Markets for many types of property/casualty insurance exhibit soft market periods, where premium rates are stable or falling and coverage is readily available, and subsequent hard market periods, where premium rates and insurers reported profits significantly increase and less coverage is available. Conventional wisdom among practitioners and other observers is that soft and hard markets occur in a regular "underwriting cycle." Like price fluctuations in equity markets, fluctuations in insurance premium rates and coverage availability are difficult to explain fully by standard economic models that assume rational agents and few market frictions.
The mid-1980s "liability insurance crisis" remains the most infamous hard market in the United States. The dramatic increases in commercial liability insurance premiums and reductions in coverage availability for some sectors received enormous attention and motivated extensive research on those specific problems and on fluctuations in insurance prices and coverage availability more generally. Large catastrophe losses in the United States during the late 1980s and early 1990s spurred further interest in and research on the dynamics of reinsurance and primary insurance market pricing following large, industrywide losses.
The hard market for commercial property/casualty insurance that began in late 2000 and accelerated following the destruction of the World Trade Center in September 2001 has focused renewed attention on markets for commercial property, medical liability, general liability, and workers compensation insurance. With respect to general liability and medical liability insurance, substantial debate has arisen concerning the causes of rate increases and reductions in coverage availability and attendant implications for policy, such as tort reform to reduce the expected value and uncertainty of liability insurance claim costs, or additional regulation of insurers to help control allegedly imprudent underwriting and investment.
This paper provides an overview of volatility in premiums, coverage availability, and insurers reported profits in U.S. commercial general liability insurance and of its broad relation to the U.S. tort liability system. I begin with a synopsis of the "perfect markets model" of insurance prices (sometimes called the arbitrage model) and its implications for commercial liability insurance. I next describe fluctuations in U.S. general liability insurance premiums, coverage availability, and reported profits during the past two decades and whether the perfect markets model is consistent with that evidence. I then summarize other factors that may affect insurance market volatility and provide some new evidence concerning one alternative: that aberrant pricing by some firms contributes to aggravates soft markets and, by implication, the severity of subsequent hard markets. I conclude with a brief summary of policy implications and areas for future research.
Download
Tort Liability, Insurance Rates, and the Insurance Cycle
