Financial and Market Conditions
Many forces affect the price, availability, and security of the insurance product. Some are external, such as the state of the economy, changes in interest rates and the stock market, regulatory activity, the number and severity of natural disasters, growth in litigation and rising medical costs. Others are internal, such as the level of competition. Fortunately, insurance companies run their businesses conservatively, as if every day might bring some new disaster, so, despite current economic and financial conditions, the industry has been able to function normally.
Unlike banks, insurers are not highly leveraged (they generally do not borrow to make investments or to pay claims); they limit the amount of risk they assume to the capital they have on hand; and because they do not sell the risks they assume to another party—they have some “skin in the game”—they must underwrite carefully or suffer the consequences. The insurance industry is cyclical. Rates and profits fluctuate depending on the phase of the cycle, particularly in commercial coverages. The profitability cycle may be somewhat different for different types of insurance. The cycle of the early and mid-1980s was among the most severe that the industry has experienced. That cycle centered on liability insurance. The most recent hard market began early in about 2001 and peaked in early 2004. The industry has been experiencing a soft market due to the poor economy. While there had been some indication that rates were flattening out, industry analysts expect to soft market to continue well into 2010.
The Insurance Cycle:
The property/casualty insurance industry has exhibited cyclical behavior for many years, as far back as the 1920s. These cycles are characterized by periods of rising rates leading to increased profitability. Following a period of solid but not spectacular rates of return, the industry enters a down phase where prices soften, the supply of insurance becomes plentiful and, eventually, profitability diminishes or vanishes completely. In the cycle’s down phase, as results deteriorate, the basic ability of insurance companies to underwrite new business or, for some companies even to renew some existing policies, can be impaired because the capital needed to support the underwriting of risk has been depleted through losses. Cycles vary in their severity. The insurance industry cycle is not unlike the cycle that occurs in agriculture, for example, in the wheat and beef markets. Demand for the product in both industries is relatively stable and is relatively unresponsive to price changes, while supply can vary from year to year. This means that when supply increases, lowering the price will not instantly “clear” the market of excess supply. If the price of auto insurance is cut in half, people will still buy only one policy, although they may increase the amount of coverage they purchase. In the 1950s and 1960s cycles were regular, with a three-year period of soft pricing followed by a three-year period of hard pricing in practically all lines of property/casualty insurance. In the 1970s and 1980s, there were only two cycles, one mainly affecting auto insurance in the mid-1970s and the other in the mid-1980s, affecting commercial liability insurance. The commercial liability insurance cycle gave rise to the “liability crisis,” when certain types of commercial liability coverages, such as insurance for daycare centers, municipalities, ski resorts and any establishment selling liquor, became difficult to obtain. Since that time, with the exception of the difficulty in obtaining medical malpractice insurance in the early part of the last decade, the insurance cycle has had less of an impact on the public.