Hardening

What Is Hardening?

Hardening refers to a phase within the insurance market dynamics characterized by higher premiums, stricter underwriting standards, and reduced capacity for coverage. During a period of hardening, insurers become more selective about the risks they are willing to take on, often due to significant losses or diminished profitability. This shift reflects a move towards restoring the financial health of insurance carriers and reinsurers.

History and Origin

The concept of hardening is deeply embedded in the historical ebb and flow of insurance market cycles. These cycles have been a recurring feature of the insurance industry for centuries, often in response to major external events that significantly impact insurers' financial positions. For instance, following the Great Fire of London in 1666, insurers became notably more cautious, leading to increased premiums and a more stringent underwriting process¹⁵. More recently, the events of September 11, 2001, triggered a notable hardening in the insurance market, forcing a sharp increase in rates due to extensive claims and erosion of capital¹⁴. Throughout the 20th century, events such as World War I, the Great Depression, and World War II also led to periods of hardening, as insurers grappled with substantial financial losses and uncertainty¹³.

Key Takeaways

• Higher Premiums: A primary characteristic of hardening is a general increase in insurance premiums across various lines of business.
• Stricter Underwriting: Insurers adopt more rigorous underwriting guidelines, demanding more information and imposing tighter terms and conditions.
• Reduced Capacity: The availability of insurance coverage decreases as insurers reduce the limits they offer or exit certain high-risk markets.
• Focus on Profitability: Hardening phases are driven by insurers' efforts to improve their underwriting profitability, often after periods of sustained losses or low investment returns.
• Impact of External Factors: Major catastrophic events, economic inflation, and low interest rates are common triggers for a hardening market.

Interpreting the Hardening

Understanding a hardening market is crucial for policyholders and businesses alike. When the market is hardening, it signals that insurers are facing increased costs or reduced financial reserves, prompting them to adjust their pricing and risk appetite. This period typically means that obtaining new coverage or renewing existing policies will be more challenging and expensive. Businesses may experience increased scrutiny during the application process, requiring them to provide more detailed information about their risks and implement enhanced risk management strategies. The goal for insurers during hardening is to restore financial solvency and ensure sustainable long-term profitability by aligning premiums with the true cost of risk.

Hypothetical Example

Consider "TechProtect Solutions," a mid-sized technology company seeking to renew its cyber liability insurance. For several years, TechProtect enjoyed stable, competitive premiums due to a "soft" insurance market. However, in the current environment, the market begins hardening following a series of significant cyber-attacks globally that resulted in widespread losses for insurers.

Upon renewal, TechProtect's insurer informs them that their cyber liability premiums will increase by 30%. Furthermore, the insurer requests a comprehensive review of TechProtect's cybersecurity protocols, including penetration test results and employee training logs, as part of a more stringent underwriting process. The insurer also proposes a higher deductible and a sub-limit for ransomware claims, indicating reduced capacity for specific types of cyber risks. TechProtect must now adapt to these new market conditions, potentially by investing more in security measures to mitigate risk and negotiating the best possible terms.

Practical Applications

Hardening manifests across various facets of the financial and insurance landscape. In property and casualty insurance, it is often seen following widespread catastrophic events like hurricanes, wildfires, or floods, which lead to significant payouts and deplete insurer reserves¹². For example, a surge in global insured losses, exceeding $100 billion annually in recent years due to catastrophes, significantly contributes to the need for hardening¹¹.

Another contributing factor to hardening is "social inflation," which refers to rising claims costs beyond general economic inflation, influenced by increased litigation, larger jury awards, and broader interpretations of coverage¹⁰. The cost of reinsurance also plays a critical role; as reinsurers face higher losses, they increase the cost of coverage for primary insurers, which is then passed on to policyholders⁹. These interwoven factors collectively push the market into a hardening phase, where insurers seek to restore equilibrium through higher rates and tighter terms. The Society of Actuaries highlights how economic factors, including investment returns and catastrophic events, significantly influence these underwriting cycles⁸.

Limitations and Criticisms

While hardening is a natural part of the insurance market cycles, it presents significant challenges. For policyholders, it can lead to financial strain due to higher premiums and potentially reduced or less comprehensive coverage⁷. Businesses, particularly those in high-risk sectors, may find it difficult to obtain adequate capacity, affecting their ability to manage unforeseen liabilities.

A criticism sometimes leveled against the industry during hardening periods is the perceived abruptness of rate increases, which can create budgeting difficulties for insured entities. Furthermore, the withdrawal of insurers from certain markets or lines of business during hardening can leave some segments of the economy underserved⁶. The interconnected nature of primary insurance and reinsurance markets means that major global events can have cascading effects, leading to widespread hardening even in regions not directly affected by the initial losses⁵. This can sometimes lead to an imbalance between the perceived risk and the cost of coverage for some entities.

Hardening vs. Softening

Hardening and softening represent opposite phases within the cyclical nature of the insurance market.

During a hardening market, insurers aim to strengthen their financial positions, often following periods of significant losses or low investment returns. Conversely, a softening market is characterized by intense competition among insurers, leading to lower premiums and broader coverage options as they compete for market share, typically when capital is abundant and claims are relatively low. The market continuously shifts between these two states, influenced by economic conditions, claims trends, and the availability of capital.

FAQs

What causes an insurance market to enter a hardening phase?

Several factors can trigger hardening, including significant catastrophic events that result in large payouts, periods of low investment returns for insurers, increased litigation leading to higher claims costs (social inflation), and rising reinsurance expenses³, ⁴.

How long do hardening markets typically last?

The duration of hardening varies, but historically, hard markets tend to be shorter than soft markets. For example, some historical hard markets have lasted a few years, such as 1985-1987 or 2001-2004². However, the specific length depends on the severity of the triggering factors and how quickly market conditions, such as insurer profitability and capital levels, stabilize.

What can policyholders do during a hardening market?

During hardening, policyholders can focus on strengthening their risk management practices, seeking advice from experienced brokers to navigate limited capacity, and preparing for potential increases in premiums and more stringent underwriting requirements¹. Providing thorough and transparent information to insurers can also be beneficial.