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Stock Strategist Industry Reports

Our Top Pick in a Soft Insurance Market

W.R. Berkley will benefit when the market hardens.

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The property-casualty insurance industry is cyclical, fluctuating between states of increasing prices (hard market) and decreasing prices (soft market) based on levels of industry capital and capacity. When capital is abundant, as we have seen over the past couple of years, insurers compete viciously for the best opportunities, driving prices downward. Without fail, the soft market eventually leads to irrational pricing. Because insurance is essentially a commodity product, most of the market is forced to match these irrational prices or risk sacrificing market share and growth. Eventually a catalyst, often a catastrophe, occurs that forces market participants to re-evaluate previous loss assumptions and companies begin to realize that they have less capital to cover their losses than they previously believed. The insurers that were most aggressive during the soft market are forced to scale back their underwriting or, in some cases, exit the market completely. This then sets the stage for harder pricing.

That leads us to the current state of the market, where insurance prices have been declining for a number of years. While a turn in the cycle is inevitable, the question is when that change will happen. We previously thought the hit to capital that many insurers felt during the financial crisis coupled with a strong hurricane season in 2008 might be the catalyst to push prices higher. However, government support of troubled institutions, the rally in the capital markets, and a benign hurricane season in 2009 has allowed many of the most financially strapped companies to claw their way back.

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Drew Woodbury does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.