How Insurance Rates Work

None of us are immune to the ever-changing whims of the insurance industry, but we rarely think about why our rates are changing so dramatically. If we try to do some digging, we run into a well-funded propaganda war by the insurers themselves, who claim skyrocketing claims are responsible for skyrocketing rates. They argue that more and more frivolous lawsuits are being filed, and juries are more and more likely to award exorbitant sums. These “abuses” of our civil justice system are sending insurance companies to the poor house, and forcing all of us to pay higher premiums.

Unfortunately for the insurance industry, all of their “poor me” claims have been debunked – repeatedly. The real reason behind the rate spikes? It’s the nature of insurance!

What insurers don’t say is that insurance pricing is cyclical, and that over the last 30 years, rates have spiked and then stabilized three times. In fact, to buy the industry’s explanation, one would have to accept the notion that juries engineered large jury awards in the mid-1970s, then stopped for a decade, then started again in the mid-1980s, stopped for 17 years, and then started again in 2002. And then they just stopped again. At no time did claims or payouts spike during any of these periods.-Joanne Doroshow of the Center for Justice & Democracy

This is how the insurance rate cycle works:

When insurance rates are stable, the market is “soft,” and insurers compete for premium dollars. To get the biggest share of premium dollars, insurers usually underprice their policies. Soft markets continue until a cataclysmic event happens, like a hurricane or terrorist attack. After these events, many policyholders begin filing claims. Increased claims force many smaller insurers to close, limiting competition. With less competition, insurers don’t have to undercut their policies anymore. For the larger companies that can survive an increase in payouts, they still need to recoup their capital, which they do through rate increases. Less competition and higher rates are indicative of a “hard” market. While less competition and higher rates are bad for consumers, they’re irresistible to companies looking to get into the insurance game. With little competition and the ability to make huge profits, more and more players join the market. And this is where the cycle starts to repeat itself; a saturated market where insurers have to ruthlessly compete with other companies to win premium dollars? Yes, you’re right – it’s a soft market.

During hard markets, insurance companies get a lot of heat from consumers and legislators. In return, insurers pin the blame on frivolous lawsuits and lobby lawmakers to enact tort reform, claiming it will put an end to these ridiculous cycles.

But the truth is, insurance companies love hard markets. That’s when their profits are at their highest, and they barely have to work for it because there’s little competition. Soft markets, however, are their natural enemy. “They hate soft market periods, because the intense free market competition keeps them from raising everyone’s insurance premiums,” continued Joanne Doroshow of the CJ&D in her analysis of the insurance cycle.

This is where insurers show their true colors when it comes to their support of tort reform. When legislators turn to you to end the hard market crisis – the “crisis” that you want to perpetuate to keep your company profitable – would you offer up a real solution, or would you push forward policies that a.) won’t hurt your chances of advancing a hard market, and b.) will also help you endure soft markets by limiting your payouts? This is the true genius behind the insurance industry’s push for tort reforms. Once you do some digging, their ulterior motive is pretty transparent.