Cycle Theory: The Importance Of Underwriting Cycles

Underwriting cycles are associated with a mystique that few topics in the area of risk and insurance share. Many explanations and theories have focused on underwriting cycles, but little research exists to discern the relative importance of these theories in explaining insurance pricing and profitability. This research provides an intuitive review of the existing literature on underwriting cycles, understanding the cycle model, the theories involved and the factors affecting underwriting cycle.

INTRODUCTION:

The underwriting cycle is the tendency of property and casualty insurance premiums, profits, and availability of coverage to rise and fall with some regularity over time. A cycle begins when insurers tighten their underwriting standards and sharply raise premiums after a period of severe underwriting losses or negative stocks to capital (e.g., investment losses). Stricter standards and higher premium rates lead to an increase in profits and accumulation of capital. The increase in underwriting capacity increases competition, which in turn drives premium rates down and relaxes underwriting standards, thereby causing underwriting losses and setting the stage for the cycle to begin again. All industries experience cycles of growth and decline, 'boom and bust'. These cycles are particularly important in the insurance and re-insurance industry as they are especially unpredictable. Lloyd's of London research in 2006 revealed, for the second year running, that Lloyd’s underwriters see managing the insurance cycle as the top challenge for the insurance industry, and nearly two-thirds believe that the industry at large is not doing enough to respond to the challenge. The Insurance Cycle affects all areas of insurance except life insu...

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...cle and some of the theories that explain the cycle i.e. capital constraint theory. The research for underwriting cycle has been extensively carries out in America, Africa, Europe , but not that extensively in Asia and mainly in India. Market structure fluctuation or competition-driven pricing, Irrational forecasting errors or rate making methods, Institutional regulatory and reporting lags, Capital or capacity constraints, Interest rate and General business cycle are some hypotheses which explains underwriting cycle. Some of the factors which influence underwriting cycle are disequilibrium in demand and supply, external shocks & general business cycles. Further study in this topic can be carried on to understand how the theories are interrelated and applying the theories to understand if the cycle is present in India where Insurance Industry is evolving over time.