An insurance cycle, also known as an underwriting cycle, is a term describing the tendency of the insurance industry to swing between profitable and unprofitable periods over time. The concept is most closely associated with property insurance and casualty insurance, where premiums, underwriting profits and the availability of cover are observed to rise and fall in a cyclical pattern rather than at a steady rate. In a typical cycle insurers experience alternating phases that are often described as hard and soft market conditions. During a hard market, underwriting standards tighten, capacity is more constrained and premium rates increase. During a soft market, competition leads to lower premiums, broader policy terms and more readily available cover, which can in turn reduce profitability. The length and intensity of cycles vary by line of business and by country, but many studies of non life insurance report cycles that last several years and sometimes around a decade. All industries experience business cycles of growth and decline, 'boom and bust'. These cycles are particularly important in the insurance and reinsurance industry as they are especially unpredictable. The insurance cycle affects all areas of insurance except life insurance, where there is enough data and a large base of similar risks (i.e., people) to accurately predict claims, and therefore minimise the risk that the cycle poses to business.
Definition and overview The insurance underwriting cycle is commonly defined as the tendency of property and casualty insurance premiums, profits and available coverage to exhibit a cyclical pattern over time. Studies of loss ratios and combined ratios in these lines find that underwriting results move through alternating periods of relatively strong and relatively weak profitability, with corresponding changes in prices and in the willingness of insurers to accept risks. The cycle is usually described in terms of hard market phases, in which premiums and underwriting margins are high and capacity is limited, and soft market phases, in which premiums and margins are low and capacity is abundant. Although cyclical behaviour has been observed in a number of insurance markets, the term insurance cycle is primarily applied to non-life lines such as property insurance and liability insurance, which are written on relatively short term contracts and are sensitive to underwriting results. Underwriting cycles are related to, but distinct from, general business cycles. Research has found correlations between underwriting results and economic variables such as interest rates and output growth. Regulators and rating agencies pay attention to the position in the insurance cycle when assessing the solvency and capital adequacy of insurance companies.
History The insurance cycle is a phenomenon that has been understood since at least the 1920s. Since then it has been considered an insurance 'fact of life'. Most commentators believe that underwriting cycles are inevitable, primarily "because the uncertainty inherent in matching insurance prices to future losses creates an environment in which the motivations, ambitions, and fears of a complex cast of characters can play out." Lloyd's counters that this has become "a self-fulfilling prophecy". In the mid-2000s, the industry sought to move from describing the cycle to managing it. Lloyd's of London published guidance on cycle management, including a paper commonly cited as “Seven steps to managing the cycle”, which argued that treating the cycle as an unavoidable force of nature encouraged undisciplined underwriting and capital management. Lloyd's annual surveys of underwriters around the same period reported that, for several consecutive years, respondents ranked managing the cycle as one of the most important challenges facing the market. These initiatives, together with later work on capital regulation and economic capital models, fed into the development of risk-based approaches that aim to keep pricing and growth policies consistent with long-run solvency constraints rather than with short-term competitive pressure.
Phases of the insurance cycle
The insurance cycle is often described as a sequence of soft and hard market conditions in property and casualty insurance. In soft markets the supply of cover is ample, competition is strong and premium rates tend to decline, while in hard markets the supply of cover is more limited, pricing is firm and insurers apply stricter underwriting standards. Cycles do not necessarily follow a simple pattern and different lines of business or geographic markets can be in different phases at the same time, but the hard and soft market distinction is used widely in both academic work and industry commentary.
Soft market Soft market conditions are most likely to occur after a period in which insurers have reported strong profits and capital has accumulated, whether through retained earnings or new equity issues. Existing companies may respond to high returns by expanding their underwriting or by offering broader terms to attract business, while new entrants may be drawn into the market by the prospect of earning similar returns. As competition increases, premium rates tend to fall and policy wordings may become more generous, for example through higher limits, lower deductibles or wider cover, which can reduce expected underwriting margins. In a prolonged soft market loss ratios and combined ratios usually move upwards as claims experience and expenses catch up with earlier price reductions. This as a phase in which the discipline imposed by solvency constraints and rating agency capital requirements weakens because recent experience has been favourable and because growth in premium volume is rewarded, which can reinforce pressure to cut prices.
… excerpt ends here. Continue reading the full article.
