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Article
Publication date: 16 January 2017

Hato Schmeiser and Daliana Luca

The purpose of this paper is to study how the discretization interval affects the solvency measurement of a property-liability insurance company.

Abstract

Purpose

The purpose of this paper is to study how the discretization interval affects the solvency measurement of a property-liability insurance company.

Design/methodology/approach

Starting with a basic solvency model, the authors study the impact of the discretization interval on risk measures. The analysis considers the sensitivity of the discrepancy between the risk measures in continuous and discrete time to various parameters, such as the asset-to-liability ratio, the characteristics of the asset and liability processes, as well as the correlation between assets and liabilities. Capital requirements for the one-year planning horizon in continuous vs discrete time are reported as well. The purpose is to report the degree to which the deviations in risk measures, due to the different discretization intervals, can be reduced by means of increasing the frequency with which the risk measures are assessed.

Findings

The simulation results suggest that the risk measures of an insurance company are consistently underestimated when assessed on an annual basis (as it is currently done under insurance regulation such as Solvency II). The authors complement the analysis with the capital requirements of an insurance company and conclude that more frequent discretization translates into higher capital requirements for the insurance company. Both the probability of ruin and the expected policyholder deficit (EPD) can be reduced through intermediate financial reports.

Originality/value

The results from our simulation analysis suggest that that the choice of discretization interval has an impact on the risk assessment of an insurance company which uses the probability of ruin and the EPD as risk measures. By assessing the risk measures once a year, both risk measures and the capital requirements are consistently underestimated. Therefore, the recommendation for risk managers is to complement the capital requirements in solvency regulation with sensitivity analyses of the risk measures presented with respect to time discretization. On the one hand, it seems to us that there is value in knowing about the substantial discrepancy between the focused time discrete ruin probability and EPD compared to the continuous version. On the other hand, and if there are no substantial transaction costs associated with more frequent monitoring of solvency figures, a frequent update would be helpful to increase the accuracy of the calculations and reduce the EPD.

Details

The Journal of Risk Finance, vol. 18 no. 1
Type: Research Article
ISSN: 1526-5943

Keywords

Article
Publication date: 17 March 2014

Joël Wagner

The concept of value at risk is used in the risk-based calculation of solvency capital requirements in the Basel II/III banking regulations and in the planned Solvency II…

1069

Abstract

Purpose

The concept of value at risk is used in the risk-based calculation of solvency capital requirements in the Basel II/III banking regulations and in the planned Solvency II insurance regulation framework planned in the European Union. While this measure controls the ruin probability of a financial institution, the expected policyholder deficit (EPD) and expected shortfall (ES) measures, which are relevant from the customer's perspective as they value the amount of the shortfall, are not controlled at the same time. Hence, if there are variations in or changes to the asset-liability situation, financial companies may still comply with the capital requirement, while the EPD or ES reach unsatisfactory levels. This is a significant drawback to the solvency frameworks. The paper aims to discuss these issues.

Design/methodology/approach

The author has developed a model framework wherein the author evaluates the relevant risk measures using the distribution-free approach of the normal power approximation. This allows the author to derive analytical approximations of the risk measures solely through the use of the first three central moments of the underlying distributions. For the case of a reference insurance company, the author calculates the required capital using the ruin probability and EPD approaches. For this, the author performs sensitivity analyses considering different asset allocations and different liability characteristics.

Findings

The author concludes that only a simultaneous monitoring of the ruin probability and EPD can lead to satisfactory results guaranteeing a constant level of customer protection. For the reference firm, the author evaluates the relative changes in the capital requirement when applying the EPD approach next to the ruin probability approach. Depending on the development of the assets and liabilities, and in the cases the author illustrates, the reference company would need to provide substantial amounts of additional equity capital.

Originality/value

A comparative assessment of alternative risk measures is relevant given the debate among regulators, industry representatives and academics about how adequately they are used. The author borrows the approach in parts from the work of Barth. Barth compares the ruin probability and EPD approach when discussing the RBC formulas of the US National Association of Insurance Commissioners introduced in the 1990s. The author reconsiders several of these findings and discusses them in the light of the new regulatory frameworks. More precisely, the author first performs sensitivity analyses for the risk measures using different parameter configurations. Such analyses are relevant since in practice parameter values may differ from estimates used in the model and have a significant impact on the values of the risk measures. Second, the author goes beyond a simple discussion of the outcomes for each risk measure, by deriving the firm conclusion that both the frequency and magnitude of shortfalls need to be controlled.

Details

The Journal of Risk Finance, vol. 15 no. 2
Type: Research Article
ISSN: 1526-5943

Keywords

Article
Publication date: 2 March 2010

K.K. Thampi and M.J. Jacob

The purpose of this paper is to investigate how queueing theory has been applied to derive results for a Sparre Andersen risk process for which the claim inter‐arrival…

Abstract

Purpose

The purpose of this paper is to investigate how queueing theory has been applied to derive results for a Sparre Andersen risk process for which the claim inter‐arrival distribution is hyper Erlang.

Design/methodology/approach

The paper exploits the duality results between the queueing theory and risk processes to derive explicit expressions for the ultimate ruin probability and moments of time to ruin in this renewal risk model.

Findings

This paper derives explicit expressions for the Laplace transforms of the idle/waiting time distribution in GI/HEr(ki,λi)/1 and its dual HEr(ki,λi)/G/1. As a consequence, an expression for the ultimate ruin probability is obtained in this model. The relationship between the time of ruin and busy period in M/G/1 queuing system is used to derive the expected time of ruin.

Originality/value

The study of renewal risk process is mostly concentrated on Erlang distributed inter‐claim times. But the Erlang distributions are not dense in the space of all probability distributions and therefore, the paper cannot approximate an arbitrary distribution function by an Erlang one. To overcome this difficulty, the paper uses the hyper Erlang distributions, which can be used to approximate the distribution of any non‐negative random variable.

Details

The Journal of Risk Finance, vol. 11 no. 2
Type: Research Article
ISSN: 1526-5943

Keywords

Article
Publication date: 1 April 2005

Jiandong Ren

The paper aims to develop a realistic, yet flexible model of insurer net worth.

Abstract

Purpose

The paper aims to develop a realistic, yet flexible model of insurer net worth.

Design/methodology/approach

Inspired by and as an improvement to Powers, the paper develops a multi‐dimensional diffusion model to describe the operations of an insurance company. The paper then explores whether or not this multi‐dimensional model can be approximated conservatively by a homogeneous one‐dimensional diffusion.

Findings

The multi‐dimensional model that is proposed can be approximated conservatively by a homogeneous one‐dimensional diffusion, which is clearly much easier to solve analytically or numerically than a multi‐dimensional system. Also, the Laplace transform of the desired first‐passage time (to ruin) distribution can be stated analytically.

Practical implications

The analysis provides a theoretical model of the relationship between the insurer's ruin‐time distribution and many aspects of the insurer's operations, including loss‐payout patterns, premium‐earning patterns, and investment strategy.

Originality/value

The paper reveals that a multi‐dimensional model can be approximated by a homogeneous one‐dimensional diffusion to achieve a realistic and flexible model that can be used practically.

Details

The Journal of Risk Finance, vol. 6 no. 2
Type: Research Article
ISSN: 1526-5943

Keywords

Article
Publication date: 18 May 2012

Nadine Gatzert and Hato Schmeiser

Definitions of pooling effects in insurance companies may convey the impression that the achieved risk reduction effect will be beneficial for policyholders, since…

1355

Abstract

Purpose

Definitions of pooling effects in insurance companies may convey the impression that the achieved risk reduction effect will be beneficial for policyholders, since typically lower premiums are paid for the same safety level with an increasing number of insureds, or a higher safety level is achieved for a given premium level for all pool members. However, this view is misleading and the purpose of this paper is to reexamine this apparent merit of pooling from the policyholder's perspective.

Design/methodology/approach

This is achieved by comparing several valuation approaches for the policyholders' claims using different assumptions of the individual policyholder's ability to replicate the contract's cash flows and claims.

Findings

The paper shows that the two considered definitions of risk pooling do not offer insight into the question of whether pooling is actually beneficial for policyholders.

Originality/value

The paper contributes to the literature by extending and combining previous work, focusing on the merits of pooling claims (using the two definitions above) from the policyholder's perspective using different valuation approaches.

Details

The Journal of Risk Finance, vol. 13 no. 3
Type: Research Article
ISSN: 1526-5943

Keywords

Article
Publication date: 21 June 2022

Jamshid Ali Turi and Muddassar Sarfraz

Political risk devastates social and economic developmental projects. Countries with political stability attract foreign direct investment (FDI) and engage domestic…

Abstract

Purpose

Political risk devastates social and economic developmental projects. Countries with political stability attract foreign direct investment (FDI) and engage domestic investment corporations. This study aims to investigate the impact of perceived organizational politics and political risk on project success, considering the moderating and mediating roles of ethical leadership and the psychological contract.

Design/methodology/approach

A multimethod approach was adopted in this work that includes an exploratory content analysis to confirm the latent factors of the variables under study. A measurement scale was developed and tested for perceived organizational politics, political risk, the psychological contract and ethical leadership in the projectized environment. Lastly, cross-sectional data were collected from the senior-level professionals of the projectized organizations and analyzed using SPSS and SMARTPLS techniques.

Findings

The findings indicate that ethical leadership and the psychological contract mitigate political risk. The study recommends that developing countries emphasize well-defined policies and standard operating procedures to streamline the project design and execution processes.

Research limitations/implications

The study claims that ethical leaders can play a vital role in mitigating perceived organizational politics and political risk and maximizing project value through the psychological contract.

Originality/value

Although previous research predicts that ethical leadership has very little effect on project success, this study provides critical theoretical and practical contributions to research on project success regarding leadership expertise and the psychological contract.

Details

Kybernetes, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 0368-492X

Keywords

Article
Publication date: 1 December 2004

Hubert Mueller and José Siberón

“Economic capital (EC) is in – Value at Risk (VaR) is out!” This statement by James Lam, well known to be the first Chief Risk Officer (CRO) worldwide, at the April 2004…

Abstract

“Economic capital (EC) is in – Value at Risk (VaR) is out!” This statement by James Lam, well known to be the first Chief Risk Officer (CRO) worldwide, at the April 2004 Enterprise Risk Management (ERM) Symposium in Chicago, caused quite a reaction by the attendees. What is EC? Why are banks and insurance companies focused on calculating EC? What are the differences between EC and regulatory or rating agency capital? What are rating agencies’ views towards EC? This paper, summarising a panel on this topic, which was held at the ERM Symposium in Chicago in April of this year, attempts to answer these questions, focusing on the application of EC to life insurance companies.

Details

Journal of Financial Regulation and Compliance, vol. 12 no. 4
Type: Research Article
ISSN: 1358-1988

Keywords

Article
Publication date: 12 November 2019

Ken Johnston, John Hatem, Thomas Carnes and Arman Kosedag

The purpose of this paper is to compare simple dynamic withdrawal strategies with the static withdrawal method, examining not only failure rates and ending wealth but also…

Abstract

Purpose

The purpose of this paper is to compare simple dynamic withdrawal strategies with the static withdrawal method, examining not only failure rates and ending wealth but also spending. All withdrawal strategies are adjusted for the Internal Revenue Service’s (IRS) required minimum distribution (RMD). In addition, this study investigates the use of small company stocks (SCS) in place of large company stocks (LCS). Results indicate SCS portfolios are superior to large. When returns are poor, some dynamic strategies will not ensure income for life. This study demonstrates that the simplest dynamic strategy is superior to two popular dynamic strategies.

Design/methodology/approach

Using historical overlapping periods, different withdrawal strategies are examined. Previous studies focused on failure rates and ending wealth. As discussed in Milevsky (2016) different statistical distributions can have similar tail properties (prob of failure) but dissimilar risk and return profile. The detailed examination of both spending and use of small stocks advances the literature in this area.

Findings

Results indicate that use of small stocks is superior to using large stocks in the portfolios. When US historical stock returns are adjusted downward, there is the potential that some dynamic strategies will not ensure income for life. This study demonstrates that the simplest dynamic strategy is superior to two popular dynamic strategies.

Originality/value

This paper is the first to examine, in detail, annual spending results for the retiree. Second, it is shown that, overall, SCS are superior to LCS for all stock/bond allocations. Even though absolute downside risk increases slightly, this increase in downside risk is dominated by the upside potential. In other words, the positive skewness of small stock returns along with the cumulative effects of compounding at a higher rate increases both the available wealth for spending and ending wealth. Third, IRS’s RMDs are taken into account for every withdrawal strategy examined. Lastly, it demonstrates that the simplest dynamic strategy is superior to two popular dynamic strategies.

Details

Managerial Finance, vol. 45 no. 12
Type: Research Article
ISSN: 0307-4358

Keywords

Article
Publication date: 1 May 2004

Fabiano Colombini and Simone Ceccarelli

This paper discusses dynamic financial approaches to solvency analysis in non‐life insurance companies by explaining cash flow simulation models which are based on the…

1762

Abstract

This paper discusses dynamic financial approaches to solvency analysis in non‐life insurance companies by explaining cash flow simulation models which are based on the planning of their typical cash inflows and outflows. Posits that these models take into account patterns of loss reserve run‐offs and asset cash flows by implementing several hypotheses that also include expectations about external economic conditions such as inflation rates and interest rates. Acknowledges the cash inflows and outflows have been planned over a period of time to evaluate how positive net cash flow (liquidity) leads to the increase in assets over liabilities (solvency).

Details

Managerial Finance, vol. 30 no. 5
Type: Research Article
ISSN: 0307-4358

Keywords

Article
Publication date: 6 March 2007

Jiandong Ren

The purpose of this article is to consider the classical risk model that is perturbed by a Brownian motion process. The article derives explicit formulas for the joint and…

Abstract

Purpose

The purpose of this article is to consider the classical risk model that is perturbed by a Brownian motion process. The article derives explicit formulas for the joint and marginal probability density functions of the surplus prior to ruin and the deficit at ruin.

Design/methodology/approach

This article first extends the dual argument to probabilistically explain the symmetry between the two random variables related to the so‐called modified ladder height. Then the paper uses renewal arguments to derive the joint distribution of the surplus prior to ruin and the deficit at ruin.

Findings

The study derived an explicit formula for the undiscounted joint density in the perturbed risk model that is directly parallel to formula (3.2) for the classical risk model. The formula clearly shows that in a perturbed risk process, when ruin is caused by a claim, the p.d.f. of the surplus prior to ruin is continuous. In addition, shows that when the claim sizes follow a phase‐type distribution, all the relevant quantities can be conveniently computed.

Originality/value

The dual argument used in this article is novel. The formula first clearly shows that in the perturbed risk model, the p.d.f. of the surplus prior to ruin is continuous. When claim sizes are phase‐type, the formulas can be conveniently computed.

Details

The Journal of Risk Finance, vol. 8 no. 2
Type: Research Article
ISSN: 1526-5943

Keywords

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