Understanding the Insurance Cycle

Insurance cycle is the term that refers to insurance policies up and down period. Insurance cycles tend to go through periods of profitability that are followed by the period of losses (and vice versa). This has implications for insurance companies and their customers alike. Insurance companies hope that their policies are profitable all the time, so they try to anticipate the cycles. In doing so, they hope to minimize their profits and maximize their losses. For customers, the cycle is a double-edged sword. Profitable phases tend to lead to inclusive policies with better terms, while loss faces tend to result in more restrictive, less accessible policies.

How Does the Insurance Cycle Work

When insurance companies sell insurance policies, they expect to be able to earn profits. As long as most of the policy holders make their monthly payments and don't file too many claims, the insurance companies will be able to achieve just that. If too many people file their claims at once, the insurance companies suffer sizable losses. That is because the amount of profits they earn gets dwarfed by all the money they would have to pay to their policy holders. The period when the gains outweigh the losses is known as the soft market. The periods where the losses outweigh the gains is known as hard market.

The insurance cycle is little more than the fluctuation between the soft and the hard markets. In the soft markets, the profits encourage insurance companies to offer their coverage to as many people as possible. They lower their premiums and generally make it easier for people to qualify for their policies. This will go on for a few years until some event triggers an upsurge of claims. For example, the September 11, 2001 terrorist attacks caused a sharp increase in property insurance claims.

As insurance companies rush to fill the claims, they are forced to try to offset the losses as quickly as possible. They raise premiums which places a greater financial burden on existing customers. At the same time, they make it harder for new customers to obtain insurance by tightening requirements. Some insurance companies cannot offset their losses quickly enough, and they wind up going out of business.

As the insurance claims are paid off and the tide of new claims subsides, the insurance companies slowly return to profitability. New insurance companies enter the market, offering lower premiums and looser requirements than the existing companies. The existing companies are compelled to loosen their requirements to stay competitive and the insurance cycle starts all over again.

What Keeps The Insurance Cycle Going

When the market is soft, the insurance companies face pressures to keep the prices low, even if doing so makes the losses during the hard market all the more devastating. Many insurance companies tend to place short-term gains over long-term stability, selling insurance without concern for what happens when the soft market ends.

The only way to mitigate the effects of the insurance cycle is to ignore short-term profitability and focus on saving capital. They should establish limits and make sure that some money is set aside. Rewarding efficiency will go a long way.

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