What it means
During a soft market, insurers have plenty of capital and compete hard for business. They cut premiums, loosen terms and accept riskier customers, so buyers find cover cheap and easy to obtain.
Over time the low prices stop covering claims and expenses, and underwriting profits shrink or turn into losses. The turn comes when losses, a large catastrophe or a fall in investment income eat into capital.
Insurers then raise premiums, tighten conditions, cut limits or refuse some risks, which creates a hard market. Higher prices rebuild profit and attract new capital, and the cycle begins again.
Insurers watch the combined ratio to see where they are in the cycle. A figure below 100% means premiums more than cover claims and expenses, while a figure above 100% means an underwriting loss.
A combined ratio rising above 100% across the industry is a typical sign that the market is about to harden. The cycle matters to any business that buys insurance.
In a soft market it makes sense to lock in longer terms or higher cover while it is cheap, and in a hard market it pays to review deductibles, risk management and alternative structures such as captives. Finance teams should budget for premium swings rather than assuming steady increases.
The cycle length and severity vary by line of insurance and region, and it is influenced by interest rates and capital markets. Reinsurance often leads the pattern because it reacts first to large losses.
Inflation, interest rates and large natural disasters all feed into the cycle. When interest rates are high, insurers earn more on their float and can afford to price cover cheaply for longer, whereas low rates push them to demand better underwriting returns.
A major catastrophe can end a soft market almost overnight.
In practice
Real-world examples.
Example
A logistics company's cargo insurance premium falls 12% at renewal because insurers are competing hard for business. Its finance director takes a three-year term to lock in the lower price before the market turns, so a $1,000,000 premium falls to $880,000 for the full term.
Example
After a series of major storms, a property insurer raises rates by 20% and withdraws cover from the highest-risk coastal areas. Local business owners find quotes expensive and hard to get, and some insurers add exclusions that were not in the previous policy.
Example
A hospital group sees its professional liability premiums double in a hard market. It raises its deductible and builds a captive insurance subsidiary to take on predictable, small claims itself.
Formula
Calculation
Combined ratio = (Claims incurred + Underwriting expenses) / Premiums earned
An insurer writes the following results in two phases of the cycle.
Soft market year: premiums earned $200,000,000; claims $150,000,000; expenses $60,000,000.
Loss ratio = $150,000,000 / $200,000,000 = 75%
Expense ratio = $60,000,000 / $200,000,000 = 30%
Combined ratio = 75% + 30% = 105%, so the underwriting result is $200,000,000 - $150,000,000 - $60,000,000 = -$10,000,000.
Hard market year: premiums earned $250,000,000; claims $150,000,000; expenses $60,000,000.
Combined ratio = ($150,000,000 + $60,000,000) / $250,000,000 = 84%, giving an underwriting profit of $250,000,000 - $210,000,000 = $40,000,000.
The swing from a combined ratio of 105% to 84% is 21 percentage points, which on $250,000,000 of premium equals $52,500,000, and shows how much more profitable a hard market can be.Case study
Seen in the real world.
Meridian Mutual is an illustrative, fictional commercial insurer that spent several years chasing market share. It cut prices by roughly 15% in total to win new customers, and its book of business grew by 30%.
Claims did not fall with the prices, so its combined ratio crept from 96% to 108%. A single large loss then wiped out the previous three years of thin profits and forced the board to raise rates and drop its most under-priced accounts.
The illustrative lesson is that growth bought with discounted premiums is not the same as profitable growth, and that the underwriting cycle punishes insurers that follow the crowd. Meridian reported the following year that its combined ratio had returned to 95%, and its chief executive told staff that the company would no longer compete on price alone.
Watch out
Common mistakes.
- Assuming that insurance prices rise steadily each year, when they move in cycles that can reverse sharply.
- Judging an insurer by premium growth alone, without checking the combined ratio.
- Waiting until a hard market begins to review insurance strategy, when options are fewer and prices are higher.
Questions
People also ask.
What causes the underwriting cycle?
Competition for premium in good years, followed by losses and capital shortages that force insurers to raise prices and tighten terms.
How do I know whether the market is soft or hard?
Look at renewal rate changes, the availability of cover and the industry combined ratio; falling prices and loose terms point to a soft market.
How should a business respond to the cycle?
Budget for swings, buy longer terms when cover is cheap, and consider higher deductibles or captives when it is expensive.
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