COMMERCIAL INSIGHTS environment , businesses should focus on addressing the factors they can control .
THE INSURANCE MARKET CYCLE : HARD VS . SOFT MARKETS
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 . ( Figure 1 )
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 September 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 .
• 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 .
FIGURE 1
• 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 . +
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