Granted all readers of CASNET are not able to read a 49 page paper on an
issue, but I don't think you should discourage participants from
providing references to appropriate research on questions raised online.
I was actually tempted to recommend Rich Phillips' paper on the issue
myself, and am glad that he provided a hyperlink copy of his work.
Basically, this paper addresses the practical difficulty of dividing
surplus and recognizes that the entire surplus of a company is at risk
for any given line, regardless of how much surplus is allocated based on
a ratemaking formula. It develops, after much high level math, that the
price of insurance of a line of business is related to the growth rate
in liabilities for that line, as well as to the total surplus of the
company. Measuring the growth rate in liabilities has not yet been
fully resolved, and you point to some of the technical difficulties (net
or direct). However, this is a promising new direction on the surplus
allocation problem.
Steve
> -----Original Message-----
> From: Blanchard, Ralph S [SMTP:ralph.s.blanchard@travelers.com]
> Sent: Wednesday, June 24, 1998 8:49 AM
> To: casnet@lists.casact.org
> Subject: Re: Allocation of surplus to individual lines, Response
> to Richard D. Phillips paper
>
> The following is in response to Richard D. Phillips paper concerning
> allocation of surplus to individual lines.
>
> In his response, he hypothesizes that the "price" for insurance
> offered by multi-company multi-line organizations would be lower, due
> to the ability of the group to "walk away" from an insolvent
> subsidiary. The implication is that default risk is higher for such
> companies. This runs completely counter to both general belief and
> past insolvency track records. For this reason, I skimmed through the
> paper referred to by Mr. Phillips.
>
> The paper he referenced is 49 pages long. Due to time constraints, I
> did not read the entire paper. Instead, I skimmed the section where
> he discussed his empirical data tests and his definition of insurance
> price measures.
>
> The paper defines price as the ratio of liabilities to premium. It
> was not readily apparent from the paper whether these numbers were
> before (gross of) reinsurance or after (net of) reinsurance, but I
> suspect it was net of reinsurance. As such, one problem with the
> analysis is the impact of company net reinsurance retentions.
>
> (To explain, an insurance company typically protects itself from
> excessive volatility in insurance results through the purchase of
> reinsurance. The level of reinsurance is dependent on risk tolerance
> and the existing risk profile of the company's business before
> reinsurance. Companies with a greater internal spread, or
> diversification, of risk, such as is accomplished by writing multiple
> lines, will generally have a higher risk tolerance for an individual
> line. Hence they need less reinsurance.
>
> The type of reinsurance may vary, between straight proportional to
> high level excess reinsurance. If a company has a high risk tolerance
> for an individual line, it will tend to buy high level excess
> reinsurance rather than low level excess or proportional reinsurance.
> As larger losses tend to have a much longer duration than the smaller
> losses, this means that the insurer will have a much longer tail, or
> duration for its liabilities, than a company with a lower risk
> tolerance by line (that cedes its long tail losses to others). This
> will lead to a deeper discount when converting its liabilities or
> losses from a nominal to an economic basis. Therefore, a company with
> a higher net retention will have a lower "price", or ratio of premium
> to net economic losses, strictly due to the level of losses it retains
> and NOT DUE TO ANY DEFAULT RISK.)
>
> Another potential pitfall of the analysis referred to was the use of
> daily stock price volatility to measure insolvency risk. During the
> time in question, the oldest and most established multi-line companies
> were being punished by the stock market for perceived future earnings
> drags from Environmental and Asbestos. As subsequent history has born
> out, the biggest danger due to this problem was earnings, not
> insolvency. The stock markets are much more focused on earnings than
> insolvency. Therefore, stock price volatility may not be a good
> measure of insolvency risk.
>
> A third problem alluded to above is the high correlation during the
> time-period in question between multi-company groups and Environmental
> & Asbestos problems. This factor may overwhelm any other correlation
> being tested during the period in question between multi-line
> multi-company groups and any other factor.
>
> Lastly, I would greatly appreciate it if future discussions on this
> forum could be done in a concise manner. Referencing a 49 page paper,
> augmented by a multi-sentence single paragraph technical abstract, is
> not conducive to effective communication. Many people on this Net are
> business people, or otherwise busy people who cannot afford to read
> long technical papers. As such, the tendency is either to rely on the
> conclusion without testing or to ignore the work entirely. Neither is
> desirable. Therefore, while I greatly appreciate an extended and
> diverse discussion from all areas, I plead with all those entering
> into the discussion to remember the entire audience and its needs.
> Thank you.
>
>
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