Contributing Leavitt Group Authors: Braxton Hobdy, Greg Suman, Rod Leavitt
The insurance market has historically been subject to pricing cycles. These cycles are influenced by a variety of factors. This article outlines the current market conditions, describes the difference between what is known as “soft” and “hard” markets, and outlines factors that influence market fluctuations.
Current Market Conditions
According to the latest Commercial Lines Insurance Pricing Survey (CLIPS), commercial insurance prices rose by six percent in the aggregate during the second quarter of 2013. This is the 10th consecutive quarter of price increases. Workers compensation and employment practices liability experienced the largest price increases compared to the same time period in 2012.1
These rate increases are due to above average losses, low investment returns, and receding reserve releases. The effect of superstorm “Sandy” (October 2012) on property insurance is still being determined, but the losses from the storm are tempering what was a “generally improving rate environment” for property insurance buyers. 2
According to Richard Kerr, CEO of MarketScout, “The commercial P&C market in the U.S. is continuing its steady trend of rate increases. There is ample capacity but underwriters continue to increase rates as appropriate.” 3
Soft Market vs. Hard Market
In the insurance marketplace, the ability to purchase insurance can vary widely depending on market conditions. The market is typically defined as either a “soft” market or a “hard” market.
Soft Market. In a soft market, insurance companies are very competitive in their pricing, and they are willing to provide insurance on a much wider array of risks than they would consider during a hard market. Pricing is lower, and it is easier to obtain insurance coverage since insurance companies are less stringent about risks they will insure.
During a soft market, pricing is low enough that insurance companies may simply break even, while some may even experience operating losses. Insurance capacity (or supply) is high during a soft market, meaning that insurance companies desire to provide more insurance than consumers demand. When this occurs, insurance companies tend to lower their prices in order to meet their premium goals.4
Hard Market. In a hard market, insurance companies are very strict in their underwriting criteria and rates are high. It is often difficult for some types of businesses to purchase insurance at any price, and insurance policies often have many restrictions or exclusions. Insurance capacity during this time is lower since insurance companies focus on growth rather than profitability. Consumers’ demand for insurance exceeds insurance companies’ capacity to provide it.
Some of the factors that influence the transition between a soft and hard market include the following:
- Losses paid by insurance companies. If losses from claims are higher, then pricing will increase. Major catastrophic losses can have a significant impact as losses paid are higher than expected for a normal year. If losses are low, insurers will be more inclined to decrease their pricing.
- Government regulation and changing of laws.
- Economic conditions. Historically when interest rates have been high, insurance markets have been “soft,” which means prices have been lower because insurance companies sought financial returns from investing their premiums. With lower interest rates, investment income decreases, thus insurance companies rely on income through profitable underwriting results, which means they are more cautious about what risks they insure.
- Availability of capital. When capital (or surplus) is scarce, supply is impacted. This leads to a price increase. The opposite is true when there is an abundance of capital—rates decrease.
- Overall profitability. When operating losses are too much for the insurance company to bear, prices have to go up to cover the losses. 4
These insurance cycles have changed over the past 40+ years. From about 1970 to 1990, the cycles were almost predictable and the complete cycle would last about five to six years. The cycles would affect the entire insurance industry. Now the market has changed in the following ways:
- The cycle duration is longer and not as severe. This may be due to more capital being available.
- Different lines of insurance are affected differently. For example, workers compensation could experience rate increases due to higher losses while at the same time general liability and commercial auto may see rate stability or even decreases. This may be attributed to the implementation of more reasonable underwriting and selection practices.
- The cycles are also somewhat regional. Property rates may be higher and underwriting more stringent for locations closer to the coast due to increased risk for or the occurrence of certain types of natural disasters.
Where Are We Now?
Over the past few years, we have experienced a fairly soft market with predictions of a hardening market due to low interest rates. The hard market has not completely exhibited itself, but the trend is moving in that direction. There has been a slow and steady increase in rates over the last 12 months but not at the rate of increase that many experts were predicting. For now the market is fairly stable, though there is some degree of uncertainty created with pending government regulations that will impact business owners and the health care industry.