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An Approach for Variable Selection and Prediction Model for Estimating the Risk-Based Capital (RBC) Based on Machine Learning Algorithms

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  • Jaewon Park

    (Department of Management Information System, School of Business, Hanyang University, Seoul 04763, Korea)

  • Minsoo Shin

    (Department of Management Information System, School of Business, Hanyang University, Seoul 04763, Korea)

Abstract

The risk-based capital (RBC) ratio, an insurance company’s financial soundness system, evaluates the capital adequacy needed to withstand unexpected losses. Therefore, continuous institutional improvement has been made to monitor the financial solvency of companies and protect consumers’ rights, and improvement of solvency systems has been researched. The primary purpose of this study is to find a set of important predictors to estimate the RBC ratio of life insurance companies in a large number of variables (1891), which includes crucial finance and management indices collected from all Korean insurers quarterly under regulation for transparent management information. This study employs a combination of Machine learning techniques: Random Forest algorithms and the Bayesian Regulatory Neural Network (BRNN). The combination of Random Forest algorithms and BRNN predicts the next period’s RBC ratio better than the conventional statistical method, which uses ordinary least-squares regression (OLS). As a result of the findings from Machine learning techniques, a set of important predictors is found within three categories: liabilities and expenses, other financial predictors, and predictors from business performance. The dataset of 23 companies with 1891 variables was used in this study from March 2008 to December 2018 with quarterly updates for each year.

Suggested Citation

  • Jaewon Park & Minsoo Shin, 2022. "An Approach for Variable Selection and Prediction Model for Estimating the Risk-Based Capital (RBC) Based on Machine Learning Algorithms," Risks, MDPI, vol. 10(1), pages 1-20, January.
    • Handle: RePEc:gam:jrisks:v:10:y:2022:i:1:p:13-:d:717722
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    References listed on IDEAS

    as
    1. Kursa, Miron B. & Rudnicki, Witold R., 2010. "Feature Selection with the Boruta Package," Journal of Statistical Software, Foundation for Open Access Statistics, vol. 36(i11).
    2. Heo, Wookjae & Lee, Jae Min & Park, Narang & Grable, John E., 2020. "Using Artificial Neural Network techniques to improve the description and prediction of household financial ratios," Journal of Behavioral and Experimental Finance, Elsevier, vol. 25(C).
    3. Kexing Ding & Baruch Lev & Xuan Peng & Ting Sun & Miklos A. Vasarhelyi, 2020. "Machine learning improves accounting estimates: evidence from insurance payments," Review of Accounting Studies, Springer, vol. 25(3), pages 1098-1134, September.
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