Insurance Guaranty Research Articles

Insurance on Insurers: How State Insurance Guaranty Funds Protect Policyholders

Insurance on Insurers: How State Insurance Guaranty Funds Protect Policyholders

Insurance on Insurers: How State Insurance Guaranty Funds Protect Policyholders

Insurance on Insurers: How State Insurance Guaranty Funds Protect Policyholders

Insurance guaranty premiums and exchange options

Insurance guaranty premiums and exchange options

Currency Uncertainty, Interest Guarantee, and Risk-Based Premiums in Life Insurance Guaranty Schemes

Abstract This paper investigates risk-based premiums in ex-ante insurance guaranty schemes. Exchange rate risk is incorporated into the asset portfolio to reflect the growing practice of life insurers taking offshore risks for yield enhancement. The closed-form solutions of the risk-based premium charged by the insurance guaranty fund are derived. Our premium rating includes currency mismatches between assets and liabilities, and the effects of early closure, capital forbearance, and grace periods are fully explored. First, we discover that the insurance guaranty fund premium is underestimated if currency fluctuation uncertainty is overlooked. Second, the premium is higher under regulatory forbearance than it is under the Merton stock put option, which implies that the cost is substantial. Finally, we note that the premium increases with higher financial leverage and greater foreign exposure in the asset portfolio. The results of our analysis provide further insight for regulators to implement regulatory policies and insurance guaranty schemes.

An examination of catastrophes, insurance guaranty funds and contagion risk

Many countries have formalised solvency insurance programmes that provide payments to policyholders of insolvent insurers. Like most insurance schemes, these programmes operate most effectively when failures are firm-specific. Using Canada as a case study, we examine the issue of using ex post guaranty fund assessments following a peak peril loss resulting in the simultaneous failure of multiple insurers. In this case, the guaranty fund assessment levied on surviving insurers is so large that it causes a contagion effect: several insurers fail because of the assessment, and the end result is the collapse of the entire industry. We conclude with a discussion of possible policy alternatives to address this issue, including increasing prudential requirements, changing the ex post funding mechanism, prefunding the guaranty fund for a peak peril loss, using the government as the insurer of large catastrophic losses, or developing public–private partnerships. We highlight both prudential and public policy implications of each of these alternatives and make recommendations for countries that face a large peak peril relative to the size of the private insurance industry.

The Florida insurance market: an analysis of vulnerabilities to future hurricane losses

Florida is the peak zone for hurricane risk. The authors evaluate the current vulnerabilities and risks associated with the residential property insurance system in Florida and its financial capability to respond to future hurricane events. The state's residential property insurance system is composed of private insurers and Florida's three public risk financing entities: Citizens Property Insurance Corp. (Citizens), the Florida Hurricane Catastrophe Fund (FHCF) and the Florida Insurance Guaranty Association (FIGA). The Florida residential insurance market has been transformed since the last Category 5 hurricane--Andrew--made landfall, and the current system has not been tested with a major hurricane loss. The authors used the characteristic event (CE) methodology to analyze the impacts of 20-, 50- and 100-year hurricanes on the Florida market from both a micro and a macro perspective. Using a set of realistic assumptions, the analysis illustrates and quantifies Florida's vulnerabilities to hurricane losses by estimating the numbers of private insurer insolvencies and resulting impacts on Florida's public risk financing entities for each of the hurricane scenarios.

New Jersey Appellate Division Affirms Allocation to Insured for Pre-December 2004 Insolvencies

ABSTRACTThe New Jersey Appellate Division has held that in long-tail allocation cases, the policyholder remains responsible for amounts allocable to insurers who became insolvent before December, 2004, and that the rule announced in Farmers Mutual Fire Ins. Company of Salem v. N.J.P.L.G.A. does not apply to such insolvencies because the Legislature specifically provided that the statutory amendments that formed the basis for the Farmers Mutual decision applied prospectively from their effective date. The decision confirms that for insolvencies that took place before the amendments' effective date, New Jersey's common law rule that the policyholder bears the risk of insolvencies and is responsible for shares allocable to them still applies. The Court's decision strengthens insurers' arguments that Farmers Mutual did not alter the common law rule for policies that are not subject to the 2004 amendments to New Jersey's Property-Liability Insurance Guaranty Association Act or Surplus Lines Insurance Guaranty Fund Act.

Response to Xiao Wang on His Comments on Our Paper Entitled, “Capital Forbearance, Ex Ante Life Insurance Guaranty Schemes, and Interest Rate Uncertainty”

Response to Xiao Wang on His Comments on Our Paper Entitled, “Capital Forbearance, Ex Ante Life Insurance Guaranty Schemes, and Interest Rate Uncertainty”

Discussion on “Capital Forbearance, Ex Ante Life Insurance Guaranty Schemes, and Interest Rate Uncertainty,” by Ya-Wen Hwang, Shih-Chieh Chang, and Yang-Che Wu, Volume 19(2)

Discussion on “Capital Forbearance, Ex Ante Life Insurance Guaranty Schemes, and Interest Rate Uncertainty,” by Ya-Wen Hwang, Shih-Chieh Chang, and Yang-Che Wu, Volume 19(2)

Guaranty Funds, Government Shareholding and Risk Taking: Evidence from China

This study examines the risk-subsidy, monitoring and ownership structure hypotheses in relation to guaranty funds using a sample from the Chinese insurance industry. Compared to the American model, Chinese insurance guaranty funds possess the following distinct features: pre-assessment, separate accumulation and partial responsibility for peer bankruptcy. We find that the risks of insurance firms decline following the establishment of guaranty funds. Pre-assessment provides a limited risk incentive to insurers and one that is easily offset by stakeholder monitoring. In terms of the ownership structure hypothesis, we find that foreign insurers are more risk-driven than their state-controlled counterparts. Our findings have implications for countries striving to lessen the adverse effect of guaranty funds as well as for the improvement of insurance regulation policy in China.

Capital Forbearance, Ex Ante Life Insurance Guaranty Schemes, and Interest Rate Uncertainty

Insurance guaranty funds have been adopted in many countries to compensate policyholders for losses resulting from insurers’ insolvencies. In this article we focus on the risk-based premiums in ex ante insurance guaranty schemes since a preassessment mechanism could reduce the shareholders’ incentive to engage in risk-taking behavior. We derive the closed-form solutions of the risk-based premium charged by the insurance guaranty fund in a setting that incorporates financial leverage, asset allocation, early closure, and capital forbearance during the grace period. Most importantly, we assume that the interest rate is stochastic, and we find that the premium is underpriced if the uncertainty of the interest rate is neglected by the insurance guaranty fund. Moreover, the influence of stochastic interest rate for the premium is more significant when we consider the capital forbearance mechanism. The impacts of the key factors in our model that decide the fair premium of the guaranty fund are examined numerically. The results of our analysis could provide valuable insights for regulators in terms of revising regulatory policies and insurance guaranty schemes.

Just When You Thought You Understood New Jersey Allocation Law: Implications, Limitations, and Complications in Applying Farmers Mutual Fire Ins. Co. of Salem v. New Jersey Property-Liability Ins. Guar. Ass’n

The New Jersey Supreme Court's recent decision in Farmers Mutual Fire Insurance Company of Salem v. New Jersey Property-Liability Insurance Guaranty Association holding that a 2004 statutory amendment requires all solvent triggered liability policies be exhausted before the Guaranty Association pays statutory benefits for an insolvent's share has created many uncertainties in allocating long-tail liabilities. This article discusses the implications and the significant limitations of the Farmers Mutual decision and the questions it leaves unanswered, and responds to arguments that the decision supports revisiting other situations where New Jersey's Owens-Illinois methodology allocates losses to the insured.

Public Policy Considerations Concerning Insurance Bad Faith and Residual Market Mechanisms

As insurance bad faith liability has evolved in the past four decades, liability for bad faith has not stopped with private insurance companies. In a number of states, state-sponsored insurance entities have been established to provide insurance coverage in residual markets where it is generally otherwise unavailable. The question of whether first-party insurance bad faith liability should be extended upon a state-run property insurer is an unresolved one in many jurisdictions. This paper contributes to the contemporary literature regarding bad faith in insurance by comprehensively analyzing the history of, the nature of the claims associated with, and public policies concerning the imposition of bad faith liability upon state-run property insurers. This paper makes its contribution by arguing that courts should not impose first-party bad faith liability on state-run property insurers who operate in the residual property insurance market.This paper begins by providing an overview of the role of residual insurance market entities of the state and federal governments. The second and third parts of the paper discuss the Oubre v. Louisiana Citizens Fair Plan case of the Louisiana Supreme Court and the Citizens Property Ins. Corp. v. San Perdido Assoc., Inc. litigation in Florida and their applicability concerning the immunity issue.The final part of the paper analyzes the policies and issues surrounding the holding of bad faith liability upon state-run property insurers. The first section of the final part examines the public policy considerations of reported cases which have addressed whether a state insurance guaranty association can be held liable for insurance bad faith claims. State insurance guaranty associations provide an appropriate comparison with state-run property insurers since bad faith claims have also been proferred against them. The second section of the final part discusses the policy rationales behind the bad faith remedy and the specific issue of the relationship between bad faith awards and assessments which are typically levied on most insurers. Finally, examining the case of Florida in particular, this paper examines the arguments concerning legislative intent on the conferral of immunity.

Proposal for a capital market-based guaranty scheme for the financial industry

In this paper, we introduce a capital market-based financial guaranty system as an alternative to current insurance guaranty funds and deposit insurance systems. The guaranty system secures clients’ claims for the event of default by the financial company using a special purpose vehicle which issues bonds to investors. The proposed system, analogous to a credit-linked note, consists of one guaranty vehicle for each financial company. In a first step, we present equations in order to derive the two main input parameters of the special purpose vehicle: the premium and the principal. Subsequently, we analyze the impact of different investment actions taken by the financial companies protected by the guaranty vehicle on various shortfall measures. We find that it will be necessary to restrict the investment volume of investors from the financial industry in order to avoid systematic risk within the proposed guaranty scheme. By deriving practical implications, we show that the capital market-based solution has some key benefits compared to current deposit insurance and insurance guaranty schemes.

The Bankruptcy Cost of the Life Insurance Industry Under Regulatory Forbearance

In this study the Taiwan Insurance Guaranty Fund (TIGF) is introduced to investigate the ex ante assessment insurance guaranty scheme. We study the bankruptcy cost when a financially troubled life insurer is taken over by TIGF. The pricing formula of the fair premium of TIGF incorporating the regulatory forbearance is derived. The embedded Parisian option due to regulatory forbearance on fair premiums is investigated. The numerical results show that leverage ratio, asset volatility, grace period, and intervention criterion influence the default costs. Asset volatility has a significant effect on the default option, while leverage ratio is shown to aggravate the negative influence from the volatility of risky asset. Furthermore, the numerical analysis concludes that the premium for the insurance guaranty fund is risk sensitive and that a risk-based premium scheme could be implemented, hence, to ease the moral hazard.

Comparison of Stakeholder Perspectives on Current Regulatory and Reporting Reforms

AbstractIn the European insurance industry, regulatory and reporting frameworks are currently subject to far‐reaching reforms. We focus on four of these frameworks, namely the Solvency II framework, insurance guaranty systems, the proposed IFRS 4 Phase II international accounting standards, and Market Consistent Embedded Value reporting. We present these frameworks, analyze them from the insurance company's management, investors, and policyholder perspectives, and compare them. Our analysis implies that the four frameworks need to be considered jointly, due to various interrelations and interactions. We argue that a coordinated introduction will be necessary to ensure that the regulatory burden is reduced and synergies can be utilized in the event of all four frameworks being implemented as planned. Furthermore, we analyze the challenges of a holistic, comprehensive approach to insurance reporting and regulation and its implementation in order to achieve the goals set by the frameworks.

The Impact of Introducing Insurance Guaranty Schemes on Pricing and Capital Structure

AbstractThe introduction of an insurance guaranty scheme can have significant influence on the pricing and capital structures in a competitive market. The aim of this article is to study this effect on competitive equity–premium combinations while considering a framework with policyholders and equity holders where guaranty fund charges are volume‐based, as levied in existing schemes. Several settings with regard to the origin of the fund contributions are assessed and the immediate effects on the incentives of the policyholders and equity holders are analyzed through a one‐period contingent claim approach. One result is that introducing a guaranty scheme in a market with competitive conditions entails a shift of equity capital towards minimum solvency requirements. Hence, adverse incentives may arise with regard to the overall security level of the industry.

Under What Conditions Is an Insurance Guaranty Fund Beneficial for Policyholders?

AbstractIn this article, we derive conditions in an imperfect market setting, under which the introduction of a self‐supporting insurance guaranty fund improves the position of the policyholders. When a guaranty fund is advantageous given homogeneous firms in the market, all policyholders benefit from it to the same extent, if they have the same underlying risk preferences and are charged identical premiums. In a more realistic heterogeneous setting, the introduction of an insurance guaranty fund is in general no longer beneficial for all policyholders in the same manner. Hence, systematic wealth transfers take place between the policyholders of different insurance companies. As a possible solution, and in order to counteract this effect, we introduce a framework for utility‐based fund charges.

Insurance Guaranty Schemes in a Contingent Claims Setting

The introduction of an insurance guaranty scheme can have significant influence on the pricing and capital structures in a competitive market. This contribution summarizes the major findings of a working paper written by Schmeiser and Wagner (Working Papers on Risk Management and Insurance (IVW-HSG), No. 80, 2010). The effect on competitive equity-premium combinations is studied while considering a framework with policyholders and equity holders where guaranty fund charges are volume-based, as levied in existing schemes. Several settings with regard to the origin of the fund contributions are assessed and the immediate effects on the incentives of the policyholders and equity holders are analyzed through a one-period contingent claim approach. One result is that introducing a guaranty scheme in a market with competitive conditions entails a shift of equity capital towards minimum solvency requirements. Hence adverse incentives may arise with regard to the overall security level of the industry.

On the Economics of Postassessments in Insurance Guaranty Funds: A Stakeholders’ Perspective

This article proposes a model that suggests there are contagion effects among members of an insurance guaranty fund when postassessments are charged to all other insurers upon the failure of a member company. Indeed, these extraordinary payments are shown to increase the default rate of other firms in the industry, ultimately lowering the value of corporate claims as well as government tax claims. The model is also used to examine the efficiency of different recoupment mechanisms (both existing and new) used by regulators and insurers to potentially reduce these contagion effects. Analysis allows us to stipulate the conditions under which a “tax carryforward” provision could be more efficient than the usual recoupment mechanisms known as “premium rate surcharge” and “premium tax credit.”