IDEAS home Printed from https://ideas.repec.org/p/nfi/nfiwps/2011-wp-19.html
   My bibliography  Save this paper

Underwriting in Property-Casualty Insurance Markets: Regulation, Risk and Volatility

Author

Listed:
  • Ronnie J. Phillips
  • David Nickerson

Abstract

We offer a novel explanation of underwriting volatility in propertyliability insurance markets in terms of private uncertainty over public regulatory policy. Underwriting involving random losses to policyholders is one source of risk to the equity value of insurance firms. Solvency regulations, however, pose a second source of risk to equity value when the implementation of such regulations randomly affects the return to underwriting but exhibits imperfect correlation with market conditions over time. Using a differential game in a standard no-arbitrage environment to model interaction between these two sources of risk, we derive the valuation equation for property-liability underwriting inclusive of the respective bestreply underwriting strategy of a representative insurance firm and the implementation strategy of a representative regulator. Owing to the conflicting effects of these strategies on firm equity, regulations adopted to reduce the solvency risk of insurers can, paradoxically, increase underwriting volatility in an otherwise efficient insurance market. Under certain parametric conditions, we also show that, even in the presence of complete financial markets, a subgame perfect Nash equilibrium of this game can exhibit a limit cycle in the value of underwriting which mirrors empirical evidence on the presence of cycles in property-liability insurance markets.

Suggested Citation

  • Ronnie J. Phillips & David Nickerson, 2011. "Underwriting in Property-Casualty Insurance Markets: Regulation, Risk and Volatility," NFI Working Papers 2011-WP-19, Indiana State University, Scott College of Business, Networks Financial Institute.
  • Handle: RePEc:nfi:nfiwps:2011-wp-19
    as

    Download full text from publisher

    File URL: http://www.indstate.edu/business/sites/business.indstate.edu/files/Docs/2011-WP-19_Phillips_Nickerson.pdf
    File Function: Full text
    Download Restriction: no

    References listed on IDEAS

    as
    1. J. David Cummins & Mary A. Weiss, 2009. "Convergence of Insurance and Financial Markets: Hybrid and Securitized Risk-Transfer Solutions," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 76(3), pages 493-545.
    2. Dutta, Prajit K & Rustichini, Aldo, 1993. "A Theory of Stopping Time Games with Applications to Product Innovations and Asset Sales," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 3(4), pages 743-763, October.
    3. André p. Liebenberg & David r. Kamerschen, 2008. "Structure, Conduct And Performance Analysis Of The South African Auto Insurance Market: 1980-2000," South African Journal of Economics, Economic Society of South Africa, vol. 76(2), pages 228-238, June.
    4. Winter Ralph A., 1994. "The Dynamics of Competitive Insurance Markets," Journal of Financial Intermediation, Elsevier, vol. 3(4), pages 379-415, September.
    5. Ovidiu Solomon & Carmen Pricină, 2008. "Time Delays And The Underwriting Cycle," Romanian Economic Business Review, Romanian-American University, vol. 3(4), pages 35-43, Winter.
    6. Grace, M. F. & J. L. Hotchkiss, 1993. "External Impacts on the Property-Liability Insurance Cycle," Working Papers 020, Risk and Insurance Archive, revised Feb 1995.
    7. Ursina B. Meier, 2006. "Multi-national underwriting cycles in property-liability insurance: Part I – some theory and empirical results," Journal of Risk Finance, Emerald Group Publishing, vol. 7(1), pages 64-82, January.
    8. Chao-Chun Leng & Ursina B. Meier, 2006. "Analysis of multinational underwriting cycles in property-liability insurance," Journal of Risk Finance, Emerald Group Publishing, vol. 7(2), pages 146-159, March.
    9. Anne Gron, 1994. "Capacity Constraints and Cycles in Property-Casualty Insurance Markets," RAND Journal of Economics, The RAND Corporation, vol. 25(1), pages 110-127, Spring.
    10. Jones, Robert A & Nickerson, David, 2002. "Mortgage Contracts, Strategic Options and Stochastic Collateral," The Journal of Real Estate Finance and Economics, Springer, vol. 24(1-2), pages 35-58, Jan.-Marc.
    11. Stephen Barnes & Dek Terrell, 2009. "The Impact of the Labor Market on Health Insurance," Journal of Labor Research, Springer, vol. 30(4), pages 328-339, December.
    12. Ralph A. Winter, 1991. "The Liability Insurance Market," Journal of Economic Perspectives, American Economic Association, vol. 5(3), pages 115-136, Summer.
    13. Higgins, Matthew L & Thistle, Paul D, 2000. "Capacity Constraints and the Dynamics of Underwriting Profits," Economic Inquiry, Western Economic Association International, vol. 38(3), pages 442-457, July.
    14. Ovidiu SOLOMON & Carmen PRICINĂ, 2008. "Time Delays and The Underwriting Cycle," Journal of Information Systems & Operations Management, Romanian-American University, vol. 2(2), pages 521-531, November.
    15. Goovaerts, M. J. & De Vylder, F. & Kaas, R., 1992. "A stochastic approach to insurance cycles," Insurance: Mathematics and Economics, Elsevier, vol. 11(2), pages 97-107, August.
    16. Russell McKenzie & John Levendis, 2010. "Flood Hazards and Urban Housing Markets: The Effects of Katrina on New Orleans," The Journal of Real Estate Finance and Economics, Springer, vol. 40(1), pages 62-76, January.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Property Casualty Insurance; Cycles; Regulatory Risk;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • K13 - Law and Economics - - Basic Areas of Law - - - Tort Law and Product Liability; Forensic Economics
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nfi:nfiwps:2011-wp-19. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ray Thomas). General contact details of provider: http://edirc.repec.org/data/nfinsus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.