What Is an Underwriting Cycle?
The underwriting cycle refers to fluctuations in the insurance business over a period of time. A typical underwriting cycle spans a number of years, as market conditions for the underwriting business go from boom to bust and back to boom again. An underwriting cycle is also known asan "insurance cycle."
Key Takeaways
- The underwriting cycle refers to fluctuations in the insurance business over a period of time.
- The fluctuations in the underwriting cycle consist of market conditions that go from a boom cycle to a bust cycle and over again.
- The underwriting cycle starts with many competitors and low premiums and then after a surge in claims and insurance company insolvencies, competition declines, and premiums go up.
- After this period, net entrants enter the market, increasing competition, resulting in a reduction in premiums and the underwriting cycle starts again.
- The underwriting cycle is one of the biggest challenges that insurance companies face and they constantly try to manage it to the best of their abilities.
Understanding an Underwriting Cycle
The underwritingcycle represents the ebb and flow of businessbetweensoft andhard insurance markets.At the beginning of an underwritingcycle,business is soft due to increased competition and excess insurance capacity, as a result of which premiums are low. Then, a natural disaster or other eventleads to a surge in insurance claims, which drives lesser-capitalized insurers out of business.
Decreased competition and lower insurance capacity lead to better underwriting conditions forsurviving insurers, enabling them to raise premiums and post solid earnings growth. As the insurance claims are paid off and the tide of new claims subsides,insurance companies slowly return to profitability.New insurance companies then enter the market, offering lower premiums and looser requirements than the existing companies.The existing companies are then compelled toloosen their requirements to stay competitive, and the insurance cycle starts all over again.
The underwriting cycle perpetuates because a majority ofinsurance companiesplace short-term gains over long-term stability, selling insurance without concern for what happens when the soft market ends.The only way to effectively regulate or insulate an insurance company againstthe effects of theinsurance cycle is to ignore short-term profitability and focus on saving capital. An insurance company may also consider establishing limits and settingmoneyaside in a "rainy day" type of account. Disciplined efficiency can have a considerable effect on a firm's financial stability and long-term business prospects.
Managing an Underwriting Cycle
As with most business cycles, the underwriting cycle is a phenomenon that is very difficult to eliminate. The concept has been an understood phenomenonsince at least the 1920sand has since been treated as a core concept in the industry.In 2006, insurance giant Lloyd's of London identified managing this cycle as the top challenge facing the insurance industry and published a report by surveying more than 100 underwriters about industry issues. In response to their survey, they were able to identify steps to manage the insurance cycle.
Most insurance industry watchdog organizationsbelieve that underwriting cycles are inevitable due to the inherent uncertainty ofmatching insurance prices to futurelosses. Unfortunately, the industry as a whole is not responding to the challenges the underwriting cycle brings. The underwriting cycle affects all types of insurance except life insurance, where there is enough information to minimize risk and reduce the effect of the underwriting cycle.
