What Is an Insurance Cycle?

The insurance cycle is a boom and bust pattern seen in the insurance industry in response to economic pressures and insurable events. It is also known as the underwriting cycle and can play an important role in the financial solvency of insurance companies, as they may need to be able to predict and manage the cycle to stay in business. Patterns in the insurance industry are a topic of interest for economists because they can interact with the larger economy, given that insurance, reinsurance, and related services make up a large segment of the economy. Health insurance, for example, generates substantial economic activity in the United States.

At the start of the insurance cycle, conditions are soft. Numerous companies are active in the industry and they compete for customers, which keeps premiums very low because firms need to be able to undercut the competition. As insurable events occur, especially major disasters like hurricanes, insurers are forced to make large payouts to honor their policies.

Smaller firms that are undercapitalized as a result of their low premiums may go out of business because they cannot afford to bear the burden of the claims. Reinsurance companies who covered other claims can also get into financial trouble because they are suddenly obligated to make good on multiple claims. This sets off a chain of events leading a bust and a contraction in the size of the insurance industry, which causes premiums to rise because there are fewer competitors. Insurance companies are also more wary about risks after seeing other companies flounder as a result of low premiums.

As the industry recovers, more firms start offering insurance and existing companies may expand their product lineups and drop premiums to remain competitive. This results in a return to the soft market, which sets up the insurance cycle for another bust. It may take a decade or more for the industry to move through a complete cycle, and it can be heavily influenced by world events; a series of natural disasters, for example, could accelerate industry contraction.

Researchers study the insurance cycle to look at previous patterns and predict future ones. Analysts working in the industry have a direct interest in pinpointing the current place in the insurance cycle so they can advise firms on financial decisions. These predictions can be challenging to make, as it is often difficult to identify financial cycles from within; hindsight often allows people to spot clues they missed at the time.