You’ll probably be aware of the terms “bull market” and “bear market” in terms of stocks and shares. But did you know that the insurance world has cycles too? It is useful to know because market changes cause a knock-on effect on insurance policies worldwide.
In investing, a bull market is characterized by strong investor confidence: capital flooding into the equity markets, and rising share prices. Conversely, a bear market sees a flight of capital out of the stock exchange to lower-risk investment classes e.g. gold. The demand to buy shares falls. So do share prices, until they dip so low that they’re undervalued. Then investment capital returns and prices begin to rise again.
While not a like-for-like comparison, the insurance world is subject to market forces, too.
Hard market? soft market? What does it mean for me?
An insurance market cycle consists of ‘hard’ and ‘soft’ markets.
In a soft market, insurance companies are awash with investment capital. This means there is a huge supply of insurance (capacity) available and to win clients, premium prices are low. In a soft market, insurance is freely available to anyone who wants to buy it. Terms are broad and comprehensive.
In short, a soft market is a buyer’s market.
When the market gradually ‘hardens’ towards a hard market, underwriting conditions tighten. In other words, sellers become choosier about who they will sell to and on what terms. As supply contracts, prices begin to rise.
What market cycle are we in now? Causes of changes in market conditions
Traditional wisdom says there will be a hard market for one year in every seven. More recently, we’ve seen a lengthy soft market, running for well over 10 years. But for the last 18 months or so, many insurers have been running at a negative operating ratio. That is, the amount of premium and investment income they receive is less than the value of claims paid out plus expenses.
In 2020, as well as billions of USD worth of COVID claims, there have been an unusually large amount of major weather events and natural catastrophes, not only in the Philippines, but all over the world. This has resulted in pay-outs of many billions more.
To further understand the underlying market forces of insurance, let’s look at how insurers share and offset the risk of such huge claims.
Please put yourself in the perspective of the insurer for a moment. If a client wanted coverage for a fleet of ships, that’s a liability that you may not want on stuck on your balance sheet. Overnight, you could be on the hook for several billion dollars. It could bankrupt your business.
So how do insurers mitigate such losses?
They “re-insure” them. This means paying their peers a premium to take on part of the risk. And oftentimes, peers enact their own risk management. To protect their own balance sheet, they go ahead and re-insure the re-insurance, on what is called the retrocessional insurance market.
Still with us?
Essentially, when insurance companies take on a risk, they seek to offset it. This sets off a chain of risk-sharing throughout the interconnected global insurance markets. It’s similar to general insurance: an agreement under what terms each re-insurance policy will pay out on, an assessment of what the chances of a claim are, and the premium-priced accordingly.
At the time of writing, there is a definite tightening of capacity in the retrocessional markets, with reinsurance premiums rising for any insurer wanting to offset risk in this way.
In more prosperous times, any increased costs of doing business would be outweighed by investment earnings. Insurers are, after all, prolific institutional investors. But since the global financial crisis, insurers have been required by rating agencies and regulators to invest ever more conservatively, and even before COVID, yields on ‘safe’ investments had fallen drastically, in some cases, into negative territory. This situation has only deteriorated with COVID.
Are we in a hard market now?
No underwriter likes to use the phrase hard market (just as Harry Potter would rather not say Voldemort).
But prices are rising, underwriting is tightening and risk appetites within insurers are changing.
To meet the opportunity of rising prices, there have been record levels of capital raising by insurers, with £29bn’ of new financing so far in 2020. More than usual, insurers are now taking more risk with more of their own money. This is another factor in the tightening of underwriting.
These are the current market conditions that all brokers and agents are working in.
So what can I do?
In a word, tailoring.
We mentioned that a soft market included very broad conditions. This can often be the result of extra clauses and bolt-ons to add value.
At your next renewal, you may be offered a policy that doesn’t cover things it used to. You may be asked to pay more, especially if you are working with smaller brokers or agents (who in fact, work for insurers, not clients).
The flight to large brokers is a definite phenomenon during tougher times, as a precautionary layer of risk management. In tough times, larger broking houses are better equipped to provide the needed support and have stronger staying power.
But how big is big enough?
Howden offers a credible alternative to the big two, the duopoly. In only 25 years we’ve grown from three friends and a dog in the UK, to one of the largest brokers on the world stage. We’re trusted all over the world, advising on more than 10bn USD of premium globally.
We’ve invested heavily in technology to streamline processes that smaller brokers and agents simply cannot afford. And when savings are made, we’re able to pass them on to our clients.
In the hardening market, and the new normal, you may find your existing insurance relationships don’t deliver the value they used to. Unless you’re already with us.
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