Corporate hedging in the insurance industry: the use of financial derivatives by U.S. insurers
In this paper we investigate the extent to which insurance companies utilize financial derivatives contracts in the management of risks. The data set we employ allows us to observe the universe of individual insurer transactions for a class of contracts, namely, those normally through of as off-balance-sheet (OBS). We provide information on the number of insurers using various types of derivatives contracts and the volume of transactions in terms of notional amounts and the number of counterparties. Life insurers are most active in interest rate and foreign exchange derivatives, while ...
The capitalization and portfolio risk of insurance companies
The strategies of financial intermediaries in the United States presumed a stability of interest rates that began to break down in the late 1960s. Not only did rising interest rates during the past two decades tend to depress the value of the assets of all intermediaries, they also fostered competition among intermediaries as all sought new opportunities for profit. In order to cope, many financial institutions assumed new bets by "reaching" for riskier assets offering higher yields or by operating with less capital per dollar of assets. To varying degrees, many insurance companies have ...
Why is automobile insurance in Philadelphia so damn expensive?
We document and attempt to explain the observation that automobile insurance premiums vary dramatically across local markets. We argue high premiums can be attributed to the large numbers of uninsured motorists in some cities, while at the same time, the uninsured motorists can be attributed to high premiums. We construct a simple noncooperative equilibrium model, where limited liability can generate inefficient equilibria with uninsured drivers and high, yet actuarially fair, premiums. For certain parameterizations, an optimal full insurance equilibrium and inefficient high price equilibria ...
Risk and the capital of insurance companies
Insurance companies, like other financial institutions, have been evolving from specialized businesses to enterprises offering a variety of financial services. Rising interest rates impelled this evolution during much of the past three decades as most insurers tried to remain competitive. However, as insurers' profit margins subsided and they attracted new business, their assets generally grew more rapidly than their capital. To maintain the safety and soundness of insurance companies, regulators increasingly are adopting risk-based capital requirements instead of rules that limit insurers' ...
Is it true that insurers benefit from a catastrophic event? Market reactions to the 1995 Hanshin-Awaji earthquake
Previous studies, investigating how the market in general viewed the impact of a big earthquake (e.g., the 1989 Loma Prieta earthquake in the San Francisco Bay Area) on insurance firm values, found a positive reaction of insurers' stock prices. This "gaining from loss" may be caused by the subsequent increased demand for insurance coverage. This paper investigates the impact of the 1995 Hanshin-Awaji earthquake on Japanese insurers' value. Contrary to the results for U.S. earthquakes, we find significant negative stock price reactions. Furthermore, our results demonstrate that Japanese ...
Public policy and life insurance
Regulatory solvency prediction in property-liability insurance: risk-based capital, audit ratios, and cash flow simulation
This paper analyzes the accuracy of the principal models used by U.S. insurance regulators to predict insolvencies in the property-liability insurance industry and compares these models with a relatively new solvency testing approach--cash flow simulation. Specifically, we compare the risk-based capital (RBC) system introduced by the National Association of Insurance Commissioners (NAIC) in 1994, the FAST (Financial Analysis and Surveillance Tracking) audit ratio system used by the NAIC, and a cash flow simulation model developed by the authors. Both the RBC and FAST systems are static, ...