What Is the Difference Between a Hard and Soft Market?
the balance small business, Front Row Insurance, PSA
February 7, 2020
- Last edition
April 22, 2020
How the System Works
To properly understand the difference between a hard and a soft insurance market, it is necessary to understand how an insurance company operates in the first place. Insurance companies make their money first by underwriting from customers who pay their premiums. When the company pays out less than it takes in, it makes a profit.
The other avenue of revenue is investment in assets like bonds or other securities that can be quickly liquidated. Such investments bring in revenue from an unrelated source, and provide a cushion to make payouts if the premiums are exceeded by claims in a given year. It is these profits that affect the market.
Hard vs. Soft Markets
Whether or not the market is hard or soft is a very simple matter of supply and demand. When the insurance companies are doing well and turning a profit with budget surpluses, the market turns soft. If money starts to dry up, say with a large-scale natural disaster leading to lots of claims, the market will harden.
A soft market is characterized by an insurance company’s willingness to provide coverage. Prices drop, terms are relaxed, and the various players in the industry will compete with one another to secure the business of potential customers. If the company is making money, it is naturally more willing to take on more clients, even if the risk increases. Conversely, in a hard market, the companies tighten up. Premiums go up, terms are stringent, and it can be difficult for a customer to find a provider.
In short, this is because the company cannot assume more risk of payout by opening new contracts or negotiating terms that favor the customer. This can affect a certain region or kind of coverage while leaving others unaffected.
In the past, the insurance market fluctuated more or less on a cyclical basis, following the ebb and flow of the economy in general. Hard markets were expected every seven years or so, and the industry would deliberately soften the market in order to retain customers and allow itself to earn a little extra profit. This has changed in recent years.
Despite several large-scale disasters, the insurance market has remained soft for more than a decade now, perhaps indicated long term changes. With new data-driven algorithms and other methods of predicting fluctuations in the economy, insurance companies have become lighter on their feet, responding almost immediately to various factors. This has allowed the changes to become smaller, keeping the market more open without the need for drastic measures.
This combined with the proliferation of sales techniques and strategies has kept the supply high, the demand relatively low. This can make it difficult to assign a label such as hard or soft to a given market.