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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
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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
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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
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Theoretical models
- dynamic equilibrium: characterizes process of entry and exit
- hazard model: estimates probability of survival
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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
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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
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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
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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
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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
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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
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Cost of insolvency in Canada (PACICC)
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