Interest Rate Risk and Equity Values of Life Insurance Companies: A GARCH–M Model

The importance of managerial decisions related to interest‐sensitive cash flows has received considerable attention in the insurance literature. Consistent with the interest‐sensitive nature of insurer assets and liabilities, empirical research has shown that insurer insolvency is significantly related to interest rate volatility. We investigate the interest rate sensitivity of monthly stock returns of life insurers based on a generalized autoregressive conditionally heteroskedastic in the mean (GARCH–M) model. We examine three different portfolios (equally weighted, risk‐based, and size‐based) with binary variables to explicitly account for varying interest rate strategies adopted by the Federal Reserve System. Results based on data for the period 1975 through 2000 indicate that life insurer equity values are sensitive to long‐term interest rates and that interest sensitivity varies across subperiods and across risk‐based and size‐based portfolios. The results complement insolvency research that links insurer financial performance to changes in interest rates.     

Empirical Evidence on the Value of Group‐Level Financial Information in Insurer Solvency Surveillance

The existing empirical research on insurer insolvency relies almost exclusively upon individual insurance company financial data, even though the insurance industry is dominated by group‐affiliated firms. This is the first study to evaluate the benefit of using group‐level data to predict insurer insolvencies for group‐affiliated insurers. The study uses financial ratios from the NAIC FAST scoring system, measured at both the company level and group level, as potential predictor variables. The results indicate that group‐level financial information substantially improves the predictive power of an insolvency prediction model relative to a model that uses only the analogous company‐level variables. In fact, the group‐level variables are found to often be substantially more powerful than company‐level variables in predicting individual insurer insolvencies. These results suggest that future insolvency analysis should, whenever feasible, include group‐level information to obtain higher predictive accuracy.     

Competition,efficiency and soundness in European life insurance markets

This paper provides cross-country evidence on the association between soundness and competition in the life insurance industry, where competition is measured by the Boone indicator. We analyse 10 European Union (EU) life insurance markets over the post-deregulation period 1999–2011. The results indicate that competition increases the soundness of the EU life insurance markets. Since the Boone indicator measures competition based on the reallocation of profits from inefficient insurers to efficient ones, our results suggest that efficiency is the mechanism through which competition contributes to insurer solvency. The soundness-enhancing effect of competition is greater for weak insurers than for healthy ones.     

New Risk-Based Capital Standards in the European Union: A Proposal Based on Empirical Data

In response to criticism concerning the current solvency system, the European Commission is developing new rules for insurance companies operating in the member states of the European Union (EU). Under this so-called Solvency II concept, an insurer is allowed to verify its solvency by using an internal risk management model previously approved by the regulatory authority. In this article we develop such an internal risk management approach for property-liability insurers that is based on dynamic financial analysis (DFA). The proposed concept uses a simulation technique and models the central risk factors from the investment and underwriting areas of an insurance company. On the basis of the data provided by a German insurer, the ruin probabilities under different scenarios and varying planning horizons are calculated.     

非寿险公司赔款准备金与盈余管理——中国市场的经验分析

利用我国非寿险公司2001~2007年的财务数据,采用分位数回归方法探讨非寿险公司赔款准备金调整的动机,并比较非寿险业务准备金评估方法改变前后公司实现盈余管理动机的差异。研究发现,非寿险公司存在实现盈余管理的现象,相比规避递延税收的目的而言,管理层故意调整公司当年赔款准备金数字进行盈余平滑的动机更为显著。当公司当期盈余表现差于前一期时,管理者倾向于低估当期赔款准备金提升账面盈余;若当期盈余表现优于前一期时,则高估准备金平滑盈余。在当年承保业务不佳,赔付率较高时,非寿险公司具有低估准备金掩饰承保质量的动机。2005年非寿险业务赔款准备金评估方法的改变,显著增强了非寿险公司利用赔款准备金进行盈余管理的动机。     

Insurance Market Effects of Risk Management Metrics

We extend the classical analysis on optimal insurance design to the case when the insurer implements regulatory requirements (Value-at-Risk). Presumably, regulators impose some risk management requirement such as VaR to reduce the insurers’ insolvency risk, as well as to improve the insurance market stability. We show that VaR requirements may better protect the insured and improve economic efficiency, but have stringent negative effects on the insurance market. Our analysis reveals that the insured are better protected in the event of greater loss irrespective of the optimal design from either the insured or the insurer perspective. However, in the presence of the VaR requirement on the insurer, the insurer's insolvency risk might be increased and there are moral hazard issues in the insurance market because the optimal contract is discontinuous.     

Production Efficiency in the Austrian Insurance Industry: A Bayesian Examination

This paper examines the developments in the production efficiency of the Austrian insurance market for the period 1994‐1999 using firm‐specific data on life/health and non‐life insurers obtained from the Austrian insurance regulatory authority. The article uses a Bayesian stochastic frontier to obtain aggregate and firm‐specific estimates of production efficiency across insurer types and time. The study provides strong evidence that the process of deregulation had positive effects on the production efficiency of Austrian insurers. The life/health and non‐life firms showed similar patterns of development in that they were less efficient during the years 1994‐1996 and significantly more efficient in 1997‐1999. If the Austrian experience is representative, similar benefits from deregulation may be expected for the Central and Eastern European countries that prepare for the accession to the European Union.     

An Exploratory Analysis of Insurer Groups

Grouping is a widespread and interesting phenomenon of the insurance industry, among both life‐health insurers and property‐liability insurers. Recognizing the potentially important implications of group membership for insurer behavior and characteristics, numerous academic researchers using insurance company data have included a dummy variable in their regression analysis to control for group membership. However, it has never been clear exactly what is being controlled for when such a variable is included. This article attempts to shed light on this question. Results indicate that group affiliated insurers tend to be larger than unaffiliated insurers, are more likely to be licensed in New York, are more likely to be stock firms than mutuals, and are likely to be less geographically concentrated.     

TOP MANAGEMENT TEAM CHARACTERISTICS AND LIFE INSURER PERFORMANCE: DO TOP MANAGERS MAKE A DIFFERENCE?

Abstract: This study examines the impact of top management team characteristics on life insurer performance. The authors argue that greater social cohesion among team members makes it less likely that the insurer will be able to adapt to the changes that have characterized the U.S. life insurance industry over the past decade and will, therefore, be detrimental to performance. Our findings support this assertion and suggest that life insurers driven by more diversified top management teams outperform life insurers with more homogenous top management teams.     

CDS as insurance: Leaky lifeboats in stormy seas

What market features of financial risk transfer exacerbate counterparty risk? To analyze this, we formulate a model which elucidates important differences between financial risk transfer and traditional insurance, using the example of Credit Default Swaps (CDS). We allow for (heterogeneous) insurer insolvency, which captures the possibility that relatively risky counterparties may exist in the market. Further, we find that stable insurers become less stable as the price of the contract decreases. The analysis includes insured parties that have heterogeneous motivations for purchasing CDS. For example, some may own the underlying asset and purchase CDS for risk management, while others buy these contracts purely for trading purposes. We show that traders will choose to contract with less stable insurers, resulting in higher counterparty risk in this market relative to that of traditional insurance; however, a regulatory policy that removes traders can, perversely, cause stable counterparties to become less stable. We conclude with two extensions of the model that consider a Central Counterparty (CCP) arrangement and the consequences of asymmetric information over insurer type.     

Reconsidering Procedural Consolidation for Multinational Corporate Groups in the Context of the Recast European Insolvency Regulation

Procedural consolidation, as a solution to the rescue of insolvent multinational corporate groups (‘MCGs’), is said to be able to preserve group value for creditors. This article explores the desirability of procedural consolidation in the EU in the light of theories of corporate rescue law, cross‐border insolvency law, multinational enterprises and relevant EU cases with reference to the European Insolvency Regulation. It argues that, based on current cross‐border insolvency rules in the EU, there is an inherent difficulty for procedural consolidation in balancing the goal of preservation of group value and the goal of certainty. The article also considers the new ‘group procedural coordination proceedings’ offered by the Recast European Insolvency Regulation and argues that it may help to supplement the gap left by the procedural consolidation in the EU. Copyright © 2017 INSOL International and John Wiley & Sons, Ltd.     

Discharge and entrepreneurship in the preventive restructuring directive

The European Council adopted the Preventive Restructuring Directive (2019/1023/EU) on June 20, 2019, which must be transposed by July 17, 2021, subject to a possible extension of a maximum of 1 year for countries encountering particular difficulties in the implementation. The Directive signals a paradigm shift in EU policy on insolvency from the traditional focus on cross‐border issues. The new Directive puts insolvency squarely at the heart of internal market regulation, following the EU's policy since the Great Recession of 2008 of promoting and strengthening the economy. Since 2016, the European Commission has issued several documents to facilitate insolvency procedures, leading to the recently adopted Preventive Restructuring Directive. Besides restructuring, the Directive promotes the discharge of pre‐insolvency debt for entrepreneurs. The Directive does not require that discharge be extended to other natural persons but recommends it. This article discusses the relationship between entrepreneurs and non‐entrepreneurs in an insolvency situation and concludes that a fair interpretation of the new Directive requires that the situation of the ordinary person with liability for business debt be closely scrutinised.     

On the exposure of insurance companies to sovereign risk—Portfolio investments and market forces

A sovereign debt crisis can have significant knock-on effects in the financial markets and put financial stability at risk. This paper focuses on the transmission of sovereign risk to insurance companies as some of the largest institutional investors in the sovereign bond market. We use a firm level panel dataset that covers large insurance companies, banks and non-financial firms from nine countries over the time period from 1 January 2008–1 May 2013. We find significant and robust transmission effects from sovereign risk to domestic insurers. The impact on insurers is not significantly different from that on banks but larger than for non-financial firms. We find that systemically important insurers are more closely linked to the domestic sovereign. Based on European data, we show that risks in sovereign bond portfolios are an important driver of insurer risk, which is not reflected in current insurance regulation (incl. Solvency II in Europe).     

The Impact of Asbestos and Environmental Reserves Increases on Shareholder Wealth

Abstract

Between 1992 and 2001 significant reserves increase announcements were made by several major property/liability insurers. These reserves increases were for the purpose of recognizing expected asbestos and environmental (A&E) liability. Although most analysts agree that U.S. insurers are underreserved for asbestos and environmental liability, how the market reacts to an insurer’s announcement of an increase in these reserves has not been analyzed. An insurer that is significantly underreserved is likely to be viewed by the market as lacking financial stability for the long term. However, when a company increases its reserves, there is a charge to income and a reduction in capital. If surplus is diminished sufficiently as a result of the increased reserving, regulatory attention and eroding shareholder and market confidence could result as well. By calculating the sample insurers’ cumulative abnormal returns surrounding the largest asbestos and environmental reserves increase announcements made between 1992 and 2001, the study estimates and documents the market’s reaction to these reserves increase announcements. We further explore the potential impact of additional asbestos and environmental liability exposure reporting requirements. Starting with 1995 statutory annual accounting statements, Footnote 24 required additional reporting by insurers of their asbestos and environmental liability exposure (1995 statements were publicly available by the end of the first quarter of 1996). When looking at reserves increase announcements prior to this additional reporting requirement, we find that most insurers announcing large increases in asbestos and environmental reserves prior to 1996 experience a significant reduction in stock price in the days surrounding their announcement. However, consistent with the notion that the additional accounting disclosure requirements after 1995 (Footnote 24) provide valuable information on insurers’ exposure, we find that the announcement of A&E reserves increases after 1995 had no statistically significant effect on the market value of announcing insurers.     

The nature and determinants of disclosure practices in the insurance industry: Evidence from European insurers

Filling a gap in the existing literature on disclosure practices by insurance companies, this research provides new empirical evidence on the nature and determinants of disclosure practices in the European insurance industry over the 2005–2010 period. The main results show that insurers are more inclined to invest in the quantity of risk information rather than in the disclosure quality of the entire annual report, as risk information is addressed to high-level financially educated people and requires fewer resources than are needed for an investment in quality. Further, the analysis also shows that insurer level characteristics, in terms of size and technical provisions, as well as country level variables, significantly affect the amount of risk information disclosed. In the years affected by the financial crisis, the level of risk disclosure quantity increases as insurers use disclosure as a tool to reassure stakeholders on their independence from the global financial crisis.     

Considerations of cost trade-offs in insurance solvency surveillance policy

We propose a process for identifying potentially insolvent insurers on a cost-effective basis. A loss cost function is developed such that the effectiveness of monitoring is maximized relative to a cost constraint. The loss cost function is supported by a model that provides a rank ordering of financial institutions according to their probability of insolvency. When tested against a full sample of property-liability insurance companies , the procedure provides information critical to maximizing the effectiveness of regulatory resources available for solvency surveillance and performs well as a predictor of insolvency. Likewise, the rank ordering of insurers overcomes an estimation problem critical to establishing risk-adjusted guaranty assessments.     

The Use of Dynamic Financial Analysis to Determine Whether an Optimal Growth Rate Exists for a Property-Liability Insurer

Prior research on the aging phenomenon has demonstrated that new business for property‐liability (P‐L) insurers generates high loss ratios that gradually decline as a book of business goes through successive renewal cycles. Although the experience on new business is initially unprofitable, the renewal book of business eventually becomes profitable over time. Within this context, insurers need to manage their exposure growth in order to maximize long run profitability. Dynamic financial analysis (DFA), a relatively new tool for P‐L insurers, utilizes Monte Carlo simulation to generate the overall financial results for an insurer under a large number of scenarios. This article uses a publicly available DFA model—along with the estimated market value of an insurer, based on 1990–2001 data for stock P‐L insurers and underlying financial variables—to determine optimal growth rates of a P‐L insurer based on mean–variance analysis, stochastic dominance, and constraints on leverage.     

‘Brexit’ and International Insolvency Beyond the Realm of Mutual Trust

The outcome of the referendum held in the UK in June 2016 is of far‐reaching and unpredictable consequences. This article focuses on the particular field of international insolvency with a view to identifying some of them, all arising out of the fact that the UK will be leaving the EU area of justice and the strong cooperation based on mutual trust between member states. This will make UK–EU insolvency cases clearly less efficient and effective. The consequences of Brexit could be mitigated by the already existing coordination among the international instruments dealing with these matters, in particular the European Insolvency Regulation and the UNCITRAL Model Law on Cross‐Border Insolvency. However, not all EU member states have in place rules dealing with these issues as regards to third states. In order to lessen the impact of Brexit in this sensitive area of law, the implementation of the Model Law in order to deal with extra‐EU cross‐border insolvency could be of avail. Copyright © 2017 INSOL International and John Wiley & Sons, Ltd     

A Comparison of Neural Network, Statistical Methods, and Variable Choice for Life Insurers' Financial Distress Prediction

This study examines the effect of the statistical/mathematical model selected and the variable set considered on the ability to identify financially troubled life insurers. Models considered are two artificial neural network methods (back‐propagation and learning vector quantization (LVQ)) and two more standard statistical methods (multiple discriminant analysis and logistic regression analysis). The variable sets considered are the insurance regulatory information system (IRIS) variables, the financial analysis solvency tracking (FAST) variables, and Texas early warning information system (EWIS) variables, and a data set consisting of twenty‐two variables selected by us in conjunction with the research staff at TDI and a review of the insolvency prediction literature. The results show that the back‐propagation (BP) and LVQ outperform the traditional statistical approaches for all four variable sets with a consistent superiority across the two different evaluation criteria (total misclassification cost and resubstitution risk criteria), and that the twenty‐two variables and the Texas EWIS variable sets are more efficient than the IRIS and the FAST variable sets for identification of financially troubled life insurers in most comparisons.     

Foreign Share, Insurance Density, and Penetration: An Analysis of the International Life Insurance Market

Recent trends toward liberalization and deregulation have sparked significant interest in the topic of international insurers' participation in foreign markets. This research develops a profile of foreign national market characteristics that attract international life insurer participation and additionally, empirically assesses the value that international participation has to the host market. Characteristics that are found to be statistically significant with respect to international participation include high levels of trade liberalization and/or low insurer market share concentration, high levels of national wealth, and high levels of government expenditure on social security retirement benefits. With respect to the benefits such participation provides, we see that the presence of international life insurers share positive relationships with both life insurance consumption and the magnitude of the role life insurance plays within the broader national economy of those host markets.