Insurance Firms’ Capital Adjustment, Profitability, and Insolvency Risk Under Underwriting Cycles

52 Pages Posted: 18 Oct 2015

Date Written: October 16, 2015

Abstract

For insurance firms, underwriting and investment strategies are defined as the dollar weights allocated to underwriting activities (direct premium, net reinsurance, etc.) and the investment of assets respectively. Using a sample of 83 Canadian property-liability insurance companies for 1996 to 2010, we first examine the impact of underwriting and investment strategies on both the level and speed of insurers’ capital adjustment. Then, we investigate how these factors affect the solvency and profitability of Canadian property and casualty insurers. We find that the need to use retained earnings that have been accumulated in soft markets forces insurers to increase their profitability to withstand upcoming hard market conditions, triggering a new stage of the insurance cycle. In addition, we show that, in hard markets, when insurers are reluctant to take on new risk and when market power increases due to higher concentration, not only does the capital level decrease but so do profitability and solvency. Our observations, while suggesting the need for greater regulatory vigilance in hard markets, might support a through-the-cycle approach to monitoring capital adequacy based on the insurance cycle.

Keywords: Capital adjustment level/speed, Insolvency risk, Profitability, Underwriting cycles, Property-liability insurance

JEL Classification: G22, G32, C23

Suggested Citation

Guidara, Alaa and Lai, Van Son, Insurance Firms’ Capital Adjustment, Profitability, and Insolvency Risk Under Underwriting Cycles (October 16, 2015). Available at SSRN: https://ssrn.com/abstract=2675353 or http://dx.doi.org/10.2139/ssrn.2675353

Alaa Guidara

Université Laval ( email )

Faculty of Business Administration
2325, Terrasse Street
Quebec, Quebec G1V 0A6
Canada

Van Son Lai (Contact Author)

Université Laval ( email )

FSA ULaval
Quebec G1V 0A6
Canada
418-656-2131, x3943 (Phone)

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