THE INSURANCE INDUSTRY IS CYCLICAL. From a business owner’s perspective, it can feel like insurance costs change unexpectedly or even sporadically. However, the insurance market is cyclical in nature, fluctuating between soft and hard markets over the course of years.
What is the Difference Between a Soft and Hard Market?
- Soft Market. A soft market is known as a “buyer’s market.” During a soft market, we see stable premiums, increased capacity, broader terms of coverage, higher available limits of coverage, and competition among insurance companies for new business. During a soft market it is easier to obtain insurance coverage and prices are favorable to the buyer.
- Hard Market. A hard market is known as a “seller’s market.” During a hard market, we see increased premiums, restricted coverage, diminished underwriting appetite and capacity, and less competition among insurance companies for new business. It can be more difficult to obtain insurance coverage and prices are not as favorable to the buyer during a hard market.
Why is the Insurance Market Hardening?
There are many factors contributing to the hardening insurance market we are currently experiencing, including an increase in natural disasters and increased claims costs.
In a recent Insurance Journal article, John Mina explains: “The industry has had persistent high loss ratios since 2013, primarily caused by an increase in frequency of severe property and liability losses and spiraling litigation costs with ever higher jury awards. Even if you haven’t had a particularly poor loss record, insured losses in the aggregate have steadily been rising without corresponding rate increases until just recently.”
The soft market we are exiting has been the longest in recent history, with companies enjoying stable insurance costs and increased coverage availability for years. Now we are starting to see reduced capacity and increased premiums, the beginning of a hard market.
The Combined Ratio and Insurance Rates
Insurance companies use the “combined ratio” measurement to determine if the premium dollars they are collecting are covering the losses being paid out on behalf of policy holders. To put the combined ratio in more exact terms, it is simply: incurred losses plus expenses, divided by earned premiums.
For example, an insurance company pays out $8 million in claims, has $4 million in expenses, and its total revenue from collected premiums is $60 million. The combined ratio of the company is 0.20, or 20%. In this case, the company is considered profitable and in good financial health.
Or in other words, for every dollar an insurance company takes in as premium, a certain percent of that is paid out for the expenses and overhead of the company. The remaining premium dollars are then invested, and—when needed—used to pay losses.
Insurance companies, ideally, like to keep the expense ratio as low as possible. As an example, a 0.90 combined ratio would be considered favorable and recognized as a 10 percent underwriting profit. A combined ratio over 1.0 could indicate an underwriting loss.
The following chart illustrates the U.S. property/casualty combined ratios over the past few years, as reported by A.M. Best Company, Inc.:
An increase in an insurance company’s combined ratio over time will eventually lead to an increase in insurance rates.
Prepare Your Business for Changes
Even the most prepared businesses will need to adapt to the hard insurance market. You can expect to face higher premiums, a lengthier and more scrutinizing underwriting process, increased coverage restrictions, and conditional or non-renewal notices.
Here are some business strategies you can employ to help navigate through the hard market:
- Review Your Insurance Program. Does your insurance program account for your business’s greatest exposures? Conduct a thorough review of your insurance coverage with your insurance agent to ensure you are not overlooking any exclusions that could leave your business exposed unnecessarily to risk.
- Budget for Unavoidable Increases. Be prepared to handle increased premiums, as in some cases they may be unavoidable. Take insurance costs into account when budgeting alongside other normal expenses. To get an idea of how much of an increase to plan for, ask your insurance agent what they are seeing with similar clients who are insured by similar carriers.
- Know Your Loss History. Underwriters will be critical when reviewing loss trends in a hard market. Be prepared to explain the factors contributing to a specific loss and the steps you’ve taken to mitigate future losses.
- Increase Your Risk Management Efforts. A solid risk management plan can help make your business more attractive to insurers. Ask your Leavitt Group insurance agent about the Risk Management Center – this platform provides tools and resources to aid in mitigating risk, keeping your employees safe, and protecting your business.
- Work with the Right Insurance Broker. During a hard insurance market, it’s crucial to have an insurance agent who has strong insurance company relationships as well as knowledge and experience in your industry.
- Communicate with Your Insurance Agent Early and Often. Starting the renewal process early can give your agent more time to secure the right coverage for your business. This also gives you time to evaluate new program structures and alternatives to traditional coverage in the face of increasing costs.
During a hard market, insurance buyers should plan to face difficult decisions regarding their insurance coverage. Thankfully, you are not without recourse in the face of a hard market. By proactively addressing risk, controlling losses, and managing exposures, you will be better prepared for the challenges of a hard market. Work with your insurance agent now to prepare your business for changes coming your way.
Contact your Leavitt Group advisor for more information about insurance marketplace trends.