Q: What constitutes a soft market? What are its characteristics?

Leimkuhler: For the past several years we have seen continual decline in prices for most lines, classes, and territories. That deterioration has extended to the coverage and terms offered to customers. The impact of this softening of coverage and terms is more difficult to measure and evaluate than that of price alone.

Costigan: Consider excess liability and umbrella coverage. In harder markets companies will demand higher underlying limits or insured retentions and be more restrictive in the breadth of coverage offered. In such a market the umbrella becomes less of an umbrella and more closely serves to extend the terms and conditions of the primary policy. But as the market begins to soften, a company is more apt to lower the underlying limit requirement from, say, $2 million to $1 million. Companies ultimately loosen terms and conditions by reverting to true umbrella coverage, i.e., covering exposures that are not insured under the primary policies.

Q: Does this pattern apply only to new business or to renewals as well?

Costigan: Both new and renewal policies are affected. One company’s new business is typically another company's renewal. What fuels the competitive fires is business lost and re-written at a lower price level by another company, at more flexible terms and conditions.

Leimkuhler: Companies expand eligibility requirements in soft markets as a defensive measure. In a harder market, a company can more easily dictate its terms—as well as its pricing—and be more selective in what it writes. In the soft market the company looks for a competitive edge to write business in order to replace the renewals that it has lost or the premium declines resulting from rate decreases made to retain accounts.

Q: Do these concessions cause a problem when markets begin to harden again?

Costigan: A common example lies with trucking risks. As the market softens, some companies, out of a concerted effort to retain their premium level, will inevitably decide to enter or to re-enter the trucking class. This class typically is under pressure during a hard market due to its propensity for lower frequency and higher severity of loss. Insuring truckers is a challenge generally, as slim operating margins and increasing fuel costs have created downward pricing pressure.

Leimkuhler: Much of this pursuit of the top-line premium arises from self-preservation. An insurer’s business is under attack and it responds with measures that appear to enable it to maintain its prior size and cover fixed expenses. But willingly writing business at a loss hurts profitability, builds more risk into the portfolio, and deepens the hole out of which the insurer must later dig itself in order to restore proper underwriting standards and price levels.

Q: What caveats or general advice can you offer? Is the takeaway message from all this that the best approach is simply sticking to your principles and being disciplined?

Leimkuhler: Managing in soft markets is a major challenge. It is unrealistic for most companies to make their target rates of return under these conditions and to maintain prices at optimal profit levels. It may be more prudent to strategically lower prices moderately and attempt to recoup the lost profits when the market hardens. It is normally more difficult to regain accounts once they are lost to competitors. But this strategy must have limits—and accounts that can be projected to produce underwriting losses, or certainly net operating losses, may not be worth chasing downward.

Companies need tools in place to measure their performances. Price monitoring is only a start. Companies need to understand how their underwriters are performing in securing necessary underwriting data, risk selection, policy construction, and pricing.

Costigan: In a soft market, companies tend to compromise their infrastructures. For example, in the name of expense control they often question the need for employees that support the underwriting process—in loss control, risk control, and premium audit. In the past, companies have even compromised their price-monitoring processes during soft markets.

Urb Leimkuhler is director of Milliman's property/casualty underwriting and operations practice and Jack Costigan is an affiliated consultant who regularly participates on Milliman engagements.