OC1 - 15: The Underwriting Cycle

Nonadmitted insurer

An insurer not authorized by the state insurance department to do business within that state.

What are two reasons why insurance demand is relatively inelastic?

-Buyers do not have much choice but to buy -Buyers cannot store insurance as they can store other products, such as automobiles, that can be used for many years depending on buyers' needs and the price of replacement. Insurance contracts have a definite, fixed life and must be regularly renewed.

What four financial factors determine insurers' profitability and influence underwriting cycles?

-Investment income -Capacity -Return on equity -Cash flow

What are the seven factors that affect the supply of property-casualty insurance?

-Reinsurance -Ease of entry -Difficulty of exit -Regulatory environment -Dedicated capital -Underreserving -Profit expectations

The reasons why and the way in which cycles occur in any industry's markets depend largely on these three economic characteristics:

-The structure of the industry's markets -The demand for the industry's products or services -The supply of the industry's products or services What sets apart the profit cycle of property-casualty insurance is the nature of its demand and supply.

Premium-to-surplus ratio, or capacity ratio

A capacity ratio that indicates an insurer's financial strength by relating net written premiums to policyholders' surplus.

Underwriting cycle

A cyclical pattern of insurance pricing in which a soft market (low rates, relaxed underwriting, and underwriting losses) is eventually followed by a hard market (high rates, restrictive underwriting, and underwriting gains) before the pattern again repeats itself.

Surplus relief

A flow of funds into an insurer's policyholders' surplus when policyholders' surplus has been reduced by the insurer's rapid growth in written premiums.

Return on equity (ROE)

A profitability ratio expressed as a percentage by dividing a company's net income by its net worth (book value). Depending on the context, net worth is sometimes called shareholders' equity, owners' equity, or policyholders' surplus.

Operating ratio

A ratio that measures an insurer's overall pretax operational profitability from underwriting and investment activities and is calculated by subtracting the investment income ratio from the combined ratio.

Profit cycle

A recurring increase and decrease in profits, usually regarding a single organization or industry.

Cash flow

Cash inflow minus cash outflow.

Why do insurance profit cycles not usually coincide with general business cycles?

General business cycles are dominated by changes in demand, whereas supply is more important in influencing insurance prices and profits.

Structural change

Gradual, long-term, and fundamental change involving institutional arrangements, products, services, roles, and regulation.

Supply

In insurance, the aggregate willingness of all insurers to assume risk at a given time.

Capacity

The amount of business an insurer is able to write, usually based on a comparison of the insurer's written premiums to its policyholders' surplus.

Capital

The accumulated assets of a business or an owner's equity in a business.

Reunderwriting

The process of analyzing the characteristics of policies within a portfolio and the trends of those characteristics.

Reinsurance

The transfer of insurance risk from one insurer to another through a contractual agreement under which one insurer (the reinsurer) agrees, in return for a reinsurance premium, to indemnify another insurer (the primary insurer) for some or all of the financial consequences of certain loss exposures covered by the primary's insurance policies.

Policyholders' surplus

Under statutory accounting principles (SAP), an insurer's total admitted assets minus its total liabilities.

Inelastic demand

Willingness to purchase a product that does not tend to respond to a change in price.

Elastic demand

Willingness to purchase a product that varies significantly with price.