Risk, information lag, and underwriting cycles in property-liability insurance industry: An application in automobile insurance

The primary purpose of this thesis is to find explanations for the unanswered questions for underwriting cycles in property-liability insurance which include the differences between underwriting profit patterns of lines and the rationality of pricing decisions. Based on rational expectations theory, this thesis provides a theoretical justification that cycles can also be generated through rational pricing decisions and suggests that loss settlement delays are the reason for the differences in profit patterns among lines. This thesis also provides empirical analyses of pricing decision based on the U.S. automobile insurance data during 1975-1988. The test results suggest that the rational expectations hypothesis cannot be rejected for either liability insurance or physical damage insurance, and that the surprise effect affects rate-making in liability insurance but not in physical damage insurance. Besides, the results suggest that rate regulation has an impact on information delays for pricing decision. This thesis concludes that information lag is an important reason for underwriting cycles. Information lag results in part from the loss settlement delays, an inherent feature of property-liability insurance, while rate regulation exaggerates the length of lag