Over the past few months, I’ve noticed a pattern emerge for gasoline price movements here in West Michigan. Every few weeks or so, gasoline prices seem to spike dramatically higher for no apparent reason. At least not the reasons we’ve grown accustomed to – geopolitical events, weather shocks, etc. Then, the prices seem to gradually subside – until the next spike higher.
I heard a GasBuddy.com analyst discuss this phenomenon on the radio recently. He suggested that this pattern is simply the natural competitive dynamics of the retail gasoline industry at work, in the absence of any specific driving forces (i.e., the aforementioned geopolitical shocks) for the price spikes. The industry’s highly competitive nature causes prices to gradually drop as the gas stations located along the same street battle for market share. Have you ever noticed how one station can have every pump in use while the gas station across the street with prices just a penny or two higher per gallon looks like a ghost town? When you’re selling a commodity, price is pretty much all you have to work with. Anyway, the analyst suggested that every few weeks the industry realizes that they can’t keep selling gasoline at those decreased price levels and still be profitable, so a price spike ensues and the pattern starts anew.
This caused me to ponder the insurance market and its penchant for soft and hard market cycles. The industry is highly competitive with literally thousands of insurance carriers competing for business, and the insurance product itself is typically perceived by consumers to be a commodity. That’s not true as I have previously discussed, but it is a perception that feeds the competitive pressures on insurance premiums. Consequently, insurers battle (predominantly over price) as long as they have capacity that they need to utilize to generate returns, and the result is a soft market cycle of lower premiums, generous underwriting terms, and broad availability of insurance. Eventually, the underwriting losses mount and the industry finds the discipline to raise premiums (prices), tighten underwriting standards, and restrict the types of risks accepted. The hard market arrives. Sometimes the hard market is abrupt and sharp, creating a crisis of availability wherein some insurance buyers suddenly cannot find the insurance they need at any reasonable price. In gasoline market terms, this is akin to the long gas lines and gas stations running out gas in the 1970s.
Obviously, the gasoline price to insurance premium comparison is not exact, but the similarities are intriguing and characteristic of highly competitive industries.