2019 Annual Meeting

Session I-A Behaviorial Insurance

What Drives Policyholders’ Relative Willingness to Pay? Empirical Analysis under Default Probability and Varying Coverage

Based on empirical data acquired by using an online survey, we investigate which parameters are key drivers for policyholders’ relative willingness to pay against the background of high insured values. Our research is conducted from the insurer’s perspective to understand which policyholder groups exhibit a high relative willingness to pay or do not cover the insurer’s expected expenses. We fi nd that the certainty effect underlies for probabilistic insurance but not for underinsurance. This implies no relevant impact of the insurance coverage on the relative willingness to pay. Furthermore, the relative willingness to pay for high insured values decreases signifi cantly with a higher default probability, higher age, lower risk aversion, or lower wealth. In addition, the average relative willingness to pay for individuals with medium financial literacy is close to 1 (fair premium), but policyholders with the highest financial literacy pay substantially less (0.621). We also nd that for overinsurance and full coverage, policyholders signifi cantly deviate from expected utility equilibria. This insight is independent of the initial wealth and the degree of risk aversion. Concerning underinsurance, the deviation is less signifi cant or even not signifi cant at all.

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Loss Aversion, Probability Weighting, and the Demand for Insurance

We examine the demand for insurance within the framework of prospect theory preferences to determine whether such preferences can explain the choice of low deductibles observed in the market. Prospect theory implies individuals make decisions by evaluating gains and losses relative to a reference point, where utility is concave over gains and convex over losses; furthermore, losses are weighed more heavily than gains in this setting. We incorporate such preferences in the utility function for an individual and investigate various reference points for an individual making insurance purchasing decisions. We find that insurance purchase decisions made within the context of prospect theory can explain several phenomena observed in insurance markets: the preference for low deductibles for mandatory insurance, the lack of demand for non-mandatory insurance like catastrophe insurance, and the over-demand to insure small losses as seen with the purchasing of warranties.

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The Predictive Validity of Risk Attitudes for Insurance Demand

We analyze the extent to which insurance demand can be explained by different theories of risk attitudes. In an incentivized experiment (n=1,730), we elicit utility curvature, probability weighting, loss aversion, and a preference for certainty. We then ask subjects to make insurance choices in twelve different scenarios, varying loss probability and loading. Our results show that probability weighting and loss aversion both help to explain insurance demand. However, we find that parameterized decision models have little to no predictive power for explaining insurance choices. We draw implications of our findings for future studies of insurance demand and welfare analyses on insurance markets.

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Session I-B Catastrophes

Diversification Benefits of Cat Bonds: An In-Depth Examination

We investigate whether the inclusion of Cat Bonds in portfolios composed of traditional assets and common factors is beneficial to investors. Various mean-variance spanning tests show that under different market conditions, the addition of Cat Bonds gives rise to previously unattainable portfolios. By way of the Engle (2002) Dynamic Conditional Correlation (DCC) model, we find that including Cat bonds increases significantly the time-varying Sharpe ratio and the Choueifaty and Coignard (2008) diversification
ratio. Cat Bonds provide needed diversification during critical times particularly during episodes of crisis and of high volatility. Under the second-order stochastic dominance efficiency (SDE) tests, the null hypothesis that portfolios without Cat Bonds are efficient cannot be rejected. Out-of-sample analyses indicate that the performance of portfolios with Cat Bonds included varies depending on the performance measure employed, the portfolio optimization technique used and the assets or factors considered.

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Market-Consistent Valuation of Natural Catastrophe Risk

Natural catastrophe risk is increasingly covered through alternative capital instead of classical reinsurance. Due to the absence of a secondary market for almost all of these instruments, their ongoing valuation poses a challenge to investors. We suggest extracting information contained in regularly observed catastrophe bond prices by means of a reduced-form model. The Poisson intensity of the latter is found to materially depend on time to maturity and initial probability of rst loss. Along these two dimensions, we estimate smooth implied intensity surfaces for peak and non-peak perils that allow us to mark any catastrophe risk contract to market.

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Session I-C Insurance Economics

On the Interaction Between Saving and Risk Reduction

This paper presents a model of the joint demand for saving and risk reduction. This is motivated by saving decisions in the presence of a future consumption risk, which is
endogenous because the decision-maker anticipates to engage in risk reduction, for example by purchasing insurance. We show that the interaction between saving and insurance
is driven by whether absolute risk aversion in the second period decreases or increases in wealth so that insurance is either a substitute or a complement for saving as long as
relative risk aversion is bounded by unity. Furthermore, for decreasing absolute risk aversion saving is a substitute for insurance. These results carry over to more general forms of nth-degree risk reduction by formulating the associated conditions based nth-degree Ross instead of Arrow-Pratt risk aversion. We also show that risk reduction is a critical determinant of the intensity of the precautionary saving motive.

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Risk Attitudes With State-Dependent Indivisibilities in Consumption

Some consumption opportunities, e.g. medical treatments, are both indivisible and only valuable in particular states of nature. The existence of such state-dependent indivisible consumption opportunities influences a person’s risk attitudes. In general, people are not risk averse anymore even if utility from divisible consumption is concave. I propose a definition of insurance in the context of state-dependent preferences and investigate the different motives underlying insurance demand. The same reasons that rule out risk aversion turn out to be the basis of a desire to insure. This calls into question the standard approach that bases insurance demand on risk aversion with important implications for policy and research.

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An Integrated Approach to Risk Measurement in Financial Institutions

Risk measurement models for financial institutions typically focus on the net portfolio position and thus ignore distinctions between 1) assets and liabilities and 2) uncollateralized and collateralized liabilities. However, these distinctions are economically important. Liability risks affect the total amount of claims on the institution, while asset risks affect the amount available for claimants. Collateralization also affects the amounts recovered by different classes of claimants. We analyze a model of a financial institution with risky assets and liabilities, with potentially varying levels of collateralization across liabilities, showing that correct economic risk capital allocation requires complete segregation of asset, uncollateralized liability, and collateralized liability risks, with different risk measures for each. Our numerical analyses suggest that the conventional approach frequently yields over-investment in risky assets.

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Session I-D Life Insurance

The Earnings Management of Subsidiary Firm and the Role of Financial Holding Company: Evidence of Life Insurance Companies in Taiwan

This paper studies the intervention of financial holding company (FHC) on the earnings management of its subsidiary life insurance company. Based on the data of life insurance companies in Taiwan, the result shows an insurance company behaves differently in earnings management if it is a subsidiary of an FHC. The FHC influences the subsidiary insurer’s earnings management through the board directors which reduces the earnings management of the subsidiary insurer. Additionally, the empirical result confirms that the operational outcomes of FHC are significantly associated with the subsidiary insurer’s earnings management. The subsidiary insurer conducts less earnings management when the parent FHC has better operational performance and better financial strength.

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Modeling Stochastic Mortality for Joint Lives Through Subordinators

Mortality model for joint lives is critical to institutions which offer joint and last survivor financial products. In this paper, we propose a new model in which we use the time-changed Brownian motion with dependent subordinators to describe the mortality of joint lives. We then employ this model to estimate the mortality rate of joint lives in a well-known Canadian insurance dataset, and a dataset collected from National Health Interview Survey (NHIS). Specifically, we first depict an individual’s death time as the stopping time when the value of the hazard rate process first reaches one, and then introduce the dependence through dependent subordinators. Compared with existing mortality models, our model better interprets the correlation of death between joint lives, and allows more flexibility of the evolution of the hazard rate process. Empirical results show that our model yields highly accurate estimations of mortality, compared to the baseline non-parametric (Dabrowska) estimation, and the most widely used Copula model. Besides, our model also has high accuracy when modeling the joint mortality for couples in advanced old age.

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Determinants of Derivative Use and the Impacts of the Financial Crisis and the

Over the last two decades, derivatives have been used extensively as a risk management tool in the financial market. In the U.S. insurance market, life insurers have accounted for over 95% of total derivative transactions, a proportion much higher than that in other countries. There are only a few prior studies examining the practical use of derivatives in the U.S. life insurance market, but several limitations exist in terms of data they used (single-year, outdated, and inaccurate). In this paper, we compile accurate derivative transaction data by taking a close look at the underlying asset and the traded market. We then examine the determinants of derivative (swap in particular) participation and the extent of transactions using samples from 2001 to 2015 which includes major events such as the U.S. financial crisis and the Dodd-Frank Act. We find that the determinants of derivative/swap participation are different from those of transaction volumes. We also find that the impact of the financial crisis on derivative usage is very limited in the life insurance market. However, the enactment of the Dodd-Frank Act not only reduces the likelihood of swap participation but also stagnates the growth of the swap transaction volumes, while the total derivative transaction volumes are significantly increased. Such findings indicate that the costs of the new regulation outweigh its benefits, due to the inefficient and inadequate regulatory changes.

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Session I-E Longevity

The Application of Affine Processes in Multi-Cohort Mortality Risk Models

This paper assesses and extends continuous time affine mortality models based on the Arbitrage-Free Nelson-Siegel (AFNS) framework showing how they have superior forecasting
performance and can flexibly incorporate factor dependence into the model structure. As well as the common assumption of Gaussian distributed mortality intensity, we assess
the Cox-Ingersoll-Ross (CIR) process based mortality model allowing for Gamma distributed mortality rates. We compare models fitted to age-period data with models fi tted to
age-cohort data and show how to capture cohort effects more effectively in the continuous time framework. The models have appealing features suited for theoretical and practical
application.

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Income Inequality Among the Old: Evidence From China

China has achieved rapid economic development and large gains in life expectancy but is also facing increasing income inequality. We analyze the income inequality of the elderly in China over the period 1989 2015 using household panel data from the China Health and Nutrition Survey (CHNS) CHNS). We compare the trends in income inequality of the elderly and the young and apply a regression based method to decompose elderly income inequality by socioeconomic group s and by income sources to identify the leading causes of elderly income inequality. We find that the urban rural disparity, mediated by the inequality of education is the most prominent dimension of the elderly income inequality We also conclude that public pension inequality is the key driver of elderly income inequality for old er household s living without younger family members while labor income from the young is the most important source of income inequality for multi generation household s. Our result s suggest that elderly income inequality in China can be reduce d by harmonizing pension benefits and, in the long run, by equalizing the educational attainment of urban and rural residents

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A Value-Based Longevity Index for Hedging Retirement Income Portfolios

The availability of a longevity index that closely tracks the value of longevity-linked liabilities has the potential to significantly lower the costs and improve the efficiency of index-based longevity hedging techniques relative to standard mortality rate indices currently referenced in financial markets. This paper presents a universal value-based longevity index constructed from US economic and population data. To construct the index and examine its effectiveness in hedging retirement income portfolios, a multi-population affine term structure model for mortality evolution is adopted, along with a dynamic Nelson-Siegel model for the dynamics of interest rates. We present numerical experiments demonstrating that the proposed hedging framework generates a material reduction in basis risk relative to indices based purely on mortality rates. Beyond longevity risk, the paper notes that interest rate and inflation risks can also materially influence the value of longevity-linked liabilities. Finally, the paper bridges the literature gap between continuous and discrete-time multi-population mortality models and notes that the two modelling frameworks suggest relatively comparable hedging outcomes.

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Session II-A Agent Preference

Occupational Pension Schemes, Moral Hazard and International Exposure

The regulatory framework and insurance of defined benefit corporate pension plans in Germany has failed to implement constraints on moral hazard incentives, as opposed to regulations in the United States or the United Kingdom. This paper tests the moral hazard incentives along pension investment risk and pension funding for a comprehensive sample of German firms. We differentiate between domestic (German) and foreign pension plans of German firms. In line with theoretical predictions when considering German plans, we find that plan sponsors with low pension funding take on more investment risk and that pension funding is lower for sponsors that have a higher probability of default. Moreover, pension fund risk-taking is also affected by a plan sponsor’s international exposure. In the event of underfunding, plan sponsors decrease (increase) the level of investment risk when their international exposure is high (low). In contrast, we find no moral hazard evidence for foreign pension plans of German firms. Comparing domestic and foreign pension plans of German firms we show that defined benefit pension plan sponsors act on their regulatory incentives.

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Consumption and Portfolio Choice Under Internal Multiplicative Habit Formation

This paper explores the optimal consumption and investment behavior of an individual who derives utility from the ratio between his consumption and an endogenous habit. We obtain closed-form policies under general utility functionals and stochastic investment opportunities, by developing a non-trivial linearization to the budget constraint. This enables us to explicitly characterize how habit formation aects the marginal propensity to consume and optimal stock-bond investments. We also show that in a setting which combines habit formation with Epstein-Zin utility, consumption no longer grows at unrealistically high rates at high ages and investments in risky assets decrease.

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Awakening of the Rational Man? Non-Cognitive Skills After the Storm

A common assumption in economics is that non-cognitive skills such as personality traits and preferences are fixed within an adult population. The extent to which this assumption holds true is being contested in the more recent empirical literature. We analyze the very short-term causal impact of exposure to one of the most powerful storms ever recorded to strike land on locus of control, reciprocity, and risk preferences for a sample of 2,352 individuals in the Philippines. While we find that post disaster people exhibit significantly higher internal locus of control, lower reciprocity, and lower risk-aversion, effect sizes at the extensive margin are modest. This type of short-term shift towards “rationality” has not been observed before, filling a gap in the emerging literature on the stability of non-cognitive skills and has potential implications for post-disaser response policies.

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Session II-B Big Data

Risk Identification: What Is in the 10-K?

The Sarbanes-Oxley Act of 2002 requires all SEC-registered firms to provide a Risk Factor Assessment in their Annual Report known as the 10K. This paper uses a structural topic model (STM) to assess the types of topics contained in the 10Ks and to see how they change over SIC code sectors and over time. While topic models are useful in many respects, they only look at the words of the document and do not account for other information about the document’s author, time, type of business, or location. An STM will allow us to refine our topic selection based upon a number of covariates external to the document. The STM approach also permits the use of independent variables to add information to the evolution of certain topics such as information security or litigation. JEL Codes: G14, C55 Keywords: Enterprise Risk Management, Structural Topic Models, Risk Factors, Text Analysis

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Exploring Cyber Risk Contagion – A Boundless Threat

As the complexity and severity of cyber risk continue to expand, businesses face greater systemic risk from cyber threats. Cyber risk is likely contagious given the increasing interconnectedness of the web-based global economy. Using a unique dataset, the SAS OpRisk Global Data, our research empirically examine contagion among cyberattacks based on a flexible modeling framework that we develop to accommodate the interdependence of entities and their risk exposures. This paper provides new insights on cyber risk contagion and can serve as an easily implementable stepping-stone for businesses, insurers, regulators, and academics to analyze cyber risk contagion.

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Session II-C Insurance Economics

The Term Structure of Capital Costs

We develop a dynamic profit maximization model for a financial institution with liabilities of varying maturity, and use it for determining the term structure of capital costs. As a key contribution, our theoretical, numerical, and empirical results show that liabilities with different terms are assessed differently, depending on the company’s financial situation. In particular, we find that for a financially constrained firm, value-adjustments due to financial frictions for liabilities in the far future are less pronounced than for short-term obligations, resulting in a strongly downward sloping term structure. Our findings provide guidance for performance measurement in financial institutions.

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Optimal Insurance Demand–Low Probability, High Consequence Versus High Probability, Low Consequence

Contrary to expected utility theory empirical studies document a rather low insurance demand for rare catastrophic risks (LPHC-low probability high consequence) and a rather high insurance demand for small but frequent risks (HPLC-high probability low consequence). We explain this puzzle by mental accounting in a basic insurance model with two independent risks. To do so, we consider two optimization problems in which one risk (either LPHC or HPLC) is insurable while the other risk is seen as (uninsurable) background risk. We find that the optimal insurance demand against LPHC risks (HPLC is background risk) can be larger or smaller than the optimal insurance against HPLC risks (LPHC is background risk). This depends on, i.e. the risk preferences or initial wealth of the decision-maker. The loss probability affects this puzzle as well.

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On a New Paradigm of Optimal Insurance Demand: How to Theoretically Model Insurance Changes Post-Catastrophe

Post-loss insurance demand is shown to be fundamentally different to that of pre-loss period due to revised risk perception with respect to loss event occurring or not. In particular, optimal insurance demand when there is an intertemporal consideration increases relative to the standard single period mode, whereas when there is not the intertemporal consideration; the optimal insurance demand is low. A basic theoretical model that examines insurance demand post-loss based on a two-period intertemporal setting is presented and applied to show the performance of the intertemporal insurance model that examines insurance demand behaviour after a loss event experience.

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Session II-D Long-Term Care

The Effect of Political Frictions on Long-Term Care Insurance

Despite sharply rising prices, the number of companies choosing to operate in the private long term care insurance (LTCI) has dropped from over 100 to just over 30 today. This paper analyzes how product mispricing and regulators’ stringency jointly affected insurer dropout in the LTCI market. Using novel data on LTCI pricing, we show that regulators’ political climate– including their election cycles, political capital, political affiliation, and campaign funding– significantly affected price changes in the LTCI market and, subsequently, insurer profits. We then develop and estimate an infinite-horizon dynamic model of insurance company and regulator interactions. Using the estimated model, we demonstrate how insurer supply and social welfare may be decreasing in regulator stringency when cost shocks are large and unpredictable. However, in most other cases, social welfare is increasing in regulator stringency.

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Duration of Long-Term Care: Socio-Economic Drivers, Evolution, and Type of Care Interactions

The time spent in dependence and the type of care an elderly receives are the two main cost drivers of long-term care (LTC). Using a comprehensive social insurance dataset covering the LTC needs in Switzerland over a 20-years-period, we aim to provide a better understanding of the duration of care. First, using the framework of survival analysis, we derive econometric models for explaining the main factors that impact the LTC duration when care is received at home and in an institution. Retaining only significant covariates, the final accelerated failure time models allow us to predict the duration for different profiles of elderly along their age, gender, region of residence, type of household composition, acuity level and preretirement income. Second, we study the interaction of care provided at home and in an institution that are often considered substitutes. While our data supports that for short at home care durations the time spent in institutional care is reduced, we find that both types of care are non-substitutes when the time spent at home has been longer. Under the latter regime, the time spent in institutional care remains at a constant level. Finally, given the longevity improvements over the period of observation, we analyze the impact of living longer on the time spent in dependence. Our results show that while the mean age at entry in dependence grows, the overall time spent in dependence does not significantly change. Given the expected increasing number of elderly in most developed countries, our study is relevant for government planning, budgeting social insurance schemes, estimating personal savings needs and calculating private insurance premiums.

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Session II-E Property/Casualty

Board Diversity and Risk-Taking of Property/Casualty Insurance Companies

We examine the impact of board diversity on the risk-taking behaviour of property/casualty insurance companies. Using a unique data set of insurance companies allows us to have a wide spectrum of risk measures, cover private companies and financial industry other than depository institutions. We find that greater female representation on board of directors is negatively associated with asset risk only. While it increases the total and insurance risk of the firm. These effects seem to be moderated by the structure of the firms, the complexity of firm operations and The different effects on risks could explain why there is inconclusive literature on the relation of board gender diversity and risk. As for the ethnicity of board members, we find no evidence that ethnic diversity is significantly associated with any measure of risk.

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An Analysis of Post-Demutualization in the Property-Liability Insurance Industry

Using data of demutualized insurers in the property-liability insurance industry from 1997 to 2009, this paper examines whether the benefits following demutualization are consistent with the motivations behind demutualization suggested by the literature. First, our results support the access to capital motivation since demutualized insurers experience higher cumulative surplus growth over five years post demutualization. However, the requirement of capital differs within demutualized insurers. Demutualized insurers with surplus notes before conversion experience stronger surplus growth and premiums growth, indicating their long-term need of capital to maintain high growth. Demutualized insurers without surplus notes, however, only experience one-time surplus increase. Second, we find organizational flexibility post demutualization facilitates demutualized stock insurers to involve in merger and acquisition activities which provide an important channel to raise capital and to pursue growth and diversification. Fifty one percent demutualized stock insurers become targets in the conversion year. Finally, we find that demutualized insurers increase premiums written in commercial lines, lower underwriting expenses, but take more investment risks post demutualization. Overall, our evidence supports the motivations investigated in this paper: access to capital, organizational structure change to facilitate operational activities, and the reduction of agency costs.

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Gains Trading as an Earnings Management Tool: The Case of Property-Casualty Insurers

We investigate the incidence of “gains trading” by property-casualty insurers, in which firms sell invested assets to achieve an earnings benchmark. We identify gains trading behavior in just over 8% of insurer financial statements in our twenty-year sample. Approximately half of this behavior was to avoid reporting losses, while the other half was to show year-over-year earnings growth. The decision to gains trade varies by firm characteristics and financial standing. Gains trading is more likely for firms organized as mutuals, which we conclude is the result of greater agency conflict for mutuals.

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Session III-A Catastrophes

Pricing the Catastrophe Reinsurance by Government

In this paper, we analyze a catastrophe insurance market with many homogenous inhabitants, one monopolistic insurer, and one government as reinsurer. The market equilibrium features that all individuals choose to buy the catastrophe insurance, the monopolistic insurer earns positive profit from offering the coverage and buys catastrophe reinsurance from the government, and the government collects reinsurance premium from the insurer and charges poll tax from each individual. We prove that in the equilibrium, there exists reinsurance contracts and corresponding reinsurance premium that eliminate the default risk of insurer, and there exists primary insurance price and exogenous tax so that both inhabitants and the insurer are better off than the case without government reinsurance program. Our theoretical predictions can be considered as an ex-ante reinsurance planning extension to Charpentier and Le Maux’s (2014) ex-post government bail-out plan. All theoretical propositions are also illustrated by a numerical case based on the extant literature and market practice.

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Race Discrimination in the Adjudication of Claims: Evidence From Earthquake Insurance

Catastrophic events, such as hurricanes and earthquakes, affect many people simultaneously. In this regard, they differ from automobile accidents and home fires, which typically inflict loss on only an individual or family at a time. We exploit this claim characteristic to test for evidence of racial discrimination in the adjudication of claims. There were eight earthquakes in Oklahoma between 2010 and 2016, most linked to fracking. Using zip code level data and publicly available information from the Oklahoma department of insurance, we test whether claim resolutions differed between the majority white population and minorities after controlling for factors including distance from the earthquake epicenter, insurance policy characteristics and the use of engineers and public adjusters in the examination of the claim. We find evidence that claims from minorities were less likely to result in an insurance company payment. Further, we find evidence that claim settlements were less for minorities when a claim was paid.

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Session III-B Cyber/Technology

Will Investors Buy Extreme Cyber Risks?

This paper aims to investigate investor preferences for cyber insurance-linked securities (ILS) and lays a foundation to understand the drivers of demand for cyber ILS. We run a choice-based conjoint (CBC) analysis for ILS in the cyber context. The analysis is based on an online survey among fund managers in the ILS market and will include five central product attributes: risk type, ILS instrument, maturity, trigger and spread. Based on this approach we aim to estimate individual-level part-worth utilities by means of a hierarchical Bayes model. Drawing on the elicited preference structures, we will then compute relative attribute importances. Our findings will give issuers of ILS contracts (e.g. insurers) a deep understanding of proper instrument attributes for different cyber risk classes they can expect to be accepted by the capital market. In addition, the results can help to find (dis-) similarities to the established transfer of other risk categories that lead to a sharper image of the cyber risk transfer.

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Session III-C Health/Behaviorial Insurance

Risk Attitude Towards On-Demand Insurance

As the technology advanced, on-demand insurance products are developed to cover risk in extremely short-term period. This proposal exams the change in the risk attitude as the period of the focused risk is cut. We run an experiment and shows that individuals become extremely risk averse when on-demand insurance is offered. This extreme risk aversion, or a decision anomaly, can be explained by two behavior biases: myopic bias and loss probability miscalculation.

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Comparing Apples to Oranges: Is It True That Medicare Administrative Expenses Are Lower?

On 9/17/2017 Bernie Sanders explained that the administrative costs for Medicare are only 4% while for private insurance it is 12-18% (one example of media coverage is at: https://www.politifact.com/truth-o-meter/statements/2017/sep/20/bernie-s/comparing-administrative-costs-private-insurance-a/) . Since we are working with the health insurance annual statement data which is very rich with information about care services (frequency) and costs (severity) of health care, we decided to examine Sanders’ assertions about expenses to pay claims by health insurers. We computed the actual average cost per insurer specializing in the Group market, the Medicare and the Medicaid markets for the period of 2002 to 2016. We checked the insurers’ expense, not the Medicare expenses when insurers are not involved. Yes, the LAE and administrative expenses of insurers are high when insurers are involved in servicing a health care market. Insurers specializing in the Group or the Medicare Advantage (Medicare C) and Medicaid markets have had as low as 1.8% for Medicaid in 2002 and as high as about 3% in 2016 loss adjustment expenses (LAE) as a ratio from all expenses including hospital cost. For the ratio of average administrative costs only from all expenses, the differences in 2016 are: 9.4% for Medicaid, 12.3 for Medicare and 13.3% average for the Group Market. We know that we are comparing apples to oranges as the Governmental Medicare does not provide all the services insurers provide such as wellness programs, managed care, fraud detection and others. Proposed work: We are planning to obtain the supplemental Health care data from the NAIC to see the costs of insurers for giving different services with the outcomes. This will be compared to what the government is doing for Medicare A and B. This is the essence of fixing “statements” as the health care debate continues and result in comparing oranges to apples.

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Session III-D Insurance Economics

The Inheritance of the Insurance Purchase Decision: Model and Evidence

This study examines the influence in terms of insurance purchase decision-making given from an elder to a younger in a household. The number of in-force policies of individual life insurance per capita increased from 0.82 in 1988 to 1.26 in 2015 in Japan and the dispersion of the figures between prefectures diminished during the periods. However, the minimum is still no more than 51.3% to the maximum in 2015. In the articles exploring the diffusion of individual insurance, a few studies factor in the behavior of the parents in terms of taking out insurance. A person receiving the insurance benefits likely enlighten her/his children on effects of insurance and the influence from the parent is larger if they live together after becoming adults. Then, the primary variables of this study are the ratio of the adults living together with their parents to the total and the fraction of insureds. The analysis adopts a two-periods overlapping-generations framework to illustrate the insurance purchase decision-making and to clarify the relationship between variables including those primary ones. Since the results depend on the parameter values, mainly the damages of the accident and its probability, the calibration is carried out for the detail.

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Mossin’s Theorem Without the Expected-Utility Framework

This article investigates the problem of the optimal insurance level without the expected-utility paradigm. For the class of insurance policy whose maximum coverage fully covers the potential loss, it is shown that (i) the first part of Mossin’s Theorem (full insurance with a fair premium) holds under risk aversion and (ii) the second part of Mossin’s Theorem (partial insurance with an unfair premium) needs to be modified: the optimal insurance level can be partial insurance or full insurance, depending on the asymptotic orders of the mean unreimbursed loss and the risk premium. Beyond this general result, further study is made for three specific types of policies: coinsurance, deductible insurance and upper-limit insurance. It is also demonstrated that the results derived without the expected-utility paradigm are conducive to further understanding of Mossin’s Theorem in the expected-utility framework.

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Linking Subjective and Incentivized Risk Attitudes: The Importance of the Loss Domain

The “general risk question” (GRQ) has been established as a quick way to meaningfully elicit subjective attitudes toward risk and correlates well with real-world behaviors involving risk. It is thus an appealing measure of risk attitudes for decision analysts designing tools to support and improve managerial decisions involving risk. Yet, it would be valuable to know more about what aspects of attitudes toward financial risk are captured by the GRQ. We examine how answers to the GRQ correlate with different preference motives and biases toward financial risk using an incentivized choice task (n=1,730). We find that the GRQ has meaningful correlation with loss aversion and attitudes toward variation in financial losses, but much weaker to non-existent correlations with attitudes toward variation in financial gains, probability weighting, and certainty preferences. These results suggest that practical applications using the GRQ as an index for financial risk preferences may be most appropriate in settings where decisions rest on attitudes toward financial losses.

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Session III-E Life Insurance

Life Insurance Settlement and Information Asymmetry

We examine the effect of life insurance settlement on insurance market with two- dimensional asymmetric information on mortality and liquidity risks. We first show that under Rothschild and Stiglitz equilibrium conditions (1976), semi-pooling equilibrium may exist without settlement. When settlement is allowed, the equilibrium is pooling contract and the utilities of all insureds decrease. Second, under Wilson conjecture (1977), pooling equilibrium at which the utility of high mortality risks are maximized is possible without settlement. When settlement is allowed, pooling equilibrium is possible and the utilities of all insureds decrease.

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Lethal Lapses—How a Positive Interest Rate Shock Might Stress Life Insurers

This paper presents a fire sale-mechanism through which the life insurance sector can amplify macroeconomic shocks. Life insurers have a common risk exposure due to their business model. They offer their customers a protection against market risk which is only credible as long as macroeconomic fluctuations remain moderate. If shocks exceed a certain threshold, customers have a common incentive to surrender their contracts. In the event of a customer run, life insurers would be forced to liquidate their assets. Using the German case as a laboratory, it is demonstrated that such fire sales could amplify interest rate shocks by up to 15%

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Interest Rate Risk of Life Insurers: Evidence From Accounting Data

Life insurers are exposed to interest rate risk as their liability side is typically more sensitive to interest rate changes than their asset side. This paper explores why insurers assume this risk using a new accounting-based method to measure interest rate sensitivity of assets and liabilities. Calculation at the insurer level yields on average a wide duration gap with pronounced heterogeneity in the cross-section. This could be explained by alternative investment strategies such as asset insulation which are at least to some extent at odds with interest rate risk management. Using a 2014-17 panel, factors associated with interest rate risk support this view.

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Presented at: 2019 ARIA Annual Meeting

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Session III-F Reserving

Joint Model for Individual-Level Reserving

In the claim payment process, the claim payment history can be predictive of a settlement. Ignoring the association between the settlement and the payment history could lead to inaccurate reserve prediction. This paper proposes the joint modeling of longitudinal claim payments and settlement processes using random effects for reserve estimation. With the joint model (JM) framework, the association between the two processes can be captured. Also, unobserved claim heterogeneities are described using random effects which improves claim-specific dynamic predictions. The JM also allows for extensive use of covariates for both the longitudinal and settlement processes to improve predictions. Results from a simulation study and an empirical analysis of data from Wisconsin Local Government Property Insurance Fund (LGPIF) shows that this is a viable approach for RBNS prediction.

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Presented at: 2019 ARIA Annual Meeting

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How Do Insurance Companies Manage Reserves? Evidence From Reserve Manipulation Across Lines of Business and Accident Years

We study the question of how insurance companies manipulate reserves. Specifically, we investigate how managerial incentives affect insurers’ reserving practice across lines of business (LOBs) and accident years (AYs). As the tax discount factor assigned by the tax authority varies across LOBs and AYs, insurers with stronger tax saving incentives will be more likely to manipulate reserves across both LOBs and AYs. As the RBC regime specifies different industry worst case factors across LOBs, insurers with stronger incentives to increase their RBC ratio will be more likely to manipulate reserves across LOBs. In terms of income smoothing incentives, only the overall level (and not the composition) of reserves is of consequence, thus we predict that there will be no similar systematic patterns in reserves manipulation by insurers based on income smoothing incentives. By using a Firm-LOB-Year sample, we find that both tax incentives and RBC incentives can not only affect the level of reserve errors (REs), but also the composition of REs. These results help us identify how managerial incentives impact insurers’ reserving behavior.

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Presented at: 2019 ARIA Annual Meeting

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Session IV-A Agent Preference

Paying for Expertise: The Effect of Experience on Insurance Demand

Mayers and Smith (1982) argue that one of the main reasons why corporations buy insurance is because insurers have a comparative advantage in providing real services, such as claims administration, monitoring, and loss prevention. We use the rich data available on the purchase of insurance by insurers to test the real services efficiency hypothesis. By exploiting within-insurer differences in line of business experience, we find that the demand for real-services is greatest when a firm enters a new line of business, and this demand decreases as the firm gains experience. We also find that the demand for real-services differs by line of business.

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Presented at: 2019 ARIA Annual Meeting

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The Effect of Genetics on Risk Preferences and Household Financial Decisions

This study investigates how genetics influence risk preferences and financial decisions. We hypothesize that genetic differences can result in heterogeneous financial outcomes through both their impact on risk tolerance and other human characteristics. We measure genetic differences using established polygenic scores and develop a measure of risk tolerance that is independent of certain demographic and genetic characteristics. Using the Health and Retirement Study, which includes a rich set of information on households including biomarkers and genetic data for a large portion of the sample, we test for the separate effects of risk preferences, demographics, and genetics on various household financial measures. We find that genetic factors that are correlated with risk tolerance also have significant direct effects beyond just their impact on risk tolerance. The polygenic score for Big Five personality trait “neuroticism” is found to be negatively related to our estimated measure of risk tolerance and positively related to risky financial decisions.

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Presented at: 2019 ARIA Annual Meeting

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Impact of Preferences on Optimal Insurance in the Presence of Multiple Policyholders

In the optimal insurance literature one typically studies optimal risk sharing between one insurer (or reinsurer) and one policyholder. However, the insurance business is based on diversification benefits that arise when pooling many insurance policies. In this paper, we first show that results on optimal insurance that are valid in the case of a single policyholder extend to the case of multiple policyholders, provided their insurance claims are independent. However, due to natural catastrophes, increasing life expectancy and terrorism events, insurance claims show tendency to be correlated. Interestingly, in the case of interdependent insurance policies, it may become optimal for the insurer to refuse selling insurance to some prospects, based on their attitude towards risk or due to their risk exposure characteristics. This finding calls for government policies to ensure that insurance stays available and affordable to everyone.

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Presented at: 2019 ARIA Annual Meeting

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Session IV-B Catastrophes

Health Insurance Plan Design and Risk Protection: Evidence on Variation in Cost-Sharing for ACA Exchange Plans

The optimal design of the financial attributes of health insurance plans receives much attention in public-policy debate and recent literature. One policy implemented in the ACA Exchange is the Actuarial Value (AV) restriction: plans’ financial attributes are regulated by their average coverage level for a nationally representative ex-ante risk distribution, but are otherwise flexible in most states. This paper studies the consumer welfare of such flexibility in plan design. Using the universe of plans launched through the Federal Individual Exchange between 2014 and 2017, I find economically meaningful heterogeneity in plans’ financial protection, conditional on the actuarial values regulated by the ACA Exchanges. Within a metal tier, consumers face more than a $1000 difference in risk premium across plans. This variation in plan value is prevalent in different geographic regions, insurers and is stable over time. The variation in plan design is hard to rationalize by moral hazard. Heterogeneity in ex-ante risk types may partially explain the pattern. Using Uniform Rate Review Data for the Exchange plans in 2015-2016, I find that the average allowed expenditure is significantly higher for lower risk premium plans, consistent with consumers sorting by ex-ante risk types within a metal tier. I discuss the implications for our understanding of evolving health insurance markets.

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Presented at: 2019 ARIA Annual Meeting

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Analyzing Repetitive Loss Properties in the U.S. National Flood Insurance Program: Mitigation Efforts and Insurance Choices

Properties that flood repetitively account only for 1% of policies but make up 25-30% of claims in the U.S. National Flood Insurance Program (NFIP). We examine how characteristics of repetitive loss properties (RLP) and non-RLPs differ and examine how policyholders respond to their properties being designated RLPs. The Flood Insurance Reform Act of 2004 constitutes a natural experiment, which lies in our policy-level observation period of 2001-2012. This setting allows us to examine the effect of the law on households’ mitigation decisions by comparing mitigation efforts before and after the reform act went into effect. We additionally compare RLPs and non-RLPs with respect to their insurance choices. Owners of RLP properties are more than twice as likely to elevate their homes and are less likely to partially insure than owners of non-RLPs. Our results are informative for subsequent NFIP reforms and the expanding private flood insurance market.

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Presented at: 2019 ARIA Annual Meeting

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Losses from your ILS Portfolio? Well, what did you expect?

Abstract Insurance Linked Securities [ILS] are unique instruments in the fixed income world. Each bond comes with a specific modeled risk analysis that gives a measure of how the bond will react to (usually 10,000) possible future natural catastrophe scenarios. These are summarized by familiar metrics including the probability of some loss and the expected level of loss. The risk analysis is provided to investors by independent third-party modelers of natural catastrophes. The market has been around for some two decades, and while still small, continues to grow. During those two decades several real natural catastrophes have occurred and the investors in ILS have suffered loss. This paper asks the question, did the realized losses that have occurred to investors correspond to the expectations promised in the initial offerings of the bond? More briefly did ex post outcomes match ex ante expectations. The question is non-trivial, not least because it is harder than one might suppose to measure either the ex-ante expectations, or the ex post results. Coverage in the bonds is multi-year but the expectation is usually perceived for a single year. In insurance-speak there is multi-year coverage but only a single limit. On the ex post side, one of the characteristics of insurance is that even though an event is known to have taken place it may take many years to recognize the loss. This paper looks at the empirical evidence to date.

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The Effect of Terrorism Risk Perception on Savings Behavior

Terror attacks are a subject of growing concern in many places around the world. Given the increasing intensity of terrorism, behavioral changes may become visible. Using microeconomic panel data of the elderly population from 13 European countries and Israel, this study analyzes the effect of terrorism risk perception on the savings behavior of households. The savings variable consists of real assets and net financial assets including the sum of life insurance holdings. We differentiate between two risk variables – number of terrorist attacks and number of fatalities – to address the potentially different reactions in the aftermath of terrorism. While number of attacks measures the uncertainty in the environment, number of fatalities refers to a personal insecurity due to fear of death. We find that the effect of number of terrorist attacks on savings is negative. However, savings is positively influenced by number of fatalities due to terrorist attacks. Both effects are statistically significant and economically meaningful. A possible explanation for this pattern could be that individuals change their risk perception as soon as people die in a terrorist attack. Our analysis contributes to the literature by focusing on a vital part of the overall economic influence of terrorism on the economy.

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Presented at: 2019 ARIA Annual Meeting

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Session IV-C Insurance Economics

Could Insurance-Linked Lotto Improve Social Welfare?

It is well known that rank dependent expected utility theory (RDEU) can explain why people purchase both insurance and lotteries. Inspired by the successful prediction of RDEU on human behavior, our paper proposes an insurance-linked lotto as a new tool of government intervention in insurance markets. The lotto is independent of the occurrence of the insurable risk, but the prize and/or the probability of winning the prize is dependent on the insurance demand. We show that when an individual’s preferences is characterized by RDEU, the insurance-linked lotto could improve social welfare and enhance the equilibrium demand for insurance.

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Presented at: 2019 ARIA Annual Meeting

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Should I Stalk or Should I Go? An Insurance Auditing Exploration/Exploitation Dilemma

We consider an insurance fraud problem where policyholders and service providers may collude. When interactions are repeated between the auditor (insurer) and auditees (service providers), auditing behaves as an information gathering mechanism to separate the wheat (honest agents) from the chaff (defrauders). We analyze a Bayesian insurer’s dynamic auditing problem under ex-post moral hazard, and characterize his optimal strategy as a strategic exploration/one-armed bandit one. We show that the insurer faces the well-known reinforcement learning exploration/exploitation trade-off between gathering information for higher future profits (exploration) and prioritizing immediate profits (exploitation). We characterize optimal auditing strategies and how exploration levels vary across time. We also show how the degree of informativeness of auditing (i.e., its separating power) and the insurer’s time preference affect optimal strategies.

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Incentive and Welfare Effects of an Idiosyncratic Interest Rate

We provide a microeconomic analysis of saving behavior with idiosyncratic interest rates, for which a budget-neutral transfer rate determines the spread between the interest rate in the good and the bad state. A positive (negative) transfer rate increases the incentive to save for correlation loving (averse) individual. We also define a critical transfer rate that induces agents to save who would not do so otherwise, and determine its comparative statics. We find sufficient conditions for a larger transfer rate to increase savings and show that an idiosyncratic interest rate is welfare increasing for individuals with non-trivial correlation attitudes. The welfare benefits of idiosyncratic interest rates are related to their insurance effects.

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Presented at: 2019 ARIA Annual Meeting

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The Affordable Care Act and Medical Malpractice Liability

This paper studies the impact of the Affordable Care Act (ACA) on the medical malpractice liability. The ACA introduced millions of new insureds to the healthcare system while the physician supply is roughly unchanged. The sudden increase in the demand for healthcare service might increase the exposure for physicians to higher malpractice liability risk. In this paper, we find that the ACA-driven abnormal health insurance coverage significantly increases medical malpractice claim losses, but the impact is significant only in states with Medicaid expansion. Medical malpractice premiums are not affected significantly overall but states with Medicaid expansion experience some premium increases. Results using a Generalized Synthetic Control approach show that unobservable common trends such as the underwriting cycle cannot explain the results.

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Presented at: 2019 ARIA Annual Meeting

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Session IV-D Property/Casualty

Multimarket Contact, Market Structure, and Hedging Decisions: An Investigation of the U.S. Property and Casualty Insurance Industry

This study extends current knowledge on competition and corporate hedging strategy by examining how firms hedge in response to their contacts with other firms in multiple geographic and product markets. Drawing on the theory of multimarket competition, we propose an inverted U-shaped relationship between multipoint contact (MMC) and hedging level. We also propose that, to gain competitive advantages over its rivals, the extent to which a firm hedges will be opposite to that of its competitors. Finally, we propose that market concentration will moderate the relationship between MMC and hedging level because a concentrated industry facilitates mutual forbearance and thus alleviates competitive pressure among rivals. Analysis of reinsurance usage in the U.S. property and casualty (PC) insurance industry generally supports our model and shows that, given a market structure, firm-specific competitive conditions are salient to a firm’s hedging level.

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Presented at: 2019 ARIA Annual Meeting

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Does One Shock Affect All?

This paper investigates under what circumstances would a loss shock affect the line-specific prices in competitive markets. Specifically, three major questions are discussed: (a) Does a loss shock have to be relevant to the lines written by an insurer to affect insurance prices? (b) Would every loss shock affect the line-specific prices if it is directly relevant to the lines of business or the firm? (c) Does and when would a loss shock affect all? A simple theoretical model in the presence of market competition is developed to analyze how the line-specific prices are affected by loss shocks from different sources. The predictions of the model show that the key factor for a loss shock to influence insurance prices is through the change in the insolvency risk of the insurers. That is, one shock does affect all as long as the shock threatens the financial quality of insurers. It could not only affect the prices from the same line, the prices of other lines under the same firm, but also the prices of other competing insurers in the market. More interestingly, empirical evidence is found that even if one insurer only writes liability lines, an industry-level property shock would increase their liability-line prices.

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Presented at: 2019 ARIA Annual Meeting

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Corporate Social Responsibility in a Panel of Global Insurers

In this paper, we propose a novel corporate social responsibility index (CSRI) that captures various aspects of an insurer’s internal and external CSR activities. We first show that insurers worldwide significantly increased their CSR activities with the average index value almost doubling between 2006 and 2015. CSR activities are particularly pronounced at large firms, composite insurers, and insurance companies in Europe. We then show that the CSR activities of an insurer are driven by the insurer’s firm size, market valuation, as well as its stock volatility in previous times. Our findings thus support the notion that experienced risk in the past cautions insurers into engaging more in CSR. Finally, we provide empirical evidence that an insurer’s CSR significantly increases its market valuation while at the same time reducing its short- and medium-term tail risk.

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Does Corporate Social Responsibility Reduce Directors and Officers Liability Risk? Evidence From Canada

Theoretical arguments regarding the effect of corporate social responsibility (CSR) on firm liability risk are abundant; however, empirical evidence about this relationship is scarce. We investigate this relationship from a unique perspective: the premium for directors’ and officers’ (D&O) liability insurance. We discuss how better CSR performance reduces liability risk against a firm’s directors and officers, and therefore should be reflected in lower D&O insurance premiums. We find evidence that firms with better CSR purchase less D&O insurance coverage and pay less D&O insurance premium. Moreover, the reduction in premium is more than the reduction in coverage so that the rate-on-line (RoL) is significantly reduced, reflecting lower D&O liability risk. In addition, we find that the impact of social and corporate governance dimensions on D&O liability risk is negative and significant, whereas the impact of environmental CSR on D&O liability risk is insignificant.

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Presented at: 2019 ARIA Annual Meeting

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Session IV-E Regulations

Corporate Pension Plans’ Return Chasing With Private Equity Investment

We investigate corporate defined benefit (DB) plans’ investment in private equity, which has replaced traditional corporate equity since 2008. For private equity investments, we test two hypotheses: return chasing and reduced monitoring. Using IRS 5500 data and 10-K filings for the period 2009–2014, we find evidence to support both hypotheses. A corporate DB plan’s return chasing with increasing investment in private equity occurs when it faces a high level of required cash contributions or is at a low funding level. In addition, the return chasing is observed only when sponsoring firms have a leadership structure of CEO duality, which relates to boards’ reduced monitoring. Our findings on private equity not only support corporate pension plans’ risk shifting behavior addressed in the literature but also suggest that the risk shifting is closely related to a leadership structure of sponsoring firms.

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Presented at: 2019 ARIA Annual Meeting

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Choose Your Pension: An Analysis of the Interaction Between Pension Rules and Overtime Work by Employees of the City of Philadelphia

Underfunding of state and local pension plans in the US is a serious problem, amounting to more than $3 trillion. City of Philadelphia plans alone may be underfunded by as much as $15bn. We show that pension rules (which include overtime and other payments in the definition of salary used to determine pensions), give city workers a strong incentive to allocate overtime to senior workers within work teams. We illustrate the nature of the incentive and use individual-level payroll and pension data from the city to show that, indeed, overtime appears to be performed systematically by workers who have the highest pension costs within their work teams. We estimate that this may have added around $1.5bn to the city’s pension liabilities. We show that this behavior appears to be consistent with an implicit contract between workers and the city, rather than arising endogenously within work teams. This paper is the first of which we are aware has examined the importance of the interaction between pension rules and workplace practices as a driver of pension cost, and illustrates the importance of integrating pension rules and workplace practices as part of overall financial planning in respect of pensions.

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Pension Protection Schemes, Contagion, and the Economy

Protection schemes shield economic subjects against financial shocks. Their premiums and services influence corporate behavior and even the depth of economic cycles. We assess the relationship between protection schemes and corporate activity using a granular risk model which builds on an expansive set of micro data and explicitly models contagion effects. We find that protection schemes should establish fair and non-cyclical premium schemes if they pursue the aims of incentive compatibility and economic stability.

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Antitrust Exemptions and Competition in Insurance Markets: Reactions to the McCarran-Ferguson Act

The insurance industry is exempt from certain aspects of federal antitrust statutes. Initially this exemption rested on a Supreme Court ruling that insurance was not interstate commerce (Paul v. Virginia, 1868) and should be regulated by the states. In 1945, passage of the McCarran-Ferguson Act (McCarran) codified the antitrust exemption. Since then, the United States Congress has periodically considered repealing McCarran to remove the federal antitrust exemption. The exemption is intended to foster competition in insurance markets. However, critics claim it leads to anticompetitive behavior. Despite more than six decades of spirited debate concerning McCarran’s merits, no empirical study has analyzed its effect on insurer market values. In this study, we empirically test the effect of McCarran on competition in insurance markets by measuring insurance company returns across segments of the industry around the time it became law. Our results are consistent with McCarran increasing competition in insurance markets.

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Presented at: 2019 ARIA Annual Meeting

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Deregulation, Competition, and Insurer Switching: Evidence From China’s Automobile Insurance Market Reform

With the rapid growth in automobile insurance premium, the regulator in China initiated a marketization reform for the industry in 2015 to grant insurers more options in rate making, policy design, and underwriting. It intended to increase competition and improve consumer welfare, yet there is little scientific evidence on the impact of deregulation so far. Using a large panel dataset of more than four million automobile insurance policies, covering all insurers operating in China from 2013 to 2017, we use insurer switching as one key indicator measuring market competitiveness, to test whether deregulation increased market competition. And we further analyze the pattern of switching among different types of insurers, and interpret the trends using “Structure-Conduct-Performance” paradigm, in order to better understand the impact of deregulation on market performance and consumer choice.

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Session V-A Enterprise Risk Management

Enterprise Risk Management and Mergers and Acquisitions: Evidence From the Insurance Industry

This paper conducts the first exploratory analysis of the impact of ERM on merger outcomes. Merger is an ideal setting to analyze the channel through which ERM impacts firm value because it combines the risk portfolios of two firms, is one of the most important strategic actions that a firm can take, and has a high failure rate. Consistent with the risk-awareness hypothesis, we find that the quality of a firm’s ERM program is negatively associated with the likelihood and frequency of its M&A activities. Further, this negative relation is driven by firms that have consistently demonstrated excellence in ERM programs. Given that a merger is completed, we find that firms with higher quality ERM programs have higher buy-and-hold stock returns, which is consistent with the technology-superiority hypothesis that firms with high quality ERM programs select better merger targets and are more capable of effectively executing the combination of potentially very different businesses. We also find that the stock market reacts more favorably to merger announcements by bidders with high quality ERM programs if the merger is complex.

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Presented at: 2019 ARIA Annual Meeting

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Enterprise Risk Management and Financial Misconduct

Internal control over financial reporting (ICFR) plays an important role in preventing financial misconduct. While strong internal controls are an important aspect of enterprise risk management (ERM) programs, these programs include important features—including reputational protection, managerial short-termism mitigation, new financing constraint relief, and financial distress alleviation—that can additionally deter financial misconduct. In this study, we examine the relation between ERM and financial misconduct by specifically considering the interrelation between ICFR and ERM. Using a hand-collected sample of ERM adopters from a sample of S&P 500 firms we test whether firms with ERM programs are less likely to commit financial misconduct. We find evidence that ERM adoption is associated with a higher quality discretionary accruals, as well as a significantly lower probability of AAER violations and class action lawsuits. These results are robust to controlling for ERM selection effects by using a treatment effects model. Additionally, our results are robust to the inclusion of variables measuring a firm’s internal control strength, indicating that ERM provides benefits to financial reporting beyond typical internal control functions. Overall, our study documents benefits to ERM specifically associated with financial reporting.

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Session V-B Health

Medicaid Managed Care: Efficiency, Medical Loss Ratio, and Quality of Care

The recent final rule on Medicaid managed care establishes the minimum medical loss ratio (MLR) requirement for Medicaid managed care and contains several provisions to strengthen delivery and payment reforms and improve efficiency and quality of care. In response, this research examines the quality of Medicaid managed care and the effect of MLR and efficiency. The results show that, Medicaid managed care is the lowest on the rating of health care compared to Medicare Advantage and private plans. However, Medicaid managed care is still delivering decent health care of acceptable quality. The medical services efficiency has an insignificant negative effect on the quality of care, as implies there should be room to improve medical services efficiency without significantly reducing the quality of care. MLR has a significant positive effect on the aggregate quality ratings. Nonetheless, the magnitude of the effect is very small. This indicates that a minimum MLR requirement of 80% or 85% does not make a huge difference on quality ratings. Other findings are that stock insurers have a significant lower aggregate quality rating than other types of insurers, but the size of the insurer has a significant positive effect on the quality of care.

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Presented at: 2019 ARIA Annual Meeting

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Do Some Health Insurers Consistently Perform Better than Others?

The results of this research were surprising. Consistently, from 2002 to 2016, there is one group of health insurers that perform well and better than others as measured by return on capital (and also return on assets). The group is of those insurers specializing in Medicaid, the public assistance program. We do not speculate why the result is so striking, but are delving into ensuring that our methodologies are accurate in arriving at such a result that can inform policymakers in this highly debated arena of health insurance and health care. We use the rich health insurers’ annual filings for 2002-2016. We have non-granular data for return on capital (and assets), care utilization, and medical expenses per insured. We are able to create five distinct health insurance market groupings of insurers: Group, Medicare, Medicaid, Individual and Federal, assigning an insurer to a market if 70+% of its insureds are in that market. Both simple and complex analyses revealed unexpected success for Medicaid specialty insurers, which consistently outperformed other specialists and did not show losses. Another surprising result has to do with the utilization: positive relationship between Medicaid and Medicare specialists’ income and the number of hospital days utilized by their members. For Group specialists (of insured employers), the opposite holds. Importantly, the ACA of 2010 did not affect these surprising results.

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Did the ACA Inject a Healthy Dose of Discipline in the U.S. Health Insurance Market?

The complex and opaque nature of health insurance is often seen as being anti-consumer, and the Affordable Care Act (ACA) sought to decrease this complexity in order to create a more transparent market. We examine the efficacy of the legislation on the industry for both price and quantity with two risk measures: surplus volatility and insurer rating. Our findings extend prior research on market discipline in several ways. First, we present evidence that health insurers with lower risk are able to command higher prices for their products. Second, we find changes in financial strength are more notable for drops below “A-” than other ratings. Finally, we analyze the industry dynamics before and after the ACA and find that post-ACA the health insurance market exhibits more market discipline.

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Spillover Effects of Medicaid Expansion on Private Premiums: Evidence From Cost-Sharing Subsidy Thresholds

The Affordable Care Act is one of the most debated and dividing pieces of legislation in recent memory. One of the main elements of the ACA is the optional expansion of Medicaid eligibility from the poverty line to 138\% of the poverty line and inclusion of non-disabled, childless adults. Nearly all of the debate has focused on the direct effects of the newly covered, but there are also important other spillover effects to consider. If the newly-eligible portion differs from the general populace then the expansion of Medicaid can affect the individual market for health insurance. We use policy-level data from the Health Insurance Exchanges to identify and estimate the effects of Medicaid expansion on the private health insurance market premiums. We find that expanding Medicaid reduces average monthly premiums by \$22.94, a decrease of 7.6\%. We find this is largely due to moral hazard from the most generous level of cost-sharing reduction (CSR) subsidies. Additionally, we are able to use the pseudo-random experiment created by the sharp discontinuity in CSR rates to estimate a price elasticity of healthcare of -0.34.

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Session V-C Insurance Economics

Estimating the Critical Parameter in Almost Stochastic Dominance From Insurance Deductibles

Knowing how small violation individuals would accept against stochastic dominance rules is a prerequisite for applying almost stochastic dominance criteria. Different from previous results obtained by experiments, this paper estimates acceptable violation against stochastic dominance rules with 940,904 observations of real data on a deductible choice of automobile theft insurance. We find that for all policyholders in the sample who optimally chose a low deductible, the upper bound estimate of acceptable violation ratio is 8.198e−08 which is close to zero. On the other hand, considering most decision makers, such as 99%(95%) of the policyholders in the sample, who optimally chose the low deductible, the upper bound estimate of the acceptable violation ratio is 0.0399 (0.0727). Our results provide reference values of the acceptable violation ratio and justification for applying almost stochastic dominance rules.

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Can Life Settlement Assets be Marked to Market?

Life settlement prices are commonly determined by present value calculus. Yet, the asset class lacks an established approach for the determination of adequate discount rates. We estimate historical yield spreads used for pricing based on a large data set of 2,863 transactions that occurred between 2011 and 2016. Subsequently, we explain the cross section of the former based on hedonic regression methodology and a comprehensive set of attributes motivated by industry know-how as well as earlier studies. Out-of-sample results indicate that market-consistent life settlement prices can be conclusively predicted by employing market-consistent discount rates generated with our model.

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Information Asymmetries and the Access Economy: The Impact of On-Demand Insurance on Competitive Insurance Market Equilibria

Access-based products and services are designed to target specific customer groups. Taking the example of on-demand insurance, which is generic for an intangible product with access-based design, we analyse market equilibria in competitive markets with asymmetric information. On-demand insurance is offered besides standard contracts and therefore stands in direct competition to them. Private information of customers comprise (1) their risk profile and (2) their frequency of usage of coverage. We find, that low frequency individuals can be attracted by the on-demand insurers’ offer as a result of an improvement of expected utility. However, high frequency individuals rather choose standard contracts. Overall, market entry of on-demand insurance companies is beneficial in the sense that market performance as well as utilitarian welfare increase. Our analyses show furthermore, that standard and on-demand markets coexist in a resulting equilibrium, which means that customers are distributed across both markets. In order to get those results, we use the optimization algorithm claimed by Miyazaki (1977) and extended by Spence (1978), and develop a proprietary optimization algorithm to meet the features of the market with two competing products.

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Session V-D Regulations/Actuarial Science

Do Solvency II Reports Appropriately Inform About European Stock Insurers’ Market Risk Exposures?

One of the major goals of the new European regulatory framework Solvency II is to foster market discipline. To this end, Solvency and Financial Condition Reports inform insurers’ stakeholders about the companies’ risk profiles. From a regulatory perspective it is important to have empirical evidence on whether the reported data reflects the insurers’ actual exposures. Therefore, we measure (stock) insurance companies’ true risk profiles based on the sensitivities of their market capitalization to movements in risk drivers and investigate which information in the reports has explanatory power for sensitivities to interest rate and credit risk. Our results demonstrate that Solvency II reports are consistent with market data in terms of interest rate risk. In particular, the company-specific calculation of the solvency capital requirement is appropriate for approximating insurers’ true market risk exposures.

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Insurance Solvency Regulation in the Shadows: Evidence and Effects of Informal Regulatory Intervention

In this proposal, we discuss how we intend to extend previous research on the incidence and effects of regulatory interventions with troubled or insolvent property-casualty insurance companies. This research has focused solely on formal, public regulatory interventions (FPRIs). Generally, prior studies have found that greater regulatory forbearance (i.e., more time between the first intervention and the liquidation of a company) tends to increase the cost of insurance insolvencies as measured by guaranty association (GA) assessments. What has not been examined is the incidence and effects of informal, nonpublic regulatory interventions (INPRIs). Our initial analysis suggests that such interventions are common; in some cases, they precede formal actions and in other cases no formal action occurs. Among the questions we wish to explore is whether INPRI is more often associated with better outcomes (e.g., companies not being liquidated, lower GA costs) than worse outcomes. In other words, does such intervention mean that regulators are acting more proactively, or does it mean that they are either putting off the inevitable or letting companies dig themselves deeper into a whole. The answers to these questions may be that “it depends” on the specific circumstances of a given company as well as the nature of the INPRIs. Regardless, we contend that the measurement of regulatory forbearance ideally should consider both categories of interventions as well as their timing. We develop a measure of INPRIs based on insurer financial statements. Using this measure, we find evidence that INPRIs are associated with a higher probability of eventual FPRI. However, we also find preliminary evidence that when a firm’s RBC ratio is not below its Company Action Level (CAL) risk-based capital (RBC) requirement, INPRIs can reduce the probability of entering FPRI. Our initial results suggest that U.S. insurance regulators exercise broader authority and discretion with respect to troubled insurers than what has been recognized in the extant academic literature.

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Regulatory Capital and Asset Risk Transfer

Life insurers manage the regulatory capital requirements associated with their liabilities using reinsurance, the transferring of their underlying product risk to another insurer. In this paper, we consider the other side of the balance sheet and explore whether and how life insurers use reinsurance to manage the regulatory capital requirements associated with their investments (assets). We undertake this exploration by first presenting the basic operations of reinsurance contracts, then we theoretically document how a specific type of reinsurance contract, RBC-relief reinsurance, enables life insurers to reduce their regulatory capital requirements associated with their investments. We find that life insurance companies with RBC-relief reinsurance are less likely to sell downgraded investment grade bonds if the sale would result in realized capital losses. Life insurers with RBC-relief reinsurance are 5% less likely to sell downgraded bonds than those not using RBC-relief reinsurance. Given the lower capital levels held by life insurance companies using RBC-relief reinsurance, solvency questions emerge as high utilization of RBC-relief reinsurance can potentially harm financial safety of policyholders.

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Presented at: 2019 ARIA Annual Meeting

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Variance Reduction Method for a Least-Squares Monte Carlo Approach to the Calculation of Risk Measures

Estimation of risk measures at a risk horizon is a challenging problem due to difficulty in obtaining a distribution of a loss random variable. A simplified approach to an approximation of the loss random variable is the usage of the quadratic form of state variables that drive uncertainty. However, if the risk horizon is a relatively extended period, this technique may deliver a meager projection of a possible event. A natural extension is to approximate the loss random variable through higher degrees of polynomials and apply it to a generation of samples to form the distribution of losses. Like other simulation methods for the risk management, a required number of simulations is also significant for estimating a probability of a massive loss or capital requirements if we rely on the functional approximated loss distribution, which is the culprit of expensive computational costs. In this paper, we provide a simple and efficient algorithm to approximate the loss random variable defined at the future time and calculate a probability of a large loss based on the Least-Squares Monte Carlo method (LSM) and the Importance Sampling (IS). We test the algorithm with a variable annuity contract and verify that a significant variance reduction is achieved with a relatively small computational budget. In particular, the algorithm can be exceptionally efficient for estimating a probability of occurring Black swan events.

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Presented at: 2019 ARIA Annual Meeting

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Session V-E Retirement

The Impact of Systematic Longevity Risk on Optimal Lifecycle Portfolio Choice With Tontines

We derive the optimal life-cycle portfolio choice and consumption pattern for a CRRA utility maximizing investor, facing risky capital market returns, systematic mortality risk and a stochastic level of living standard. In addition to stocks and bonds, the individuals have access to tontines. Tontines are cost-efficient financial contracts providing age-increasing, but volatile cash flows, generated through the pooling of mortality without guarantees, which can help to match increasing financing needs at old ages. We find that tontines can generate significant welfare gains. We find a decreasing optimal stake in tontines over the lifecycle to smooth consumption. However, higher risk aversion reduces tontine investments and increases stock investment. Depending on the level of bequest motive, the tontine is crowded out by bequeathable assets. Furthermore, we find that the value of the tontine increases in the tontine size and risk aversion. However, since stochastic mortality affects both, expected tontine returns as well as tontine payout uncertainty, the welfare gains diminish.

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Presented at: 2019 ARIA Annual Meeting

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An Experimental Study of the Demand for Hybrid Longevity and Health Insurance Products

Medical expenses in retirement are becoming one of the largest expenditures of retirees. It is unclear how households plan to use guaranteed income to insure against retirement health care consumption risk. We surveyed employees over fifty at fourteen higher education institutions about their perceptions and plans toward retiree health expenditures. Despite the large concern for these costs and expected reliance on social security to pay for retiree medical expenses, less than half plan to use annuities, and most plan to use non-annuitized retirement plan assets. We find significant differences on the use of (non)guaranteed income for retiree medical expenses by financial literacy, retirement plan assets, and whether individuals save specifically for retiree health costs. The large reliance on non-annuitize assets for retiree health expenses leaves households to bear much risk in retirement that could be mitigated by additional annuitization.

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Presented at: 2019 ARIA Annual Meeting

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Session VI-A Cyber/Technology

Probable Maximum Cyber Loss: Empirical Estimation and Reinsurance Design With Private- Public Partnership

This study defines the probable maximum cyber loss (PMCL), which stands for the worst cyber loss likely to occur, by conducting a statistical procedure to fit the cyber loss maxima for different time blocks and estimating the potential size of a next worst cyber scenario. We identify that the series of cyber loss maxima in different time blocks are stationary, short-range temporal dependency exists, Fréchet type of generalized extreme value distribution (GEV) is well fitted with fat-tailedness of loss maxima and extreme dependency is observed. We find that our PMCL estimates likely to occur in the next five years are almost 3.8 times larger than the estimate by the recent literature with a Pareto-based model. Particularly, the estimates based on the more recent data period show a dramatic increase compared to the ones for the older period with a significant structural break at the end of 2013. We propose a reinsurance design with private-public partnership based on PMCL estimates. Our findings are important for risk managers, actuaries and policymakers, who are concerned about a (social) cost by a next super-extreme cyber loss as a New Normal in the digital era.

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Presented at: 2019 ARIA Annual Meeting

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Peeking Into the Black Box: Technological Transparency and Its Impact on Self-Protection

Technological transparency refers to perfectly understanding the joint determination of a risky outcome by nature and the decision-maker’s action. This paper discusses the impact of technological transparency on self-protection (loss prevention). When combined with ex ante observable exogenous risk factors, technological transparency creates value by always inducing the most efficient preventive effort. When the exogenous risk factors are only ex post observable, technological transparency allows the decision-maker to objectively attribute the (non-)occurrence of the loss to his own effort and external causes in hindsight, which provides a channel for regret aversion to raise self-protection. The results highlight the positive value of understanding causal determinants of risks in promoting adequate and efficient preventive effort.

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Presented at: 2019 ARIA Annual Meeting

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Cyber Insurance Supply and Performance: An Analysis of the U.S. Cyber Insurance Market

This article examines the determinants of cyber insurance participation, the amount of coverage offered, and the performance of current cyber insurers. We find that insurers offer cyber insurance to capitalize on their competitive advantage in understanding and pricing cyber risks and to balance their risks between investment and underwriting. We find limited evidence that insurers participate in cyber insurance to compensate for constraints on business growth. In addition, the type of coverage offered (standalone or packaged) and the amount of coverage offered vary substantially across firm characteristics. Despite being profitable at the industry aggregate level, cyber insurance has highly volatile loss ratios, with performance varying across individual firms and types of coverage. Standalone coverage incurs higher loss ratios than packaged coverage, demonstrating its riskier nature. Growth in the cyber insurer loss ratio is not driven by premium growth, but by claim frequency and severity growth, emphasizing the significance of cyber insurance policy design.

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Presented at: 2019 ARIA Annual Meeting

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Session VI-B Health Insurance

Efficiency-Based Comparisons of One-Sided and Two-Sided Medicare Accountable Care Organizations (ACOs) and Their Potential Cost Savings

Medicare ACOs represent the nation’s largest initiative of Medicare alternative payment models toward value and health outcomes. Various ACO models have been experimented at differential risk structures, and the CMS has issued a final rule to accelerate the ACOs to assume greater downside financial risks. In response, this research conducts a comprehensive efficiency analysis of Medicare ACOs incorporating quality measures, investigates whether superiority exists among the various ACO models and determines their potential cost reductions. The results indicate that in minimizing expenditures given quality services, or maximizing quality services given health expenditures, one-sided ACOs are more efficient than two-sided ACOs, so it might not be advisable to mandate the transition of ACOs from one-sided to two-sided, as far as efficiency is concerned. This research also shows that the ACOs should be able to reduce expenditures significantly through efficiency improvement. Maintaining the same level of enrollment, utilization, and quality, without switching to two-sided ACO tracks, Track 1 ACOs are expected to reduce expenditures by 4.1% using the median efficiency target, and 1.5% using the 25th percentile efficiency target (compared to actual expenditures). Another finding is that the benchmark expenditures for one in four Medicare ACOs are below the efficient expenditures using the median efficiency target, and one in three using the 25th percentile efficiency target. The benchmark expenditures are probably too low for these ACOs, and should be adjusted upward.

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Presented at: 2019 ARIA Annual Meeting

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Health Insurance, Pension, and Health Status of Middle-Aged and Elderly in China

Health insurance and pension play an essential role in determining middle-aged and elderly people’s health status. However, previous studies only investigate the impact of health insurance or pension on health separately, and less attention has been paid to the difference in these two insurances’ impact on health, as well as the difference in their influence mechanisms. We build a general equilibrium Overlapping Generation (OLG) model on the impact of health insurance and pension on health status to propose our hypotheses for empirical analysis. We then use a nationally representative data for middle-aged and elderly Chinese to empirically investigate the impact of health insurance and pension on health status and multiple transmission channels. This study aims to shed lights on the overall impact of health insurance and pension on the health status of the middle-aged and elderly Chinese.

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Presented at: 2019 ARIA Annual Meeting

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Health Insurance, Chronic Disease, and the Affordable Care Act: How Important Are Selection Effects?

We examine the impact of the Patient Protection and Affordable Care Act (ACA) on risk selection among the policyholders. With the individual mandate and its tax penalty, the ACA affects the individuals decision to take out health insurance. We hypothesize that the introduction or an increase of the penalty incentivizes more individuals to purchase health insurance coverage. This effect should be stronger for lower risk type individuals. We find supporting empirical evidence for our derived hypotheses utilizing the Behavioral Risk and Surveillance System (BRFSS) survey. We discover that the penalty is an important instrument to counteract general selection effects, i.e. that higher risks are more likely to take out health insurance. Consequently, the individual mandate induces lower risks to join the health insurance market and improves the overall risk pool.

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Presented at: 2019 ARIA Annual Meeting

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Health Insurance Plan Design and Risk Protection: Evidence on Variation in Cost-Sharing for ACA Exchange Plans

The optimal design of the financial attributes of health insurance plans receives much attention in public-policy debate and recent literature. One policy implemented in the ACA Exchange is the Actuarial Value (AV) restriction: plans’ financial attributes are regulated by their average coverage level for a nationally representative ex-ante risk distribution, but are otherwise flexible in most states. This paper studies the consumer welfare of such flexibility in plan design. Using the universe of plans launched through the Federal Individual Exchange between 2014 and 2017, I find economically meaningful heterogeneity in plans’ financial protection, conditional on the actuarial values regulated by the ACA Exchanges. Within a metal tier, consumers face more than a $1000 difference in risk premium across plans. This variation in plan value is prevalent in different geographic regions, insurers and is stable over time. The variation in plan design is hard to rationalize by moral hazard. Heterogeneity in ex-ante risk types may partially explain the pattern. Using Uniform Rate Review Data for the Exchange plans in 2015-2016, I find that the average allowed expenditure is significantly higher for lower risk premium plans, consistent with consumers sorting by ex-ante risk types within a metal tier. I discuss the implications for our understanding of evolving health insurance markets.

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Presented at: 2019 ARIA Annual Meeting

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Session VI-C Insurance Economics

The Effects of Unemployment Insurance Taxation on Multi-Establishment Firms

This paper investigates whether and to what extent state-level differences in business taxes influence the location decisions and labor demand of multi-establishment firms. In the United States each state administers its own unemployment insurance (UI) program, and cross-state variation leads to significant differences in the potential UI tax costs faced by employers in different states. Leveraging the existing locations of multi-state manufacturing firms for identification, I find that high tax plants were more likely to exit during economic downturns, and less likely to hire during the recovery. Moving a plant’s outside option from a high tax state to a low tax state would increase its likelihood of exit by 20% during the Great Recession. These findings suggest that decentralized administration of UI taxes may contribute to jobless recoveries and additional misallocation in the economy.

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Presented at: 2019 ARIA Annual Meeting

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CEO Compensation and Internal Capital Markets in the U.S. Property-Liability Insurance Industry

This paper examines the relationship between CEO compensation and internal capital market efficiency in the U.S. property-liability insurance industry for the period 2000-2015. The results indicate that a CEO’s total equity ownership has a significant and positive influence on the efficiency of internal capital allocation. However, this incentive would be lowered if unvested equity comprises a large proportion of total equity holdings. In addition, I find evidence of a non-linear relationship between efficiency and the size of internal capital markets. Internal capital markets should continue to expand as long as the benefit of relaxing credit constraints is greater than the cost of managing large internal capital markets. The results of a subsample analysis show that a CEO’s incentive for efficient internal capital allocation is different depending on the type of compensation, the size of internal capital markets, and external events such as the global financial crisis. These findings are robust to corrections for potential endogeneity bias. Overall, the result of the study is consistent with the view that better alignment of CEO incentives with shareholder interests leads to efficient internal capital allocation.

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Presented at: 2019 ARIA Annual Meeting

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Session VI-D Property/Casualty

Do Winners Keep Winning? Evidence of Efficient Winner Picking in the Property-Casualty Insurance Industry

Current literature shows that groups allocate capital based on prior performance, consistent with the winner picking hypothesis. While this capital allocation practice is consistent with performance-based capital allocation, prior research has not examined how these winners perform subsequent to receiving internal capital. We examine not just the intent of internal capital market transactions, but the outcomes as well. We extend the literature by providing empirical evidence that “winners” who receive internal capital continue their relatively high performance, consistent with efficient winner picking.

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Presented at: 2019 ARIA Annual Meeting

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Interaction Between Multimarket Competition and Product Distribution Channel: Evidences From U.S. Property-Casualty Insurance Industry

U.S. property-casualty insurers utilize a variety of distribution channels to deliver insurance products. At the same time, insurance firms using different distribution channels often compete in several product markets. This article is the first one to investigate the interaction between multimarket competition and insurance distribution channel in U.S. property-casualty insurance industry. We find that the level of multimarket contact is negatively related to insurers’ direct underwriting cost in the focal product market. This result is in line with the Mutual Forbearance hypothesis. We also find that such an effect is stronger in the focal market that is important to the insurers, and more pronounced for insurers with independent agent distribution channel, who tend to forbear more to each other. Furthermore, we find that insurers react differently to rivals’ multimarket competition depending on rivals’ distribution channel. Insurers using independent agent distribution channel tend to avoid excess competition with each other, but compete more aggressively through increasing the direct underwriting cost with rivals using direct response distribution channel. These results imply that mutual forbearance exists between insurance companies using independent distribution channel and these insurers tend to reduce underwriting cost to avoid excess competition.

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Presented at: 2019 ARIA Annual Meeting

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Women in the Insurance Industry: Does Board Gender Diversity Matter to Insurers?

We document that female board representation in the U.S. property-liability insurance industry increased considerably over the period 2008 – 2017. Through empirical analysis, we find a gender diversity premium of at least 1 percent of return on assets or 3 percent of return on equity. Our results are robust to corrections for potential endogeneity bias, alternative performance and diversity measures, and alternative estimation techniques. Event study evidence shows increased performance following the appointment of a female director and subsample analysis suggests that performance gains are attributable to enhanced monitoring.

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Presented at: 2019 ARIA Annual Meeting

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Session VI-E Retirement

Motivate Saving: The Impact of Projections on Retirement Saving Intentions

The implications of current balance information for retirement provision are considerably difficult to grasp or anticipate. We study how balance and/or income projections motivate the voluntary savings intentions of pension plan participants over a sequence of ten choices. To this effect, we collect savings intentions from 1,615 respondents aged 25-57 years via an online experimental survey that compares four different formats for retirement account information. The formats are (i) current balance; (ii) current balance and projected retirement balance; (iii) current balance and projected retirement income; and (iv) current balance, projected retirement balance and retirement income. Regardless of information format, merely inviting plan participants to top up their retirement account prompts substantial increases in savings, especially among older respondents. At the first choice round, the income projection triggers marginally more voluntary saving intentions than the lump sum projection alone. However at both the first choice and over sequential choices, the combination of balance and income projections is what matters most. Furthermore, even though older respondents save at a higher level across all treatments, younger respondents are more sensitive to income balance projections than the older survey respondents.

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Presented at: 2019 ARIA Annual Meeting

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De-Risking DB Pension or Not? Facts From U.S. Empirical Data

This paper investigates de-risking activities of U.S. defined benefit (DB) pension plans using empirical data from 1993 to 2018. We identify multiple avenues for pension risk reduction by expanding the scope of de-risking to shift, freeze, termination, buyout, buyin, and longevity hedge. We find heterogeneity in de-risking behaviors across different industries. Our empirical results indicate that active management of pension risk contributes to the firm value. In addition, the firms with smaller size, less tangible assets, higher return volatility, or lower profitability are more likely to de-risk their pension plans. Furthermore, we propose two theoretical models to verify the soundness of plans’ empirical de-risking activities. The theoretical models can provide ex ante strategic suggestions to the DB firms that plan to conduct de-risking.

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Presented at: 2019 ARIA Annual Meeting

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Session VII-A Behavior Insurance

Decision-Making on Cyber Risk Management: Interaction Between Market Insurance and Risk Control Measures Under Loss Aversion

This paper studies decision-making on cyber risk management in the presence of interdependent risk by considering market insurance and risk control measures: self-protection and self-insurance. We construct an economic framework with a descriptive decision model under loss aversion to reflect a market behavior, which has not been examined in the literature. The model demonstrates the effect of loss aversion on potential decision-making with interaction between cyber insurance and risk controls in different scenarios. We find that an agent with the reference point of self-protection as an essential effort against cyber risk is more likely to give up additional risk management tools (market insurance and self-insurance), supporting the presence of a fatalistic behavior against cyber loss in the current cyber-insurance market. We further compare our findings with empirical evidence on the frequency rate of cyber loss and find that it is more likely to implement additional measures particularly for small-sized companies as time goes on. The focus of our paper is on cyber risk, nonetheless, the results can be generalized to any other interdependent risk under loss aversion.

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Presented at: 2019 ARIA Annual Meeting

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Session: VII-B Catastrophes

Why Don’t People Buy Insurance Even After a Catastrophe?

Using Japanese data on the purchases of residential earthquake insurance, we test hypotheses concerning how an experience of a major EQ would affect the relationship between EQ insurance take-up and economic and demographic factors, and how the severity of loss experience would marginally change the relationship as well. We find several important implications of catastrophe insurance take-up. First, when the market still has a low penetration, cross-subsidization aiming for level premium rates may not achieve its purpose. Second, some factors becomes important determinants of insurance take-up after an occurrence of a major catastrophe, whether direct or indirect loss experience, explaining the reasons of deterring a take-up surge after a catastrophe. We also show that the post-catastrophe effect of economic and demographic factors depends on the severity of loss experience. Direct loss of a major catastrophe seems overwhelming so that the factors tend to be less relevant to decision making of insurance purchase.

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Presented at: 2019 ARIA Annual Meeting

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Risk and Insurance in Agricultural Economy

The negative effects of climate change have begun to exceed expectations and are likely to intensify. This paper studies the effects of the agricultural risk and the insurance on agricultural economy in the context of climate change. First, this paper establishes the model incorporating with the agricultural risk and insurance. The model indicates that the agricultural insurance can effectively reduce the negative impact of risks on agricultural production when the moral hazard has little influence. Next, I verify the hypothesis through the panel data models and the difference-in-difference analysis. The impact of moral hazard in agricultural insurance is very modest. Agricultural insurance can effectively control agricultural risks, especially for the agriculture in the primary industry.

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Presented at: 2019 ARIA Annual Meeeting

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Geospatial-Risk-Based Recoupment for TRIA-Eligible Insurance

Terrorism risk has become a major threat to human lives and businesses around the world. In an effort to make insurance against such risk available and affordable in the United States, the Terrorism Risk Insurance Act (TRIA) was passed in 2002 to establish a public-private partnership and to provide subsidies for insuring terrorism losses. Essentially, under TRIA, government subsidies apply only to the insured losses above the market retention level. For those below the retention level, the government will recoup any claim payments it initially shares plus a 40\% surcharge. The loss-sharing mechanism has been running untested for the past decade. The specification of its recoupment process has never been clear and remains a challenge. We propose an easily implemented recoupment scheme based on the geospatial risk of terrorist attacks. We use a geospatial point process to model terrorism risk and its occurrences, estimated using the Global Terrorism Database, and also illustrate our suggested recoupment for a hypothetical insurance portfolio.

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Presented at: 2019 ARIA Annual Meeting

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Session VII-C Insurance Economics

Equilibrium Recoveries in Insurance Markets With Limited Liability

This paper studies optimal insurance in partial equilibrium in case the insurer is protected by limited liability, and the multivariate insured risk is exchangeable. We focus on the optimal allocation of remaining assets in default. We show existence of an equilibrium in the market. In such an equilibrium, we get perfect pooling of the risk in the market, but a protection fund is needed to charge levies to policyholders with low realized losses. If policyholders cannot be forced ex post to pay a levy, we show that the constrained equal loss rule is used in equilibrium. This rule gained particular interest in the literature on bankruptcy problems. Moreover, in absence of a regulator, the insurer will always invest all its assets in the risky technology. We illustrate the welfare losses if other recovery rules are used in case of default; a different recovery rule can substantially effect the profit of the insurer.

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Presented at: 2019 ARIA Annual Meeting

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Geographic Expansion Strategy of Property-Liability Insurers: Patterns and Determinants

Diversification has been studied extensively in economics, industrial organization, and financial service over the past decades. Majority of the literature has focused on the product diversification but overlook the strategy of geographic diversification. This article focuses on the geographic expansion strategy of property-liability insurers, rather than the extent of their diversification. The questions of interest are twofold. First, we investigate what are the “push” factors that drive the geographic expansion decision; second, once the firm decided to expand, where to grow? Our preliminary findings suggest that insurers with more excessive resources and stronger managerial mechanism are more likely to expand geographically. The geographic expansion is not likely to be driven by growth constraints. States that are closer to the insurer’s existing market(s) are more likely to be chosen. In addition, the state’s quality of life plays a more important role than regulatory environment in attracting insurers.

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Presented at: 2019 ARIA Annual Meeting

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Session VII-D Life Insurance

Participating Life Insurance Contracts With Periodic Premium Payments

We consider participating life insurance products and their benefits to the insured. Our main focus is on the impact of different contribution schemes, i.e. when and how much the insured contributes. This is important since the insured’s benefits depend on the performance of the investment strategy conducted by the product provider. In addition, we consider the interactions of the premium contribution scheme, embedded guarantees and different management rules accounting of a regime switch in the risk profile of the insurance company. We shed light on two effects on the utility of the insured. The combination of contribution scheme, embedded guarantees and management rule has an impact on the investment risk of the insured. A second main effect is a price effect. Assuming that the guarantees are fairly priced, the guarantee costs also depend on all the above mentioned factors.

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Presented at: 2019 ARIA Annual Meeting

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Hedging of Variable Annuities Under Basis Risk

I study dynamic hedging for variable annuities under basis risk. Basis risk, which arises from the imperfect correlation between the underlying fund and the proxy asset used for hedging, has a highly negative impact on the hedging performance. I analyze whether the choice of a suitable hedging strategy can help to reduce the risk for the insurance company. Comparing several cross-hedging strategies based on the proxy asset, I observe very similar hedging performances. Particularly, I show that well-established but complex strategies from mathematical finance do not outperform very simple and naive approaches. Nonetheless, I find that a naive delta-gamma hedge, where plain vanilla options on the proxy asset are used as additional hedging instruments, performs better than the one-instrument strategies. A more substantial risk reduction could, however, be achieved by diversification, that is, by distributing the policyholders’ premium among several underlying funds.

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Presented at: 2019 ARIA Annual Meeting

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Determinants of Surrenders and Lapses of Life Insurance

Understanding the causes of early terminations is important to the service quality, profitability, and risk management of the life insurer. This paper extends the literature on the determinants of the early termination propensities in four aspects. Firstly, we decompose early terminations into surrender and lapse and build models accordingly. This decomposition is important because the motives, causes, and consequences of lapse and surrender are distinct. Secondly, we construct models for the surrender and lapse propensities by product type. Without such construction, the insurer will over- or under-charge the policyholders with different characteristics who purchase different types of product. Thirdly, we introduce new explanatory variables in modeling the propensities to mitigate the omitted-variable bias. Fourthly, this is the first paper on the determinants of early terminations for the market of Taiwan and shed light on the early termination behaviors of Chinese.

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Presented at: 2019 ARIA Annual Meeting

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