Interest rates and insurance price cycles

Abstract Property liability insurance prices and profits appear to move in a six year cycle. The common explanation for the cycle amongst many industry analysts is that the insurance market is inherently unstable and that prices fail to converge on clearing levels. Our explanation is different. We identify spot equilibrium prices using the Capital Asset Pricing Model. But informational, regulatory and contractual lags preclude instantaneous adjustment. We therefore model the temporal movement of prices using a partial adjustment model in which actors form rational expectations. The actual movement of insurance prices does seem to track closely those estimated by the partial adjustment model. The cycle may be better viewed as a series of converging responses to changing spot prices.