You may have recently received a renewal for your auto, home or business insurance and seen a higher than usual increase in your premium. When you called to ask your insurance broker what’s happening, and heard the words “market cycle” or “hard market” as a reason for these increases, you started to wonder what on earth these terms actually mean and why they are affecting your premium.
We wanted to give you an insider’s view on this subject, as it is an important part of the reason why your premium may have increased even if you didn’t make a claim.
What do the terms “market cycle” and “hard market” mean?
Similar to most other products or services, the price of insurance can rise or fall in response to changes in the larger market. The biggest factor is the cost of claims, but premiums can also be affected by taxation and other costs, investment returns, and competition. Stay tuned. We’ll provide more detail on each of these factors.
When times are good, it’s usually because costs are in check and insurers are making a healthy profit (To give you a rough idea, overall industry profit has fluctuated between 2% and 18% over the last 25 years). When insurers are making money, they gain confidence, and try to increase their market share. That creates competition and drives prices down. And we enter what is called a soft market. This usually takes the form of a gradual reduction or stability of insurance premiums over a number of years, as insurers compete for new customers.
On the opposite side of the coin, when times are bad, costs are usually on the rise and insurers are either losing substantial amounts of money, or making so little profit that it’s not worth the risk (investors could earn similar returns by investing in very secure things like Government Bonds rather than more risky ventures like Insurance). This is when competition goes way down, and prices go up – sometimes so fast that you can get whiplash – while insurers try to restore profitability. This is known as a hard market.
This can be a surprisingly important factor in your insurance premiums and can affect the majority of business, home and auto insurance policyholders.
Do Insurance Companies Really Ever Lose Money?
Believe it or not, the answer is yes. There are a number of factors which drive the profitability of insurance companies, which can lead to periods of substantial unprofitability. Some of the factors which lead to a hard market and subsequent increases in premium are as follows:
Natural or man-made catastrophes:
In Canada alone it’s not too difficult to remember events like the Fort McMurray fires in 2016 or the floods of 2013 in Calgary and Toronto, and of course, the ice storms of 1998 in Eastern Canada. Each of these events cost insurance companies multiple billions of dollars in claims. You would be surprised to know that in the last couple of years alone in Ontario, insurers have also paid out hundreds of millions of dollars in claims as a result of localized windstorms causing damage to thousands of homes and businesses.
In addition, some of the major catastrophes south of the border in the last couple of years also matter. The recent California wildfires, and multiple Hurricanes (Irma, Harvey, Maria etc.) have cost the insurance industry billions of dollars. While these claims might not directly affect the bank balances of Canadian insurers, they have a substantial effect on re-insurance costs.
What is re-insurance and why should I care?
Just like you pay premiums to your home, car or business insurer, they too pay premiums, to larger global insurance companies called re-insurers. The reason is this: If a small insurance company collects $500 million in premiums one year, and then a big storm hits and leads to $200 million in claims, that company could have to declare bankruptcy and the claims wouldn’t get paid. To protect themselves and their customers, insurers buy re-insurance, and that means that the larger re-insurers will pay for claims that are beyond a certain value. On the downside, when there are major events like hurricanes, ice storms, 911 etc., reinsurers have to increase the premiums they charge to your insurance company, and that will affect your premium as well.
Increasing claims costs:
The biggest cost for insurers is paying claims. They charge you premiums based on how much they expect to pay in claims, but those costs can increase for a number of reasons. Let’s just look at some day-to-day examples like auto collision repair. Many modern cars now have various pieces of technology built into windshields and bumpers. These are great because they improve safety, but what used to be a fairly straightforward and low-cost repair (say, to your bumper) is now more expensive and time-consuming, with higher parts and labour costs. The average home now also has lots more expensive technology (e.g., flat-screen TVs and sound systems in finished basements) and can also be outfitted with more eco-friendly building materials like energy-efficient windows. These also cost more to repair and/or replace.
From a business insurance standpoint, the industry is beginning to see a substantial increase in water damage claims in older apartment buildings or condos that are starting to break down. In terms of newer buildings, a trend toward more wooden frame construction is leading to a higher risk of widespread fire damage (as opposed to stone, concrete and steel, which tend to contain fires and lead to less damage). Also, as we become a more litigious society, more lawsuits means higher costs of defending customers under their liability policies.
All of these costs have increased in recent years at a faster rate than premiums, to the point where many insurers are now losing money on the insurance policies they sell.
What Else Can Affect the Level of Pricing?
Level of competition in the market: Like in any industry, healthy competition helps to bring prices down for customers. The number of insurers who will be actively competing for your insurance increases when they believe that premiums are at a profitable level. As a customer, you usually won’t see new insurance companies enter the market, or existing insurance companies leave. What does happen behind the scenes is that insurance companies will either want more business (if they think they can make a good profit), or won’t (if they think they’re going to lose money). They will focus on selling certain types of insurance that they feel are more profitable, and will avoid selling insurance that they think will lose them money. A recent example of this would be in the hospitality industry – where many Canadian insurance companies have stopped offering insurance to this kind of business (due to a lack of profitability). Of course, the remaining insurers now have less competition, so they will increase their prices and be very selective about which hospitality businesses they choose to insure. That causes a big problem for high-risk hospitality businesses that, in some cases, can’t find insurance at all.
Insurers that don’t want to sell new policies of a particular type can sometimes achieve that goal by reducing the number of brokers who are able to sell their product. In a soft market, insurers will want to have as many insurance brokers as possible represent them in the market. When times are tough, insurers may cancel their agreements with certain brokers, making it harder for potential customers to find them. Although they are still technically open for business, in a practical sense, this reduces competition.
Insurers are often holding substantial amounts of money from premiums, and reserves that they are holding for claims that they believe will be paid out to customers over time. This money is invested by the insurer in things like bonds, which make a positive return for them. In times of high investment returns, these earnings can offset claims costs and, in theory, the insurance company may settle for a lower profit from its insurance business. Of course, in times of lower investment returns (like in recent years), insurers need to be more profitable from their insurance business, and premiums tend to rise.
General capacity in the market:
By law, insurers need to hold a substantial amount of capital (money) in order to write insurance policies. This rule is in place to protect you, the customer, from a situation where the insurance company does not have the physical cash to pay claims that might happen. An insurer’s “capacity” is a reflection of how much business they are able to write with the amount of capital that they are holding. In times where the industry is profitable for insurers, they will attract substantial amounts of capital from shareholders and other investors. In times where the industry is unprofitable, it is more difficult for insurers to attract investors and raise capital. Less capital means they can’t sell as much insurance.
What Part of the Insurance Cycle Are We in Today?
Most observers will say that we have been in a soft market now for 15+ years. Prices have been fairly flat over that time, and if you look at premiums for auto insurance in Ontario, for example, they’ve increased less than inflation over that time. There have been some fairly modest increases in premiums for auto and home insurance in recent years, but at the same time, premiums for commercial liability and property insurance have been gradually dropping for a number of years.
The last couple of years have not been profitable for the majority of insurers in Canada. Auto insurance in Ontario has been especially unprofitable for a number of insurers and there is a fair chance that you will see an increase in your premiums this year. The same can be said for home insurance, where increasing claims costs and a few bad storms in recent years have led to unprofitability.
Business insurance has been highly unprofitable in some areas such as trucking and transportation insurance, and in the hospitality industry. Commercial property insurance is also challenging right now for many insurers. At the same time, liability insurance for businesses such as consultants, contractors and medical professionals are more stable.
There’s definitely less competition for many types of business insurance right now, with insurers withdrawing from products like transportation and hospitality. In this low interest rate economy, investment returns are not substantial enough to subsidize losses from increasing claims.
While we are not quite in what could be described as a “hard market”, there are signs that price increases are on the way, and without question, insurers are all being more selective about the kind of insurance they want to sell, and to whom.
How long does a hard market last?
Our prediction is that we will not enter a full-blown hard market unless we see further catastrophic losses in Canada (major weather events etc.). Instead, we will see more of a market correction by insurers who will a) be more careful about the kind of policies they sell, and b) gradually increase premiums in areas where they don’t make enough profit. Many insurers will be content to not grow until they are able to sell insurance at a price that makes them what they consider to be a healthy return.
Depending on what type of insurance you are buying, you can expect to see moderate premium increases over the next couple of years, and in some rare cases, mostly related to business insurance, you may find it challenging to find insurance at all. We expect it to stabilize after that. Of course, regulatory changes, severe weather and other unforeseen events could change all that.
What can I do to minimize the increase?
During these periods of reduced competition and increased premiums, our recommendation is that you speak with your insurance broker to understand your full range of options. It’s important to make sure your broker has access to a very wide range of insurers, because the difference between the highest quote and the lowest quote will be larger than normal. If you still can’t get a quote that makes sense for you, your broker may suggest a higher deductible to keep your costs down.