Understanding Hard and Soft Insurance Market Cycles

A soft market, sometimes called a buyer’s market, is characterized by stable or lowering premiums, broader terms of coverage, increased capacity, higher available limits of liability, easier access to excess layers of coverage, and greater competition among insurance companies for new business.

A hard market, sometimes called a seller’s market, is characterized by increased premium expenses for insureds, stricter underwriting criteria, reduced capacity, restricted terms of coverage, and less competition among insurance companies for new business. During a hard market, some policyholders may receive nonrenewal notices from their insurance company. In addition, hard market cycles may prompt insurers to stop writing business in high-risk locations or even exit certain unprofitable lines of insurance altogether.

Top Contributors to Hard Markets

A wide range of factors can affect insurance pricing, but the following are some of the top contributors to hard markets:

Catastrophic (CAT) Losses
Floods, hurricanes, wildfires, and other natural disasters, also called CAT losses, have become increasingly common and devastating. Years of large-scale disasters like these can compound losses for insurance companies and drive up the cost of coverage overall, especially when it comes to commercial property policies.

Inconsistent Underwriting Profits
Underwriting profits refer to the difference between the premiums an insurance company collects and the money paid out in claims and expenses. When a company collects more in premiums than it pays out in claims and expenses, it will earn an underwriting profit. Conversely, a company that pays more in claims and expenses than it collects in premiums will sustain an underwriting loss. The company’s combined ratio after dividends is a measure of underwriting profitability. This ratio reflects the percentage of each premium dollar a company puts toward spending on claims and expenses. A combined ratio above 100 indicates an underwriting loss. If insurers repeatedly experience combined ratios above 100, they will likely increase insureds’ premiums to help combat their underwriting losses.

Mixed Investment Returns
Insurance companies also generate income through investments. Companies operating in the commercial insurance sector typically invest in various stocks, bonds, mortgages, and real estate investments. Due to certain regulations, most companies invest significantly in bonds. These investments provide stability against underwriting results, which can vary from year to year. When interest rates are high and returns from other investments are solid, insurers can make up for underwriting losses through their investment income. However, when interest rates are low, companies must pay close attention to their underwriting standards and other investment returns.

Economic Concerns
The economy also affects an insurance company’s ability to write new business. Amid periods of economic downturn or uncertainty, some policyholders—although it’s not recommended—may purchase less coverage or forgo insurance completely to cut costs. Additionally, a business’s revenue and payroll, which factor into how its premiums are set, may decline. This creates an environment where there is less premium income for insurance companies, motivating them to increase their policyholders’ coverage expenses going forward.

Inflation Issues
Rising inflation can make it challenging for insurance companies to maintain coverage pricing and subsequently keep pace with more volatile loss trends. Unanticipated increases in loss expenses can result in higher incurred loss ratios for companies, particularly as inflation affects key cost-driving factors (e.g., medical care, litigation, and construction expenses).

Reinsurance Challenges
Reinsurance provides coverage for insurance companies, also known as primary insurers. With reinsurance, primary insurers can secure financial protection for risks they can’t or don’t wish to retain fully, thus offering a way to protect against extraordinary losses. As a result, reinsurance helps stabilize premiums for regular businesses by making it less risky for primary insurers to provide coverage. Nevertheless, reinsurers are exposed to many of the same events and trends affecting primary insurers and must make pricing adjustments of their own. For instance, compounded CAT losses could cause reinsurers to limit capacity and increase primary insurers’ premiums, ultimately creating a trickle-down effect for regular businesses.

Other Factors That Affect Coverage Costs

Here are other key factors that may influence a business’s coverage costs:

Type of Policy Being Purchased
The forms of insurance a business is seeking, as well as the details of such coverage (e.g., limits of liability and value of the insured property), will affect its insurance pricing.

Size of the Business
Generally, the more employees a business has and the larger its revenue is, the more it will pay for insurance.

Industry of Operation
Certain industries carry more risk than others. As a result, businesses operating in high-risk sectors are more likely to file insurance claims. A business involved in a risky industry will, on average, pay more in premiums.

Location of the Business
The location of a business will also influence its coverage expenses. For example, if a business operates in an area prone to certain natural disasters, insurance companies may determine that its facility is more at risk for property damage. This increased risk will translate to higher commercial property insurance premiums.

Claims History
A business’s claims history, often referred to as loss history, will also impact insurance pricing. If a business has an extensive claims history, then insurance companies will tend to consider the company more likely to file future claims. In turn, this means the business will be deemed risky to insure, subjecting it to higher premiums.

Risk Management Practices
A business that conducts a careful assessment of its unique exposures and establishes effective, well-documented risk management practices can appear more attractive to insurance companies. Having a robust risk management program in place reduces the likelihood of costly claims occurring and minimizes the potential losses a business could experience from an unexpected event.

Overall, during a hard market, policyholders may face complex considerations regarding their coverage. Thankfully, businesses are not without recourse; those that proactively address their commercial exposures will be better prepared for a hardening market than those that don’t. Additionally, policyholders who educate themselves on the trends influencing their insurance pricing will better understand how to manage their associated costs. Contact your Griffin Owens insurance advisor for further coverage guidance and risk management solutions.