If you’re a business owner who works with the worldwide Property & Casualty insurance industry, you’ve likely heard colleagues and insurance experts use the term “hard market” while discussing the recent spikes in insurance rates. Increasing insurance rates and an overall reduction in the availability of insurance coverage are taking a toll on Texas companies. In order to analyze the impact of these conditions, we must first understand hard markets at large.
The insurance market is cyclical; it moves between “soft markets,” when insurance is inexpensive and easy to come by, and “hard markets,” when it can be hard to find a policy, let alone an affordable one. Soft markets usually happen when insurance companies can afford to be competitive with each other.
Insurance companies get a lot of their money from investments, mostly bonds; when interest rates are high, they can afford underwriting losses, meaning that the payouts for claims are actually less than what they make in premiums. More generally, insurance companies can run absolute losses for periods of time to retain or expand their market share – that is, so long as they meet regulatory requirements that mandate a certain amount of liquid reserves held for the payout of claims.
“Hard” insurance markets are the result of capital being unavailable and reserves being low. While a necessary consequence of an extended and unsustainable soft market, the conditions for a hard insurance market can be precipitated by specific events. For example, widespread, unexpected losses, such as those resulting from a particularly bad hurricane season, drain reserves.
In addition, recessions decrease the amount of money available for insurance premiums. During recessions, countries typically respond by lowering interest rates, which cuts into investment income. On the other hand, if the stock market average is performing markedly better than the insurance segment, investors might move their capital out of insurance and into a different sector.
On the surface, it might seem as though a decrease in supply would naturally lead to an increase in premiums, keeping insurance available and balancing things out. But the regulatory and practical need for reserves – as well as laws regulating when and to what extent insurance companies can access premium payments – creates a temporary shortage in the amount of insurance coverage available. When there’s a food shortage, price increases alleviate some of the pressure, but some people will still end up going hungry. The same applies here; in some cases where there is a greater risk, insurance companies will simply refuse to offer coverage, at any price. In others, they may tighten their underwriting requirements, meaning that they will be much less likely to negotiate on terms.
In their 2019 Q2 Global Insurance Market Index, Marsh reported a 6% overall increase in premium pricing in just the second quarter of the year (to be fair, this was much more heavily reflected in certain regions and certain market segments than in others
The most notable contributing factor that Marsh cites, at least for my clients, is reflected in the fact that catastrophe pricing (the cost of insurance where a catastrophe, like a hurricane, could trigger a claim) has increased at twice the rate of non-catastrophe pricing. This shouldn’t be much of a surprise; 2017 and 2018 were the first and second most expensive years for catastrophe losses ever.
It’s hard to say exactly how long or widespread the effect of a hardening insurance market will be. Indeed, there are arguments that we are past the age of long-term hard markets, due in part to improved efficiency and available capital. There’s also the argument that hard markets tend to last for less time than short markets do. However, in my experience, it is certainly becoming more expensive and more difficult to get insurance, and as such, I have been advising my clients that they need to allocate additional budget to their insurance premiums and acquisition processes.
How long the market as a whole will remain hardened is anyone’s guess. In the past, hard markets have lasted a year or so. However, there are specific concerns in this case. As mentioned previously, a large part of this recent hardening is motivated by the record-breaking catastrophe losses observed over the last few years; hurricanes Sandy, Harvey, and Matthew were particularly destructive and expensive, as were the California wildfires. This has made it exceedingly difficult to get insurance in areas prone to catastrophes, particularly in the coastal Texas region, where I do a lot of my business. Right now, obtaining coverage for my Houston and coastal-Texas clients is less an opportunity to save money on premiums but rather an exercise in managing adverse market conditions.
The long-term prognosis for coastal properties in Texas is less clear, but I’m concerned that coverage limitations and rising prices may become the new normal. In particular, the effects of climate change may at least in part be to blame for the particularly damaging catastrophe events that we have seen recently and could complicate acquiring insurance in these areas in profound ways. Ultimately though, whether this situation is permanent or not, the effects of a hardening market are especially visible in areas prone to catastrophe events.