Insurers struggled mightily with losses in the first quarter, with property and casualty insurers (P&C) putting up an underwriting loss of more than $7 billion, the biggest first-quarter underwriting loss in at least a decade. The industry has faced challenges including increasingly expensive weather-related losses and lingering inflationary pressures.

However, insurance stocks can still be a solid part of a diversified portfolio. If you're considering buying insurers or insurance-related stocks, here's what you need to know about the current state of the industry, where companies go from here, and investments you should consider.

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P&C insurers had their worst first quarter in more than a decade

According to an S&P Global Market Intelligence analysis, P&C insurers put up their largest first-quarter underwriting loss in 12 years. Their profitability took a big hit in the quarter, as measured by their combined ratio.

The combined ratio is a crucial metric to analyze how profitably a company is underwriting insurance policies. The ratio divides the total losses and expenses by collected premiums, and a ratio below 100% means a company is writing profitable policies. S&P Global found that the industry average combined ratio was 102.2% in the first quarter. Last year, insurers' average combined ratio was 96.1%, while underwriting profits were more than $4 billion. 

Natural disasters and inflation have weighed on the industry

Several factors have weighed on insurers. For one, the first quarter saw an unusually active period of natural disasters and weather-related events. An increase in tornado, hail, and wind events led to sizable losses throughout the U.S., with Texas leading the way in insurance losses. 

Inflation-related challenges have also weighed on auto-focused insurers like Progressive (PGR 1.23%) and Allstate (ALL 1.45%). This segment of the insurance industry saw its worst loss ratio in two decades. Auto insurers have felt the effects of inflation for a couple of years. Last year, high car prices increased the cost of replacements, while increased labor costs have contributed to elevated repair costs.

Social inflation is another issue insurers have dealt with in recent years. The term describes how insurers' claims costs are rising above general economic inflation.

According to the National Association of Insurance Commissioners, social inflation is partly due to increasing litigation claims by plaintiffs and changing societal attitudes about who is responsible for absorbing those risks. According to a report by Swiss Re, third-party litigation funding has been "contributing to growing loss ratios for excess liability, commercial auto, medical malpractice, and general liability." 

The cyclical insurance industry is now experiencing "hard" market conditions

The insurance business is cyclical and oscillates between what's known in the industry as a soft market and a hard market. All the conditions above have resulted in a hard market: rising claims costs, a supply-demand imbalance, and stricter underwriting standards.

In such markets, insurers can pass off costs to customers without losing them to competitors. Insurers can also be more selective about what policies they are willing to cover, allowing them to focus on high-profit opportunities. While hard markets are associated with higher claims costs, they eventually benefit insurers that can increase their revenue and cash flows in the long run.

Consider these investments to diversify your portfolio

Despite the difficult conditions, insurers remain sound investments that can diversify any portfolio. Insurance brokers are one solid choice. These companies receive commissions on sales, so rising premiums benefit them. Also, brokers don't take on any risks of losses, as insurers do. Marsh & McLennan (MMC 0.50%) and Arthur J. Gallagher (AJG 1.24%) are two solid insurance brokers to consider.

Well-run insurers, like Progressive or Cincinnati Financial (CINF 2.19%), face more risk of losses in the near term but have displayed an ability to handle difficult conditions.

Lastly, specialty insurers that write policies on hard-to-place risks can do exceptionally well in a hard insurance environment. That's because these insurers have more flexibility in pricing their policies and choosing what risks they are willing to take. Kinsale Capital (KNSL 1.94%) is an excellent stock that has crushed the market since going public in 2016, rising almost 2,000% versus the S&P 500's 110% gain.

Rising claims costs due to increasing weather events and inflation have made it a challenging environment for insurers. Despite this, their ability to grow alongside the economy and inflation can make these stocks an excellent addition to your diversified portfolio.