Underwriting Cycle
The underwriting cycle describes recurring fluctuations in the insurance market between “soft” and “hard” conditions. These swings—typically spanning several years—affect competition, capacity, pricing, profitability, and insurers’ underwriting standards.
Key takeaways
- The cycle alternates between soft markets (high competition, low premiums, looser underwriting) and hard markets (reduced competition, higher premiums, stricter underwriting).
- Triggering events—large catastrophes or spikes in claims—often shift the market from soft to hard by reducing capacity and capital.
- Many insurers respond to soft markets by prioritizing short-term growth over long-term stability, which helps perpetuate the cycle.
- Effective management focuses on capital discipline, prudent pricing, reinsurance, and long-term risk controls.
How the cycle works
- Soft market phase
- Excess capacity and many competitors push premiums down.
- Underwriting standards loosen to grow volume.
- Shock event or accumulation of losses
- Natural disasters, large claim years, or insurer insolvencies create a surge in payouts and losses.
- Hard market phase
- Weaker insurers exit or shrink, reducing capacity.
- Remaining insurers tighten underwriting and raise premiums, improving profitability.
- Re-entry and softening
- As losses subside and profits return, new entrants or expanding incumbents increase capacity.
- Competition rises, pricing softens, and underwriting standards ease—starting a new cycle.
Why the cycle persists
- Short-term incentives: Firms often chase market share during soft periods, sacrificing reserve strength and pricing adequacy.
- Pricing uncertainty: Insurers must set premiums based on uncertain future losses, which is inherently difficult.
- Market dynamics: Capital inflows and outflows respond to recent results—attractive profits draw entry; heavy losses trigger exits—reinforcing cyclicality.
Managing the underwriting cycle
Eliminating the cycle is unlikely, but insurers can reduce its impact through disciplined risk and capital management:
Explore More Resources
- Capital and reserves
- Maintain conservative reserves and surplus to absorb adverse loss years.
-
Build contingency funds or “rainy day” accounts rather than distributing all profits.
-
Pricing discipline
- Set premiums to reflect expected long-term loss costs plus adequate margin for volatility.
-
Resist competitive pressure to underprice, especially after profitable periods.
-
Underwriting standards
- Enforce strict underwriting rules and risk selection criteria regardless of market softness.
-
Use data analytics to better assess exposures and price appropriately.
-
Reinsurance and risk transfer
- Purchase reinsurance to cap catastrophic losses and stabilize results.
-
Use alternative risk transfer (cat bonds, insurance-linked securities) where appropriate.
-
Diversification
-
Spread risk across products, geographies, and lines to reduce concentration and sensitivity to specific events.
-
Long-term performance metrics
-
Emphasize economic capital, combined ratio over cycles, and return on risk-adjusted capital rather than short-term growth metrics.
-
Regulatory and industry measures
- Robust regulation and prudent supervision can encourage solvency and discourage excessive risk-taking.
- Industry-wide loss modeling and transparency help improve pricing and capacity decisions.
Exceptions and notes
- Life insurance is generally less subject to underwriting cycle effects because mortality and morbidity can be estimated with greater actuarial certainty, reducing pricing volatility.
- The cycle has been recognized for decades; managing it remains a central strategic challenge for insurers.
Conclusion
The underwriting cycle is a long-standing feature of insurance markets driven by shifts in capacity, competition, and claims experience. While it cannot be fully eliminated, insurers that prioritize capital strength, disciplined pricing, prudent underwriting, and diversified risk transfer can better withstand cyclical swings and preserve long-term stability.