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.