Understanding the Insurance Industry’s Hard Market

Understanding the Insurance Industry’s Hard Market

May 08, 2024


The insurance landscape is dynamic, fluctuating between what industry professionals refer to as "soft" and "hard" markets. Since September of 2019, there has been a noticeable shift toward a hard market, characterized by rising premiums and the increasing challenge of acquiring insurance. Over time, this hardening of the market intensified further as we witnessed a series of significant events, each adding layers of complexity and financial strain. These events have systematically escalated the claims and losses, leading insurers to adopt even more stringent underwriting standards and higher premiums. This shift has a profound impact on consumers and businesses alike, prompting a need for a deeper understanding of the forces at play. Blue Ridge Risk Partners is committed to guiding you through these changes, offering insights into the main causes of the hard market, and how they might affect you, our valued clients and partners.

 

Defining the Insurance Markets


Hard Market in the insurance industry refers to a period characterized by higher premiums, stricter underwriting standards, and reduced availability of insurance coverage. This typically occurs when insurers have experienced significant losses, leading to reduced capacity and increased caution in assessing risk. During a hard market, insurers may limit the types of risks they insure and the coverage they offer, resulting in fewer choices and higher costs for consumers and businesses seeking insurance.

A Soft Market is the opposite condition in the insurance industry, marked by lower insurance premiums, more lenient underwriting criteria, and increased competition among insurers. This environment often emerges when the industry experiences fewer claims and accumulates substantial capital, leading to more insurers competing for business. As a result, consumers and businesses can find more favorable insurance terms, broader coverage options, and reduced costs. A soft market benefits insurance buyers with easier access to coverage and competitive pricing.


 

Economic Conditions and Inflation


Our economic landscape plays an important role in shaping the insurance industry's trajectory. Inflation stands out as a critical factor driving the market towards a harder phase.

Inflation refers to the overall increase in prices of goods and services over time, which affects the cost of virtually everything, from construction materials and medical services to repair work and replacement parts.

As the cost of goods and services rises, the expenses associated with settling insurance claims (such as repairing a damaged vehicle or rebuilding part of a commercial property after a disaster) also climb. This is because the insurer is bound to cover the higher costs of repairs, replacements, and services as per the policy agreements. This pressure necessitates an increase in premiums to ensure insurers can cover costly claims while remaining solvent and profitable.

  • Historical Patterns: Historical data demonstrates a clear pattern; during periods of high inflation, insurance premiums surge. For instance, the commercial property insurance sector has observed rate increases of 20% or more in some areas, driven by the escalating costs of materials and services.

Example: Economic Volatility and Its Impact

  • A fine example of the impact economic volatility has is the aftermath of the COVID-19 pandemic.

Inflation at the beginning of the Covid-19 pandemic was in a downhill trend with several items like gasoline, traveling costs, and clothing seeing a decrease in price. However, by 2021 prices began to increase drastically and by 2022, the inflation rate in the U.S. reached approximately 7% in 2022, an increased level not seen in four decades.

These pandemic-induced economic disruptions led to unforeseen fluctuations in the cost of materials and labor, significantly influencing the operational costs and claims expenses for insurers directly impacting the insurance sector's pricing models and profitability.

For homeowners and drivers, the increased costs of labor and materials means your regular repairs and replacements for homes and vehicles have increased in cost as well. Insurers increase premiums in order to cover the potential payouts from higher materials and rebuilding costs.

For business owners, premiums will not only rise because of the higher costs of materials and services. Premiums will also increase due to the increased risk associated with operational and supply chain disruptions. High-risk companies and companies with physical assets have seen a rise in premiums as the price to ensure their assets increases.


As we consider the effects of traditional economic inflation, it's also crucial to address the concept of social inflation, which introduces additional complexities into the insurance landscape.

 

Social Inflation


Social inflation refers to the trend where insurers experience increases in liability costs that exceed the typical rates expected from standard cost-of-living inflation. Social inflation is hard to quantify, as it is a human risk, making it complicated for insurers to combat. This phenomenon can be driven by a variety of factors, each contributing to the overall hardening of the insurance market.

  1. Shift in the legal system:

The frequency of nuclear verdicts, a court judgment in which the damages awarded are significantly high, has increased, as juries are now more willing to award large sums to plaintiffs. Nuclear verdicts are known to exceed $10 million, a significant amount that may result in severe consequences for the defendant company. This is due to a shift in attitude in juries. Juries have grown to distrust large corporations; they may empathize with the plaintiffs for their suffering and intend to hold large corporations liable for their injuries.

 

  1. Litigation Funding:

The rise of litigation funding, where third parties finance legal cases in exchange for a portion of the settlement, has made it easier for plaintiffs to pursue costly lawsuits. This trend has led to more cases going to trial and larger settlement demands.

 

  1. Deteriorating Tort Reform

Tort reform refers to changes in the law aimed at making it more challenging for plaintiffs to initiate lawsuits or to limit and/or decrease the amount of compensation they can be awarded if they successfully win a case. In many jurisdictions, the limit on how much can be awarded in a lawsuit has been eliminated, making the mentioned nuclear verdicts possible.

 In the realm of commercial insurance, social inflation presents challenges on a wide scale. The commercial insurance sector often deals with more complex and higher stake claims, particularly concerning liability and property insurance.

For businesses, especially those in sectors like construction or manufacturing where the potential for workplace accidents or consumer harm is higher, the risk of facing a nuclear verdict can drastically increase insurance costs. Companies may need to carry higher liability insurance to protect against potentially ruinous legal judgments, or they may have difficulty finding the necessary coverage at all.

As social inflation and its contributing factors, such as nuclear verdicts and litigation funding, lead to a harder insurance market, we also need to consider the implications for industries that are highly dependent on insurance for operational stability, such as construction.

 

Construction Costs


The construction sector's cost dynamics have a direct bearing on the insurance market, affecting both personal and commercial lines. As previously discussed, the years 2020 and 2021 witnessed a dramatic escalation in the prices of goods, including key construction materials:

  • Lumber prices soared by over 300% at their peak.
  • Steel prices jumped by approximately 200%.
  • Copper prices increased by around 50%.

Such price hikes, coupled with a persistent labor shortage in the construction industry, have compounded the cost pressures. The labor shortage alone has the potential to increase construction costs by 10-20%, significantly affecting the insurance claims related to building and repairs.

For homeowners, the surge in material costs means higher costs for home repairs and rebuilds, which directly translates into higher homeowners' insurance premiums. For instance, if a storm damages a house, the increased costs to replace roofing materials or structural components can lead to larger claims, pushing insurers to adjust premiums upward.

Commercial properties face similar issues on a larger scale. Consider a manufacturing facility that experienced significant storm damage to its warehouse roof and machinery. Before the storm, the cost of repairs and replacements was manageable within their commercial property insurance coverage. However, the landscape changed drastically due to the surge in construction material costs. This means the insurance company faced claims costs much higher than those estimated when the policy was underwritten, based on pre-2020 prices.




Cost to Repair & Rebuild


We mentioned that the cost of construction materials has seen a drastic increase. What does that mean for property owners?

Whether it is a personal property or a commercial property, the condition of a building, including the age and upkeep of structures like roofs, play a huge part in the premium you receive for that property. Buildings with outdated or poorly maintained features are more susceptible to damage. An Insurance Institute for Business & Home Safety study revealed that commercial buildings with roofs over 20 years old are more prone to filing claims related to roof damage. This vulnerability translates into higher premiums for such properties.

 

Roof Conditions and Insurance Costs for Homeowners

  • Age of the Roof: Older roofs, particularly those over 20 years, are more likely to incur damage from weather events or wear and tear. Insurance companies often view these properties as higher risk, which can lead to higher premiums for both homeowners and business owners.
  • Material and Maintenance: The materials used in a roof and how well it has been maintained can also affect insurance costs. Durable materials and regular maintenance may lower risk and thus premiums, while neglected or inferior materials can increase them.

High-Risk Industries and Property Conditions

  • Sector-Specific Risks: Businesses in industries considered high-risk, such as manufacturing, chemicals, or hospitality, might see higher insurance premiums. These sectors often involve more significant potential for damage or liability, influenced by the property's condition and the nature of the business conducted.
  • Example: Manufacturing Facilities: A manufacturing plant with aging infrastructure may pose a higher risk of fire or structural failure. Insurers might require detailed inspections and impose higher premiums to offset this risk. Upgrading electrical systems or reinforcing structures could mitigate these risks and potentially lower insurance costs.

 

How do insurers accurately assess the cost to repair or rebuild?

Advancements in technology, such as drones and satellite imagery, have significantly improved insurers' ability to accurately assess the property’s condition. These tools can identify risks like roof conditions, structural weaknesses, or even flood-prone areas with precision, leading to more accurate premium pricing. Additionally, accurate roof condition data can influence the decision between offering ACV (Actual Cash Value) or RCV (Replacement Cost Value) coverage, ensuring premiums reflect the true risk.

  • Drones for Roof Inspections: Drones can capture detailed images of a roof, revealing issues like missing shingles, pooling water, or structural damage that might not be visible from the ground. This thorough assessment helps insurers price policies more accurately, potentially reducing the need for costly in-person inspections.
  • Satellite Imagery for Large-Scale Assessments: For insurers managing vast portfolios, satellite imagery can provide a macro view of property risks, especially in areas prone to natural disasters. This broad perspective can inform underwriting decisions and disaster response strategies.

Actual Cash Value (ACV) vs. Replacement Cost Value (RCV)

When it comes to property insurance, two primary methods are used to determine the value of a claim: Actual Cash Value (ACV) and Replacement Cost Value (RCV). Understanding the distinction between these two can help policyholders grasp how their coverage works and the potential reimbursement they can expect in the event of a claim.

Actual Cash Value (ACV) represents the cost to replace property with new property of similar kind and quality, minus depreciation. Depreciation is a reduction in value due to wear and tear or age.

  • In the event of a claim, policies that reimburse based on ACV may result in lower payout amounts because they account for the depreciation of the item or property. This means that if a policyholder's roof is damaged and the roof is 10 years old, the insurance payout would reflect the value of a 10-year-old roof, not the cost of a brand new one.
  • Policies that offer ACV reimbursement are less expensive in terms of premiums because they typically lead to lower payouts for claims.

Replacement Cost Value (RCV) is the cost to replace the damaged or lost property with new materials of like kind and quality, without deducting for depreciation. This means the policyholder receives the full cost to repair or replace the damaged property, subject to the policy's limit.

  • Policies based on RCV provide a more comprehensive coverage level, ensuring that policyholders can restore their property to its pre-loss condition without considering depreciation. This can be particularly important for significant assets like homes or essential business equipment.
  • Since RCV policies can lead to higher claim payouts, the premiums for these policies are higher compared to ACV policies.

Often, when a property needs extensive repair or rebuild, the majority of that damage is caused by weather-related incidents.

Natural Disasters


The frequency and severity of natural disasters have seen a notable increase, putting additional pressure on the insurance industry. These events not only lead to significant immediate losses due to claims but also influence long-term pricing and availability of insurance in affected regions. The Mid-Atlantic region, prone to a variety of natural disasters, provides a clear example of how such events can drive insurance premiums higher:

Hurricane Isabel in 2003 serves as a poignant example of a natural disaster affecting insurance premiums in the Mid-Atlantic region. Isabel was one of the most significant hurricanes to impact the area in recent decades, causing widespread destruction across several states, including North Carolina, Virginia, Maryland, and Delaware.

Hurricane Isabel resulted in billions of dollars in damage, with Virginia alone reporting over $1.85 billion in losses. The extensive damage ranged from downed trees and power lines to severe flooding and property destruction. In the aftermath of Isabel, the insurance industry faced a substantial surge in claims, putting a strain on resources and leading to significant financial losses for insurers.

The increased risk profile of the region, highlighted by Isabel's devastation, led insurers to re-evaluate their exposure in the Mid-Atlantic. Consequently, many homeowners and businesses saw their insurance premiums rise as insurers adjusted to the increased risk. Additionally, some insurers reconsidered their presence in the most vulnerable areas, as geographic location often has a big play in whether insurers will cover properties in that area or not.

These increasing trends in frequency and severity of claims have led to heightened loss ratios in the commercial insurance sector, necessitating higher premiums to cover the escalating costs. The ongoing challenge for businesses is not just the increased cost but also the potential for limited coverage options as insurers aim to limit their risk exposure in disaster-prone areas.

For homeowners and drivers, the effects are similarly challenging. Elevated premiums and potentially more restrictive coverage terms are becoming the norm. Homeowners in high-risk areas susceptible to natural disasters may face higher deductibles or even a complete lack of availability for certain types of damage coverage. Drivers may also see their insurance costs rise, particularly if their locale is deemed high-risk due to frequent or severe natural events.

Amidst the hardening of the market, the pivotal role of underwriters comes into sharp focus. As the insurance landscape grapples with and severe natural disasters and inflation, it is the underwriters who meticulously assess the risk and adapt insurance policies accordingly. Their expertise is crucial for insurers as they strive to balance risk and coverage in a hard market.

The Role of Underwriters


The task of adjusting premiums, especially in a hard market, is a balancing act that involves the expertise of underwriters. Underwriters take a key role in determining the risk associated with providing coverage to individuals or businesses and setting the premiums that reflect this risk accurately. Their role becomes even more critical when insurers navigate the challenges of increased claims and operational costs.

Assessing Risk and Setting Premiums

Underwriters meticulously evaluate the potential risk presented by insuring a property, a vehicle, a business, or an individual. This evaluation includes a detailed analysis of historical data, current trends, and predictive modeling to estimate future losses. In a hard market, where the volume of claims is higher, and the cost of those claims are rising, the precision of underwriting decisions is paramount.

  • Market Conditions: Underwriters must constantly monitor the market for changes that could affect risk. For example, in areas prone to natural disasters, they might adjust premiums more frequently to reflect the increased risk.
  • Competitive Landscape: While assessing risks, underwriters also need to be aware of the premiums competitors are offering. Setting premiums too high might lead to a loss of business, while setting them too low could result in financial instability.

Underwriters operate within a framework of regulatory requirements that dictate how premiums can be adjusted and what factors can be considered. These regulations ensure that premium adjustments are justifiable based on the assessed risk and that they are not discriminatory.

The primary challenge for underwriters is to set premiums that are high enough to cover potential claims and operational costs but also competitive enough to retain and attract customers.

As we consider the increasing risks that industries and properties face, especially under the pressures of a hard market, it becomes important to consider how insurance companies manage these heightened liabilities.

One key strategy employed by insurers to mitigate these risks and ensure the availability of coverage, even in challenging times, involves reinsurance. This element of the insurance landscape plays a crucial role in maintaining market stability and supporting insurers as they navigate the complexities of high claims and operational costs. Reinsurance is a mechanism for insurers to manage increased liabilities and maintain stability in the insurance market, particularly during the challenging conditions of a hard market.

What is Reinsurance?


Reinsurance is essentially insurance for insurance companies. It allows insurance companies to transfer a portion of their risk to other entities, reducing their potential liability in the event of significant claims.

This process helps insurers manage their risk levels and offer coverage even for large-scale disasters or losses. By spreading risk, reinsurers play a critical role in stabilizing the insurance market, enabling primary insurers to underwrite policies that they might otherwise be unable to afford or would be too risky to take on alone.

 

The Impact of the Hard Market on Reinsurers

The hard market poses significant challenges not only for insurance companies but also for the reinsurers that back them. Several factors contribute to these challenges, notably the increased frequency and severity of claims, driven by natural disasters and economic fluctuations. These conditions have led to a tightening in the reinsurance market, characterized by:

  • Reduced Limits: Many reinsurers have opted to reduce the limits they offer on single policies. This decision is largely a response to the increased risk and uncertainty in the market, aiming to protect reinsurers from overexposure to potential massive losses.
  • Increased Rates: To compensate for the heightened risk environment and to ensure their financial stability, reinsurers have raised their rates. This increase in reinsurance costs is subsequently passed on to insurance companies, which may then translate into higher premiums for consumers.
  • Market Withdrawal: In response to the hard market conditions, some reinsurers have decided to withdraw from certain markets entirely, deeming them too risky or not profitable enough. This retreat affects the availability and cost of insurance in those areas, as insurers rely on reinsurance to help manage their risk.

 

What Does This Mean for New Businesses?


For new businesses, these changes and unique challenges presented by the hard market create even more challenges and considerations when it comes to securing insurance coverage. Understanding these implications is crucial for effective risk management and financial planning.


Difficulty Finding Affordable Coverage

One of the most immediate impacts of a hard market on new businesses is the difficulty in finding affordable insurance coverage. With insurers adjusting their underwriting criteria to mitigate increased risks and costs, the threshold for obtaining coverage becomes higher. This scenario is even more pronounced for businesses in sectors considered high-risk or those located in areas prone to natural disasters, such as Florida.

New businesses might find their options for coverage significantly limited, as insurers and reinsurers pull back from high-risk markets or impose stricter underwriting criteria.

Higher Premiums

The tightening of the insurance market leads to higher premiums. As insurers seek to balance their books against the increased claims and operational costs, the financial burden is passed on to policyholders.

Businesses must carefully assess their risk exposure against the cost of premiums, determining the optimal level of coverage necessary to protect against significant losses while maintaining financial viability.

As policies come up for renewal, businesses may face steep rate increases or changes in terms. In some cases, insurers may no longer offer certain types of coverage, forcing businesses to seek alternatives in a less favorable market.

 

The current hard market in the insurance industry presents a complex array of challenges and opportunities for businesses and individuals alike. For new and existing businesses, understanding these dynamics is crucial for navigating the uncertainties of securing adequate and affordable insurance coverage. At Blue Ridge Risk Partners, we are committed to guiding our clients through these turbulent times with advice, comprehensive risk management strategies, and a steadfast dedication to securing the best possible outcomes for our clients.

As the market continues to evolve, staying informed and adaptable will be key to overcoming the challenges posed by the hard market. By working together and employing strategic risk management practices, we can navigate the hard market effectively and emerge stronger on the other side. Our goal at Blue Ridge Risk Partners is not just to help our clients survive in these challenging times but to thrive, ensuring that their insurance needs are met with the professionalism and dedication they've come to expect from us so that you can move forward with confidence.

Whether you're looking for home or auto insurance, or need to reassess your business insurance in light of these market changes, Blue Ridge Risk Partners is here to help. Discover how to get a personalized quote and ensure you're optimally covered—click here to start your journey with us.