Insurance is cyclical; there are hard markets and soft markets, and insurance companies typically make money in two ways: underwriting profit, and investment income. When the market is soft, insurance companies are looking for market share, so they lower their premiums and relax their underwriting guidelines, which allows them to write more business. New carriers or programs enter the marketplace and charge lower premiums to gain market share, which reduces premiums further. Insurance companies can afford to charge lower premiums, as they typically are making a nice bang for their buck via investments.
In a hard market, it is the opposite. When the market is hard, insurance companies are not making money by investments, and losses start adding up. This makes them unprofitable at the premiums they are charging, so to become profitable, they raise premiums. They also tighten their guidelines to try and write only preferred risks, which limits the number of companies the “average” association can get a quote from. Sometimes they add exclusions to restrict coverage. To make matters worse, some carriers or programs simply stop writing insurance during this time, so there are fewer options for community associations.
We are currently in a full-blown hard market, one of the worst I have seen in my 25 years of being in the insurance industry. What is contributing to this?
In the property arena, natural disasters such as hailstorms in the South and Midwest, wildfires in California, various hurricanes, flood and water issues in a number of states have resulted in billions of dollars in losses for insurance companies. Because of this, they are purchasing more reinsurance – which is insurance that insurance companies buy. So if there is a building insured for $50M, an insurance company may not want to take on the full exposure, so they may only directly insure $25M of it, and will purchase the other $25M from a reinsurance company. Currently, they are unwilling to use their own capital, so they are purchasing more reinsurance – and so the reinsurance costs have increased.
In addition, the replacement cost of building materials like brick, wood, cement, etc. has increased. Insurance companies are looking closer at what the actual replacement cost of a building is, and are finding that many buildings are underinsured. Whereas this may have been OK in the past, as the thought process may have been that total destruction was unlikely – especially on multi-building complexes or fire-resistant buildings – now companies are requiring buildings to be insured to their full replacement value. They also have more accurate software these days that can better determine the actual replacement cost. So property limits are increasing.