What You Need to Know About Insurance Market Cycling

The insurance market cycle can impact your bottom line by increasing or decreasing your premiums. Like any industry, the insurance market contracts and expands. As it does, this impacts the availability of insurance and the premiums charged. If you run a business, understanding the insurance market cycle can help you anticipate changes and plan ahead, especially with the Australian market set to enter a ‘hard’ phase. Here’s a quick overview of a ‘hard’ or ‘soft’ market and how these affect premiums.

How insurers make money

Insurers make money by underwriting, but also through investment.

• Underwriting profit – the difference between what an insurer pays out in claims and expenses and the premiums collected. If the insurer pays out more in claims and expenses, it’s recording an underwriting loss. If it earns more in premiums than it pays out in claims and expenses, it’s making an underwriting profit.
• Investment income – Insurers also generate income by investing money in assets, which may include things like government bonds and other assets that can be quickly converted into cash. Investment income allows them to stay profitable enough to pay out claims.

Whether an insurer is profitable depends on the net outcome of their underwriting profit (or loss) and their investment income. They could be profitable in one area but losing money in another.

The insurance market cycle

The insurance market cycles between hard and soft stages. No two cycles are ever the same and each cycle typically lasts between 2 to 10 years. When the market is in a hard phase, premiums are higher. When it’s in a soft phase, premiums are lower.

Soft market

When the insurance market is soft, you tend to have lower premiums, broader coverage and reduced underwriting criteria or easier underwriting. Insurers tend to write more policies and allow higher limits and there’s increased capacity overall. Competition also tends to be higher.

Soft markets can also be characterised by larger claims, poorer investment returns and claims inflation. Soft markets can be driven by a range of factors, including strong economic conditions and fewer catastrophic events. These factors can boost capacity and in turn create a soft market. A soft market is a buyer’s market.

Hard market

When the insurance market is in a hard phase, the premiums tend to be higher and stricter underwriting criteria tend to apply. It’s no surprise then that there’s reduced capacity and insurance carriers end up writing fewer policies. Insurers become more selective about the policies they write. Competition in the insurance market is lower in a hard market.

Factors like a series of catastrophic events, a litigious legal environment and weak economic conditions can lower insurance companies’ capacity to write new policies, leading to a hard market. A good example is the succession of hurricanes Harvey, Irma, and Maria in 2017, which affected North America and areas in and around the Caribbean. However, despite all the costly disasters, insurers had access to capital from non-traditional sources and this helped them avoid a hard market for some time. A hard market is a seller’s (carrier’s) market, with stronger profits and capital flows into the market.

How does insurance market cycling affect premiums?

A soft market is associated with lower premiums, while a hard market tends to mean higher premiums.

How does this impact claims?

While a hard market means tighter limits on underwriting, stricter criteria, reduced capacity, and greater selectivity, it won’t directly impact the ease of making claims if you took out the policy during a soft phase and you fulfil all the claim criteria. However, over the long term, a hard market means on the whole, claims are subject to to tighter criteria.

The opposite is true for soft markets. During a soft phase, carriers tend to have reduced underwriting criteria and allow for higher limits. So over the long term, those making a claim tend to find it easier to satisfy the claims criteria.

Where are we headed to in the insurance market cycle?

While the Australian insurance market has been soft for some time, signs point to a hardening. This means higher premiums. And you’ll find it hard to make claims thanks to narrow policy wording and wider exclusions.

Insurance markets go through cycles like any other sector, and the cycle tends to swing between soft and hard. The Australian insurance market looks set to enter a hard phase, which means you’ll want to prepare for higher insurance costs by locking in more favourable policies now. By understanding what’s happening now, you can better prepare your business or property management budget for the shifts ahead.

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