INSURANCE CYCLES - INTEREST-RATES AND THE CAPACITY CONSTRAINT MODEL

Insurance profits exhibit cyclical behavior that has been attributed to capital market constraints. We show that changes in interest rates simultaneously affect the insurer's capital structure and the equilibrium underwriting profit. Depending upon asset and liability maturity structure, capital market access, and reinsurance availability, insurers will be differently affected by changing interest rates. We find that the average market response to changing interest rates roughly tracks market clearing prices. These ''cyclical'' effects are enhanced for firms with mismatched assets and liabilities and more costly access to new capital and reinsurance. This evidence supports the capacity constraint hypothesis.