Insurance Market Cycle: What Factors Drive Cyclicality?

The insurance market cycle is characterized by fluctuations between soft and hard markets, which affect coverage availability, terms, and pricing. Soft markets, also known as buyer's markets, are marked by stable or decreasing premiums, broader coverage, and intense competition among insurers. On the other hand, hard markets, or seller's markets, are characterized by increased premiums, stricter underwriting criteria, and reduced competition. This cycle is influenced by factors such as catastrophic losses, inconsistent underwriting profits, and the inherent uncertainty of matching insurance prices to future losses. Understanding these dynamics is crucial for policyholders to navigate the market effectively and secure favourable deals.

Soft markets

A soft market in the insurance industry is characterised by more sellers than buyers and low prices. It is also known as a buyer's market, as the purchasers hold more power in negotiations. In a soft market, insurance companies compete intensely with each other to gain more customers, and this drives down prices. This competition also results in 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 carriers for new business.

A soft market can be contrasted with a hard market, where there is competition among buyers and low fund availability among insurance companies. Insurance companies tend to be selective about who they will provide insurance to, and they generally avoid high-risk cases. In a hard market, insurance premiums are high, and it is difficult for consumers to acquire coverage.

The insurance market cycle, or underwriting cycle, refers to fluctuations in the insurance business over a period of time. A typical underwriting cycle spans several years, as market conditions for the underwriting business go from boom to bust and back to boom again. The cycle starts with many competitors and low premiums, and then after a surge in claims and insurance company insolvencies, competition declines, and premiums go up. As the insurance claims are paid off and the tide of new claims subsides, insurance companies slowly return to profitability. New insurance companies then enter the market, offering lower premiums and looser requirements than the existing companies. The existing companies are then compelled to loosen their requirements to stay competitive, and the insurance cycle starts all over again.

The underwriting cycle perpetuates because a majority of insurance companies place short-term gains over long-term stability, selling insurance without concern for what happens when the soft market ends. The only way to effectively regulate or insulate an insurance company against the effects of the insurance cycle is to ignore short-term profitability and focus on saving capital.

Hard markets

A hard market in the insurance industry is the upswing in a market cycle, when premiums increase and capacity for most types of insurance decreases. This can be caused by a number of factors, including falling investment returns for insurers, increases in the frequency or severity of losses, and regulatory intervention deemed to be against the interests of insurers.

During a hard market, insurance companies have less desire for growth and more restrictions in the marketplace as they re-evaluate their books of business, their risk appetites, and how much capacity they want to present in the marketplace. In hard market conditions, underwriters often adhere to stricter standards in an attempt to correct any adverse loss ratios developed during soft market conditions. As a result, insurance rates often go up, the amount of limit carriers are willing to provide decreases, and the number of players in the market restricts. This makes it harder for insureds and their agents to find coverage options, which means the carriers that are offering coverage can push up their rates.

In a hard market, there is a high demand for insurance coverage but a reduced supply. Insurance companies impose strict underwriting standards and issue a limited number of policies. Premiums are also high, and insurers are disinclined to negotiate terms. There may be attrition in the insurance market as fewer players offer coverage to consumers. In a soft market, insurance companies cover almost every typical insurance need. Companies are usually looking for more clients and try to increase their market share against their competitors. Due to the reduced cost of insurance and the consumer’s ease of accessing insurance, the coverage rates are high.

During a hard market cycle, carriers may stop writing business in high-risk locations or even exit certain unprofitable lines of insurance altogether. A wide range of factors can affect insurance pricing, but some of the top contributors to hard markets include catastrophic (CAT) losses—floods, hurricanes, wildfires, and other natural disasters. Years of large-scale disasters can compound losses for insurance carriers and drive up the cost of coverage overall, especially when it comes to commercial property policies.

Underwriting cycles

The underwriting cycle, also known as the insurance cycle, refers to the fluctuations in the insurance business over a period of time, usually spanning several years. It represents the cyclical nature of the insurance market, with business alternating between soft and hard markets.

A soft market is characterised by intense competition among insurance companies, leading to stable or decreasing premiums, broader terms of coverage, and less stringent underwriting rules. Insurance companies aim to expand their market share by offering discounted rates and attractive policy terms. This increased competition results in a decline in profits for the industry as a whole.

However, a natural disaster or a significant event can trigger a surge in insurance claims, driving less capitalised insurers out of business. This reduces competition and improves underwriting conditions for surviving insurers, who can then raise premiums and impose stricter underwriting standards, marking the transition to a hard market.

In a hard market, insurance companies focus on recovering losses and avoiding further risks, leading to increased premium expenses for insureds and stricter underwriting criteria. Competition decreases, and insurance carriers may exit unprofitable lines of business. Policyholders may face complex considerations regarding their coverage and may receive non-renewal notices.

As the insurance claims from the soft market are paid off, new entrants join the market, offering lower premiums and less stringent requirements, increasing competition. This compels existing companies to loosen their requirements and lower premiums to stay competitive, thus initiating another soft market and completing the underwriting cycle.

Catastrophic losses

CAT losses can drive the insurance market cycle by affecting insurance pricing and coverage availability. When insurance carriers experience significant CAT losses, they may sustain underwriting losses, which occur when the money paid out in claims and expenses exceeds the premiums collected. As a result, insurance carriers may increase premiums for insureds to combat their underwriting losses. Higher premiums can make it more difficult for consumers to acquire or maintain their insurance coverage.

In addition to increasing premiums, insurance carriers may also implement stricter underwriting criteria and restricted terms of coverage to manage their exposure to CAT losses. They may also exit certain unprofitable lines of insurance or stop writing business in high-risk locations prone to natural disasters. These actions can further reduce the supply of insurance coverage and drive up costs for consumers during a hard market cycle.

To mitigate the impact of CAT losses, insurance carriers can focus on risk management and establish effective programs to reduce the likelihood and potential losses from unexpected events. Additionally, carriers can invest in reinsurance, which provides coverage for primary insurers, protecting them from extraordinary losses and helping to stabilize premiums. However, reinsurers are also exposed to the same CAT loss events, and they may need to make pricing adjustments to compensate for their own losses.

Overall, CAT losses can significantly impact the insurance market cycle by driving up insurance costs, reducing coverage availability, and influencing the strategies of insurance carriers to manage their exposure to these events.

Risk management practices

The insurance market cycle, also known as the underwriting cycle, is characterised by fluctuations between soft and hard markets. During a soft market, insurance companies compete for new business by offering lower rates, attractive policy terms, and discounted coverage. This results in stable or decreasing premiums, broader terms of coverage, and greater competition among insurance carriers.

In contrast, a hard market is marked by increased premium expenses for insureds, stricter underwriting criteria, and restricted terms of coverage. Insurance carriers may also exit certain unprofitable lines of insurance or stop writing business in high-risk locations. Businesses with robust risk management practices can better navigate these cycles and appear more attractive to insurance carriers.

To build resilience, insurance companies need to upgrade their stress-testing capabilities and incorporate scenario analyses into their risk management practices. They must closely monitor geopolitical developments and develop agile strategies to navigate uncertainties arising from conflicts, trade tensions, and geopolitical shifts. Additionally, the trajectory of interest rates and inflation rates significantly influence the profitability of insurance companies, requiring adjustments to risk models and investment strategies.

Furthermore, the insurance industry must also focus on protecting customer information and ensuring data confidentiality, integrity, and availability. By categorising risks, insurance firms can assign specific teams to monitor and manage each risk category effectively. Implementing flexible strategies and agile operational frameworks enables insurance organisations to respond dynamically to market shifts, technological advancements, and regulatory updates.

Overall, proactive risk management practices enable insurance businesses to adapt to changing dynamics, foster innovation, and position themselves for sustainable growth in a complex and interconnected global landscape.

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