Property-liability Insurance Research Articles

Adverse Selection in Reinsurance Markets

This paper looks for evidence of adverse selection in the relationship between primary insurers and reinsurers. We test the implications of a model in which informational asymmetry—and therefore, its negative consequences—decline over time. Our tests involve a data panel consisting of U.S. property-liability insurance firms that reported to the National Association of Insurance Commissioners during the period 1993–2012. We find that the amount of reinsurance, insurer profitability, and insurer credit quality all increase with the tenure of the insurer–reinsurer relationship.

Solvency Prediction for Property-Liability Insurance Companies: Evidence from the Financial Crisis

The financial crisis of 2008 generated sizeable losses in the financial sector around the world. Because regulators are used for predicting insurers’ financial strength in order to detect financially distressed firms as early as possible, we question how reliably regulators can forecast financial strength, especially during a financial crisis. We use the company-level data of German property-liability insurers from 2004 to 2011 to examine factors that affect the insurer’s regulatory solvency ratio. Furthermore, we develop a prediction model to classify the insurers regarding their financial strength. We show that, in particular, the lagged solvency ratio can be used to predict the future regulatory solvency ratio irrespective of the economic conditions. Thus, our results imply that German regulators are able to detect insurers in financial distress early enough to take appropriate actions to protect policyholders’ interests. Our results do not support the adoption of tighter regulations or higher capital requirements.

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.

Corporate Governance and Cash Holdings: Evidence From the U.S. Property–Liability Insurance Industry

AbstractThis article examines the impact of board and finance committee characteristics on insurers' cash holdings using a sample of 1,454 U.S. stock property–liability insurer‐year observations. We focus on the roles of independent board members and independent finance committee members. Our results suggest that independent board members allow managers to hold excess cash holdings to avoid underinvestment and play a monitoring role in managers' cash spending behavior in a regulated industry. The overall findings are consistent with the independent director responsibility hypothesis, which suggests that independent directors play a monitoring role in managers' cash spending behavior and avoiding underinvestment problems.

Cyclicity in the French Property–Liability Insurance Industry: New Findings Over the Recent Period

AbstractThis article reinvestigates the presence and the causes of the underwriting cycle in the French property–liability insurance industry as displayed by the combined ratio for the 1963–2008 period. The question is still a timely issue if we refer to regulation issues and the recent proposals in the Solvency framework to take into account the fluctuations of the profitability in specifying the solvency capital requirement. In the literature, two approaches are traditionally adopted to investigate the underwriting cycle. The first one refers to an endogenous characterization of the cyclical properties from an AR(2) model. The second one claims that the cycle in the property–liability insurance has exogenous sources related to the financial markets and the general economy. In this article, we reconcile the two approaches by using a smooth transition regression model. This model shows that the AR(2) model is relevant in a first regime where the capacity constraint is binding. In contrast, the fluctuations in the combined ratio are positively influenced by the lagged stock market return in a second regime where the capacity is not constrained, as for the most recent period. Moreover, we find that the current capacity is related to the lagged inflation rate in the latter case. These results confirm the idea that the European rules regarding the solvency capital requirement for insurance companies should take into account the state of the economy and the financial markets.

Property Insurance and Liability Insurance of Pharmacists and Pharmacies in the Olsztyn Market

This article brings up a very important and current issue concerning the insurance of pharmacists and pharmacies. The aim of the research undertaken was to present the range and factors determining the choice of insurance products for pharmacies and pharmacists operating in Olsztyn. The study is focused on products ensuring protection for the properties owned and used in pharmacies, as well as third-person liability insurance related to the business activity and to the professional practice of a pharmacist. It identifies the most popular insurances in the examined population and specifies the factors determining their choice.

Information Risk and the Cost of Capital

AbstractThis article applies a unique accruals measure to empirically test whether accruals quality affects the cost of capital for property–liability insurers. We utilize insurer loss reserve errors to accurately measure the quality of accruals. This measure, as well as conventional accruals measures, is used to investigate the extent to which accruals quality is priced into both debt and equity capital. We find that accruals quality is priced into debt capital; however, we find virtually no evidence that accruals quality is priced into equity capital. Our results should be of particular interest to insurers as it affects pricing ability. Specifically, insurers who provide primary debtholders (i.e., policyholders) less information risk are able to command higher prices. Furthermore, our results suggest that insurance is not a diversifiable asset.

Deriving the minimal amount of risk capital for property-liability insurance companies utilizing asset liability management

Deriving the minimal amount of risk capital for property-liability insurance companies utilizing asset liability management

Risk-Based Capital and Firm Risk Taking in Property-Liability Insurance

This research investigates the relationship between capital and risk in property-liability insurers from 1993 to 2007. Three-stage least squares estimation is used to investigate the relationship between capital and two types of risk: underwriting and asset risk. Overall the results suggest that risk and capital are positively related, so that capital increases are associated with increases in investment and underwriting risk. This positive relationship was not consistently significant in 1993, prior to the implementation of risk-based capital (RBC) requirements. Both under-capitalised insurers and marginally adequately capitalised insurers adjusted their capital and risk towards firm targets at a higher speed than well-capitalised insurers in the post-RBC period. But underwriting and asset risk also increased for less well-capitalised insurers.

The Relationship Between Regulatory Pressure and Insurer Risk Taking

AbstractThe article examines the risk‐taking behavior of property–liability insurers in the presence of risk‐based capital regulation. An option pricing model is developed to evaluate the expected regulatory cost and predict a nonlinear relationship between regulatory pressure and insurers’ risk taking. We then conduct an empirical test using the simultaneous threshold regression. The result shows that there is a threshold effect of regulatory pressure on insurer risk taking. Poorly capitalized insurers seem to be aware of their proximity to regulatory interventions but do not fully respond to the impending regulatory pressure. This implies either regulatory interventions are not costly enough or they are too late, or both.

Coupling a memetic algorithm to simulation models for promising multi-period asset allocations

The use of simulation models to manage and regulate property–liability insurers has gained in popularity over the last decade. This paper introduces a hybridized search optimization algorithm, also known as a Memetic Algorithm, for use with these insurer simulation models. The proposed algorithm combines the merits of both local and global search optimization techniques, and provides an efficient and robust approach for insurance model application. Our research investigated whether this enhanced optimization algorithm could further improve the results of a simulation model. As part of this investigation, a company-wide simulation model of a property–liability insurer was coupled with the proposed hybrid algorithm to tackle a typical multi-period asset allocation problem. The resulting asset allocations obtained by the proposed memetic algorithm coupled with the simulation model demonstrated better results than currently available investment strategies. The significant and robust improvements put forth in the present research demonstrate the great potential of our multi-phase hybrid algorithm in enhancing simulation model capabilities.

Quantile Regression Analysis of Corporate Liquidity: Evidence from the U.S. Property–Liability Insurance Industry

This study analyses the determinants of corporate liquidity for the U.S. property–liability insurance industry from 2006 to 2010. Unlike previous studies using the ordinary least squares (OLS) approach, this study applies the quantile regression (QR) method. The QR method provides further insights on how insurers’ liquidity level is determined, especially for the firms at the lower and the higher quantiles. We found that leverage and organisational structure have opposite effects on insurers’ liquidity in the lower and the higher quantile groups. The empirical results also show that most firm-specific characteristics and macroeconomic conditions influence the insurers’ liquidity, which are consistent with the findings of the OLS approach in previous studies.

Efficiency and Productivity in the US Property-Liability Insurance Industry: Ownership Structure, Product and Distribution Strategies

Efficiency and Productivity in the US Property-Liability Insurance Industry: Ownership Structure, Product and Distribution Strategies

Efficiency, productivity, and scale economies in the U.S. property-liability insurance industry

The paper examines efficiency, productivity and scale economies in the U.S. property-liability insurance industry. Productivity change is analyzed using Malmquist indices, and efficiency is estimated using data envelopment analysis. The results indicate that the majority of firms below median size in the industry are operating with increasing returns to scale, and the majority of firms above median size are operating with decreasing returns to scale. However, a significant number of firms in each size decile have achieved constant returns to scale. Over the sample period, the industry experienced significant gains in total factor productivity, and there is an upward trend in scale and allocative efficiency. More diversified firms and insurance groups were more likely to achieve efficiency and productivity gains. Higher technology investment is positively related to efficiency and productivity improvements.

Optimal Capital Structure for a Property-Liability Insurer

Traditional finance studies have found that firm value is maximised at a mid-range level of leverage. This paper empirically tests the effect of leverage on firm value for property-liability insurers. We analysed an international data set of 96 insurers from 1992 to 2006 using two measures for firm value (price-to-earnings and market-to-book) and three measures of leverage (liabilities-to-equity, premiums-to-equity and surplus duration). We found that price-to-earnings at first increases with leverage, as measured by liabilities-to-equity and premiums-to-equity, but decreases past a certain point. Market-to-book exhibited a similar pattern for the premium-to-equity ratio but had a positive relationship with liabilities-to-equity and a negative relationship with surplus duration.

Reinsurance Counterparty Relationships and Firm Performance In the U.S. Property-Liability Insurance Industry

This research investigates reinsurance counterparty relationships in U.S. property-liability insurance. Counterparty relationships are measured in terms of reinsurance premiums ceded and reinsurance recoverable on paid and unpaid losses. Multiple regression analysis is used to analyze insurer characteristics that determine reinsurance utilization, exposure, and counterparty concentration. We also analyze the relationship between firm performance and reinsurance utilization. Performance is measured using ROA and ROE as well as frontier efficiency scores (cost, revenue, and profit) estimated using data envelopment analysis (DEA). Firm performance is positively related to reinsurance utilization, especially with foreign reinsurers, but performance is adversely related to concentration in reinsurance counterparties.

Fitting insurance claims to skewed distributions: Are the skew-normal and skew-student good models?

This paper analyzes whether the skew-normal and skew-student distributions recently discussed in the finance literature are reasonable models for describing claims in property-liability insurance. We consider two well-known datasets from actuarial science and fit a number of parametric distributions to these data. Also the non-parametric transformation kernel approach is considered as a benchmark model. We find that the skew-normal and skew-student are reasonably competitive compared to other models in the literature when describing insurance data. In addition to goodness-of-fit tests, tail risk measures such as value at risk and tail value at risk are estimated for the datasets under consideration.

An Analysis of Reinsurance and Firm Performance: Evidence from the Taiwan Property-Liability Insurance Industry

This study investigates the relationship between reinsurance and firm performance by sourcing panel data from the 1999 to 2009 period of the property-liability insurance industry in Taiwan. The results of this investigation offer some insight that firm performance and reinsurance are interdependent. We find that insurers with higher return on assets (ROA) tend to purchase less reinsurance and insurers with higher reinsurance dependence tend to have a lower level of firm performance. Therefore, managers have to strike a balance between decreasing insolvency risk and reducing potential profitability. Other empirical results show that ROA, underwriting risks, liquidity ratio, business line concentration, return on investment (ROI) and financial holding dummy have a significant correlation with reinsurance. In addition, firm size, financial leverage, reinsurance, underwriting risks, liquidity ratio and ROI have a significant influence on firm performance. Our results have practical implications for the property-liability insurance industry and competent authorities in Taiwan.

The Role of RBC, Hurricane Exposure, Bond Portfolio Duration, and Macroeconomic and Industry‐wide Factors in Property–Liability Insolvency Prediction

AbstractThis research analyzes the performance of the risk‐based capital (RBC) ratio and other variables in predicting insolvencies in the property–liability insurance industry during the period 1994–2008. The results indicate that the accuracy of the RBC ratio in predicting insolvencies is inconsistent over time and that some previously tested financial ratios that are part of the FAST system do not always reliably predict insurer insolvency. In addition, the insolvency propensity is found to be significantly related to an insurer's hurricane prone area exposure, changes in interest rates, the industry‐wide combined ratio, and the industry‐wide Herfindahl index of premiums written.

Determinants of Board Structure: A Comparison of Publicly-Traded and Privately-Owned Insurance Companies

This paper compares board determinants of publicly-traded and privately-owned property-liability insurance firms and the impact of the Sarbanes-Oxley Act (SOX) on board structure of those firms. Although regulation imposes severe constraints on board structure of insurance firms, we find strong evidence that both public and private insurance firms endogenously choose board structure in ways consistent with the economic theory. Specifically, we find evidence in support of the scope-of-operation hypothesis, the information-cost hypothesis, the incentive-alignment hypothesis, and the executive-power hypothesis for public insurance firms and evidence in support of the scope-of-operation hypothesis and the managerial-discretion hypothesis for private insurance firms. Overall, our board determinants models explain as much as 54% variation in board structure of public insurance firms and 44% variation in board structure of private insurance firms. Although SOX applies to only publicly-traded firms, we find that SOX effects had spilled over to private firms. Larger and less levered private insurance firms are more likely to increase board independence post-SOX, suggesting board governance is resource dependent.