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Reinsurance from the viewpoint of institutional economics
Abstracts and Reviews the speed of the approach of each method’s indication to the true value of the aggregate costs is examined. Suggestions for enhancement of the simulation model and performance tests follows. Keyword: Claim process, Simulation. 222017 (M40, M22) A Comparative Study of the Performance of Loss Resewing Methods through Simulation Narayan P., Warthen T.V., Casualty Actuarial Sociew Forum, Volume I, 1997, 175-196. Actuaries are often asked to provide a range or confidence level for the loss reserve along with a point estimate. Traditional methods of loss reserving do not provide an estimate of the variance of the estimated reserve and actuaries use various ad hoc methods to derive a range for the indicated reserve. Regression models for loss reserving are getting increasing attention in actuarial research as they provide an estimate of the variance of the loss reserve, along with a point estimate. However, these methods are rarely used in practice, both because of their complexity and the lack of their historical use. In this paper the authors use a Monte Carlo simulation method to compare loss reserve estimation methods, including traditional methods, and regression based methods of loss reserving. Their apprdach is similar to that of Stanard (S), where he compares several traditional actuarial methods using simulation techniques. However, they use different methods for simulating loss triangles, and compare the estimated reserve based on several characteristics. Keywords: Loss reserving methotis, Simulation. 222018 (M40) Loss Reserve Testing: Beyond Popular Methods Weber R.A., Van Slyke 0. E., Russo G., Casualty Actuarial Society Forum, Volume 1, 1997,381-448. These are a number of popular actuarial methods in wide use which estimate ultimate claims costs from data in loss development triangle format. The typical actuarial reserve analysis shows the application of several methods to the data, with little other description of the nature of the world. The popular methods rely on assumptions that may not be consistent with the facts in any given case. In particular, the popular methods assume that most of the drivers of loss costs do not change from year to year, an assumption that more often than not is clearly violated. Loss reserve estimates can be tested against the data they are designed to reflect. An actuarial report showing this
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results of these tests is sufficient for the purposes of the independent audit (of the insurance entity’s reserves or the work of the individual who prepared the report). Loss reserve estimates which do not pass the tests can be revised as appropriate. Loss reserve estimates that pass all of the tests - or rather, strike a balance between the conflicting indications of various tests - are more robust than estimates made using the popular methods. They are less likely to be unreasonable because of incorrect assumptions. Also, at least in most cases, such estimates tend to be more stable from year to year than estimates based on the popular methods. Keywords: Loss reserves, IBNR, Financial statements, Audit, Actuarial studies, Insurance, Reviewing the work of another professional. 222019 (M40) Robust Lagfactors Uremer E., Bbtter, Band 13, Hefr 2, 1997, 147-l 72. A method to compute robust lagfactors in lossreserving is presented in all details and compared with classical procedures. Keywords: Lagfactors, Loss reserving. 222020 (M40) Reinsurance from the Viewpoint of Institutional Economics Altenburger O.A., Zeitschrifi fiir die Gesamte Versicherungswissenschaj?, 1997, 157-l 70. Applying the concept of (new) institutional economics to reinsurance creates numerous questions. Can reinsurance be considered an institution? Can the concept of transaction costs help to explain the specification of reinsurance contracts, the type of the amount of reinsurance? How are principal-agent problems incorporated? Can reinsurance be explained by concepts of institutional economics? Reinsurance can hardly be named an institution, but the reinsurance system including markets, companies, brokers, rules and practices as well as types of contracts could be subsumed under the term “institution”. The rules are unwritten but internationally commonly used e.g. the submission to arbitration, or the use of the occidental calendar. The concept of transaction costs - which are minim&d to increase effkziency - can be identified in the reinsurance system: information costs are reduced by using standardised products, handling costs by preferring treaty to facultative reinsurance (and reinsurance to coinsurance). If tbe choice between reinsurance and
180
Abstracts and Reviews
retention is based on transaction costs, retention turns out to be more advantageous because costs for generating information about the reinsurers, negotiation costs, and other costs are avoided. The concept of transaction costs fails to include production costs, which are also relevant for a correct (complete) comparison of costs. Furthermore, each choice between “tirm” and “market” should not be based on minimal costs, but on maximal net utility (i.e. utility minus costs). In direct insurance principal-agent problems are well known (moral hazard, adverse selection), and the roles of agent and principal are clearly defined: the insured (agent) generally is better informed about his distribution of losses than the insurer (principal). In reinsurance, however, the reinsurer can be principal as well as agent. The underwriting decision in the direct business often depends on the confirmation of the contract by the reinsurer - he apparently is better informed about the risk. The double role as agent and principal becomes obvious when the prior insurer accidentally reaccepts a part of a risk which originally was transferred in the reinsurer. Certain contractual specifications and the importance of pro-rata reinsurance indicate the reinsurer’s role as the principal. Thus, the agency theory can explain the governance of reinsurance contracts but not reinsurance itself. The existence of reinsurance companies is difficult to explain. More helpful than the new approaches are older concepts within the &unework of institutional economics, especially the reasoning about the functions of the entrepreneur. According to this theory entrepreneurs reduce the uncertainty of income for other persons by accepting risks (e.g. by employing people) - typical functions of the insurance business. Although insurance companies, above all reinsurance companies, tYfi1 the mentioned functions to a great extent, this explanation is not specific for insurance or reinsurance companies. In other words: reinsurance is, like insurance, a business as any other business, subject to the general economic theory. Keyworak Reinsurance. 222021 (M40, E50) Additional Policy Reserves: No Market for the Equitylinked Life Insurance in Germany? Nonnenmacher D., Schittenhelm F.A., Zeitschrifrfir die Gesamte Versicherungswissenschaft, 1997, 393-416. Equity linked life insurance policies under asset value guarantee are currently considered to be one of the most interesting innovations in the German life insurance
market. Though this product is generally assumed to have a high market potential, there is only one German insurance company offering such a product so far, A main reason for this is the problem of additional policy reserves according to recent statements of a member of the German supervisory authority, policy reserves have to be calculated as the maximum of the market value of the policy and the discounted guaranteed sum. This lead to so-called additional policy reserves whenever the market value of the policy drops below the discounted guaranteed sum. Since these additional policy reserves cause (potentially substantial) additional costs, insurance companies have to quantify the distribution of these additional policy reserves accurately before the policy is written. This paper discusses all relevant aspects which have to be considered in order to introduce an equity-linked life insurance in Germany from the perspective of a German provider. All of the analysis is based on a concrete product example. The product is linked - via the index participation rate - to the DAX30 (German equity index) and provides a guaranteed payment of interest (on the net premiums) at maturity. Because of a specific tax legislation the policy term is chosen to be 12 years with 5 annual premiums. Pricing formulas which are derived within a Black-Scholes environment are used to determine the fair rate of index participation. The paper discusses all legal issues of interest and quantities, for the first time, important parameters of the distribution of the additional policy reserves. Keyword: Equity-linked Lije insurance, German life insurance market.
M43: FLUCTUATION RESERVES, SOLVENCY MARGINS 222022 (M43) Solvability of Finance Conglomerates and Insurance Groups - Is a new Directive Necessary? Van den Berghe L., Zeitschrtji fir die Gesamte Versicherungswissenschafi, 1997, 251-268. This paper analyses the most important aspects of the proposed EU Directive on insurance groups. 1. This proposed directive defines the insurance group and thus the field of application - on the basis of the concepts of a group of enterprises in general and of a credit institution more specifically. Although insurance companies and credit institutions can both be considered as financial institutions, the important differences on the
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results of these tests is sufficient for the purposes of the independent audit (of the insurance entity’s reserves or the work of the individual who prepared the report). Loss reserve estimates which do not pass the tests can be revised as appropriate. Loss reserve estimates that pass all of the tests - or rather, strike a balance between the conflicting indications of various tests - are more robust than estimates made using the popular methods. They are less likely to be unreasonable because of incorrect assumptions. Also, at least in most cases, such estimates tend to be more stable from year to year than estimates based on the popular methods. Keywords: Loss reserves, IBNR, Financial statements, Audit, Actuarial studies, Insurance, Reviewing the work of another professional. 222019 (M40) Robust Lagfactors Uremer E., Bbtter, Band 13, Hefr 2, 1997, 147-l 72. A method to compute robust lagfactors in lossreserving is presented in all details and compared with classical procedures. Keywords: Lagfactors, Loss reserving. 222020 (M40) Reinsurance from the Viewpoint of Institutional Economics Altenburger O.A., Zeitschrifi fiir die Gesamte Versicherungswissenschaj?, 1997, 157-l 70. Applying the concept of (new) institutional economics to reinsurance creates numerous questions. Can reinsurance be considered an institution? Can the concept of transaction costs help to explain the specification of reinsurance contracts, the type of the amount of reinsurance? How are principal-agent problems incorporated? Can reinsurance be explained by concepts of institutional economics? Reinsurance can hardly be named an institution, but the reinsurance system including markets, companies, brokers, rules and practices as well as types of contracts could be subsumed under the term “institution”. The rules are unwritten but internationally commonly used e.g. the submission to arbitration, or the use of the occidental calendar. The concept of transaction costs - which are minim&d to increase effkziency - can be identified in the reinsurance system: information costs are reduced by using standardised products, handling costs by preferring treaty to facultative reinsurance (and reinsurance to coinsurance). If tbe choice between reinsurance and
180
Abstracts and Reviews
retention is based on transaction costs, retention turns out to be more advantageous because costs for generating information about the reinsurers, negotiation costs, and other costs are avoided. The concept of transaction costs fails to include production costs, which are also relevant for a correct (complete) comparison of costs. Furthermore, each choice between “tirm” and “market” should not be based on minimal costs, but on maximal net utility (i.e. utility minus costs). In direct insurance principal-agent problems are well known (moral hazard, adverse selection), and the roles of agent and principal are clearly defined: the insured (agent) generally is better informed about his distribution of losses than the insurer (principal). In reinsurance, however, the reinsurer can be principal as well as agent. The underwriting decision in the direct business often depends on the confirmation of the contract by the reinsurer - he apparently is better informed about the risk. The double role as agent and principal becomes obvious when the prior insurer accidentally reaccepts a part of a risk which originally was transferred in the reinsurer. Certain contractual specifications and the importance of pro-rata reinsurance indicate the reinsurer’s role as the principal. Thus, the agency theory can explain the governance of reinsurance contracts but not reinsurance itself. The existence of reinsurance companies is difficult to explain. More helpful than the new approaches are older concepts within the &unework of institutional economics, especially the reasoning about the functions of the entrepreneur. According to this theory entrepreneurs reduce the uncertainty of income for other persons by accepting risks (e.g. by employing people) - typical functions of the insurance business. Although insurance companies, above all reinsurance companies, tYfi1 the mentioned functions to a great extent, this explanation is not specific for insurance or reinsurance companies. In other words: reinsurance is, like insurance, a business as any other business, subject to the general economic theory. Keyworak Reinsurance. 222021 (M40, E50) Additional Policy Reserves: No Market for the Equitylinked Life Insurance in Germany? Nonnenmacher D., Schittenhelm F.A., Zeitschrifrfir die Gesamte Versicherungswissenschaft, 1997, 393-416. Equity linked life insurance policies under asset value guarantee are currently considered to be one of the most interesting innovations in the German life insurance
market. Though this product is generally assumed to have a high market potential, there is only one German insurance company offering such a product so far, A main reason for this is the problem of additional policy reserves according to recent statements of a member of the German supervisory authority, policy reserves have to be calculated as the maximum of the market value of the policy and the discounted guaranteed sum. This lead to so-called additional policy reserves whenever the market value of the policy drops below the discounted guaranteed sum. Since these additional policy reserves cause (potentially substantial) additional costs, insurance companies have to quantify the distribution of these additional policy reserves accurately before the policy is written. This paper discusses all relevant aspects which have to be considered in order to introduce an equity-linked life insurance in Germany from the perspective of a German provider. All of the analysis is based on a concrete product example. The product is linked - via the index participation rate - to the DAX30 (German equity index) and provides a guaranteed payment of interest (on the net premiums) at maturity. Because of a specific tax legislation the policy term is chosen to be 12 years with 5 annual premiums. Pricing formulas which are derived within a Black-Scholes environment are used to determine the fair rate of index participation. The paper discusses all legal issues of interest and quantities, for the first time, important parameters of the distribution of the additional policy reserves. Keyword: Equity-linked Lije insurance, German life insurance market.
M43: FLUCTUATION RESERVES, SOLVENCY MARGINS 222022 (M43) Solvability of Finance Conglomerates and Insurance Groups - Is a new Directive Necessary? Van den Berghe L., Zeitschrtji fir die Gesamte Versicherungswissenschafi, 1997, 251-268. This paper analyses the most important aspects of the proposed EU Directive on insurance groups. 1. This proposed directive defines the insurance group and thus the field of application - on the basis of the concepts of a group of enterprises in general and of a credit institution more specifically. Although insurance companies and credit institutions can both be considered as financial institutions, the important differences on the