Experience shows that insurance prices can vary significantly from one year to another depending on the vagaries of the insurance market.
They can swing rapidly from low-priced (‘soft’) to high-cost (‘hard’), depending on the supply of financial capital.
This phenomenon is known as the ‘Insurance Cycle’ (see graph below).
This cyclical pattern is quite unlike the typical ‘business cycle’ that’s often seen in other industries or in the wider economy. It's different in two main ways.
The first difference is that the ‘insurance cycle’ is more pronounced – its swings are greater – than in industry generally. And the second difference is that the supply of insurance – and hence its price – depends primarily on the availability of financial capital.
Capital is a fickle commodity: supply is very volatile. Capital becomes readily available when insurance companies are making profits: but it’s quickly withdrawn when losses appear.
In very simple terms, the ‘cycle’ works like this.
When prices (premiums) are relatively high – and insurance companies are making money – other companies quickly enter the market to compete for a share of the lucrative business.
With increased capacity – and greater competition – prices begin to fall. As competition intensifies, prices continue to drop – indeed, they often fall below their true business cost.
This creates (in insurance jargon) a ‘soft market’.
Sooner or later, this has to stop. As claims roll in, losses begin to mount and profits fall. Once this happens, insurance companies leave the market and this causes the market supply to contract.
Then, as the supply of insurance reduces, cover becomes more and more difficult to obtain and prices escalate. This eventually leads to very tough conditions – a (so-called) ‘hard market’.
Let’s now look back at what’s happened in the insurance industry in Ireland over the past decade.
There was a ‘soft’ – i.e. low-priced – insurance market in Ireland between 1995 and 2000. Prices fell steadily: and the insurers’ profits took a hammering.
This was replaced by a ‘hard market’ of high prices between 2001 and the latter part of 2003. Since then, insurance prices have plummeted: they’ve probably gone down by 30% – 40% in the past year alone.
Some insurance practitioners believe that, because of the massive losses caused by the devastating hurricanes in 2005, tough market conditions will return in 2006.
The counter argument is that, with the recent drop in the number of claims in Ireland, insurance business remains profitable.
In truth, no one knows when the market will turn. But turn it will.
