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10 December 2018

Buying insurance in different market cycles

Since the 1980s, the New Zealand insurance market has been oscillating through both soft and hard markets. These shifts affect the availability and price of insurance. To fully understand why and how you are affected as a consumer, it is helpful to know a bit about how insurance companies make money.

Insurance 101

Insurance companies have two main sources of revenue: underwriting profit - the difference between the premiums collected and the money paid out in claims and expenses - and investment income. Insurers generate income by investing in assets, bonds, funds etc.

Reserve requirements

Insurers must hold premiums they haven't yet earned in an unearned premium reserve. This money is used to pay future claims.

In addition to the unearned premium reserve, an insurer must also maintain loss reserves: money set aside to pay losses that have already occurred, including those anticipated.

Underwriting capacity

Even though a significant portion of an insurer's money is tied up in reserves, an insurer can still underwrite insurance cover by purchasing reinsurance; thereby transferring some of the risk of future losses to the reinsurer. The transfer of risk reduces the amount of money the insurer must hold as unearned premium reserves.

Soft and hard insurance markets

Changes in the markets are driven by the

  • supply of capital
  • the risk appetites of both insurers and reinsurers

Catastrophic events like the earthquakes in Canterbury or terrorist attacks such as 9/11 generate huge property insurance losses. Insurers and reinsurers who have paid large claims may be unwilling to insure those risks in the future. Without access to reinsurance, insurers have limited capacity to write new policies.

In times of recession, the supply of capital is lessened, and businesses may purchase less coverage or forgo insurance altogether. The result is less premium income for insurers. Recessions can also trigger low interest rates, which reduce insurers' investment income.

What do soft and hard markets means for you?

A strong economic climate with few catastrophic events creates a soft insurance market where many insurers are competing for your business; premiums are generally low, coverage is widely available and often comes with negotiable terms.

A series of catastrophic events and a poor economy with less capital available means insurers can write fewer new policies. The result is a hard insurance market where some coverages may be difficult to secure, premiums are relatively high, and insurers are disinclined to negotiate terms.

Buyer's market

During a soft market phase, insurance companies are competing for your business. As a buyer, you only benefit from this if you have the time and energy to compare the offerings. Your solution: see a broker. Let them do the shopping for you.

Because insurance companies are competing against each other, they will try to offer lower rates. However, insurance based purely on price may lead to a short-term gain in premium saving counteracted by the long-term suffering of a claim that isn’t paid. Brokers are largely far more efficient at cross checking policies than consumers. Work with them and you will likely reap the rewards in terms of lower premiums as well as the correct cover for you, possible additional coverages, flexible terms and even extensions for free.

Seller's market

Conversely, in a hard market phase, underwriting gets tougher and companies look more closely at companies’ financials and safety records. Some companies pay higher prices for less comprehensive coverage, other companies find it difficult to obtain insurance at all. Again, work with your broker and you will benefit from lower premiums.

Why? Principally because insurance companies have more trust in brokers. They know them, so they provide different rates because the risk is lower for the insurer. Brokers are professionally trained to choose the right policy for their customers, and not to underinsure. They spend the time educating their customers, explaining what types of cover are available, the best combinations and answering queries.

As history has proven, when times are tough, some competitors will use unprofessional approaches to attract business. Don’t be left without the proper cover or substantial and often unnecessary fees. Protect yourself and your assets by using a trusted broker.