Market cycles demystified

By Resolve Editor Kate Tilley

Insurance market fluctuations have existed since the days of the Lloyd’s coffee shops, but the time frame between hard markets is lengthening, says Marcus Thomas, Head of Casualty and Professional & Financial Risks with Liberty Specialty Markets, Asia Pacific.

Mr Thomas was the keynote speaker at the AIDA World Insurance Congress Australia (WICA 2023) in Melbourne, hosted by AILA.

He said market cycles would continue but the industry was generally managing them better.

There was now greater use of modelling analytics and capital deployment and heightened awareness of risks like forever chemicals, for example PFAS, and silica.

“The industry is on high alert for the next asbestos, of which the long-tail liabilities flowing from that were a key driver of the mid-1980s and early 2000s hard markets,” he said.

“Often high-profile events, such as the World Trade Centre attacks in 2001 or the Covid-19 pandemic, coincide with the start of hard markets, but they have rather ironically arrived at a time in the market cycle when pricing is at or approaching the bottom.”

Increased risk exposures

Increased risk exposures likely contributed to the extended duration of hard markets. Capital was now more often dutifully re-deployed elsewhere or “placed on the sidelines” awaiting a better opportunity.

Mr Thomas said an example of increased risk exposures was broader financial lines products having a major impact on the current hard market, particularly D&O risks. A positive of the current hard market was that no insurers or reinsurers collapsed, unlike the demise of HIH, Reliance and Independent Insurance in the 2001 to 2004 hard market.

An example of climate change’s impact was the increased frequency of secondary perils. “They are weather events not large enough to be classed as natural catastrophes (cats) but are sort of mini cats and their aggregation certainly has an impact in any given year.” The January 2023 Auckland floods and major hailstorms and tornadoes in the US could each be considered secondary perils.

Mr Thomas queried whether high-profile events, such as Covid-19 or large natural catastrophes, caused a hard market.

“The answer is not that simple,” he told delegates. “They’re often the straw that breaks the camel’s back. Without them, a hard market would’ve been inevitable in the not-too-distant future.”

Corrective action

High-profile events could create fear, prompting “everyone in the industry to have a good hard look at themselves and often precipitating underwriting corrective action”.

But they were generally not the underlying cause, given major events and natural catastrophes occurred throughout the cycle, and did not result in broad market disruption.

For example, Hurricane Katrina in August 2005 caused more than US$100 billion in losses but occurred when global market results were sound. The industry was well capitalised and in reasonable financial health, thus the market impact was localised and short lived.

Mr Thomas said liability classes were often big drivers for hard markets because of the products’ long-tail nature. “When exposures are under-priced, it takes many years for the impacts of that under-pricing to emerge. Given the competitive nature of insurance that is often a ‘market’ problem and realisation and correction (often over correction) fuels the market turn.”

He said cat modelling, which was in its infancy in the early 1990s, was now much more advanced and helped insurers better manage aggregates and exposed capital.

“Insurance and reinsurance markets are deeper and augmented by alternative capital markets.”

Insurance marketplace

Mr Thomas said economists would term insurance an inelastic product, which meant when people had increased wealth, they were more likely to buy a new BMW or Taylor Swift tickets than additional insurance.

The industry was more influenced by the supply of capital and operated in a globally competitive marketplace. Insurers had to estimate liabilities and consider costs to be paid in an uncertain future. That future would be impacted by fluctuating inflation, changing legal and regulatory environments, and other unforeseen perils.

“Insurers can never get it exactly right, which drives the cyclical nature of the market.”

Listed insurers would prefer their shareholders to have more patience, but ultimately were governed by quarterly reports. “Given the long-tail nature of our business, it’s probably not the most ideal situation.”

Profit margin zero

Mr Thomas said S&P statistics showed combined ratios in the US property and casualty market over the last decade had averaged about 100%, meaning insurers’ underwriting profit margin was zero.

“If you went back to the 1980s or early 1990s, that might be okay, given a high interest rate environment.” However, the last decade had been a well-below-average interest rate environment, so the results were “not satisfactory”.

Mr Thomas suggested the nature of insurance could breed overconfidence and there had traditionally been poor retention of corporate memory.

“Too many insurers flush corporate memory away and then, in 5-10 years’ time, go back and repeat the exact same things that got them to the position where they decided to pull capacity out.

“Having a strong company culture and retaining key people goes a long way to ensuring you capitalise on corporate memory.”

Mr Thomas said insurers often ventured into new areas, segments, or products ill-equipped or armed with the wrong tools. He advised insurers planning to launch a new product or go into a new segment or geography to ask themselves what real differentiation they would bring to the market.

Competitive advantage

As former General Electric CEO and chair Jack Welch said: “If you don’t have a competitive advantage, don’t compete.”

The differentiator could be price (although that was often short lived), but it could also be claims handling, service, product quality or risk engineering.

Mr Thomas urged big insurance organisations to implement effective feedback loops and encourage teamwork to avoid creating silos.

He said relationships were key to insurance success. In intermediated markets those relationships should be tripartite and respectful between insurer, broker and client. Senior people needed to be in the market with their clients and brokers.

He predicted artificial intelligence (AI) would not replace expertise in the property and casualty market in the short-to-medium term. “All AI relies on past data and experience, but we generally face environments that are continually changing, including human behaviours.”

However, AI would be revolutionary in increasing operational efficiencies and enhancing analytics. It could provide the next productivity boost at a time when productivity had stalled.

Mr Thomas said the industry needed to invest more in training and development and ultimately be proud of itself. “We’re not very good at promoting ourselves.”