capacity constraints and cycles in property casualty insurance markets underwriting cycles are unexpected in a structurally competitive industry where financial capital is the major determinant of output capacity arbitrage theories explain underwriting cycles as largely an artifact of institutional lags and reporting practices capacity constraint theories view insurance markets as characterized by real frictions that cause underwriting cycles by temporarily reducing the industry s capacity to insure risks arbitrage theories imply nofsystematic relationship between capacity and underwriting margins while capacity constraint hypotheses predict a negative relationship this article provides a test of the two theories by examining the empirical relationship between casacity and underwriting margins the results using data on four insurance lines generally support the capacity constraint hypothesis unanticipated decreases in capacity cause higher profitability and prices

does productive capital affect the order of resource exploitation abstract the purpose of this paper is to show that in a general equilibrium framework it is not always optimal to exploit resources in strict sequence beginning with the lowest cost deposit even if it is possible to accumulate productive capital indeed if there is an exogenous upper bound on the flow of the substitute it is always optimal to consume it simultaneously with a lower cost stock moreover it may be optimal to consume the high cost substitute before using a lower cost resource

a theory of mutual formation and moral hazard with evidence from the history of the insurance industry nonprofit mutually owned insurance and banking organizations have significant market shares in the insurance and banking industries a first step in a systematic study of these financial mutual is to examine the reasons for their formation doing so provides empirical support for the view that these mutual arose as an efficient means of addressing contracting challenges caused by aggregate uncertainties and moral hazard a formal model with this property is presented we argue that information asymmetries do more to explain the kinds of contracts offered by financial mutual than do agency problems between owners managers and customers article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

the liability insurance market t his paper offers an overview of the u s liability insurance market and the link between its performance and developments in tort law over the last few decades the dominant feature of the insurance market has been the intermittent periods of rapidly rising premiums and cutbacks on the availability of coverage the insurance cycle appears to be increasing in amplitude and since the 1960s has been concentrated increasingly in liability lines an episode of rising premiums in the late 1960s was followed by a six year period of declining and eventually negative growth rates in total liability insurance premiums over the 1975 1977 period the annual growth rate jumped to 30 percent then followed another period of declining real premiums until premiums nearly tripled in 1984 1986 accompanied by cancellations of policies and massive withdrawal of insurers from some lines this crisis had an economic impact beyond the insurance market leading to the withdrawal of many goods and services from u s markets in mid 1987 the market began to turn again with premiums falling by as much as 40 percent for some commercial policies since then aggregate revenue from premiums has been relatively stable the liability insurance market is intertwined with the tort system in addition to providing incentives to avoid accidents the tort system allocates the risks of accident costs in providing compensation for accident victims the modern expansion of liability in tort law as described by priest in this issue represents a shift in the burden of supplying insurance from first party insurance markets to liability or third party insurance markets clearly this shift will

capacity constraints and the dynamics of underwriting profits paul d thistle the presence of an underwriting profit cycle in property liability insurance has become a stylized fact models of this underwriting cycle imply that the insurance market is governed by two regimes as capacity is constrained or not we apply the smooth transition regression model to insurance industry data for 1934 1993 to test for a regime shift we find a rapid shift between two distinct regimes with different dynamics when capacity is not restricted we find no evidence of a cycle the cycle is present in periods when capacity is restricted immediately following world war ii and after 1968 the underwriting cycle appears to be a recent phenomenon jel g22 c32 i introduction it is well known that the property liability insurance industry is subject to cycles in premiums and underwriting profits the main features of the underwriting cycle are also well known in a soft market coverage is readily available while premium revenue and underwriting profits are low in a hard market coverage becomes difficult to obtain while premium revenue and profits increase the onset of a hard market is typically quite rapid and is followed by the erosion of premium revenue and profits as market conditions return to a soft market 1 it is also generally accepted that the cycle has a period of approximately six years although there is some variation across lines and among countries this approximate period for the underwriting cycle is based on time series estimates of second order autoregressive models e g venezian 1985 and cummins and outreville 1987 understanding the causes of the property liability underwriting cycle is important for public policy and insurance regulation sof t markets may contribute to insurer insolvencies if firms price and underwrite too aggressively while high prices and restrictive underwriting in hard markets may disrupt the flow of goods and services a number of alternative theories have been proposed to account for the cycles in premiums and profits in the property liability insurance market initially attention focused on aspects of the process for determining insurance rates e g harrington and danzon 1991 1994 simmons and cross 1988 stewart 1981 venezian 1985 and wilson 1981 more recent research has developed equilibrium models of the underwriting cycle financial pricing models based on discounted cash flows imply that insurance prices are equal to policy expenses plus the expected present value of future claims under the policies issued 2 financial pricing models implicitly or explicitly assume perfect capital markets in the absence of capital market imperfections there should be no cycles and prices and profits should vary inversely with interest rates cummins and outreville 1987 and doherty and kang 1988 argue that if insurers have rational expectations then as a result of insurance accounting practices and inst itutional features of insurance markets underwriting profits follow an autoregressive data generating process which gives the appearance of a cycle the capacity constraint hypothesis developed by cummins and danzon 1991 gron 1994a b and winter 1988 1991a b 1994 is based on the fact that an insurer must have sufficient policyholders surplus capacity to support the policies it writes 3 capital market imperfections lead firms to rely on internal capital as the source of underwriting capacity this in turn implies that hard markets must be temporary and that soft markets will persist the capacity constraint hypothesis implies that premiums and profits will depend on interest rates and are negatively correlated with surplus or capacity in the short run in the long run capital enters the industry until the constraint is not binding so profits and surplus are not correlated in the long run cagle and harrington 1995 and cummins and danzon 1997 add the assumption that policyholders are willing to pay more for policies with higher financial quality lower insurer default risk and that insurer default risk is endogenous

evidence of capacity constraints in insurance markets this article provides empirical support for the primary predictions of capacity constraint theories of property casualty insurance cycles the primary implications concern industry capacity and the difference between the price of insurance and noncapital costs referred to here as the price payment margin ppm capacity constraint theories predict that low capacity will lead to higher ppms and that capacity growth will follow ppm increases as insurers rebuild capacity price payment margin and capacity series are constructed using industry time series for 1949 90 the estimation finds that ppm growth varies inversely with capacity at the beginning of the period and also inversely with changes in capacity in addition declines in capacity are associated with ppm growth next period while increases in capacity generally have no significant effect on next period s ppm growth furthermore current capacity growth is positively correlated with last period s ppm growth

insurance cycles interest rates and the capacity constraint model insurance profits exhibit cyclical behavior that has been attributed to capital market constraints the authors show that changes in interest rates simultaneously affect the insurer s capital structure and the equilibrium underwriting profit depending upon asset and liability maturity structure capital market access and reinsurance availability insurers will be differently affected by changing interest rates the authors find that the average market response to changing interest rates roughly tracks market clearing prices these cyclical effects are enhanced for firms with mismatched assets and liabilities and more costly access to new capital and reinsurance this evidence supports the capacity constraint hypothesis copyright 1995 by university of chicago press

health care costs on the rise again since 1999 health care costs have been growing faster than national income this rapid growth has occurred as the ability of private and public purchasers to reduce service utilization and bargain for lower prices has fallen insurers have recouped lost profits through higher premiums and new technologies have driven up costs throughout the sector private insurance market responses to these rising costs may lead to reductions in the number of people with insurance and to increased fragmentation of the insurance market over time technological change in medicine both increases costs and improves the quality of care the challenge for public policy is to maintain insurance and some degree of equity in the face of these rising costs

crises in medical malpractice insurance evidence of excessive price cutting in the preceding soft market abstract prior work suggests that heterogeneous information or weak incentives for solvency could have caused some general liability insurers to charge low ex ante prices during the early 1980s and mid to late 1990s putting downward pressure on other firms prices and plausibly aggravating subsequent periods of rapid premium growth we analyse whether the 1994 1999 soft market in medical malpractice insurance led some firms to underprice grow rapidly and subsequently experience upward revisions in loss forecasts loss development which could have aggravated subsequent market crises consistent with the underpricing hypothesis the results indicate a positive relation between loss development and premium growth among growing firms underpricing was likely more prevalent among non specialist malpractice insurers

risk overhang and market behavior we show that exposure from past business transactions risk overhang can reduce activity in related business lines sometimes to the point where no new trade occurs we focus primarily on the role of overhang in nonlife insurance market disruptions our model predicts that the relative impact duration and character of supply disruptions are related to the extent of overhang these predictions are consistent with differences between the mid 1980s liability insurance crisis and the early 1990s catastrophe reinsurance crisis the overhang model predicts attributes of these crises that prior explanations relying on adverse selection do not we also discuss applications of the overhang model to disruptions in lending and securities markets

price cutting in liability insurance markets this article analyzes alleged underpricing of general liability insurance prior to the mid 1980s liability insurance crisis the theoretical analysis considers whether moral hazard and or heterogeneous information for forecasting claim costs can cause some firms to price too low and depress other firms prices cross sectional analysis of insurer loss forecast revisions which should be greater for firms with low prices caused by moral hazard or heterogeneous information and premium growth provides evidence consistent with low pricing due to moral hazard but not heterogeneous information the evidence also implies that shifts in the loss distribution produced large industrywide forecast errors copyright 1994 by university of chicago press

the property liability insurance cycle a comparison of alternative models the objective of this paper is to compare alternative models of insurance pricing as theories of the property liability underwriting cycle the existing literature has focused on comparing two models the financial pricing and capacity constraint models however these are not the only relevant models we show that six alternative models imply the same general form of the pricing equation we apply the model to data on stock property liability insurers for the period 1935 1997 we find that the actuarial model and the capacity constraint hypothesis are the only theoretical models that are consistent with the data

dividends safety and liquidation when liabilities are long term and stochastic abstract this paper investigates the optimal management of a firm faced with a long term liability that occurs at a random date three issues are analysed the optimal dividend policy optimal expenditure on safety to delay the occurrence of the liability and the optimal liquidation date of the firm an owner faced with dynamic unlimited liability never liquidates and therefore accumulates capital to the golden rule level for long term liabilities dividend payments and safety expenditure are non decreasing over time the owner protected by limited liability may liquidate the firm in finite time in order to avoid paying the liability if this is the case then it accumulates less capital than the dynamic unlimited liability owner and may decrease dividend payments and safety expenditure over time the paper shows that a finite liquidation date is more likely to be optimal when the arrival rate of the liability occurrence increases over time

adverse selection aggregate uncertainty and the role for mutual insurance companies a model of insurance markets analogous to that of rothschild and stiglitz 1976 is considered with the additional feature that risk neutral insurers face aggregate undiversifiable risk in the presence of adverse selection and aggregate uncertainty and under a simple nondegeneracy condition on loss probabilities the authors show that any equilibrium has the feature that some agents purchase participating policies from mutual insurers while others purchase nonparticipating policies and hence do not share risk with their insurer specifically agents with low loss probabilities signal their type by sharing aggregate risks with their insurer some empirical support for this prediction is provided copyright 1990 by the university of chicago

the determination of fair profits for the property liability insurance firm although the property liability insurance industry has been subject to price regulation for many years surprisingly little research has been directed at producing valuation models of a property liability insurance firm although property liability price regulation has historically involved setting minimum prices to reduce the risk of insolvency some commissions have begun to move toward setting prices more in the spirit of public utility regulation 1 if in an effort to promote efficiency the working objective of such regulation requires the determination of prices that would prevail under competition then regulation must be founded on some model of the costs of regulated firms under competition with free entry prices just cover all economic costs including the opportunity costs of investment by suppliers of capital and a valuation model is required to explain how the market value of the firm and therefore the cost of capital reacts to changes in the prices it charges our objective in this chapter is to provide such a framework

taxation corporate financial policy and the cost of capital the cost of capital plays an important role in the allocation of resources among competing uses in a decentralized market system the purpose of this paper is to organize and present what is known and what is hypothesized about the effects of taxation on the incentive to invest via the cost of capital taking full account of important issues that arise independently from the question of taxation included in the analysis is a discussion of empirical findings about the interaction of inflation and taxation in influencing the incentive to invest and a treatment of taxation and uncertainty this abstract was borrowed from another version of this item

anomalies the winner s curse abstract next time that you find yourself a little short of cash for lunch try the following experiment in your class take a jar and fill it with coins noting the total value of the coins now a

why bank credit policies fluctuate a theory and some evidence in a rational profit maximizing world banks should msdntain a credit policy of lending if and only if borrowers have positive net present value projects why then are changes in credit policy seemingly correlated with changes in the condition of those demanding credit this paper argues that rational bank managers with short horizons will set credit policies that influence and are influenced by other banks and demand side conditions this leads to a theory of low frequency business cycles driven by bank credit policies evidence from the banking crisis in new england in the early 1990s is consistent with the assumptions and predictions of the theory

the coexistence of distribution systems under price search theory and some evidence from insurance abstract this paper analyzes a pure price search model of an insurance market in which two different search technologies are simultaneously available sequential search and nonsequential search sequential search characterizes firms that sell directly to consumers and nonsequential search characterizes firms who use independent agents that sell the products of a number of different firms the separation of firms and consumers into the two market sectors is endogenously determined and the conditions for equilibrium coexistence are derived the characteristics of price distributions in the two sectors are then compared in a coexistence equilibrium price distributions observed in automobile insurance markets are found to be consistent with the predictions of the theoretical model

should business groups be dismantled the equilibrium costs of efficient internal capital markets abstract we analyze the relationship between conglomerates internal capital markets and the efficiency of economy wide capital allocation and we identify a novel cost of conglomeration that arises from an equilibrium framework because of financial market imperfections engendered by imperfect investor protection conglomerates that engage in winner picking stein 1997 internal capital markets and the competition for corporate resources journal of finance 52 111 133 find it optimal to allocate scarce capital internally to mediocre projects even when other firms in the economy have higher productivity projects that are in need of additional capital this bias for internal capital allocation can decrease allocative efficiency even when conglomerates have efficient internal capital markets because a substantial presence of conglomerates might make it harder for other firms in the economy to raise capital we also argue that the negative externality associated with conglomeration is particularly costly for countries that are at intermediary levels of financial development in such countries a high degree of conglomeration generated for example by the control of the corporate sector by family business groups could decrease the efficiency of the capital market our theory generates novel empirical predictions that cannot be derived in models that ignore the equilibrium effects of conglomerates these predictions are consistent with anecdotal evidence that the presence of business groups in developing countries inhibits the growth of new independent firms because of a lack of finance