Failure Risks in the Insurance Industry: A Quantitative Systems Analysis

• Date: 01 September 2009
• DOI: http://doi.org/10.1111/j.1540-6296.2009.01162.x
• Author: Léa A. Deleris,Elisabeth Paté‐Cornell
• Published date: 01 September 2009

C

Risk Management and Insurance Review, 2009, Vol.12, No. 2, 199-212

FEATURE ARTICLES

FAILURE RISKS IN THE INSURANCE INDUSTRY:

AQ

UANTITATIVE SYSTEMS ANALYSIS

Elisabeth Pat´

e-Cornell

L´

ea A. Deleris

ABSTRACT

We present in this article the findings from a study on insolvency in the

property–casualty insurance industry that was commissioned by the Risk Foun-

dation. The Risk Foundation contacted us for this work to draw from our ex-

perience in risk analysis based on systems analysis and probability. Therefore,

we provide a different perspective on failurein the insurance industry by open-

ing the “black box” to assess the contribution of different factors to the overall

risk. Besides the development of a quantitative model for insolvency risk, our

study for the Risk Foundation included insights from (1) unstructured inter-

views with 15 insurance industry experts and with six insurance regulators in

different states, and (2) a statistical analysis of insolvency data (A.M. Best) cov-

ering the 1970 through 2005 period. Our focus here is centered on the practical

insights that came out of the study, rather than on the technical details that led

us to those insights.

INTRODUCTION

In the last few years, the insurance industry has been exposed, worldwide, to large losses

and disruptions, from the payments that had to be made following the attacks on the

World Trade Center on September 11, 2001, to the costs of asbestos claims, the collapse

of high-tech segments of financial markets, and government investigations of industry

practices. Taken separately, these kinds of events do not seem to be the main causes of

firms’ insolvencies. Yet, the failures of insurance companies such as Kemper, Reliance,

and Trenwick, among others, illustrate the reality of the exposure of insurance firms to

a spectrum of business failure scenarios.

There is more to insurance companies’ insolvencies than the usual suspects: catastrophes

(natural or man made) and stock market collapses. The problem is that the different

factors that weaken these firms are dependent and evolving. Statistics are useful but

Elisabeth Pat´

e-Cornell is Professor and Chair of the Department of Management Science and

Engineering, Stanford University, Stanford, CA 94305; phone: 650-723-3823; fax: 650-736-1945;

e-mail: mep@stanford.edu. L´

ea A. Deleris is Post-Doctoral Researcher at T.J. Watson Research

Center, IBM Research, 1101 Kitchawan Road, 31-222, Yorktown Heights, NY 10598; phone: 914-

945-1798; fax: 914-945-3434; e-mail: Lea.deleris@us.ibm.com. This article was subject to double-

blind peer review.

199