2005) “Firm-Level Data Analysis of the Effects of Net Investment Income on Underwriting Cycles: An Application of Simultaneous Equations

Abstract: This study tests two major theories of insurer underwriting cycles and extends the hypotheses to explain insurers ’ reserving behaviors. By applying a simul-taneous equations model to cross-sectional and time-series firm-level data, this study proposes that insurers ’ net investment income can be used to explain both hypotheses regarding processes for establishing premiums and reserves. Our results confirm that the industry cycle phenomenon is reflected in individual firm dynamics. We find that net investment income is inversely related to both premiums and loss reserves, as expected, and we identify how the magnitudes of these effects correspond to the phases of the underwriting cycle. The results indicate that the effects are greatest in the hard market of underwriting cycles. Moreover, the yearly differential responses of premi-ums and reserves to net investment income are coincident with the formation of cycles. [Keywords: underwriting cycles, investment income, simultaneous equations