Underwriting Cycles in Property-Casualty Insurance: The Impact of Catastrophic Events

Abstract

This paper challenges the question of existence and predictability of underwriting cycles in the U.S. property and casualty insurance industry. Using an approach in the frequency domain, we demonstrate the existence of a hidden periodic component in annual aggregated loss ratios. The data support an underwriting cycle length of 8–9 years. Going beyond previous research and studying almost 30 years of quarterly underwriting data, we can improve forecasting performance by (dis)connecting cycles and catastrophic events. Superior out-of-sample forecast results from models with intervention variables flagging the time point of catastrophic outbreaks is achieved in terms of mean squared/absolute forecast errors. We evaluate model confidence sets containing the most accurate model with a certain confidence level. The analysis suggests that reliable forecasts can be achieved net of the irregular major peaks in loss distributions that arise from natural catastrophes as well as unusual “black swan” events.