Does cash flow underwriting work? Evidence from the U.S. insurance markets

This research delves into the cash flow underwriting in the U.S. property-casualty insurance market, a strategic approach in which insurance companies trade off underwriting profits in hopes of higher investment returns. Spanning from 1954 to 2023, this study utilizes nonlinear autoregressive distributed lag (NARDL) and multiple threshold NARDL (MTNARDL) models to uncover how interest rate fluctuations affect underwriting profits and investment income ratios. We discovered compelling differences: while the short-tail line aligns with rational market behavior, the long-tail line reacts significantly, echoing the nature of cash flow underwriting. At the aggregate industry level, the dominance of cash flow underwriting in the long run is primarily driven by these long-tail business lines, which account for a substantial share of underwriting exposure. Furthermore, a pattern of long-run asymmetric adjustment is also observed between investment income ratios and interest rates, indicating that while underwriting profits decline with rising interest rates, investment income can offset these losses to a certain extent. Through asymmetric causality tests, we further illustrate how positive and negative interest rate shocks uniquely influence profitability across various business lines. This study not only bridges conflicting theories of rational markets and strategic underwriting but also equips industry stakeholders with critical insights to navigate the complex rhythms of the insurance market.