Global insurance pricing is on the rise. According to Marsh’s latest Global Insurance Market Index, all three major product lines – property, casualty, and financial and professional – are showing rate increases. As of September 2019, there had been eight straight quarters of global insurance price increases reported in the brokerage giant’s market index.
In the most hard-hit sectors and geographies, people are starting to throw about the term “hard insurance market” with increasing frequency. But what does that actually mean? Here are eight characteristics that typically emerge during a hard insurance market:
1. Combined ratios are up; return on equity is down
Leading up to a hard market, the insurance industry will likely post average combined ratios well above 100% - somewhere in the 105% to 112% range – for a few successive years. This means the industry is paying out more in losses and expenses than it is collecting in premium. At the same time, the industry’s average return on equity (ROE) will likely drop dramatically. Generally speaking, insurers want to achieve ROE of around 10% in order to cover the cost of capital and generate ample return for shareholders. Heading into a hard market, the average ROE might be down in the 1% to 4% range, because climbing combined ratios are eating into the returns. To offset these challenges, insurers have to collect more premium. Depending on the severity of the issues and the regulatory backdrop, a market correction of this kind can take several years.
2. Sustained and significant rate increases
A hard market is characterized by sustained and significant rate increases. But insurers can’t just raise rates off the hook. They have to do it in response to the challenges named above – poorly performing combined ratios and ROE. Some key factors causing poor performance in property/casualty lines around the world include climate change and/or an increase in catastrophic weather events; social inflation and an increasingly challenging litigation environment; and macroeconomic developments.
3. Increased reinsurance costs
One indicator of a hard insurance market is a rapid increase in reinsurance costs. Typically, the reinsurance market drives insurance pricing trends. If reinsurers increase their costs significantly, insurers react by increasing the primary premium. It’s only natural that as one rises, so does the other.
4. Reduced capacity
When faced with hard market conditions, insurance carriers often start restricting the amount of capacity they’re willing to put up against certain risks. Many will conduct what’s known as portfolio remediation, meaning they will shore up their underwriting and risk selection guidelines on existing lines of business, while also shedding non-core or poorly performing risks. Sometimes, carriers don’t want to withdraw their capital completely. In such instances, they might look to move capital away from challenging areas and deploy it more effectively elsewhere.
5. Reduction in the number of new market entrants
With profit margins significantly reduced in a hard market, it’s no surprise that new players are often very hesitant about entering the insurance industry under these conditions. Most new players prefer to time their entrance towards the end of a hard market, so they can ride the wave and attract new business as insurance pricing trends downwards.
6. Growth of risk transfer options
No-one likes being told they have to pay more for their insurance. When premium prices shoot up in a hard market, corporate entities often seek reprieve in alternative risk transfer. This allows entities to insure more of their own risks. They might do this via self-insurance (retaining more of their own risk), by joining a risk retention group where they pool premium with similar entities to cover specific risks, or by setting up a captive insurance company. Hard markets tend to broaden the appeal of captives, in particular.
7. More mergers and acquisitions in the distribution channel
Consolidation in the retail distribution channel is alive and well. Hard market conditions can be a bonus for both buyers and sellers in the brokerage/agency consolidation market. When premium rates rise, a brokerage or agency’s revenue should also go up, which potentially makes them more valuable for a merger or acquisition. It also helps brokerages or agencies to grow post-sale. If structured transactions include earn-outs for the seller, they can grow their firm in a hardening market and therefore earn more value for their transaction.
8. Loss portfolio transfers
When times are hard, insurers can use a certain type of alternative risk financing called loss portfolio transfer. This is a reinsurance treaty through which an insurance carrier cedes a poorly performing portfolio to a reinsurer. The reinsurer takes on the insurer’s open and future claim liabilities through the transfer of the insurer’s loss reserves. This helps insurers in a hard market by removing liabilities from their balance sheets.