Most industries are cyclical to some extent. The property/casualty (P/C) insurance industry cycle is characterized by periods of soft market conditions, in which premium rates are stable or falling and insurance is readily available, and by periods of hard market conditions, where rates rise, coverage may be more difficult to find and insurers’ profits increase.
A dominant factor in the P/C insurance cycle is intense competition within the industry. Premium rates drop as insurance companies compete vigorously to increase market share. As the market softens to the point that profits diminish or vanish completely, the capital needed to underwrite new business is depleted. In the up phase of the cycle, competition is less intense, underwriting standards become more stringent, the supply of insurance is limited due to the depletion of capital, and, as a result, premiums rise. The prospect of higher profits draws more capital into the marketplace, leading to more competition and the inevitable down phase of the cycle.
The chart below shows both nominal and inflation-adjusted growth of P/C net premiums written over four decades and three hard markets. Premiums can be accounted for in several ways. This chart uses net premiums written, which reflect premium amounts after deductions for reinsurance transactions.
During the last three hard markets, inflation-adjusted net premiums written grew 7.7 percent annually (1975 to 1978), 10.0 percent (1984 to 1987) and 6.3 percent (2001 to 2004).
During soft markets customers are able to negotiate lower insurance prices, as insurers compete for business, sometimes at below cost. When the market inevitably hardens, prices rise as insurers make adjustments to inadequate rates. The chart below tracks fluctuations in the cost of insurance, as tracked by the Risk and Insurance Management Society.
Mechanisms have sprung up to help businesses find coverages during hard markets or times when some coverages are difficult to obtain for other reasons, such as an overly litigious environment.
One such mechanism is the alternative market (discussed later); another is the Market Assistance Program. A MAP is a temporary, voluntary clearinghouse and referral system designed to put companies or individuals looking for insurance in touch with insurance companies. They are organized when something happens to cause insurance companies to cut back on the amount of insurance they are willing to provide. Recently, MAPs have been created in states such as Washington, where the medical community is having difficulty finding malpractice insurance.