The Winner’s Curse in Insurance and Underwriting Cycles

Abstract

In this paper, we develop a simple economic model to explain how an entrant insurer may suffer the winner’s curse in the sense that the entrant insurer’s risk pool is less profitable than that of an incumbent insurer. In addition, we exploit the strategic interactions and the pricing dynamics between entrant and incumbent insurers to describe the formation of an insurance underwriting cycle. Empirical tests based on the predictions of our economic models are conducted in the homeowners and product liability insurance markets for the period 1995-2001. We find that (1) the winner’s curse is present in the product liability insurance market, but not in the homeowners insurance market; and that (2) larger insurers tend to be more profitable in underwriting than their smaller competitors.