Geneva Papers on Risk and Insurance - Issues and Practice

Published by Palgrave Macmillan
Online ISSN: 1468-0440
Publications
Article
The insurance industry is a critical foundation of the global economy, a fact that is often overlooked in our haste to deal with the challenges of our competitive markets. Because of the financial security and protection we provide for people, property and reputations, new buildings are built, planes fly, risks are taken and economies around the world grow. Our world is changing, and we must change with it. As insurers, we must recognize the broader, global reality in which our businesses are operating. This paper will address how rating agencies, regulatory scrutiny, underwriting discipline, loss-cost inflation, catastrophes, tort costs, and emerging issues are affecting the industry. Solutions and best practices will be discussed. In addition to facing and eliminating the issues discussed in this paper, we must deliver what customers want: consistency, service, expertise, security, financial strength and integrity. The best way to deliver all of this is through customer service; it's at the centre of GE Insurance Solutions’ brand promise. The Geneva Papers (2006) 31, 38–45. doi:10.1057/palgrave.gpp.2510062
 
Article
Before discussing the effects of the attacks of 11 September 2001, we should be aware that the effects on the insurance industry, as serious as they may be, are small compared with the enormous human tragedy and the direct and indirect economic losses suffered by the City of New York.When analysing the effects of the terrible events of September 11, it is useful to make a distinction between direct and indirect effects. The Geneva Papers on Risk and Insurance (2003) 28, 65–70. doi:10.1111/1468-0440.00207
 
Article
The paper discusses the development and operation of terrorism insurance programmes established in France, Germany and the U.S as reaction to 9/11. These three programmes are all based upon a public–private partnership with government backup. However, there are some fundamental differences regarding issues such as exclusions, price differentiation, risk mutualization, current level of terrorism insurance demand and the government exit strategy. In particular, significant differences of prices and degree of market penetration in the three countries have been observed and we discuss some factors that could contribute to this. Recent changes in the nature of international terrorism worldwide indicate that these issues will remain in our future. Hence, we think that government and industry would at the very least benefit from better understanding of how others operate abroad. The Geneva Papers (2005) 30, 144–170. doi:10.1057/palgrave.gpp.2510009
 
Article
In the opening essay in Embracing Risk: The Changing Culture of Insurance and Responsibility, Jonathan Simon and I assert that western society is engaged in a transformation from a dominant paradigm of spreading risks to a paradigm that involves embracing risk. (Baker & Simon, eds. 2002) The core idea behind this trend is the recognition that too much protection against loss produces too much loss. Not all risks should be spread. For their own and society's good, individuals should embrace some risks. As we wrote: As more of life is understood in terms of risk, taking risks is increasingly what one does with risk. Embracing Risk closes with a wonderful essay by Francois Ewald that also posits a paradigm shift. (Ewald 2002) But this paradigm shift revolves around the precautionary principle, an evolving principle in international law that calls for hesitating in the face of uncertainty, avoiding risk - zero risk rather than embracing risk. Ewald identifies popular support for this principle as among the most important reactions to the failure of the insurance state to protect citizens from risk, a charge that surely resonates in the wake of September 11th. The concept of embracing risk resonates much less well with September 11th. None of the victims made any relevant choices. No one, or at least no one we would want to emulate, is embracing terror risks. Precaution is the order of the day. Yet, I continue to see evidence of the embracing risk thesis at work, though September 11th has made that claim a more measured one. My goal in this essay is to suggest how it might be that the insurance state spawned these two seemingly contradictory reactions, how those reactions are in fact less contradictory than they at first appear, and what the embracing risk thesis and the precautionary principle might portend for liability and insurance after September 11th. I will conclude by suggesting that part of the answer to some looming 21st century insurance problems is to resurrect two distinctly two 19th century ideas: the assessment approach to insurance and the concept of insurance regulation as an antidote to destructive competition.
 
Article
This paper explores the use of inspections or audits to monitor compliance with environmental standards, whether these are set by government agencies or as self-regulatory measures by business. The key issue studied here is the "privatization" of this auditing or inspection process through the use of third parties (the auditors). Such auditors are private (and likely profit-oriented) organizations that may be certified to undertake the task by the competent regulatory authority. We will focus, in particular, on the recent move to implement ISO 14000 environmental standards (and related EMAS standards in the European Union) through precisely this kind of process. The ISO 14000 standards are management system standards and not prescriptive technological or performance standards. Since it is clear that the latter standards also have an important role to play in achieving acceptable environmental performance in an economy, we discuss how the ISO standards might act as a lever for implementing other more detailed specification or outcome-based standards. The paper analyses the costs and benefits of relying on such market-based provision of auditing services at several levels: regulatory compliance and transactions costs at a regional or national level; business performance, including the potential for improved risk management and insurability conditions; and the impact on local community knowledge and welfare. It is argued that management system standards of the kind currently being developed under the ISO 14000 initiative have the potential to achieve a positive balance at all levels, but to do so such standards must emphasize measurable results and not just process and management system standardization.
 
Article
Welfare state arrangements not only mitigate income risk, they also create new types of risks; we may call them “policy-induced risks”. In some cases, market risk is replaced by the risk of changes in politically determined rules, “rule instability” for short. In other cases, welfare state arrangements change the character of market risk, and may even increase it. I call this “policy-induced market risk”
 
Article
In his famous essay on London's Royal Exchange, Joseph Addison marveled at the international concord produced when commercial men freely pursued their economic interests: “Factors in the trading world are what ambassadors are in the politic world; they negotiate affairs, conclude treaties, and maintain a good correspondence between those wealthy societies of men that are divided from one another by seas and oceans, or live on the different extremities of a continent.”1 But men with more than Addison's armchair experience of mercantile affairs had a less irenic view of international trade. Nicholas Magens, a merchant and insurer with a distinguished career and great authority among his fellows, argued that “the great object of a maritime nation should be, to take advantage of any rupture with another trading state, to destroy and distress their [sic] shipping, and commerce, and to cut off all resources for naval armaments.”2 Nowhere in 18th-century economic policy was the clash between the promotion of international trade and the beggaring of commercial rivals so keenly felt as in the British debate over the wisdom of insuring enemy ships in wartime. The controversy and the resulting parliamentary acts of 1746 and 1748 reveal a complicated and vacillating strategy by which the British sought to exploit their dominance of the international marine insurance industry for wartime advantage. The Geneva Papers on Risk and Insurance (2004) 29, 247–257. doi:10.1111/j.1468-0440.2004.00285.x
 
Time Series Properties on Annuity and Consol Rates
Deciles for the 3-lag VAR simulation using boot-strapped residuals
Deciles for the 2-lag VAR simulation using boot-strapped residuals
Article
This paper constructs a time series of annuity rates in the U.K. for 1957-2002, and examines the pricing of U.K. annuities, and the relationship between the accumulation and decumulation phases of a defined contribution pension scheme by focusing on the properties of the pension replacement ratio. The paper computes the money's worth of annuities over the sample period, and finds that on average the money's worth has been just less than unity, implying that annuities are fairly priced. Using data on annuity returns and the returns on other financial assets, the paper simulates replacement ratios, to build up a frequency distribution of the pension replacement ratio for a U.K. individual. These frequency distributions illustrate the risk in the pension replacement ratio faced by an individual who saves in a typical defined contribution pension scheme. Copyright 2004 The International Association for the Study of Insurance Economics.
 
Article
A simulation model is developed to account for observed changes in mean household wealth both overall and by age cohort over the 1962–92 period in the U.S. There are three major findings. First, capital gains are the major factor explaining overall wealth changes and account for three-fourths of the simulated growth in wealth over the entire period, while savings account for the other quarter. Second, for cohorts under age 50, inter vivos transfers dominate observed changes in wealth. Indeed, the oldest age groups appear to have transferred sizable amounts of their wealth to younger generations inter vivos, raising the wealth of these younger groups substantially above what it would be based on saving alone. Third, over the lifetime, I estimate that savings, inheritance, and inter vivos transfer each contribute about one-third to the lifetime accumulation of wealth. The Geneva Papers on Risk and Insurance (1999) 24, 27–49. doi:10.1111/1468-0440.00003
 
Article
This short note highlights price regulation in the United States Personal Automobile Market by reviewing the results of the most highly-regulated U. S. market, the fix-and-establish system in Massachusetts during 1978 to 1990. Financial outcomes of the state-run market are shown. Effects of pricing policy on the size of the residual market, interclass subsidies and the participation of national property-casualty companies in the Massachusetts market are discussed. Contrasts with the post-proposition 103 California personal auto market are explored. Implications for guaranty funds are derived. Finally, the outlook for the Massachusetts and California personal auto markets is discussed together with implications for the upcoming integration of the EEC insurance markets.
 
Sources of funds paid on claims, 1990-2003
Article
Using medical malpractice claims with payments of $25,000 or more that closed in Texas from 1990 to 2003, this study quantifies physicians' insurance limits and examines the connection between policy size and payments on claims. It finds that most physicians had less than $1 million (nominal) in coverage, that real policy size declined, that settlements at the policy limits were common, that payment size was stable or falling, and that payments above the policy limits were rare. It also finds that physicians rarely made out-of-pocket payments, suggesting the policy limits often cap recoveries, and that the frequency of out-of-pocket payments declined as policy size increased. Results are presented separately for “perinatal physicians.”The Geneva Papers (2008) 33, 177–192. doi:10.1057/gpp.2008.3
 
Article
This paper provides a comprehensive analysis of efficiency and productivity in the German property-liability insurance industry, a market that has experienced significant change in recent years. Using data envelopment analysis (DEA) and covering the period 1995–2006, we find that there is potential for the market to improve by about 20 percentage points in terms of technical efficiency and about 50 percentage points in terms of cost efficiency. Furthermore, the analysis shows moderate total factor productivity growth and low efficiency growth during the sample period. A major contribution of the paper is its analysis of six efficiency determinants – firm size, distribution channels, ownership forms, product specialisation, financial leverage and premium growth – using a truncated regression and bootstrapping approach to avoid invalid inference. The Geneva Papers (2009) 34, 483–505. doi:10.1057/gpp.2009.10
 
Article
While the market for private long-term care insurance in the U.S. has grown dramatically, consumer advocates have argued for increased regulatory attention and for broadened consumer education programs concerning long-term care insurance. We analyse Health and Retirement Survey data from 1996, 1998, and 2000 using a zero-inflated negative binomial regression model of the counts of consecutive periods of long-term care insurance coverage. We find that while a significant proportion of Americans over the age of 50 purchase long-term care insurance, many of these purchasers drop their coverage within a five-year period. This finding raises questions for long-term care insurance researchers and it contains implications for market regulators, public policy makers interested in financing long-term care, as well as for insurance companies and consumer advocates. The Geneva Papers on Risk and Insurance (2004) 29, 640–651. doi:10.1111/j.1468-0440.2004.00307.x
 
Article
If the insured can tilt losses towards catastrophes, or if his efforts will do the most to reduce catastrophes, either by reducing probabilities or reducing magnitudes, then traditional lessons about the form of optimal insurance are likely to be wrong.35 Even if the insurance company is risk neutral and has infinite resources, it should keep the insured at some risk when losses are high. And the insured, who in our formulation reaps any savings in the form of reduced premiums from stronger incentives for care, has the same interest as the insurer in finding the optimal form of policy.
 
Article
One measure of the health of the Social Security system is the difference between the market value of the trust fund and the present value of benefits accrued to date. How should present values be computed for this calculation in light of future uncertainties? We think it is important to use market value. Since claims on accrued benefits are not currently traded in financial markets, we cannot directly observe a market value. In this paper, we use a model to estimate what the market price for these claims would be if they were traded. In valuing such claims, the key issue is properly adjusting for risk. The traditional actuarial approach – the approach currently used by the Social Security Administration in generating its most widely cited numbers - ignores risk and instead simply discounts “expected†future flows back to the present using a risk-free rate. If benefits are risky and this risk is priced by the market, then actuarial estimates will differ from market value. Effectively, market valuation uses a discount rate that incorporates a risk premium. Developing the proper adjustment for risk requires a careful examination of the stream of future benefits. The U.S. Social Security system is “wage-indexedâ€: future benefits depend directly on future realizations of the economy-wide average wage index. We assume that there is a positive long-run correlation between average labor earnings and the stock market. We then use derivative pricing methods standard in the finance literature to compute the market price of individual claims on future benefits, which depend on age and macro state variables. Finally, we aggregate the market value of benefits across all cohorts to arrive at an overall value of accrued benefits. We find that the difference between market valuation and “actuarial†valuation is large, especially when valuing the benefits of younger cohorts. Overall, the market value of accrued benefits
 
Article
The prevalence of cancer is set to increase sharply with new pressures for change in treatment and prevention. This paper reviews evidence on likely changes in treatment costs, which will increase with improved survival, and on the distribution of costs to society. It then presents a profile of likely change in technology. A concluding section draws out implications for service design and an enhanced role for insurers. The Geneva Papers on Risk and Insurance (2004) 29, 728–737. doi:10.1111/j.1468-0440.2004.00314.x
 
Projections of age ratio and private sector pension expenditures before the reform  
Article
A major reform in the Finnish private-sector earnings-related pension system came into effect on 1st January, 2005. It was negotiated in 2001–2002 between the central organisations of employers and trade unions and representatives of the central government. This paper describes the reform and analyses its effects on selected macroeconomic variables, on the pension system and on the position of different birth cohorts and different educational groups. The reform appears to be successful in many respects. It simplifies the private-sector pension system and makes it a model that other pension systems in Finland will converge to. The reform rewards postponing retirement. It curbs the increase in contribution rate without endangering the adequacy of replacement rates. The increase in labour supply will have beneficial welfare effects. The new system also responds rather well to uncertain future demographics. Despite this apparent success of the reform there remains a serious doubt of its adequacy, as contribution rates are still expected to rise by several percentage points. The Geneva Papers (2007) 32, 75–94. doi:10.1057/palgrave.gpp.2510108
 
Article
In this study we compare the interplay between capital and asset risks before and during the 2007–2009 financial crisis for the U.S. life and health insurance industries partitioned into segments by product specialisation, size and governance. The results show substantial intra-industry variation in the partial elasticity of capital with respect to asset risk, as well as significant impact of the crisis. Segment variation was driven by product focus. Most notable is the greater impact of the crisis on the U.S. insurers specialising in annuities (least risky product) than on specialists in health lines (riskiest product). During the crisis, the elasticity between asset risk and capital declined for all segments indicating that insurers’ operation may have shifted from offsetting risk to seeking risk.
 
Article
In this paper, we explore U.S. life insurers’ exposure to mortgage backed securities (MBS) and its potential impact on capital should the credit ratings of these bonds be lowered. We analyse 2 years: 2003 (well before the realisation of problems with these instruments) and 2006 (immediately prior). We create five potential scenarios of different severity for recategorising MBS credit ratings and compute the theoretical impact on measured insurer asset risk, via a proxy for the C-1 component of life insurers’ risk-based capital. Under all scenarios, we find large increases in assessed asset risk. We then model insurer capital structure as a function of asset risk and other factors to assess whether insurers had prepared their capital structures for the possibility of problems with these instruments. Our findings indicate not only that insurers were unprepared for MBS downgrades, but also that they reduced capital as they accumulated MBS, as though acquiring MBS should raise the overall quality of the investment portfolio. Finally, we analyse possible adjustments to capital to accommodate the now recognised increased risks of MBS. Our models suggest, for example, that an insurer with median residential MBS exposure might be expected to increase its capital by 10 per cent or more to maintain a historical relationship between capital and risk factors, in the event of a moderate recategorisation of MBS risk. Even larger adjustments are indicated should the crisis spread to commercial MBS as well. The Geneva Papers (2009) 34, 100–118. doi:10.1057/gpp.2008.40
 
Article
The purpose of this article is to review and summarize the papers published in The Geneva Risk and Insurance Review in 2009. Asymmetric information, adverse selection and moral hazard are the keywords in several papers in this volume. These papers highlight how applied research in insurance could help understand the behaviour of policy-holders and have important implications for the insurance industry. This is an important issue in insurance and the papers summarized in this article raise some interesting potential empirical research questions and call for a behavioural research approach applied to insurance, a field that could be defined as behavioural insurance.
 
Article
The purpose of this paper is to review and summarise the papers published in The Geneva Risk and Insurance Review in 2010. Historical reference to Willet and Knight is emphasised to illustrate the importance of risk and uncertainty in our modern economies and how it is still the starting point of economic research not only in public finance as proposed by Agnar Sandmo, but also in other papers published in this volume. Many issues touch upon anomalies like adverse selection, asymmetric information, moral hazard and rating restrictions that can influence the performance of insurance markets. These issues are of particular relevance for insurers and the proper functioning of insurance markets.
 
Article
This Special Issue of Geneva Papers on Risk and Insurance - Issues and Practice contains 10 contributions to the academic literature all dealing with longevity risk and capital markets. Draft versions of the papers were presented at Longevity Six: The Sixth International Longevity Risk and Capital Markets Solutions Conference that was held in Sydney on 9-10 September 2010. It was hosted by the Australian Institute for Population Ageing Research, the Australian School of Business and the University of New South Wales. It was sponsored by PricewaterhouseCoopers, Australian Prudential Regulation Authority (APRA), Coventry Capital, Swiss Re, and Institute of Actuaries of Australia.
 
Article
The 2007–2009 financial crisis resulted in failures of many large financial institutions and among the G8 countries, only Canada did not have to provide financial support to distressed financial institutions. We first examine the existing Canadian regulatory architecture in relationship to underlying principles arising from the public theory of regulation. Elements of the Canadian regulatory framework that contributed to the success of the insurance industry in weathering the crisis include the presence of a federal regulator who monitors system-wide issues also ensures consistent solvency standards; investment guidelines that encourage prudent risk-taking; and a holistic approach to insurer monitoring. A comparison of the Canadian experience with that of other jurisdictions highlights the importance of a holistic risk management approach to firm viability, especially in light of the inherent risks arising from complex group structures. A lesson from the crisis is the need for effective ex ante and ex post cross-border and holistic supervision as most distressed institutions belonged to large complex groups operating in multiple regulatory jurisdictions.
 
Article
Cost and other pressures are increasingly forcing governments to seek more cost-effective solutions in a variety of policy areas. This approach could with advantage be applied to the handling of the major risks faced by the nation, in the same way that leading business corporations operate an active risk management strategy. A prerequisite for the successful pursuit of such a policy would be the collection and analysis of the costs associated with the range of hazards in question; for fire, the work of the World Fire Statistics Centre provides an example. To improve cost-effectiveness, some radical re-thinking may be needed, for example: (i) Policy: Integrating some risk management activities currently the responsibility of different government departments or other agencies; (ii) Operations: Greater integration of activities, e.g. fire and ambulance services, perhaps accompanied by more delegation and, in some cases, by privatization.
 
Article
My subject today is the universe of risks. There is currently a lot of talk about finance and banking, distribution channels and new technologies that may disrupt or circumvent insurance. But I propose that today we talk about risks, and the universe of risks which is, in fact, our universe. It is important to keep in mind that risk is the raw material of the insurance industry. And we would not be in business if this raw material did not exist. By the same token, any change in the nature of this raw material is bound to have an impact on ourbusiness. The Geneva Papers on Risk and Insurance (2001) 26, 1–7. doi:10.1111/1468-0440.00088
 
Top-cited authors
Martin Eling
  • University of St.Gallen
Geoffrey M. Heal
  • Columbia University
Peter Zweifel
  • University of Zurich
Stefan Felder
  • University of Basel
Christian Biener
  • University of St.Gallen