Understanding an Underwriting Cycle
The underwriting cycle encapsulates the fluctuating phases of the insurance business over extended periods. This cycle moves from a phase of significant market activity or ‘boom’ to a downturn or ‘bust’ and back to a boom, effectively repeating over time. Often referred to as the “insurance cycle,” understanding it is crucial for both insurers and policyholders alike.
Key Takeaways
- The underwriting cycle refers to fluctuations in the insurance business over a period.
- These fluctuations move from a boom cycle to a bust cycle and back again.
- The cycle begins with numerous competitors and low premiums, leading to high competition. However, subsequent surges in claims and resultant insurer insolvencies decrease competition and drive premiums up.
- As new entrants inevitably join the market, competition spikes, premiums drop, and the cycle renews.
- The underwriting cycle presents significant challenges, compelling insurance companies to continually adapt and manage market conditions.
Flow of the Underwriting Cycle
The underwriting cycle characterizes the transitions between soft and hard insurance markets. Initially, business conditions are soft due to high competition and excess insurance capacity, which results in lower premiums.
However, events such as natural disasters trigger a spike in insurance claims, forcing smaller or less-capitalized insurers out of business. This contraction reduces competition and insurance capacity, creating better conditions for surviving insurers to increase premiums and enjoy strong growth in earnings.
As claims reduce, insurance firms regain profitability, attracting new entrants into the market. These newcomers typically offer lower premiums and more relaxed requirements to gain market share. Established insurers then follow suit to remain competitive, restarting the cycle.
The cycle persists as many insurers prioritize short-term profits over long-term stability, issuing policies with minimal immediate concern. Insulating against these cycle effects requires long-term strategic planning, by saving surplus capital or putting money aside in reserve accounts. Disciplined financial management significantly enhances a company’s stability and growth prospects.
Managing an Unyielding Cycle
Like most business cycles, the underwriting cycle is difficult to eradicate. Recognized widely since the 1920s, it remains intrinsic to the industry. In 2006, a notable report from a leading insurance institution underscored the challenge of managing these cycles, gaining insights from over 100 industry underwriters.
Industry analysts consider underwriting cycles inevitable due to the complexities of forecasting accurate insurance prices against prospective losses. Although these cycles are more pronounced in most insurance sectors, life insurance maintains relative stability due to extensive data that mitigate risks, thus buffering the effects of the underwriting cycle.
Related Terms: underwriting, insurance premium, insurance claims, insurance market, business cycle.
