Can anyone throw some light on the “underwriting cycle” mentioned in Non-life insurance companies material. In Schweser, please refer book 2, Study Session 5, Page 22.
As I understand it insurance industry is cyclical ( the cycles are basically characterized by losses vs collected premiums). These cycles (changing profitability due to different levels of competion, large claims, etc) are rather short-term (3-5 years, i.e the situation with profitability changes every 3-5 years). Taking into account that potential claims in non-life insurance are very uncertain in both timing and value insurance companies are very susceptable to underwritnig cycles (need to match asset duration with lenghth of the cylce).
uncertain and very short term. i dont remember what exactly cfai or schweser means by unerwriting cycle but i think it is the fact that in recessions for instance insurances companies have a lot of payouts, so not only financial situation is worse, but their payouts increase too Return goals for insurance companies (non-life) 1) Sufficient funding of all current and future liabilities 2) Capital growth of surplus 3) Supporting competitive position Risk is specific per product but in general tolerance is below average.
To my understanding, “underwriting cycle” is the period of insuring the underlying asset (average assumption period). Here is the connection I can draw from underwriting cycle to IPS (liquidity, time horizon). If you are at the beginning of your underwriting cycle==>LOWER liquidity, LONGER time period. At end of your underwriting cycle===>HIGHER liquidity, SHORTER time period. Helps?
Like any other business, casualty insurance companies are susceptible to competitive pressures. When times are good (good investment returns, high premiums, low losses), companies would want to capture market share, i.e. grow, by becoming more competitive through lowering premiums and loosening underwriting standards. As rivals follow, this starts a downward trend in profitability as premiums decrease while losses are increasing. At some point, few will go bust. Eventually chastened, insurance companies will raise premiums and tighten underwriting losses. At this point, profitability starts improving. And this cycle repeats itself.
Thanks a bunch peter19, comp_sci_kid,ws, CFAAtlanta for clarifying. On a side note, does this mean that assets returns of the non-life insurance companies need to be negatively correlated with the business cycle. i.e. during recessions, they should get more returns. Can you guys comment on the relation between the asset allocation during various phases of the underwriting cycle (i.e., at the start and the end of it).
Corpfinguy, As I understood it business cylces are often but not always coincide with underwriting cylces. That is not always when you have business cylce changed the insurer has changed profitabilty. and aslo I think it’s more about matching assets durations with the length of underwiting cylce than correlation of returns with any cylces… It seems that during the underwiting cycle in most cases you don’t need to reallocate. You know that in 3-5 years the profitability trend will change and you most likey need funds, hence you are invested mostly in intermediate fixed-income in order not lose money if market value fluctuates when you need to cash out (for non-insuarance) Correct me if I’m wrong