Math 479/568
Casualty Actuarial Mathematics
Fall 2014
University of Illinois at Urbana-Champaign
Professor Rick Gorvett
Session 3: Economics and
Insurance Markets
September 2, 2014
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Last Time
• Insurance contracts
• Lines of business
• Insurability
• Etc…
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CAS Exam 5, Spring 2008, #1
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CAS Exam 5, Spring 2008, #1
Sample Answer
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CAS Exam 5, Spring 2008, #2
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CAS Exam 5, Spring 2008, #2
Sample Answer
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Today’s Agenda
• Underwriting cycle
• Macroeconomic approach to the cycle
• Impact of the cycle on insurers and industry
behavior
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The
Property / Casualty
Insurance
Underwriting Cycle
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P/C Underwriting Cycle
Profitability
or
Written Premium
Growth
Hard
Time
Soft
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Insurance Information Institute
Presentation: “Overview and Outlook for the P/C
Insurance Industry: Trends, Challenges and
Opportunities in 2014 and Beyond”
http://www.iii.org/presentation/overview-andoutlook-for-the-p-c-insurance-industry-trendschallenges-and-opportunities-in-2014-and
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A
Macroeconomic Approach
to the
U/W Cycle
(Boor, 1998)
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Characteristics of the
Insurance Market
• Relatively fixed demand
– Buy out of necessity
• Required by law
• Required by others
• Protect against financial ruin
– Thus, a relatively flat demand curve
– Supply  price
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Characteristics of the
Insurance Market (cont.)
• Product is largely a “commodity”
– Policies are similar (for a given line / type)
• Regulation
• Policy forms of bureaus
– Individual sellers  no control over price
–  Seek “brand names”
• Differentiate policies
• Different values associated with different policies
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Characteristics of the
Insurance Market (cont.)
• Relatively easy entry and exit of firms
– Entry
• Capitalization and regulatory requirements
• Not many expensive facilities needed (as compared with,
say, manufacturing)
– Exit
• Perhaps regulatory issues
• Perhaps marketing issues
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Characteristics of the
Insurance Market (cont.)
• Supply curves
– Different between companies
• Underwriting
• Expenses
• Reserve management
– Profitability may affect reserve levels
– Reserves may be used to manage reported
profitability
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How These Characteristics
Affect the Insurance Cycle
• Commodity  cycle
– Suppose low supply (e.g., from low profits)
– Raise prices; profits increase; firms enter  excess
capacity
– Prices lowered; profits fall; firms exit  low
supply
– Issues affecting length & severity of cycle
• Accuracy of claim cost estimates
• Reserving practices
• Financial conditions
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Impact of the
Insurance Cycle
on Insurers
(Boor, 2004)
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Soft Markets
• Occur when aggregate written premium goal of
all insurers is greater than aggregate insurance
demanded
– To reach volume or growth targets, companies
begin dropping their prices
– Other companies either follow or fail to meet their
premium / growth targets
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Soft Markets (cont.)
• Price-reducing mechanisms
– Rate filing requirements
• Theoretically, can slow down falling prices
• But: political and institutional realities
– Company rating plans
– Risk classification systems
– Affiliated corporate entities
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Hard Markets
• Occur when aggregate written premium goal of
all insurers is low relative to aggregate
insurance demanded
– Can result after poor financial condition of
insurer(s)
– Certain accounts cannot be written at desired terms
– Inadequate capacity  prices and profitability rise
– Eventually, leads to new entrants
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Issues
• Leverage
– Ratio of premiums to surplus
– Increasing prices can lead to a higher ratio, contrary
to regulatory guidelines
• Degree of reserve adequacy
– Can improve during hardening market
– Impact on historical loss data used for prospective
pricing
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Issues (cont.)
• Potential “cycle-changers”
– Catastrophe loss experience
– Financial conditions
• Underwriting
– Commodity market  company cost structure is
critical
– Losses are the biggest component
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Insurer Strategies with respect to
the Insurance Cycle
• Maintaining market share
– Keep business
– Drop / match prices as needed
• Conserving capital
– Insisting on profitable business
– Maintaining infrastructure during soft markets
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CAS Exam 5, Spring 2010, #13
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CAS Exam 5, Spring 2010, #13
Sample Answer
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CAS Exam 5, Spring 2010, #14
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CAS Exam 5, Spring 2010, #14
Sample Answer
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CAS Exam 5, Spring 2009, #14
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CAS Exam 5, Spring 2009, #14
Sample Answer
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CAS Exam 5, Spring 2009, #15
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CAS Exam 5, Spring 2009, #15
Sample Answer
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CAS Exam 5, Spring 2008, #42
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CAS Exam 5, Spring 2008, #42
Sample Answer
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CAS Exam 5, Spring 2007, #25
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CAS Exam 5, Spring 2007, #25
Sample Answer
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CAS Exam 5, Spring 2007, #26
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CAS Exam 5, Spring 2007, #26
Sample Answer
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CAS Exam 5, Spring 2005, #11
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CAS Exam 5, Spring 2005, #11
Answer
A. 1 only.
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Next Time
• Loss Reserving
• A fundamental actuarial process
• Chapter 5 of Foundations of Casualty
Actuarial Science
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