The property/casualty insurance industry is cyclical, continually fluctuating between a hard and soft market. These fluctuations affect the availability and price of business insurance, so it is helpful to understand why they occur.
Key Takeaways
- A hard insurance market is when there is high demand for insurance coverage and low appetite to insure.
- A soft market is when there is little demand for insurance coverage and companies are competing for business.
- Insurers make money from underwriting profit and investment income.
- When there is a surplus of investment income, it can keep the market soft.
Hard and Soft Markets
Hard and soft markets are different parts of the insurance economic cycle.
Hard Insurance Market
A hard insurance market is characterized by a high demand for insurance coverage and a reduced supply.1
Insurers impose strict underwriting standards and issue a limited number of policies. Premiums are high and insurers are disinclined to negotiate terms.
Soft Insurance Market
A soft insurance market is the opposite of a hard one. When the market is soft many insurers are competing for business and premiums are generally low.2
Insurers relax their underwriting standards and coverage is widely available. Underwriters are generally flexible and willing to negotiate coverage terms.
Broad coverage is available with some extensions available for free.
How Insurers Make Money
To comprehend why the insurance market fluctuates between hard and soft, you must first understand how insurers make money. Insurance companies have two main sources of revenue: underwriting profit and investment income.
Underwriting Profit
The term underwriting profit means the difference between the premiums an insurer collects and the money it pays out in claims and expenses (including agent and broker commissions).
An insurer that collects more in premiums than it pays out in claims and expenses will earn an underwriting profit. Conversely, an insurer that pays more in claims and expenses than it collects in premiums will sustain an underwriting loss.
Investment Income
Insurers also generate income by investing in assets. Property/casualty insurers normally hold an assortment of stocks, bonds, mortgages, and real estate investments. Their largest asset group is typically bonds, including corporate, municipal, and U.S. government bonds. Bonds are “safe” assets that can be converted into cash quickly.