Insurance Handbook - Alaska Department of Community and ...

Updates at www.iii.org/issues_updates Insurance Topics
Financial and Market Auto Conditions
Insurance
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, 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
I.I.I. Insurance Handbook www.iii.org/insurancehandbook 45