B.03. Dibra & Leadbetter

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B.03. Dibra & Leadbetter
2013-10-12 14:19:15
03 Dibra Leadbetter

B.03. Dibra & Leadbetter
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  1. Main conclusions
    • incidence of insolvency in the 90s is higher than 80s, which is in turn higher than preceding decades
    • inadequate pricing and deficient loss reserves are the leading causes of failure for Canadian insurance companies
    • incidence of insolvencies varies with industry profitability and the UW cycle
    • new insurers are more likely to fail than established insurers, and survival rate tends to stabilize after a decade of operation
  2. Characteristics of insolvent companies
    • size: 86% had less than $10M in capital
    • ownership: 21% were subsidiaries of failed parent companies
    • age: 28% operated for less than 10 years
    • growth: 68% experienced unusual growth in premium
    • UW: 70% occurred in property and auto lines
    • license type: 2/3 were federally supervised
  3. Proximate cause of involuntary exit
    • 31% = inadequate pricing or deficient loss reserves (DLR)
    • 20% = foreign parent
    • 17% = rapid growth
    • 9% = foreign parent DLR
    • 9% = fraud
  4. Theoretical models
    • dynamic equilibrium: characterizes process of entry and exit
    • hazard model: estimates probability of survival
  5. Dynamic equilibrium model
    • industry = continuum of firms producing homogeneous product
    • firms behave competitively by taking output and input price as given
    • output is a function of productivity shock and labour
    • costs = fixed operating cost and entry cost (>0)
    • after shock, firm evaluates environment; exit decision is determined by reservation value
  6. Hazard model approach
    • estimated probability of survival based on certain attributes
    • diversified firms survive longer and grow faster
    • strong reservoir of support is important for firm survival - subsidiary companies survive longer than stand-alone companies
    • pre-entry experience and experienced managers have large and persistent effect
    • new entrants learn by doing, with improved results over time
    • survival rate is increasing with respect to age
  7. Empirical analysis
    • primary internal causes are DLR and rapid growth
    • rapid growth occurs most frequently during soft market conditions with weak industry profits, when diminished capital strength drive insurers to aggressive expansion strategies
  8. Risk map
    • involuntary exit is not the outcome of a single factor
    • 2 types of underlying causes = internal and external
    • 60% of companies showed poor UW or reserving as a contributing factor
    • second cause is asset risk stemming from investments whose value was likely to be adversely affected by the same occurrences leading to large claims
  9. US & Canada vs Singapore
    • growth of surplus is negatively correlated to insurer's financial health in Singapore, while in other countries the authors found a negative correlation between combined ratio and financial health
    • all studies show adverse effect of interest rate and inflation on insurance companies' performance
    • unanticipated changes in inflation and interest rate level were not significant predictors for US industry exits
  10. Cost of insolvency
    • UEPR, claim cost
    • costs incurred by regulatory authorities, agents, accountants, reinsurers
    • lost wages, commissions, tax & other expenditures
    • simplest measure is to stick with UEPR and claim cost
  11. Cost of insolvency in Canada (PACICC)