Brehm CH 5 Flashcards
What is the definition of the P&C UW cycle?
recurring pattern of increases and decreases in insurance premiums and profits
can be traced back to the beginnings of fire insurance in the 19th century
separate by LOB mostly, but can be linked via common economic and societal shocks and multiline companies supported by common capital
What are the four stages of a line of insurance business?
(1) Emergence: Data is thin or nonexistent. Demand quickly grows and price wars set in. Crisis of insolvency eventually and a sudden price correction and weak competition is gone followed by a profitable period, bringing in more competition, rinse and repeat.
(2) Control: Stabilization reached by collective coercive control. Rates regulated.
(3) Breakdown: Due to tech and social changes, control regime breaks down. New competitors, not under control, take away business
(4) Reorganization:Return to first stage conditions, as new version of old LOB emerges
Institutional factors
Pricing involves forecasting historical results (time lag)
“actuaries are dumb” theory because they naively extrapolate past data regression style
reporting delays can cause the second order autoregression
Competition
UW strat alternates between aggressive growth and price maintenance
four phases: cheating, pain, fear, and restoration
Supply and demand, capacity constraints and shocks
a shock that reduces capital will raise prices and supply becomes constricted
declining profits may be worsened by adverse selection
Economic linkages
profitability is linked to investment income, and cost of capital linked to the wider economy
exp losses are impacted by inflation, unemployment, etc
What are some potential predictor variables for modeling the UW cycle (typically modeling a profitability measure)?
Previous time period values of the target
reserves, investment income, cat losses
regulatory/rating variables (upgrades and downgrades)
reinsurance sector financials
inflation, unemployment, GNP
interest rates and stock returns
Competitor intelligence approach to modeling the UW cycle
Sources: firm’s own agents and field staff, customers surveys, trade publications, rate filings and the internet
Be careful of anti-trust issues
search for leading indicators
Soft approaches to modeling
human approach to human issues
start with focus on data gathering and intelligence
analysis includes scenarios, delphi method and competitor analysis
What is the delphi method?
Method of obtaining expert consensus on an issue
participants all given same background material and asked for their opinions in a carefully designed questionnaire. Responses are summarized and returned to participants for them to reconsider, repeat until convergence
Technical modeling approach
focus on small number of industry financial stats
basic method: time series analysis (AR model)
AR(N) = Xt = a + sum(bix(t-i)) + sigmaepsilon(i)
n = 2,3 seems to be the best
more sophisticated approach might be a more general factor model
Econometric modeling
aka behavioral modeling (middle ground between soft and technical)
most revolve around supply and demand price P, quantity Q
individual demand curves are flatter due to competition relative to industry
since you can only observe the equilibrium, estimating supply-demand curves is tough
What components for an econometric model?
How economic factor influence the s-d curves
How capital influences the s-d curves
how current level of prices and losses influence the s-d curves
how s-d curves jointly determine price and quantity
how prem and loss affect capital stock directly
how profitability impacts external capital flows
implemented as a set of interlinked equations: key output is average market price level
