Insurance and the Myth of the Hard Market

The hard market is the stuff of legend as far as I'm concerned. To me, it appears to be a cyclical and arbitrary theory promulgated by the insurance company to justify the need for increased premiums to fuel shortfalls caused by free market conditions and certain disasters that adversely affect the insurance industry.

First, let me say that there may have been a time that the theory of a hard or soft market may have been justified. I've only been in the business since 1986, but the research on the issue is a little sketchy.

From what I have gathered, soft markets, in which insurance premiums drop and the market is more advantageous to the buyer, generally lasted two to five years and would follow the cyclical trends of the economy.

By 2001, we were almost nine years into a soft market, and there were no real signs that it was going to turn anytime soon. By the insurance industry's estimation, we were at least four years overdue for the market to harden, which would have led to significant and, in my opinion, arbitrary price increases, and all I heard from the industry professionals was this:

"Be prepared. The market is starting to harden. These low rates can't last for long.¨

Then there were the bombings of the World Trade Center and the Pentagon on September 11, 2001. Now, there is no doubt that this was a catastrophic event, the likes of which have never been seen on American soil. But from an insurance standpoint, and particularly from a property casualty standpoint, this was not a catastrophe that should have ushered in the hard market in the insurance industry that came about immediately after these events¡ especially in the property casualty market.

Much of the loss of life was covered through life insurance. As of this writing, the property claim at the World Trade Center has yet to be resolved, although a federal jury has categorized the event as two occurrences, meaning that the ownership group could collect the limits twice because the policy was written on an occurrence basis. The losses that ensued from business interruption and loss of revenue coverage were well funded prior to this loss, and therefore should have been a non-factor. I firmly believe that the insurance industry took this event and used it as an excuse to arbitrarily "harden¨ the market. The losses were well funded, and although the fallout from 9/11 did result in the bankruptcy of some insurance carriers, these companies can find no fault beyond their own parking lots because of their internal reserve and surplus policies before the event.

Now that the industry has had the opportunity to review the economic fallout from these attacks, these appear to be a consensus of understanding:

*The property damage to the World Trade Center alone was approximately $7 billion of the total.

*Much of the losses were covered by life insurance, which would not significantly affect the property casualty side of insurance.

Thus, you are looking at property casualty losses, independent of the WTC loss, which was absorbed by one group of insurers and reinsurers, of less less than $10 billion. In contrast to this, the economic effects of Hurricane Katrina are estimated to be in excess of $50 billion. Hurricanes Ivan and Charley in the summer of 2004 have estimated losses of $19 billion. Yet, neither of these events seem to have had the impact on the insurance markets that the 9/11 attacks did.

I believe there was a watershed decision made in 1999 that should have put the debate of the hard market to rest. In that year, Congress passed the Financial Services Modernization (Gramm-Leach-Bliley) Act. This act allowed, for the first time, banks to offer insurance products and for insurers to offer banking services through holding companies. This created a synergy between the two industries which allowed both to tap into their customer bases and mine business from the other industry. Banks and insurance companies could offer their clients a one-stop alternative for both insurance and banking.

The result was an increase in competition in the marketplace, which led to consolidation of companies that were too weak to compete in the more dynamic market. The increased competition increased supply for a fairly stable demand, reducing the prices in the marketplace. The increased competition also caused some weaker insurers to lower their qualifications for coverage, which weakened their overall book of business and made them susceptible to the vagaries of the free market. At the same time, it provided a need for coverage in the secondary market that was not being fulfilled at a reasonable price.

These market conditions were becoming evident prior to 2001 and fell back into line fairly quickly after 2001. From an indemnity standpoint, the 9/11 attacks should have been a nonevent but for the insurance industry's need to have an excuse to raise premiums and rid themselves of some bad risks they were forced to take due to the increased competition from FSMA.

Now be forewarned. I'm told the market is going to start to harden later this year.

Having been in P&C since 68 I find your comments very interesting. I see each of the insurance product markets to be quite complex with a large number of factors impacting rates, not to mention profitability, growth of market share, and good service to customers.

Clearly the "climate change" risk that claims there will be more and bigger hurricanes in 2006 than 2005 is a major factor. Despite what insurance companies pretend are rational decisions, they make many decisions based on irrational superstitions. I could give other examples.

Clearly the "judicial activism" risk has a major impact on decisions. When the plaintiff and defendant agree on what the clear language of the insurance contract is ... and yet the plaintiff (Republican Leader Trent Lott's brother-in-law) can argue that the Judge should throw out the insurance contract and do what the trial lawyer clique wants him to do ... and the judge finds for the defense by total judicial activism that says the clear language of the insurance contract is meaningless ... That judicial activism risk makes decision makers very nervous.

Clearly the nature of competition in P&C has changed due to technology. Previously insurance was the sharing of risk accross broad and large groups of insureds. Due to the power of computers, insurance is now priced on a custom basis for each individual quote and each individual renewal offer. Thus there is no real group premium with most insurance companies. That is certainly true of the insurance companies that are grabbing market share. These nimble high tech companies are grabbing market share from those companies that are slow to adapt to the shift of rating of large groups to rating of individuals.

There are many other factors. It is a complex business.

I found your comments to be quite interesting, however, there is one major component that is tied to hard/soft markets that you failed to comment on. Hard and soft markets are created from an industries ability to be profitable or unprofitable with the premiums they are charging. These premiums are often supported through investment gains made overnight by the insurance carriers to offset losses. September 11th, in my opinion, was not the reason the market hardened. It was more that the industry was beginning to take a hit from the lack of investment growth after the dot-com debacle. The stock market began to have miserable gains in 2000 and heading into 2001 and then September 11th added to stock market pressures with great uncertainty to the future. Uncertainty creates risks and allows companies to impose higher premiums. Spintreebob made a great point about technology as well. To add to the benefit that technology has brought to the industry, I feel it will play a huge role in how hard and soft markets will play out. Technology will allow companies to adjust quicker and respond to ever-changing market conditions. I have only been in the business for 16 years and am an independent contractor with Nationwide Insurance so take my insights with a grain of salt, as these are just my opinions. Rates can only go so low before they erode into company profits. Many companies have been aggressive in lowering underwrtiting and company expenses as far as they can, so I feel premiums are within 5% of bottom and we will see prices firm in the first/second quarter of 2008. Good luck to all in the business and I wish you a prosperous 2008!

re: companies have been aggressive in lowering underwrtiting and company expenses as far as they can,”

We must work for different companies. I’ve contracted at many of the big insurance companies in the midwest. They all are inefficient bureaucracies with unnecessary overhead and inefficient ways of using technology. The biggest inefficiency is the number of coordinators who are coordinating facilitators. Their sole goal is to get as many people to a meeting as possible. That the meeting has no useful purpose and accomplishes nothing ... except to schedule the next meeting ... is lost on management.

Actuarial segmentation competition from Progressive is driving the others to take small steps in that direction. But those small steps are taken inefficiently. GEICO which has better marketing than actuary people, is likely to take market share from Progressive ... at least that seems to be the concensus of the trade press.

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