market cycles, you can develop strategies to mitigate rate spikes and coverage reductions.
The insurance market swings between hard and soft cycles lasting 5-10 years driven by shifts in insurer profitability, losses, and capital capacity.
Hard markets feature rate increases, tighter underwriting, restricted terms, and reduced capacity that make insurance more expensive and difficult to obtain.
Key factors that can prompt a hard market turn include reduced insurer profits, increased claims losses, and diminished capacity due to capital constraints.
Hard markets create challenges for insurance buyers, but being informed on market dynamics allows you to make proactive strategic decisions to manage your risks and costs.
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