Insurance Pricing Cycles: Hard vs. Soft Market

Similar to how the broader economy shifts from expansion to recession, the insurance market has a cycle as well.

There are two distinct periods of the cycle, known as the “hard” and “soft” markets. Much like other markets, they tend to cycle back and forth, and professionals who stay in the insurance industry long-term have to adjust to them.

We’ll do our best to present the basics of the concept to give you a general idea of how it all works. More importantly, we’ll explain how the cycle affects the cost (and availability) of insurance coverage. As an insurance agent or broker, you don’t need to understand every little detail. But having a general idea of what to expect can make more difficult markets more tolerable. It can also help you develop a strategy to keep making a steady living even in difficult market conditions. Professionals who can stick it out during depressed markets often end up seeing a boom in business during these times.

It is important to understand how insurance companies make money in order to further grasp the explanation below.

In short, insurers can make money using our insurance premium dollars to invest for return in the stock market and/or simply by generating more premium dollars than what they pay out in insurance claims over a specified period.

The latter is referred to as an “underwriting” profit (or loss if more is paid in claims than brought in from premiums).

What should you know about soft insurance market?

In a soft market, which we have been in for several years now, insurance companies have a broader appetite for “risk” and compete with one another by (generally) lowering premiums to attract more customers. This can mean more agents out there to underprice you. Some customers go straight to the source by getting their quotes online. For agents who are just entering the market, this is often an ideal time to get your feet wet due to the relaxed underwriting criteria. But don’t get too used to it. The market can change dramatically and unexpectedly.

A soft market is generally a period of time when insurance companies have high-dollar reserves and can make money in the stock market. Thus, they can lower their premiums to a point where they either don’t make money or even lose money on the “underwriting” side of the equation. Keep in mind, with lower premium rates comes lower commissions per policy. So you will have to get used to selling more policies to make the same amount of income.

What should you know about a hard insurance market?

In a hard market, insurers have dwindling reserves (of money in the bank), cannot make money on the “investment” side, and need to generate a profit based on generating more premium than what is paid out in claims.

What’s next? You guessed it; insurers accept less overall risk and raise premiums to ensure more money is coming in from “underwriting.” Their standards are more exacting, and they’re more likely to challenge things like an older roof or request an updated home inspection. This could drag out timelines to get a policy approved.

Again, the scope of this topic is too large for any one post, but keep in mind that each line of insurance (car, home, general liability, worker’s compensation) has its own independent cycle.

So one market “hardening” may not necessarily lead to the others doing so. This may also lead some insurers to specialize. So they’ll limit the consumers they accept requiring brokers to do more research to find the right fit for their applicant.

What causes the insurance market to switch between hard and soft?

There are a few factors that can cause any particular line of insurance (or the whole industry) to move through the cycle. Let’s take a look.

1. Continued underwriting losses – As discussed above, rates can only go down for so long before the insurers are not making enough money from underwriting. To stay afloat, insurance companies constantly have to balance

2. Decrease in Reserves – The industry is highly regulated. One of these regulations requires insurance companies to PROVE they have enough money to pay for their claims. Once they get to a point where they don’t have enough in the “bank,” they have to raise premiums to fill the coffers back up.

3. Risk Adversity – In a soft market, insurers are more lenient about the level of risk they will accept. In a hard market, insurers reduce their risk tolerance…and only want to insure those of us who they think have a LOW chance of filing claims, which leads to an underwriting profit (hopefully).

4. Reinsurance – Reinsurers are the companies who insure the insurance companies. If their premiums increase (for all of the same reasons above), those costs are passed on to the end consumer.

5. Natural Disasters – Any large scale loss can put a pinch on an insurance company’s finances. Insurers are typically used to paying out claims throughout the year allowing them to constantly rebalance their finances. If there’s a hurricane or other major disaster, thousands of people are affected and filing claims at once. This requires more manpower and money to pay the claims in a short period. The insurance cycle may harden for a long period after to recover.

Depending on where in the cycle insurers are in the above referenced points, the market may find itself “softening” or “hardening.” As a consumer, you would prefer the soft market.

For the record, the losses stemming from 9/11 caused the last hard insurance market. It has been soft ever since.

Tip: 10 ways to lower your car insurance premium.