Anyone who has ever stood in line for a coveted item, only to find out it’s been sold out while you waited, already understands the concept of an insurance hard market. It’s supply and demand – the amount of a product or service that’s available is lower than the demand from buyers.
Simply put, a hard market in the insurance world is a time when demand for insurance coverage is high, but the supply is low.
Medical malpractice insurance, cyber liability, property insurance and nearly every type of insurance for business or personal use can experience the ups and downs of the insurance market. When supply is low, prices go up. But how does an insurance company run out of supply for something that isn’t tangible?
The Insurance Market in a Nutshell
When you buy insurance, you’re buying protection from a risk of loss. The policy acts as a way for you to transfer your risk of loss to the insurance company, for which you’re charged a premium.
In order to afford to take on your risk, the company must do a few things to ensure your risk is what they consider a safe bet. First, they ask questions and evaluate your risk. Second, the company will take on enough customers in that particular line of insurance to spread the risks out over a bigger pool of customers. As long as the claims in that pool of buyers stay within the insurance company’s expected losses, they can sell policies with the same premium cost and coverage terms.
Insurance companies also rely on investment income to pay claims. They invest part of their revenue in order to maintain adequate reserves. Insurance companies (also called carriers) are required to put back money – reserves – adequate to cover any potential claims. The total amount of reserves an insurance company has accumulated is often referred to its surplus.
In the same way, claims can impact pricing. The number of claims and how expensive the payouts are also determines the availability and price of your insurance coverage. When there are fewer claims, carriers have ample reserves and can afford to sell more policies. This is known as a soft market – when carriers have plenty of money, when claims are low, and when carriers are financially secure enough to take on new business.
Enter the Hard Market
When there are more claims, or when claims costs go up over a sustained period of time, the money companies set aside for them gets spent quickly. This is a hard market – when pricing goes up and supply goes down. The causes could be any number of factors: low investment returns for carriers (investments are part of how they can pay claims), increase in claims frequency and/or severity, flawed underwriting of risks, and catastrophic losses that impact a large number of policyholders. For instance, Hurricane Sandy in 2012 caused $70 billion in losses across eight countries.
That kind of large loss has an impact on how much insurance risk a carrier can take on. Because large events can often deplete a carrier’s reserves as well as result in reduced investment income, carriers must make adjustments to how much insurance they can offer, how much a policy premium will cost, and what business they’re willing to renew.
In most cases, carriers will increase the amount you pay for your insurance. That change is made so that carriers can recoup the reserves they’ve spent. They might also change the policy terms, such as excluding certain events from coverage. Carriers might also offer less coverage for the same or increased price. For example, if you filed a large claim, or had more than one claim in a specified period of time (3 to 5 years is a common length of time that most carriers evaluate), your carrier could decide you’re too big of a risk to continue to insure. In that case, they might choose to non-renew your policy.
How Long Will It Last?
When a hard market emerges, it’s difficult to determine when it will end. Typically, that depends on a few factors: the carrier’s ability to replenish reserves, the state of the investment market, and a change in circumstance that may have caused a large loss event – for example, new regulations, better technology, stricter safety regulations, more restrictive building codes, etc.
When carriers can improve both their financial portfolio and the conditions that had caused the financial headaches, they will be able to offer one or more of the following: more insurance, higher amounts of coverage, and reduced rates. Hard markets are not permanent. Insurance carriers are skilled at balancing the needs of their customers along with the financial ability to cover claims. Talk with your insurance advisor to understand more about hard markets, and what you can do to reduce your premiums and still get adequate coverage.
Insurance rates change for reasons beyond your control; with expertise and knowledge from your insurance advisor, you can manage the impact to your business. Contact one of our trusted advisors today.