Insurance Cycles: Interest Rates And The Capacity Constraint Model

Although financial pricing models imply that profits of property-liability insurance firms should conform to an unpredictable time series process, cycles are widely reported. We show that changes in interest rates simultaneously affect the insurer’s capital structure and the equilibrium level of underwriting profit. Depending on factors such as 1) asset and liability durations, 2) access to capital markets, and 3) availability of capital substitutes such as reinsurance, insurers will be differently affected by changing interest rates. Over time, we find that the average market response to changing interest rates roughly tracks market clearing prices, although the response is somewhat muted. However, firms with mismatched assets and liabilities, as well as those with more costly access to new capital and reinsurance, are more likely to respond to interest rate changes by either rationing supply or instituting abnormal price changes.

Insurance Cycles: Interest Rates And The Capacity Constraint Model,” (with Neil A. Doherty), Journal of Business, Vol. 68, No. 3 (July 1995), pp. 383-404.

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