The Liability Regime of Insurance Pools and Its Impact on Pricing

This work formally derives fairly priced premiums for the policyholder of an insurance pool and the risk-adequate equity contributions of the pool insurers’ equity holders in a contingent claims approach. The approach distinguishes between two liability regimes: joint liability and several liability. These regimes regulate the pool’s indemnification when one or more of the pool insurers cannot meet their full obligations because of insolvency. Joint liability is deduced to be the preferable regime for the policyholder in cost-savings terms if corporate income taxation is introduced as a market friction. This regime advantage vanishes if the pool insurers’ asset correlation is substantial or if their risk sharing becomes unbalanced. Additionally, we address risk-shifting problems and their regime-dependent effects on both stakeholder groups.     

Deterring Fraud: The Role of General Damage Awards in Automobile Insurance Settlements

Awards for pain and suffering and other noneconomic losses account for over half of all damages awarded under third‐party auto insurance bodily injury settlements. This article hypothesizes that third‐party insurers use general damage awards to reduce the incentive to submit exaggerated claims for specific damages for injuries and lost wages. Consistent with this hypothesis, the article finds evidence using data on over 17,000 closed bodily injury claims that special damage claims that exceed their expected value receive proportionally lower general damage awards than claims that do not. Among the implications of this research is the possibility that insurers will be less zealous in challenging fraudulent special damage claims under a third‐party insurance regime than they will be under a first‐party insurance regime in which access to general damages is limited.     

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.”     

Does boardroom nationality affect the performance of UK insurers?

Drawing on the board capital literature, we use a panel data design to investigate the effect of boardroom nationality on the profitability and solvency of property-casualty insurers operating in the United Kingdom (UK). We find that boardroom nationality influences corporate outcomes depending on the financial aspects being measured. For example, North American directors are linked with profitable outcomes, while European directors tend to be associated with better solvency. This reflects differences between the shareholder value corporate culture in North America and stakeholder approaches more common in Europe. Our results could help insurers, regulators, and others (e.g., investors) to better understand the potential performance implications of the appointment of directors of different nationality.     

Credibility in Loss Reserving

This article proposes using credibility theory in the context of stochastic claims reserving. We consider the situation where an insurer has access to the claims experience of its peer competitors and has the potential to improve prediction of outstanding liabilities by incorporating information from other insurers. Based on the framework of Bayesian linear models, we show that the development factor in the classical chain-ladder setting has a credibility expression: a weighted average of the prior mean and the best estimate from the data. In the empirical analysis, we examine loss triangles for the line of commercial auto insurance from a portfolio of insurers in the United States. We employ hierarchical model for the specification of prior and show that prediction could be improved through borrowing strength among insurers based on a hold-out sample validation.     

Estimating the Cost of Equity for Property-Liability Insurance Companies

Due to the highly skewed and heavy‐tailed distributions associated with the insurance claims process, we evaluate the Rubinstein‐Leland (RL) model for its ability to improve the cost of equity estimates of insurance companies because of its distribution‐free feature. Our analyses show that there is as large as a 94‐basis‐point difference in the estimated cost of insurance equity between the RL model and the capital asset pricing model (CAPM) for the sample of property‐liability insurers with more severe departures from normality. In addition, consistent with our hypotheses, significant differences in the market risk estimates are found for insurers with return distributions that are asymmetrically distributed, and for small insurers. Third, we find significant performance improvements from using the RL model by showing smaller values of excess return of the expected return of the portfolio to the model return for a portfolio of insurers with returns that are more skewed and for a portfolio of small insurers. Finally, our panel data analysis shows the differences in the market risk estimates are significantly influenced by firm size, degree of leverage, and degree of asymmetry. The implication is that insurers should use the RL model rather than the CAPM to estimate its cost of capital if the insurer is small (assets size is less than $2,291 million), and/or its returns are not symmetrical (the value of skewness is greater than 0.509 or less than ?0.509).     

Claims Auditing in Automobile Insurance: Fraud Detection and Deterrence Objectives

Research on insurer management of opportunism in claiming has developed in two parallel literatures. One is a theoretical literature on insurance contracting that yields predictions about the nature of optimal auditing strategies for the deterrence of fraud. The other is a literature based upon statistical analysis of claims that yields empirical strategies for the detection of fraudulent claims. This article links the two literatures by providing an empirical assessment of insurers’ auditing practices in relation to theoretical predictions. The analysis makes use of a data set on the disposition of more than 1,000 randomly selected automobile personal injury protection claims settled in the state of Massachusetts. The findings of the article are consistent with the use of rational auditing strategies by insurers and with the use of audits for both deterrence and detection.     

Personal Bias in Automobile Claims Settlement

Despite the importance of claims handling practices to consumers and insurers, relatively little research has been done in this area. Our purpose here is to consider one aspect of automobile bodily injury liability claims management: the assignment of fault across parties as judged by the insured defendant's claims adjuster. Because legal fault assessment directly affects whether a defendant is held liable, and if so, for how much, this aspect of claims management is significant. We use accident data from the 1997 Insurance Research Council Closed Claim Survey to test for relationships between fault assessment and gender, age, and state comparative negligence rules. Controlling for actual fault, we find a greater assessment of fault against female, young, and elderly drivers. The results of the study are of interest to insurers seeking to provide better customer service, to consumer advocacy groups interested in claims settlement practices, and to insurance regulators.     

The Impact of Insurance Fraud Detection Systems

This article analyzes the impact of detection systems in an insurance fraud context. In a noncommitment Costly State Verification setting insurers can only detect fraudulent claims by performing costly audits, and policyholders are overcompensated by the optimal insurance contract. We show that auditing becomes more effective and overcompensation can be reduced, when insurers are able to condition their audits on the information provided by detection systems.     

Eine neue Typologie real existierender deutscher Erstversicherer

The Criterions of insurance companies in Germany are changing as consequences of market competition and regulation. Trends of differentiation follow former trends of assimilation. A modern typology of direct insurers resp. groups of insurers is less oriented by legal form of companies, more by targets of activities and stakeholder situation. In case of mutual companies there are effects of demutualization.     

Efficiency in the UK life insurance industry: Mutual firms versus proprietary firms

The paper discusses the main tenets of stakeholder theory and agency theory and goes on to analyse the relative performance of a sample of 100 mutual and proprietary life insurance companies in the UK during the period 1992–1996. The paper concludes that there is weak evidence to support the contention that mutual life insurers are relatively more cost efficient than proprietary insurers. Mutual companies in the sample perform well relative to proprietary companies in terms of annual surpluses and expenses ratios. There is also evidence that fund managers in mutual companies perform at least as well on average as those in proprietary companies.     

Value Maximisation, Stakeholder Theory, and the Corporate Objective Function

This paper examines the role of the corporate objective function in corporate productivity and efficiency, social welfare, and the accountability of managers and directors. I argue that since it is logically impossible to maximise in more than one dimension, purposeful behaviour requires a single valued objective function. Two hundred years of work in economics and finance implies that in the absence of externalities and monopoly (and when all goods are priced), social welfare is maximised when each firm in an economy maximises its total market value. Total value is not just the value of the equity but also includes the market values of all other financial claims including debt, preferred stock, and warrants. In sharp contrast stakeholder theory, argues that managers should make decisions so as to take account of the interests of all stakeholders in a firm (including not only financial claimants, but also employees, customers, communities, governmental officials and under some interpretations the environment, terrorists and blackmailers). Because the advocates of stakeholder theory refuse to specify how to make the necessary tradeoffs among these competing interests they leave managers with a theory that makes it impossible for them to make purposeful decisions. With no way to keep score, stakeholder theory makes managers unaccountable for their actions. It seems clear that such a theory can be attractive to the self interest of managers and directors. Creating value takes more than acceptance of value maximisation as the organisational objective. As a statement of corporate purpose or vision, value maximisation is not likely to tap into the energy and enthusiasm of employees and managers to create value. Seen in this light, change in long‐term market value becomes the scorecard that managers, directors, and others use to assess success or failure of the organisation. The choice of value maximisation as the corporate scorecard must be complemented by a corporate vision, strategy and tactics that unite participants in the organisation in its struggle for dominance in its competitive arena. A firm cannot maximise value if it ignores the interest of its stakeholders. I offer a proposal to clarify what I believe is the proper relation between value maximisation and stakeholder theory. I call it enlightened value maximisation, and it is identical to what I call enlightened stakeholder theory. Enlightened value maximisation utilises much of the structure of stakeholder theory but accepts maximisation of the long run value of the firm as the criterion for making the requisite tradeoffs among its stakeholders. Managers, directors, strategists, and management scientists can benefit from enlightened stakeholder theory. Enlightened stakeholder theory specifies long‐term value maximisation or value seeking as the firm’s objective and therefore solves the problems that arise from the multiple objectives that accompany traditional stakeholder theory. I also discuss the Balanced Scorecard, the managerial equivalent of stakeholder theory. The same conclusions hold. Balanced Scorecard theory is flawed because it presents managers with a scorecard which gives no score—that is, no single‐valued measure of how they have performed. Thus managers evaluated with such a system (which can easily have two dozen measures and provides no information on the tradeoffs between them) have no way to make principled or purposeful decisions. The solution is to define a true (single dimensional) score for measuring performance for the organisation or division (and it must be consistent with the organisation’s strategy). Given this we then encourage managers to use measures of the drivers of performance to understand better how to maximise their score. And as long as their score is defined properly, (and for lower levels in the organisation it will generally not be value) this will enhance their contribution to the firm.     

Pricing the Option to Surrender in Incomplete Markets

New international accounting standards require insurers to reflect the value of embedded options and guarantees in their products. Pricing techniques based on the Black and Scholes paradigm are often used; however, the hypotheses underneath this model are rarely met. We propose a framework that encompasses the most known sources of incompleteness. We show that the surrender option, joined with a wide range of claims embedded in insurance contracts, can be priced through our tool, and deliver hedging portfolios to mitigate the risk arising from their positions. We provide extensive empirical analysis to highlight the effect of incompleteness on the fair value of the option.     

Deregulation,Pricing Strategies,and Claim Behavior in the Taiwan Automobile Insurance Market

Stringent pricing regulations have long been in effect in the Taiwan automobile insurance market. In April 2009, a pricing deregulation was adopted, enabling insurers to establish their own auto insurance premium rates. This study examines the effects of deregulation in terms of three hypotheses that we propose pertaining to market shares, loading factors, and last policy month claims. The quantitative analysis results show that pricing deregulation prompts insurers to lower their rates. The effects of deregulation for insurers are determined by not only the decision to deduct premiums and the deduction percentages, but also by policy type.     

Stakeholders and the composition of the voting rights of the board of directors

We propose a new approach to dynamic representation of different groups of stakeholders on the board of directors. This approach is based on a simple economic model of the firm, with an objective function to maximize its market value. We look at the marginal claim of each stakeholder on the assets of the firm. It divides the voting rights based on the change in value of each stakeholder with a one dollar change in the value of the firm as a whole. We translate these conditions to relative voting powers on the board. While there are many claims in the academic and popular literature on sharing voting rights on the board, our paper is the first to propose a quantitative dynamic model of the power sharing in the corporation.     

Die Berücksichtigung klimatisch bedingter Veränderungen der Sturmaktivität in den Entscheidungs-prozessen deutscher Erstversicherer

Climate Change will lead to an increased number and intensity of severe winterstorms in Northwest-Europe and Germany. Along with this development comes a rise in potential claims; insurers are particularly affected in the storm and tempest insurance, the homeowner’s and householder’s comprehensive insurance and the motor hull insurance. Although, the predictions of storm changes refer to the next 50 or 100 years a consideration of the expected changes in today’s decissions is recommended. Several measures are already helpful in reaching the insurers’ goals and should therefore be realised soon.     

The market for catastrophe risk: a clinical examination

This paper examines the market for catastrophe event risk – i.e., financial claims that are linked to losses associated with natural hazards, such as hurricanes and earthquakes. Risk management theory suggests protection by insurers and other corporations against the largest cat events is most valuable. However, most insurers purchase relatively little cat reinsurance against large events, and premiums are high relative to expected losses. To understand why the theory fails, we examine transactions that look to capital markets, rather than traditional reinsurance markets, for risk-bearing capacity. We develop eight theoretical explanations and find the most compelling to be supply restrictions associated with capital market imperfections and market power exerted by traditional reinsurers.     

An Empirical Examination of Stakeholder Groups as Monitoring Sources in Corporate Governance

Insurers are formally and informally monitored by a variety of stakeholders, including reinsurers, agents, outside board members, and regulators. While other studies have generally examined these stakeholders separately, they have not accounted for the fact that there is some relation among the stakeholder groups, and the presence of these groups is likely to be jointly determined. By empirically controlling for these potential interrelations, we create a more complete assessment of the impact of these stakeholders/monitors on insurers’ risk taking. Specifically, we find that the presence of some stakeholders offsets the degree or presence of others, and that most stakeholders/monitors are associated with a reduction of overall firm risk.     

A Review of Catastrophic Risks for Life Insurers

Catastrophic mortality events are characterized by a sudden and concentrated increase in mortality and as such present a major risk to life insurers. Such events include pandemics, war, natural disasters, terrorist attacks, and industrial, transport, and other accidents. Of these, pandemics arising from influenza are considered the most significant threat to the life insurance industry due to their capacity to cause a major increase in claims. We review the features and mortality implications of an influenza pandemic for life insurers, and describe a range of other risks that are likely to emerge as well.     

Determinanten der Liquidität in der deutschen Schaden- und Unfallversicherungsindustrie: Bedeutung,Erklärungskraft und Auswirkung der Finanzkrise

The aim of this paper is to analyze the corporate liquidity and its determinants for the German property-liability insurance industry using company-level data for the period 2002–2014. We first investigate the differences in cash holdings across insurers. We then quantify the relative importance of firm-level determinants compared with macroeconomic determinants in explaining insurers’ cash holding choices. In addition, we examine whether the financial crisis of 2008 has an impact on the liquidity situation of insurers. Our results indicate that cash holdings vary significantly across German property-liability insurers. The firm-level determinants size, group affiliation and reinsurance utilization explain more than 50% of the variation. We also find that macroeconomic conditions appear to have negligible effects on the liquidity situation of insurers. In addition, we do not find evidence that the liquidity of German property-liability insurers is influenced by the financial crisis of 2008. The proportion of cash remains relatively stable at 6% of the total assets.