If you’ve had conversations about insurance in recent months, you’ve likely heard the terms “hard market” or “market hardening.” Many policyholders are experiencing dramatic rate increases that pinch budgets. Here’s a summary of the root causes and what you can do:
What is a hard market?
The Insurance Risk Management Institute (IRMI) defines a hard market as an “upswing in a market cycle when premiums increase and capacity (the supply of insurance available to meet demand) for most types of insurance decreases.” That means insurance is more expensive and harder to obtain.
In contrast, during a “soft market,” buyers benefit from attractive rates, abundant capacity, and flexible policy terms and conditions. Insurance is available and affordable.
What causes a hard market?
Market hardening begins when carriers take corrective action to shore up their profitability. Economic, political, climate, and other events can trigger hardening. For example:
• Falling investment returns for insurers caused by stock market declines
• Increases in frequency or severity of losses
• Regulatory intervention deemed by insurers to be against their interests
Insurance carriers may restrict capacity, strategically deploy limits on coverage, or not offer coverage at all. They may discontinue or reduce their involvement with certain industries and product lines.
Carriers retrench in order to get their books of business healthy by limiting appetite (the risk an insurance company will take on) and adhering to strict underwriting discipline.
How often do hard markets occur?
Since 1985, the insurance industry has experienced three hard markets: 1985-1987, 2001-2004, and 2019-current.
In 1985, a tort crisis (extensive liability lawsuits that almost collapsed the US insurance industry) contributed to hardening. In 2001, the events of 9/11 triggered a hard market.
Multiple factors paved the way for the current hard market, which began forming in 2019 and stubbornly persists. While the COVID-19 pandemic did not initially cause the hard market, it’s one of several factors prolonging the pain.
Why did the market begin hardening in 2019?
As 2019 progressed, insurance carriers’ books of business became increasingly unprofitable and unsustainable.
The role of investment income
Insurance companies count on generating income through investments as a key strategy to remain profitable. Higher interest rates, and thus higher investment yields, allow insurers to write to a combined ratio (losses plus expenses) closer to 100% (break-even).
Conversely, falling interest rates and low yields mean insurers cannot rely on investment income. Instead, to remain profitable, they must maintain exceptional underwriting performance, raise prices, and keep combined ratios below the 100% level.
The insurance term “social inflation” refers to factors beyond “economic inflation” that increase overall costs and are harder to predict. For example, there’s societal pressure to resolve issues through the legal system. A pro-plaintiff legal environment can lead to “nuclear verdicts” (extra-large jury awards). These higher loss payments drive up insurance costs and lead to price increases.
Catastrophic events worldwide have increased in frequency and severity over the past two decades. Hurricanes such as Katrina, Harvey, Irma, Maria, and most recently Ian, are occurring more often. Wildfires in the west have become an annual event. We’ve seen windstorms, hailstorms, the Texas freeze, flooding in Europe and Thailand, earthquakes in Japan, China, and New Zealand, and now droughts in the US. These tragedies severely and negatively affect a carrier’s surplus, underwriting performance, and the cost of reinsurance (“insurance” for insurance companies).
Rising inflation and supply chain issues are adding to the woes. And many insureds are learning their current policies have insufficient property values and improper limits. Rectifying these gaps will add to insureds’ costs for the foreseeable future, prolonging the hard market.
How long do hard markets last?
Typically, hard markets are shorter in duration than soft markets. For example, compare the hard market of 2001-2004 to the soft market of 2004-2019.
Unfortunately, this current hard market is likely to persist. While some types of insurance show signs of rate deceleration, the factors mentioned above will continue to affect insurance pricing and availability in 2023.
Inadequacy of carrier reserves can also prolong the length of a hard market. If carriers need to take reserve charges due to poor loss development or other reasons, they will need to raise rates to replenish those reserves.
What strategies help in a hard market?
Eventually, the hard market will subside, and things will become more stable for buyers. But until that happens, here are three strategies to soften the impact on your budget:
1. Start thinking about your insurance renewals in advance. Talk with a Risk Strategies specialist to examine the adequacy of your coverage and whether you need to meet any new requirements to get the most favorable renewal terms. Waiting until the last minute will hurt your chances for a successful renewal and limit your options.
2. Determine what additional actions you can take to improve your risk profile. For example, have you acted on engineering recommendations? Do you need to adjust your business practices to reduce cyber risk? Underwriters like to see a strong focus on continuous risk mitigation.
3. Explore how captives can help you manage costs. When capacity shrinks in the insurance marketplace, driving up costs, a captive may be an attractive alternative for financing risk. An actuary can help you run the numbers to determine if a captive could help you meet your risk management goals.
A hard market can be frustrating, but these tips can help you navigate the rough waters. To brainstorm options for your unique situation, talk with a Risk Strategies specialist today.