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

the american business cycle continuity and change in recent decades the american economy has experienced the worst peace time inflation in its history and the highest unemployment rate since the great depression these circumstances have prompted renewed interest in the concept of business cycles which joseph schumpeter suggested are like the beat of the heart of the essence of the organism that displays them in the american business cycle some of the most prominent macroeconomics in the united states focuses on the questions to what extent are business cycles propelled by external shocks how have post 1946 cycles differed from earlier cycles and what are the major factors that contribute to business cycles they extend their investigation in some areas as far back as 1875 to afford a deeper understanding of both economic history and the most recent economic fluctuations seven papers address specific aspects of economic activity consumption investment inventory change fiscal policy monetary behavior open economy and the labor market five papers focus on aggregate economic activity in a number of cases the papers present findings that challenge widely accepted models and assumptions in addition to its substantive findings the american business cycle includes an appendix containing both the first published history of the nber business cycle dating chronology and many previously unpublished historical data series

new issues in corporate finance flow of funds data are used to compare methods of finance in 5 countries over the period 1970 to 1985 many of the problems associated with previous studies are avoided by estimating net instead of gross financing proportions the degree of consolidation of accounts reciprocal arrangements between borrowers and lenders and compensating deposit requirements on borrowers no longer distort financing patterns corrections for inflation are provided by employing flow rather than stock figures and using own aggregation procedures to derive stock measures significant variations in financing emerge these are not readily explained by traditional descriptions of corporate finance in particular taxation as an alternative the paper suggests that relationships between borrowers and lenders establish forms of commitment that are conducive to the provision of long term finance the separation between investment and finance which has been the starting point of corporate finance theory is untenable in a multiperiod context in which terms of finance define future allocation of control

multiperiod sales production decisions under uncertainty abstract this paper studies the behavior of an expected profit maximizing multiperiod firm under uncertainty in output and demand the firm s problem is to determine in each period the level of sales and inventory and the expected output for the coming period the optimal policy is derived in an explicit closed form and is proved to be myopic it is shown that the observed phenomenon of downward price inflexibility can be explained and further specified by using the results of our model

inventory behaviour and market power an empirical investigation abstract this paper examines the empirical relation between the market power of a firm and the level and variability of its inventories we suggest that firms with greater market power hold more inventories and that their inventories are more volatile these hypotheses were tested on a large sample of industrial firms using two different measures of market power and applying a number of estimation techniques the results strongly support our hypotheses

pricing and capital allocation in catastrophe insurance abstract this paper studies multi line pricing and capital allocation by insurance companies when solvency matters to consumers capital is costly to hold and the average loss is uncertain in this environment product quality concerns lead firms to diversify across markets and charge high prices for risk that threatens company solvency even if the risk is unrelated to other asset risk price differences across markets are traced to differences in capital required at the margin to maintain solvency finally the paper shows that capital costs have significant effects on catastrophe insurance markets because of high marginal capital requirements

mexico stabilization debt and growth mexico rudiger dornbusch mexico today is at a crossroads as the de la madrid presidency which has been dominated by the debt crisis comes to an end a number of major policy difficulties remain inflation is still a problem and the continuation of stagnation in a country where the population grows by 3 a year is clearly unsustainable the outlook for inflation is dependent on the government s ability to keep its budget under control the stabilization programme has been quite successful in this respect but the cost in terms of foregone growth is staggering the issue here is how to collect the disinflation benefits of policy restraint analysing the peculiar process of rapid inflation both in mexico and elsewhere the author calls for an incomes policy as for growth it is closely linked to the external situation mexico which triggered the debt crisis in 1982 has made remarkable progress in achieving a non interest current account surplus yet its external debt remains huge and requires a continuation of net transfers abroad the experience though is that debt service comes at the expense of productive investment and growth the author proposes to escape from the unacceptable choice between debt service and growth by adopting what he calls interest rescheduling a debt equity swap applied to interest payments rather than to the principal

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

price smoothing and inventory this paper explains the phenomenon of price rigidity or price smoothing as the outcome of the optimal inventory policy of a multi period profit maximizing firm under demand and output uncertainties price smoothing may be manifested in two forms first price changes may be moderated with respect to those implied by the demand function and second the firm may choose to restrict price fluctuations by establishing upper and or lower bounds on prices we show that the extent of the asymmetry in price smoothing depends on the relationship between the inventory holding cost and the backlog penalty cost our model accommodates a wide range

relative price dispersion and economic shocks an inventory adjustment approach the issue of relative price dispersion rpd has gained prominence in recent years as the economy was subject to economic shocks and to high and variable levels of inflation the concern about the increased rpd was due to its potentially harmful effect on the economy recently blejer and leiderman 4 evaluated empirically the effect of rpd on economic activity in the postwar united states and found that increased rpd leads to a decrease in the level of output and to an increase in the rate of unemployment israelsen and mcdonald 13 showed in a partial equilibrium context that when wage changes are firmly linked to the general price level and labor mobility between markets or industries is limited an increase in rpd may lead to increasing unemployment pischer 10 suggested that rpd is not necessarily harmful but when coupled with unexpected inflation it may be associated with information confusion leading to a loss through the misallocation of resources these concerns have raised the interest in understanding the factors causing and affecting rpd both theoretically and empirlcally the prevailing theoretical explanations of the factors affecting rpd are based on two main approaches c ne approach is based on misinformation type models inspired by lucas s work 14 where individuals are confused between aggregate shocks and relative marketspecific ones barro 3 and cukierman and wachtel 9 have proposed that the greater the vanance of the aggregate shocks the greater the rpd barro 3 pp

the technology of decontrol some macroeconomic issues by the time east europe was being pressed into stalin s authoritarian mould as soviet troops took over the region at the end of the second world war there was little more to be said in western theorising about the subordination of markets to a central plan from barone s i908 ministry of production in a collectivist state to lerner s i944 economics of control the issue was the allocative efficiency of the state in maximising a social preference function by the late i 940s a communist party determined to assume that role was in power in nine european and three asian countries each having a long term objective to overtake and surpass the performance of capitalism but more immediately to use central planning as the economic expression of a political monopoly in i990 the east european parties have forfeited that monopoly and have patently failed in the competition with capitalism as successor governments turn to the market it is the economics of decontrol that must be formulated throughout the industrialised capitalist world during the i98os the state has been rolled back in favour of the market deregulation and privatisation took place within a well established environment of market clearing prices and profit seeking transactions not so in the ussr and eastern europe for four decades stretching to six for the soviet union administrative direction has eliminated or marginalised the market which now must be rebuilt virtually from scratch the history of the two countries which broke with stalin s form of control is of no help yugoslavia had too little of a central plan and hungary had too little of a market 1 when mikhail gorbachev launched perestroika in i985 hungary and china had begun to re establish market relations and to allow some private enterprise to compete with a dominant state there and elsewhere the process was impeded by the hold of the communist party2 on political and economic activity those countries in which by i990 that hold had been relaxed started the process of decontrol and the establishment of equilibria within which a normal market can operate section i of this paper describes the preconditions for dismantling the soviettype economy section ii sets out the institutional and structural characteristics of the economy which must be unmade the required changes are considered

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

catastrophic risk and credit markets we provide a model of the effects of catastrophic risk on real estate financing and prices and demonstrate that insurance market imperfections can restrict the supply of credit for catastrophe susceptible properties using unique micro level data we find that earthquake risk decreased commercial real estate bank loan provision by 22 in california properties in the 1990s with more severe effects in african american neighborhoods we show that the 1994 northridge earthquake had only a short term disruptive effect our basic findings are confirmed for hurricane risk and our model and empirical work have implications for terrorism and political perils

the output inflation relationship abstract this paper shows how the optimal pricing and production policy of a multiperiod profit maximizing firm under demand and output disturbances leads in the aggregate to a positive relationship between production and price deviations from the expected level as depicted by the lucas type supply function the pricing and production decisions are made simultaneously by market agents who base their decisions on the same rational expectations before the disturbances are realized here although the planned production is not affected by the price deviations there is still a contemporaneous positive relationship between them where both production and prices reflect the firm s adjustment to unexpected levels of inventory we show that this positive relationship prevails even when the production decisions are made ex ante based only on expectations before the realization of the random shocks a closed form linear approximation for the supply function is derived which captures the effect of both systematic and unsystematic economic disturbances finally we present an empirical test which supports our assertion that our inventory adjustment mechanism contributes to the creation of the positive relationship between production and price deviations

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

investment and market power abstract this paper argues that the degree of market power within an industry is an important determinant of interindustry differences in investment behavior a neoclassical investment model is analyzed to show that market power is positively associated with capital stock flexibility the intuition for the result is that firms adjust their stocks and investment plans quickly in response to new conditions so as to capture the rents asssociated with their market power

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

insurance self protection and the economics of terrorism abstract this paper investigates the rationale for public intervention in the terrorism insurance market it argues that government subsidies for terror insurance have the effect of discouraging self protection and limiting the negative externalities associated with self protection cautious self protective behavior by a target can hurt public goods like national prestige if it is seen as giving in to the terrorists and may increase the loss probabilities faced by others by encouraging terrorists to substitute toward more vulnerable targets we argue that these externalities in protection are essential for normative analysis of government intervention in insurance markets and may also explain why availability problems in this market have engendered much stronger government responses than similar problems in other catastrophe insurance markets

broker monitoring of premium adequacy the role of contingent commissions contingent commissions which are payments made by an insurer to brokers based on the volume and profitability of insurance placed with the insurer have been criticized as damaging to the relationship between the insured and its broker the argument is made that contingent commission payments encourage brokers to select insurers for their clients based on the potential to earn contingent commissions rather than on the needs of the insured we argue that contingent commission payments which while directly paid by the insurer are ultimately paid by the insured through higher premiums are beneficial to insureds because they provide an incentive for the broker to place their coverage with an insurer that is charging an adequate premium we contend that although inadequate premiums are perhaps good for the insured in the short term in the longer term inadequate premiums will result in price hikes or coverage restrictions that are harmful to the insureds our empirical analysis demonstrates that insurers

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

price dynamics in uk manufacturing a microeconomic view this paper examines the response of prices to cost and demand shocks in seventy five three digit and four digit industries in the united kingdom during the 1980s the results suggest that prices responded sluggishly to costs but virtually not at all to demand the short run response to materials and fuel shocks was much larger than the response to unit labor cost shocks and some of this difference persisted into the long run prices responded more sluggishly to cost and demand shocks when aggregate inflation was lower and finally pricing dynamics were more sluggish in less competitive industries copyright 1992 by the london school of economics and political science

relative price variability and inflation a disaggregated analysis relative price variability has been studied at the cross sectional intermarket level this paper addresses the equally important phenomenon of intramarket variability the dispersion of commodity price movements around the industry average using quarterly price data for 80 disaggregated commodity groups in the united kingdom from 1974 to 1984 the paper investigates the determinants of intramarket price variability and replicates some previous crosssectional tests for the united kingdom intermarket price variability is found to be positively related to inflation which confirms previous results for the united states and other countries intramarket variability is found to be positively related to the average market rate of price change but the strength of this relationship appears to be inversely related to the level of industry concentration these results generally support the propositions and findings reported by stigler and kindahl