The Fluctuations of Insurers’ Risk Appetite

Abstract

The risk appetite of insurance companies fluctuates over time in a quasi cyclical fashion. When their capitalization is high (low), companies choose portfolios with a high (small) share of risky assets. We show that this phenomenon has the same source as the underwriting cycle, namely recapitalization costs. We build a dynamic stochastic general equilibrium model of the insurance sector where financial frictions prevent companies from maintaining a target leverage. Portfolio decisions of insurers fluctuate with their aggregate capitalization. The model rationalizes two apparently disjoint pieces of evidence: long-standing empirical evidence on underwriting cycles and more recent evidence on the fluctuations of insurance companies’ risk appetite.

JEL codes

Reference

Elisa Luciano, and Jean-Charles Rochet, “The Fluctuations of Insurers’ Risk Appetite”, Journal of Economic Dynamics and Control, vol. 144, 2022, p. 104543.