The Insurance Market Cycle: Hard Versus Soft Markets

May 2, 2023

The commercial insurance market is cyclical in nature, fluctuating between hard and soft markets. These cycles affect the availability, terms and price of commercial insurance, so it’s helpful to know what to expect in both a hard and soft insurance market.

A soft market, which is sometimes called a buyer’s market, is characterized by stable or even lowering premiums, broader terms of coverage, increased capacity, higher available limits of liability, easier access to excess layers of liability and competition among insurance carriers for new business. On the other hand, a hard market, sometimes called a seller’s market, is characterized by increased premium costs for insureds, stricter underwriting criteria, less capacity, restricted terms of coverage and less competition among insurance carriers for new business.

During a hard market, some businesses may receive conditional or nonrenewal notices from their insurance carrier. What’s more, during hard market cycles, insurance carriers are more likely to exit certain unprofitable lines of insurance.

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In what was one of the longest soft markets in recent years, businesses across most lines of insurance enjoyed stable premiums and expanded terms of coverage for decades. While the commercial insurance market hardened for a short period of time after the terrorist attacks of Sept. 11, 2001, the last sustained hard market occurred in the 1980s. However, after years of gradual changes, the market has largely firmed since 2019, leading to increased premiums and reduced capacity.

Many factors affect insurance pricing, but the following are some of the most common contributors to the hard market:

Catastrophic (CAT) losses—Floods, hurricanes, wildfires and other natural disasters are increasingly common and devastating. Years of costly disasters like these have compounded losses for insurers, driving 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 insurer collects and the money it pays out in claims and expenses. When an insurance company collects more in premiums than it pays out in claims and expenses, it will earn an underwriting profit. Conversely, an insurance 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 an insurance company puts toward spending on claims and expenses. A combined ratio above 100 indicates an underwriting loss.

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

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The economy—The economy as a whole also affects an insurance company’s ability to write new policies. During periods of economic downturn and uncertainty, some businesses may purchase less coverage or forgo insurance altogether. A business’s revenue and payroll, which factor into how premiums are set, may decline. This creates an environment where there is less premium income for insurers.
The inflation factor—Prolonged periods of inflation can make it challenging for insurance carriers 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 insurance carriers, particularly as inflation affects key cost factors (e.g., medical care, litigation and construction expenses).
The cost of reinsurance—Generally speaking, reinsurance is insurance for insurance companies. Carriers often buy reinsurance for risks they can’t or don’t wish to retain fully. It’s a way for insurers to protect against extraordinary losses. As a result, reinsurance helps stabilize premiums for regular businesses by making it less of a risk for insurance carriers to write a policy. However, reinsurers are exposed to many of the same events and trends affecting insurance companies and make pricing adjustments of their own.

Additional Factors Influencing Insurance Rates

In addition to the above, here are other key factors that may influence your insurance rates:

	The coverage you’re seeking— The forms of insurance you’re seeking, as well as the details of such coverage (e.g. limits of liability and value of the insured property), will affect your insurance pricing.
	The size of your business— As a general rule, the more employees your business has and the larger your revenue is, the more you will pay for your insurance.
	The industry in which you operate— Certain industries carry more risk than others. In general, businesses in these sectors are more likely to file insurance claims. As a result, businesses involved in risky industries tend to, on average, pay more in insurance premiums.
	The location of your business— The location of your business will also influence your insurance rates. If your business is located in an area prone to certain natural disasters, insurers may determine that your facility is more at risk for property damage. This increased risk will translate to higher premiums.
	Your claims history— Your business’s claims history, often referred to as loss history, will also have an impact on insurance rates. If your business has an extensive claims history, then insurance carriers will tend to consider your company more likely to file future claims. In turn, this means that your business will be viewed as risky to insure, subjecting you to higher commercial insurance premiums.
	Your risk management practices— Now more than ever, conducting a careful assessment of your business’s unique exposures and establishing effective, well-documented risk management practices can make your establishment more attractive to insurance carriers. After all, having a robust risk management program in place reduces the likelihood of costly claims occurring and minimizes the potential losses your business could experience from an unexpected event.

As a whole, during a hard market, insurance buyers may face complex considerations regarding their coverage. Thankfully, businesses are not without recourse in the face of a hard market. Business owners who proactively address risk losses and manage exposures will be better prepared for a hardening market than those who do not. Furthermore, those who educate themselves on the trends that influence their insurance will better understand what can be done to manage their associated costs.

For additional information or questions, please reach out to your Cottingham & Butler representative.