Journal of Risk and Insurance

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• Issue Information: Journal of Risk and Insurance 4/2023
• Do insurers use internal capital markets to manage regulatory scrutiny risk?

  Empirical evidence suggests that insurance groups allocate capital to members with better performance or growth prospects and use internal capital markets (ICMs) to protect the franchise value of less capitalized members. We propose and test an additional motivation for the use of ICMs—to manage regulatory scrutiny risk. We show that almost 50% of insurers at risk of facing additional regulatory scrutiny due to failing four Insurance Regulatory Information System (IRIS) ratios received sufficient internal capital to avoid enhanced regulation. Moreover, the likelihood and extent of internal capital allocation are related to regulatory scrutiny risk and the amount of capital allocated is typically just enough to avoid regulatory scrutiny. Time series evidence indicates that groups manage regulatory scrutiny risk by allocating capital toward affiliates when their pre‐capital contribution IRIS ratio failures exceed three, and away from affiliates when they are no longer at risk of additional regulatory scrutiny.

• Are female CEOs associated with lower insolvency risk? Evidence from the US property‐casualty insurance industry

  This paper investigates the relationship between female CEOs and insolvency risk of US property‐casualty insurance companies. We show that female CEOs are associated with lower insurer insolvency propensity, higher z‐score, and lower standard deviation of return on assets. These findings are robust to alternative econometric specifications to address potential endogeneity concerns and self‐selection issues, including propensity score matching, the instrumental variable approach, and the difference‐in‐difference approach. Furthermore, we find that the impact of female CEOs on insurer insolvency risk is moderated by firm capitalization, the presence of female directors, and political conservatism of insurers' home states.

• The peer effect in adverse selection: Evidence from the micro health insurance market in Pakistan

  The peer effect may amplify adverse selection in social networks, hampering the sustainable operation of microinsurance. This paper uses data from a micro health insurance program in Pakistan to test for the peer effect in renewal decisions and the role it plays in amplifying adverse selection within social networks. The paper finds evidence supporting that insurance renewal decisions are similar among peers in the same network, and the peer effect is stronger among households of the same risk type than households of different risk types, indicating that the heterogeneous peer effect acts as an amplifier for adverse selection. The paper provides policy implications for effective ways to mitigate the peer effect and adverse selection, based on the results of heterogeneity analyses. The policy recommendation is to enforce a minimum group enrollment rate requirement of at least 60% for large groups to mitigate the peer effect.

• Insurance demand in the presence of loss‐dependent background risk

  We analyze insurance demand when insurable losses come with an uninsurable zero‐mean background risk that increases in the loss size. If the individual is risk vulnerable, loss‐dependent background risk triggers a precautionary insurance motive and increases optimal insurance demand. Prudence alone is sufficient for insurance demand to increase in two cases: the case of fair insurance and the case where the smallest possible loss exceeds a certain threshold value (referred to as the large loss case). We derive conditions under which insurance demand increases or decreases in initial wealth. In the large loss case, prudence determines whether changes in the background risk lead to more insurance demand. We generalize this result to arbitrary loss distributions and find conditions based on decreasing third‐degree Ross risk aversion, Arrow–Pratt risk aversion, and Arrow–Pratt temperance.

• Analyst coverage, executive compensation and corporate risk‐taking: Evidence from property–casualty insurance firms

  Using an exogenous drop in analyst coverage introduced by broker closures and mergers, we test for the causal impact of analyst coverage on corporate risk‐taking, in an opaque industry. We document an increase in risk using several book‐based and market‐based risk measures, including tail and default risk measures. Results are driven by firms with stronger managerial risk‐taking compensation incentives. The increase in risk is stronger in more opaque firms, and firms with weaker policyholder monitoring. Firm risk increases through at least one risk‐taking action, such as investing firm assets in higher‐risk bonds. Our study highlights the importance of stock analysts in affecting corporate risk‐taking, especially in the presence of stronger managerial, compensation risk‐taking incentives.

• Risk classification with on‐demand insurance

  On‐demand insurance is an innovative business model from the InsurTech space, which provides coverage for episodic risks. It makes use of a simple fact in a practical way: People differ in their frequency of exposure as well as the probability of loss. The extra dimension of heterogeneity can be used to screen the insured and shifts the utility‐possibility frontier outward. We provide a sufficient condition under which type‐specific full insurance at the actuarially fair price is incentive compatible. We also show that our results hold for various real‐world implementations of on‐demand insurance.

• Regulatory capital and asset risk transfer

  We explore whether life insurers use a unique reinsurance arrangement to manage assets tied to their regulatory capital. Typical reinsurance allows insurers to reduce their regulatory capital by transferring liabilities (reserves), and the associated assets, to reinsurers. With modified coinsurance (ModCo), insurers maintain control of their liabilities and assets while transferring regulatory capital requirements to the reinsurer. Holding fixed an insurer's reported capital, we find that ModCo allows insurers to report higher risk‐based capital ratios. Insurers with ModCo are less likely to fire sale downgraded bonds. We also find suggestive evidence of regulatory arbitrage, as most ModCo is purchased from reinsurers in countries with low capital requirements or within the same insurance group.

• Fixed and variable longevity income annuities in defined contribution plans: Optimal retirement portfolios taking social security into account

  This paper investigates retirees' optimal purchases of fixed and variable longevity income annuities using their defined contribution (DC) plan assets and given their expected social security benefits. As an alternative, we also evaluate using plan assets to boost social security benefits through delayed claiming. Using a calibrated life‐cycle model, we determine that including deferred income annuities in DC accounts is welfare‐enhancing for all sex/education groups examined. We also show that providing access to well‐designed variable deferred annuities with some equity exposure further enhances retiree well‐being, compared to having access only to fixed annuities. Nevertheless, for those facing the highest mortality rates, delaying claiming social security is mostly preferred, whereas those anticipating living longer than average will benefit more from using accumulated DC plan assets to purchase deferred annuities.

Featured documents

• Insurers and Lenders as Monitors During Securities Litigation: Evidence from D&O Insurance Premiums, Interest Rates, and Litigation Costs

  This study examines whether directors’ and officers’ insurers and lenders effectively monitor securities litigation and respond through pricing before case outcomes are known. By “monitoring,” we refer to tracking case progress and obtaining information from the insured (defendant) firm and its...

• High‐water mark fee structure in variable annuities

  This paper proposes a novel high‐water mark fee structure and investigates its impact on the marketability of variable annuities. To evaluate the welfare effects of holding a variable annuity, we adopt mean‐variance analysis. By also examining the welfare effects of holding two alternative...

• A common thread linking the design of guarantee and nonescalating payments of public annuities

  Motivated by recent experiences in economies adopting the defined‐contribution pension system, we study public annuities in the presence of survival probability heterogeneity. It is found that the difference of annuitization‐weighted and unweighted averages of survival probabilities is a useful...

• The efficiency of voluntary risk classification in insurance markets

  It has been established that categorical discrimination based on observable characteristics such as gender, age, or ethnicity enhances efficiency. We consider a different form of risk classification when there exists a costless yet imperfectly informative test of risk type, with the test outcome...

• Capital requirements and claims recovery: A new perspective on solvency regulation

  Protection of creditors is a key objective of financial regulation. Where the protection needs are high, that is, in banking and insurance, regulatory solvency requirements are an instrument to prevent that creditors incur losses on their claims. The current regulatory requirements based on value...

• Wishart‐gamma random effects models with applications to nonlife insurance

  Random effects are particularly useful in insurance studies, to capture residual heterogeneity or to induce cross‐sectional and/or serial dependence, opening hence the door to many applications including experience rating and microreserving. However, their nonobservability often makes existing...

• Risk pooling and solvency regulation: A policyholder's perspective

  We investigate the benefits of risk pooling for the policyholders of stock insurance companies under different solvency standards. Using second‐degree stochastic dominance, we document that the utility of risk‐averse policyholders is increasing in the pool size if the equity capital is proportional ...

• Insurance demand in the presence of loss‐dependent background risk

  We analyze insurance demand when insurable losses come with an uninsurable zero‐mean background risk that increases in the loss size. If the individual is risk vulnerable, loss‐dependent background risk triggers a precautionary insurance motive and increases optimal insurance demand. Prudence alone ...

• Comparative risk aversion in two periods: An application to self‐insurance and self‐protection

  Risk management decisions provide a means to elicit individuals' risk preferences empirically. In such a context, the literature often presumes that the decision to invest in risk management and the benefit of this investment occur contemporaneously. There is, however, no consensus in the...

• Robust estimates of insurance misrepresentation through kernel quantile regression mixtures

  This paper pertains to a class of nonparametric methods for studying the misrepresentation issue in insurance applications. For this purpose, mixture models based on quantile regression in reproducing kernel Hilbert spaces are employed. Compared with the existing parametric approaches, the proposed ...