April 14th, 2009

Manage the Cycle, Part VI: Step Out of Cyclical Thinking

Posted at 12:30 AM ET

venter_gary_thumbGary Venter, Adjunct Professor, Statistics, Columbia University

The cycle is a myth, albeit a popular one. The recognition of patterns leads many to believe that the market is due for an event after a certain period of time has passed. The reality, though, is that there is no substitute for disciplined risk and capital management, regardless of when the last disaster occurred. Instead of thinking about cycles, think about risk. Think about capital.

The illusion of cyclicality entails the inherent danger of failing to prepare for the unexpected. Seemingly off-cycle catastrophes can burn through balance sheets, jeopardize earnings, and even threaten solvency. Risk and capital management are ongoing endeavors, and insurers and reinsurers must remain vigilant, as the most profound risks are those not expected.

Maintaining a constant state of preparedness has been demonstrated to work. At the beginning of 2008, carriers had an abundance of capital and were looking back on a streak of quiet years. Twelve months later, the industry has survived the dual shocks of September and started the new year unsure of what even the near future holds. The extra capital on hand softened the blow. The beginning of 2009, therefore, does not resemble the beginnings of 1993, 2002, or 2006. Insurers and reinsurers were ready, as reflected by the outcome of 2008.

The conclusion of 2008 highlights the fact that every event has a unique set of consequences. Carrier capital management, rather than “cycle management,” is the reason.

As the tools of the risk management trade continue to evolve, the apparent evidence of cyclicality will become harder to find. This has already been seen in the private-passenger automobile line, and their management practices are spreading. Post-event peaks will not reach so high, and the plunges associated with disaster events will be shallower. The space in between — long the domain of risk and capital managers — will remain the period in which carriers stand watch over their portfolios, steeling their balance sheets for the unknown.

Gary Venter was previously a Managing Director in Guy Carpenter’s Instrat® Unit

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