Showing papers in "The North American Actuarial Journal in 1999"
TL;DR: In this article, extreme value theory plays an important methodological role within risk management for insurance, reinsurance, and finance, and the authors highlight the convergence of finance and insurance at the product level.
Abstract: The financial industry, including banking and insurance, is undergoing major changes. The (re)insurance industry is increasingly exposed to catastrophic losses for which the requested cover is only just available. An increasing complexity of financial instruments calls for sophisticated risk management tools. The securitization of risk and alternative risk transfer highlight the convergence of finance and insurance at the product level. Extreme value theory plays an important methodological role within risk management for insurance, reinsurance, and finance.
449 citations
TL;DR: In this paper, the authors review the properties of coherent risk measures and examine their implications for capital requirement in insurance, and also comment on the specific risk-based capital computations. But their focus is on the setting of capital minima by companies as well as by regulators.
Abstract: Risk measurements go hand in hand with setting of capital minima by companies as well as by regulators. We review the properties of coherent risk measures and examine their implications for capital requirement in insurance. We also comment on the specific risk-based capital computations.
173 citations
TL;DR: The role of probabilistic models in the debate over genetics and insurance is discussed in this paper, where a Markov model is used to show that adverse selection in life insurance ought to be controllable.
Abstract: The role of probabilistic models in the debate over genetics and insurance is discussed. A Markov model is used to show that, under quite extreme assumptions, adverse selection in life insurance ought to be controllable. The statistical problems of estimating small differences in mortality are discussed; these might limit the use of many genetic disorders as rating factors. The influence of the insurance industry on policy-making, especially through its support of research, is discussed. It is suggested that participating contracts are suitable and simple vehicles to carry the genetic risks in life insurance.
54 citations
44 citations
TL;DR: In this paper, a simple model for defined benefit pension plans with independent and identically distributed rates of investment return and a stationary membership is considered, and three methods of adjusting the normal cost as gains or losses arise are compared, and a suitable choice of amortization or spread period is made.
Abstract: A simple model for defined benefit pension plans with independent and identically distributed rates of investment return and a stationary membership is considered. Three methods of adjusting the normal cost as gains or losses arise are compared, and a suitable choice of amortization or spread period is made. We also investigate the evolution in time of the first and second moments of the pension fund and contribution levels.
40 citations
TL;DR: The properties for a coherent risk measure are considered, outlined by Artzner et al. (1996), and these requirements are related to a well-known measure, value at risk (VaR), which attempts to evaluate economic risk.
Abstract: In this paper I consider the properties for a coherent risk measure, outlined by Artzner et al. (1996), and relate these requirements to a well-known measure, value at risk (VaR), which attempts to evaluate economic risk. I show how the usual method of calculating VaR does not adhere to the coherency requirements and discuss the implications of such a result. As well, I discuss the use of the mean excess loss function to help solve this problem.
35 citations
TL;DR: In this paper, the authors discussed the asymptotic behavior of yields on default-free zero-coupon bonds and showed that the longer the maturity of the yield is, the less volatile it will be.
Abstract: Term structure models based on dynamic asset-pricing theory are discussed by taking a perspective from the long rate. This paper partially answers two questions about the asymptotic behavior of yields on default-free zero-coupon bonds: in frictionless markets having no arbitrage, what should the behavior be; and, in known term structure models, what can the behavior be. In frictionless markets having no arbitrage, yields of all maturities should be positive and uniformly bounded from above. The yield curve should level out as term to maturity increases. Slopes with large absolute values occur only in the early maturities. In a continuous-time framework, the longer the maturity of the yield is, the less volatile it will be. The long rate should be a nondecreasing process. Furthermore, the long rate in continuous-time factor models with nonsingular volatility matrices should be a nondecreasing deterministic function. In the Black, Derman, and Toy model and factor models with the short rate having t...
26 citations
TL;DR: In this article, the implications of genetic testing on the insurance industry are discussed and three major perspectives emerge when the discussion of the implications on the industry commences: one viewpoint, strongly advocated by certain consumer groups and ethicists on the basis of societal responsibility, categorically denies any necessity for connecting the results of genetic test and issuance of insurance.
Abstract: Three major perspectives emerge when the discussion of the implications of genetic testing on the insurance industry commences. One viewpoint, strongly advocated by certain consumer groups and ethicists on the basis of societal responsibility, categorically denies any necessity for connecting the results of genetic testing and issuance of insurance. By contrast, the insurance industry, upon examining the economics and dynamics of participation in voluntary insurance markets, lives in fear of a world filled with asymmetrical information (counter to the axioms for competitive markets), adverse selection (action by the insured as a result of asymmetric information to the perceived economic disadvantage of the insurer), and ultimately even the possibility of potential market failure or insurance company insolvency. An actuarial perspective considering the benefits (to the insurer) of this new genetic information concentrates primarily on the possibility of developing improved quantitative assessments...
25 citations
TL;DR: In this paper, the authors describe a financial model currently being used by a major U.S. multiline property-casualty insurer for internal management purposes, including the allocation of equity to corporate units, as well as analysis of the progression of free surplus.
Abstract: This paper describes a financial model currently being used by a major U.S. multiline property-casualty insurer. The model, which was first developed for solvency monitoring purposes, is now being employed for a variety of internal management purposes as well, including (1) the allocation of equity to corporate units, thereby allowing measurements of profitability by business segment and policy year, as well as analysis of the progression of “free surplus,” (2) the analysis of major risks–such as inflation risks, interest rate risks, and reserving risks–that have heretofore been difficult to quantify, and (3) consideration of varying scenarios on the company’s financial performance, both of macroeconomic conditions as well as of the insurance environment.Many aspects of financial modeling do not differ significantly between life and property-casualty insurers, and these are not discussed in the paper. Rather, the paper focuses on the following topics:1. Surplus allocation and profitability: how economic surplus and the returns on this surplus are determined by line of business, separately for new business and for the runoff of existing business, and how the progression of free surplus is viewed.2. Multifaceted risks: how to model risks that affect multiple components of the insurer’s operations, such as economic risks and financial risks. The multiple effects of macroeconomic conditions and changing inflation rates on workers’ compensation claim frequencies and severities complicate the basic interest rate path modeling of life insurance products and annuity contracts.3. Scenario building: how to construct scenarios of macroeconomic conditions or industry cyclical movements to test the resilience of the company to changing external conditions.
24 citations
TL;DR: The North American Actuarial Journal is honoring the Society of Actuaries on its golden anniversary in 1999 by publishing a series of articles on the contributions of actuaries to the development of ideas.
Abstract: The North American Actuarial Journal is honoring the Society of Actuaries on its golden anniversary in 1999 by publishing a series of articles on the contributions of actuaries to the development of ideas. In this issue, the second of the series, we explore the development of the credibility idea and the relationships of this development to deep issues in the methodology of science. We begin with a short essay by James C. Hickman and continue with comments by three actuaries who were deeply involved with the development of credibility: Robert A. Bailey, Hans Buuhlmann, and Charles C. Hewitt.
24 citations
TL;DR: In this paper, the use of Bayesian models to analyze time series data is explored, which produces output that can be readily understood by actuaries and included in their own experience studies.
Abstract: This paper explores the use of Bayesian models to analyze time series data. The Bayesian approach produces output that can be readily understood by actuaries and included in their own experience studies. We illustrate this Bayesian approach by analyzing U.S. unemployment rates, a macroeconomic time series. Understanding time series of macroeconomic variables can help actuaries in pricing and reserving their products. For example, a change in the level and/or variance of the unemployment series is of interest to actuaries, because its movement can explain a changing pattern of lapse rates of incidence rates. Our Bayesian analysis, based on models developed by McCulloch and Tsay (1993, 1994), allows for shifts in the level and in the error variance of a process. We develop a measure of model fit, based on the Akaike Information Criterion, that can be used in choosing between alternative models. Posterior prediction intervals for the fitted values are also created to pictorially show the range of pa...
TL;DR: Upper and lower bounds of ruin probabilities for the S. Andersen model with large claims are proposed in this article.The bounds are stated in terms of the corresponding ladder height distribution and have a reasonable accuracy, which is illustrated by numerical examples.
Abstract: Upper and lower bounds of ruin probabilities for the S. Andersen model with large claims are proposed. The bounds are stated in terms of the corresponding ladder height distribution and have a reasonable accuracy, which is illustrated by numerical examples. Comparison with other known bounds is given.
TL;DR: In this article, the problem of estimating the yield rate for a pure-discount bond that matures in 100 years was investigated and confidence intervals on these rates were constructed with bootstrap methods.
Abstract: Consider the problem of valuing a life insurance or annuity on a person aged 20. The valuation formula requires that we know the prices of pure-discount bonds with maturities of up to 100 years. This article investigates the problem of estimating the yield rate for a pure-discount bond that matures in 100 years. It is shown how to estimate this yield rate with parametric and nonparametric models on the price of U.S. Treasury strips. Moreover, confidence intervals on these rates are constructed with bootstrap methods.
TL;DR: In contrast to alternative measures of risk, value at risk (VaR) has important virtues that make it a potentially valuable tool for strategic decision making and capital management in a wide variety of industries.
Abstract: In contrast to alternative measures of risk, value at risk (VaR) has important virtues–intelligibility, comparability, and practicality–that make it a potentially valuable tool for strategic decision making and capital management in a wide variety of industries. However, capital-management decisions in most industries–including financial services, such as property/casualty insurance–have time horizons far longer than the one-day horizon that prevails in commercial and investment banking, where the use of VaR is now concentrated. For VaR to be usefully applied to longhorizon decisions, it must address three fundamental problems unique to that context: estimation risk, adaptive risk modification, and franchise risk. This paper describes each of these problems, shows how they can be solved, and provides examples applicable to property/casualty insurance.
TL;DR: This work has shown that the ability of the U.S. insurance industry to risk-select may be severely hampered if these restrictions on access to and use of genetic information are implemented.
Abstract: Recent advances in genetic technology and progress in the multinational Human Genome Project are providing scientists with the ability to look into and manipulate the very makeup of life: the DNA molecule. We can already examine many dozens of plant and animal genes for disease producing abnormalities. In the near future, we will have the ability to alter specific genes in living tissue. This genetic technology holds great promise in our quest for preventing, diagnosing, treating, and predicting disease, not just in humans, but in all forms of life. But there are some problems. Philosophically many are not ready for the implications of this technology. There are social and ethical issues that have not been well addressed, and which have, in part, resulted in an unprecedented amount of legislative activity over the past four years aimed at restricting access to and use of genetic information. The ability of the U.S. insurance industry to risk-select may be severely hampered if these restrictions a...
TL;DR: In this article, the authors considered the fractional independence (FI) survival model, studied by Willmot (1997), and analyzed the ordering of risks of the FI survival model and its consequences for the evaluation of actuarial present values in life insurance, and their main fractional reduction theorem states that two FI future lifetime random variables with identical distributed curtate future lifetime are stochastically ordered (stop-loss ordered).
Abstract: We consider the fractional independence (FI) survival model, studied by Willmot (1997), for which the curtate future lifetime and the fractional part of it satisfy the statistical independence assumption, called the fractional independence assumption. The ordering of risks of the FI survival model is analyzed, and its consequences for the evaluation of actuarial present values in life insurance is discussed. Our main fractional reduction (FR) theorem states that two FI future lifetime random variables with identical distributed curtate future lifetime are stochastically ordered (stop-loss ordered) if, and only if, their fractional parts are stochastically ordered (stop-loss ordered). The well-known properties of these stochastic orders allow to find lower and upper bounds for different types of actuarial present values, for example when the random payoff functions of the considered continuous life insurances are convex (concave), or decreasing (increasing), or convex not decreasing (concave not i...
TL;DR: In this paper, a comprehensive approach to risk and return produces some interesting conclusions with respect to asset allocation, active versus passive asset management, and the mix and pricing of liabilities for financial institutions.
Abstract: It is important to include both risk and return in finding the optimal balance of assets and liabilities for financial institutions. Insurance companies, with their range of sophisticated assets and liabilities, are perhaps the best example of the value of such an approach. Examples in the paper refer to the insurance industry, but parallels to other types of financial institutions are easily drawn. The analysis in the paper shows that a comprehensive approach to risk and return produces some interesting conclusions with respect to asset allocation, active versus passive asset management, and the mix and pricing of liabilities.
TL;DR: The authors analyzes policy developments at the national level during 1997, including proposed federal legislation and the response of the insurance industry with broad bipartisan support, and it appears that some form of federal regulation is likely within the next two sessions of Congress The debate appears to be centering on the definition of genetic information and whether regulation will extend to a blanket prohibition on testing.
Abstract: This paper analyzes policy developments at the national level during 1997, including proposed federal legislation and the response of the insurance industry With broad bipartisan support, it appears that some form of federal regulation is likely within the next two sessions of Congress The debate appears to be centering on two issues: the definition of genetic information and whether regulation will extend to a blanket prohibition on testing The insurance industry is suggesting that restrictions based on an “unfair discrimination” standard would permit coverage and cost distinctions based on actuarially sound data, while the health care industry is opposed to any discrimination based on genetic information A utilitarian ethical perspective would likely support restrictions on testing for life insurance but not health insurance
TL;DR: In this paper, the authors examine the performance of a collective of the building blocks of the insurance process, using portfolio historical performance to endogenously parameterize the default cost function unique to a particular portfolio.
Abstract: This paper demonstrates that the building blocks of the insurance process, under similar assumptions, produce identical results to the option-pricing approach in the case of pricing individual loans. We examine the performance of a collective of such building blocks, using portfolio historical performance to endogenously parameterize the default cost function unique to a particular portfolio. Having estimated the appropriate default cost function, we can then specify the reserve requirement for a bank operating such a portfolio. In this respect, the additivity of the Poisson parameter is a powerful feature, allowing one to decompose portfolio performance over time and homogeneous portfolio subsections. Portfolios with greater and lesser risk and profitability respectively are hypothesized, and a capital adequacy framework which equates risk across such portfolios is examined. Finally, we simulate the operation of the proposed capital adequacy model. Observed insolvencies are fewer than those obse...
TL;DR: The authors discusses model risk, gives specific examples of how model risk can affect fixed-income portfolio valuation, and explains why risk measurement should involve stress testing of key modeling assumptions. But it is critical to recognize that even the most sophisticated models must make assumptions about key parameters that affect the results of the analysis.
Abstract: Over the past few years, risk measurement has become an important, high-profile responsibility for most firms in the financial services industry. With advances in academic theory and in technology, financial risk modeling has grown increasingly sophisticated. Most firms rely on a number of models to analyze their market risks (for example, sensitivity to changes in interest rates, exchange rates, commodity prices, and so on) for asset/liability management. But it is critical to recognize that even the most sophisticated models must make assumptions about key parameters that affect the results of the analysis. This so-called “model risk” reflects the fact that in the real world risk factors are unstable and the historical data upon which many modeling inputs are based can change. This paper discusses model risk, gives specific examples of how model risk can affect fixed-income portfolio valuation, and explains why risk measurement should involve stress testing of key modeling assumptions. If the r...
TL;DR: It is argued that the regrettable history and current risks of genetic discrimination warrant a presumption that genetic predisposition status should not be used in any nonmedical contexts, unless compelling evidence can demonstrate that serious harm will result to third-party interests without such use.
Abstract: A number of problematic issues have arisen in anticipation of the potential role of molecular tests for genetic predispositions to illness in risk assessment by insurance underwriters. We argue in this paper that the regrettable history and current risks of genetic discrimination warrant a presumption that genetic predisposition status should not be used in any nonmedical contexts, unless compelling evidence can demonstrate that serious harm will result to third-party interests without such use. We argue that insurers should not be able to initiate testing for genetic predisposition. We also argue that there are many reasons to doubt whether patients’ test results will result in such serious adverse selection as to cause substantial harm to insurance markets, except possibly at higher policy amounts in life or disability income insurance. We conclude that the burden of proof must be on insurers to demonstrate necessity of use in specific cases in which test availability shows high probability of ...
TL;DR: In this paper, a special attention is paid to the calculation of the provision for adverse deviations with respect to the interest rate risk, and the determination of this provision is the analog for life insurance and annuity policy liabilities of the calculation by banks of Value at Risk (VaR).
Abstract: The cash-flow valuation method (CFVM) has been developed in Canada for the valuation of insurance company annuity products. Its range of application is expected to be extended shortly to the valuation of most other life insurance company products. The CFVM is based on the use of “best-guess” assumptions, supplemented by specific provisions for adverse deviations. In this paper, special attention is paid to the calculation of the provision for adverse deviations with respect to the interest rate risk. We show that the determination of this provision is the analog for life insurance and annuity policy liabilities of the calculation by banks of Value at Risk (VaR) with respect to portfolios of securities held for trading.
TL;DR: The essential role that actuaries play in countering problems that can cause market failure is explored in this article, and the advantages to society of actuaries as a well defined, recognized group of trustworthy and trustworthy professionals are discussed.
Abstract: Insurance markets are different from most other markets. Insurance markets have an inherent self-destructive tendency that can cause market failure. However, insurance markets not only exist, they thrive. This paper explores the essential role that actuaries play in countering problems that can cause market failure. Armed with our mathematical and business skills and strong sense of professionalism, actuaries are essential to the successful growth of insurance companies and insurance markets. The breakdown of barriers among segments of the financial services industry creates an opportunity for actuaries to apply these same skills to noninsurance financial institutions. Actuaries have a strong claim to becoming the profession the public relies upon to ensure that an adequate balance is kept between profits and solvency. The foundation of this claim is not the superiority of our intellectual tools. It is the advantages to society of actuaries as a well-defined, recognized group of trustworthy and p...
TL;DR: From the inception of Social Security in 1935 to the present time, a variety of measures for evaluating the actuarial status of the program have been employed as discussed by the authors, and how the results of these measures have been displayed and interpreted has also evolved.
Abstract: From the inception of Social Security in 1935 to the present time, a variety of measures for evaluating the actuarial status of the program have been employed. In addition, how the results of these measures have been displayed and interpreted has also evolved. These results have had great influence on policymakers’ and the general public’s perceptions of the financial condition of the program. This paper is intended to be an update of my earlier paper on the same subject, that is, a historical review of the development of these methods and their interpretation. The paper closes with suggestions as to future changes in the measurement methods, in the light of possible future changes in the program itself.
TL;DR: The epic genetic testing issue within the context of the insurer’s decadeslong struggle against increasing numbers of people who question the fairness and social legitimacy of risk classification is described.
Abstract: This paper describes the epic genetic testing issue within the context of the insurer’s decadeslong struggle against increasing numbers of people who question the fairness and social legitimacy of risk classification. The fact that this uniquely personal and emotional genetics issue is now erupting at the very time that our industry seems preoccupied with other challenges begs the question of our industry’s ability to manage this issue in a way that will preserve the basic fabric of our being. A major goal of this paper is to articulate a visionary tenpart industry management strategy. Four specific and critically important industry management recommendations are made. Although some will be easier than others to accomplish, each is exceedingly important.