Request for Proposals: Testing of Liability Pricing Models
CASUALTY ACTUARIAL SOCIETY
Committee on Valuation, Finance, and Investments
Revised October 1, 2009
- Casualty Actuarial Society (CAS)
The CAS was organized in 1914 as a professional society with the purpose of advancing the body of knowledge of actuarial science applied to property, casualty and similar risk exposures. This is accomplished through communication with the publics affected by insurance, the presentation and discussion of papers, attendance at seminars and workshops, collection of a library, funded research activities, and other means. The membership of the CAS includes over 4,600 actuaries employed by insurance companies, industry advisory organizations, national brokers, accounting firms, educational institutions, state insurance departments, the federal government, and independent consultants.
- Committee on Valuation, Finance, and Investments
The Committee on Valuation, Finance, and Investments (VFIC) is charged with providing direction, guidance, and support to the profession, regulators, and others regarding valuation and financing of property and casualty risks and investments. The Committee is also responsible for monitoring and coordinating activities with other organizations or CAS committees working in areas related to property and casualty valuation, finance, and investments.
VFIC will sponsor the research to be conducted under this RFP on behalf of the CAS.
- CAS Interest in the Subject
Despite recent innovations in capital markets securitization, insurance liabilities do not trade in liquid markets. As a result, there are no such things as insurance "prices" as this term is understood in financial economics. However, there is a considerable body of literature that attempts to develop ground-up "values" for insurance contracts. This body of literature goes under the classification of "risk loading", "economic profit margins", or "capital allocation". For uniformity, we shall refer to all of these methods as "valuation" approaches, to distinguish them from "pricing", which is performed in a market. What often goes unstated is that valuation techniques are, ideally, attempts to simulate how insurance contracts would be priced in efficient markets. Methods which are poor simulations of a market pricing mechanism are now seen as increasingly "ad hoc", and modern research has focused on translating insurance pricing into known asset pricing frameworks. Adaptations to CAPM, with the addition of the frictional cost of capital, are typical examples of this. Unfortunately, CAPM has rather strong market-based assumptions that may not be appropriate for insurance pricing (e.g. no ability to short insurance contracts in an unlimited fashion). It might be the case that these strong assumptions are not actual limitations, and that CAPM-based models are "good enough". But the reality is that we simply do not know. The literature seems devoid of research that tries to test whether or not a model is actually appropriate to the structure of insurance liabilities as they actually exist. The CAS would benefit from further research in this area.
- Research Problem Description
The purpose of this RFP is to solicit research that tests whether or not existing theoretical valuation methods actually predict real market pricing, or aspects thereof. While the researchers may propose a method for testing, the RFP would be pre-disposed to existing well-documented theoretical models. One such model is that specified in the Risk Premium Project (see CAS Forum, Fall 2000, p. 165).
It might be necessary for the CAS to obtain a base dataset of anonymous insurance transaction for use by researchers. Part of the problem is that financial economics is much less familiar with insurance data compared to the copious amounts of market data available in the capital markets. Of course, methods that make use of public information, like the statutory statements, would be welcome (the Mildenhall paper below is an example of this).
Examples of this kind of research are infrequent, but they exist. The following papers are examples of tests that have already taken place, and that would satisfy the requirements of this RFP. All 3 papers provide a thorough exposition of a theoretical framework, followed by empirical testing of that framework. Two of these papers (Major/Kreps, Venter) focus on catastrophe pricing, while the third (Mildenhall) examines the structure of risk loads. Papers focusing on primary lines of business would be particularly welcome, particularly in the context of the Risk Premium Project Models.
- Major, J. and Kreps, R., 2002, Catastrophe Risk Pricing in the Traditional Market, Alternative Risk Strategies, ed. Lane, M., London: Risk Books
- Venter, G., Barnett, J., Owen, M., 2004, Market Value of Risk Transfer: Catastrophe Reinsurance Case, International AFIR Colloquium
- Mildenhall, S., 2006, Actuarial Geometry, Proceedings of the Risk Theory Society
- Project Requirements
VFIC requests proposals from qualified researchers to produce a research document that tests existing theoretical models of liability pricing against some form of empirical data. The paper may use an existing liability pricing model (e.g., that of the Risk Premium Project), or a different model can be used. There is a preference for existing well-researched theoretical models. The key deliverable is a test of the model against empirical liability pricing data to see if the model assumptions are observed in practice. Note that "pricing" can be broadly interpreted as "risk loading" depending upon the specific model. Negative results are acceptable.
- Proposal Requirements
Proposals should include a clear outline of the work that will be performed and the time frame in which it will be performed (including key dates). The more specific the proposal covers the goals the better. A cost estimate or range should accompany each proposal.
This proposal will be reviewed in conjunction with the attached Research Agreement which defines the terms and conditions under which the work is performed.
The proposal should be accompanied by the resumes of the researcher(s), indicating how their background, education, and experience bear on their qualifications to undertake the research.
Respondents should demonstrate their interest in and familiarity with the literature on the evaluation of risk by including a resume (if a firm, of the principal consultant(s) performing or directing the work) showing relevant work/research experience and professional accomplishments (e.g., papers published).
Receipt of proposals will be acknowledged in a timely manner.
All decisions regarding the evaluation of responses to the RFP will be awarded entirely based on the information provided in the written proposals. The CAS will award the contract to the respondent who, in the judgment of VFIC, is best able to perform the work as specified herein. If VFIC determines that no proposal meets the requirements of the RFP, then no contract will be awarded.
When a respondent is chosen by VFIC and the contract awarded, respondents not awarded the contract will be so informed shortly thereafter.
Interested researchers should submit their proposals and any questions in writing to:
Casualty Actuarial Society
Attention: Chairperson, VFIC
4350 N. Fairfax Dr. Suite 250
Arlington, VA 22203
Phone: (703) 276-3100
Fax: (703) 276-3108
The proposals will be reviewed by members of a subcommittee of VFIC. The current membership of the VFIC includes:
|Jason Russ, Chair||Chris Gross||Claus Metzner|
|Todd R. Bault||Philip Kane||David A.|
|Michael Belfatti||Lawrence F. Marcus||Meyer Shields|
|Kirk D. Bitu||Michael McCarter||Chester John|
|Kirk Conrad||Rasa Varanka McKean||Yuanhe Yao|
|Richard Goldfarb||Todd C. Meier|
- Proposed Schedule
October 23, 2009
Deadline for questions (must be written) from researchers regarding the RFP.
November 6, 2009
All written questions together with their answers will be distributed to all proposers.
November 20, 2009
Proposal deadline - end of business day
December 4, 2009
Proposal selection by VFIC
Draft Report and Final Report due date to be decided by researcher and included in proposal.
A maximum total of $25,000 is available to be awarded to one or more researchers. Payment of award(s) will be contingent upon delivery of an acceptable research product.
- Presentation, Ownership and Publication of Report
If asked, the researcher(s) agree to be available to present the report at a CAS meeting or seminar. If travel is required, reasonable expenses will be paid in addition to the compensation provided in Section 8. The researcher(s) are also encouraged to make sample calculations available in spreadsheets or code for a widely used analytical language such as R.
As a condition of selection, the CAS requires that all right, title, and interest, including copyright and patent, in and to the report be owned by the CAS. The selected researcher must sign a formal Agreement (attached) that assigns all such rights to the CAS. Of course, in any publication of the report, the researcher will receive appropriate credit. The CAS may publish the report in any CAS publication, including electronic versions such as on its Web site or on compact discs.
- Research Agreement
A standard research agreement will be provided to the researcher(s).