Updated: Mar 31, 2022
In part 1 of this blog, we firstly explore how insurers look to achieve profit, before discussing the key characteristics of a soft vs hard insurance market and then conclude with what triggers a hard insurance market.
Like many markets, insurance is cyclical, where conditions shift from a ‘soft’ to a ‘hard’ cycle. Despite many industries, such as construction and financial services, seeing growth, some businesses are currently struggling to obtain competitive insurance, especially in certain lines of insurance such as Professional Indemnity and Directors & Officers Liability. As a result, some firms are being forced to accept higher premiums, increased excesses, and restrictions in coverage or, in some cases, are not able to obtain insurance at all.
How Do Insurers Achieve Profit?
Insurance is a contract between two parties whereby one party, the “Insured”, transfers their specific risk to an “Insurer” in line with the agreed terms of the policy and in return for a premium.
To achieve a profit, some Insurers may place more emphasis on underwriting for a profit whilst others may underwrite for investment income. Of course, many insurers will combine the two models.
#1: Underwriting for Profit
An insurer who places a greater emphasis on underwriting for a profit is setup to underwrite profitable business through careful risk selection. To achieve a profit, the insurers end goal is to collect more in premium than they pay out in claims and expenses. In this scenario, they will look to achieve a loss ratio of below 100% after all costs and expenses have been paid. Like any business, insurers will experience profitable years, where they generate more in premium than they pay out in claims, whilst in other years they may pay out more in claims than they generate in premium income. For example, in 2014, Liability insurance made an overall underwriting loss of - £516m but, in contrast to this, it made an underwriting profit of £297m in 2019. (Source ABI Key Facts)
#2: Underwriting for Investment Income
An insurer who places a greater emphasis on underwriting for investment income will use the premium they generate as a vehicle to invest this into more profitable enterprises. In this model the insurer may place less importance on achieving an underwriting profit, so their overall loss ratio could exceed 100%. Many insurance lines, such as motor, often do not have profitable underwriting years, where the insurer pays out more in claims than they generate in premium income. With the often-huge sums insurers can generate in premium income this is then put aside into reserves to ensure they have sufficient funds to pay all the claims anticipated over the near term. Any surplus income is then invested. Many insurers will invest relatively conservatively, perhaps by investing in bonds or stable blue-chip companies. In the current economic and regulatory climate many insurers are relying far less on investment income due to low investment returns and enhanced regulation which requires them to hold reserves in the safest of assets which may return low or negative interest. As a result, insurers can no longer solely rely on this model to try and achieve a profit.
Based on the ongoing profitability of insurance companies, the cycle of insurance is either in a soft or hard market condition, which usually lasts between 2 to 10 years per cycle.
What is a Soft Insurance Market?
A soft market is a cycle in which insurance companies achieve modest profit. The key features of this market include the following:
Lots of insurers / high supply
Loose underwriting criteria
Easier to obtain insurance
What is a Hard Insurance Market?
In contrast, a hard insurance market is greeted with insurers who look to exercise caution, by adjusting their underwriting criteria and increasing rates, with the end goal of returning to profitably. The key features of a hard cycle are as follows:
Lack of insurers / low supply
Strict underwriting criteria
Difficult to obtain insurance
What Factors Trigger a Hard Market?
A combination of significant global and catastrophic events such as Brexit, Covid-19 and Grenfell Tower have led to uncertainty in financial and property markets, which in turn increases pressure on insurers, where they have incurred significant losses. For example, according to many sources, Covid related claims pay-outs could reach up to £5 billion (Source BBC).
As a result of such events and having been in a soft insurance market for over a decade, rates eventually reach their lowest point, as many insurers struggle to make an underwriting profit and / or find alternative forms of capital. The soft market then becomes unsustainable, and the hard market is triggered.
To combat the losses sustained in a soft insurance market, insurers will try and return to profitability by carefully reviewing their portfolio. During this review, they may look to completely withdraw from unprofitable industries, increase their rates and / or scrutinise each application in more detail, ensuring they are fully satisfied and comfortable with the firm’s risk management processes and contractual relationships before putting forward their terms.
In this blog, we have discussed how insurers look to achieve profit, the key characteristics of a soft vs hard insurance market and what factors trigger a hard insurance market. Our next blog will examine which industries have been most effected by the hard Professional Indemnity insurance market. We will provide some practical tips on how businesses can better navigate themselves through the complexities of a hard market and how they can achieve the best possible terms with the full support of their Insurance Broker.