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Cycles In Casualty: Balancing Loops in the Insurance Industry

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Presentation on theme: "Cycles In Casualty: Balancing Loops in the Insurance Industry"— Presentation transcript:

1 Cycles In Casualty: Balancing Loops in the Insurance Industry
Kawika Pierson MIT Sloan PhD Candidate

2 Presentation Outline The Insurance Industry Past Research The Model
Economics Control Theory System Dynamics The Model Boundary Causal Loop Diagram Important Structures PID Control Behavior How You Can Help

3 The Insurance Industry
Basic Idea Two Sides to the Business Insurance Investing Insurance Cycle – What is Cycling? Underwriting Loss Ratio or Combined Loss Ratio Loss Ratio – Adjustments/Premiums Expense Ratio – Expenses/Premiums Combined Ratio – Loss + Expense = (A + E) / P

4 A View to A Cycle

5 A View to A Cycle

6 The Insurance Industry
Insurance Cycle – What Causes It? Industry View: “The next stage is precipitated by a catastrophe or similar significant loss, for example Hurricane Andrew or the attacks on the World Trade Center.” – “The Insurance Cycle” wikipedia Academic View: “Using quarterly data from 1974 through 1990, we provide evidence of a long-run link between the general economy and the underwriting performance as measured by the combined ratio.” – Grace and Hotchkiss, 1995 J o Risk and Insurance “Fluctuations in the supply of property-liability insurance may be exacerbated by regulation.” Winter, 1991 Economic Inquiry

7 Past Research in Economics
Early 1980’s through Mid 90’s Three Main Schools of Thought Cycle Caused by Interest Rate Fluctuations Doherty and Kang (1988) – Insurance Prices Change in Lagged Response to Interest Rates Grace and Hotchkiss (1995) – “External Impacts on the Property-Liability Insurance Cycle” Cycle Caused by Limits to the Supply of Insurance Winter (1988, 1991, 1994), Gron (1989, 1994) Cycle Caused by Feedback Processes Brockett and Witt (1982) – Loss expectations from the past inform current premiums, causing autocorrelation

8 Past Research in Control Theory
If a Cycle Exists we Will Create a Lagged Negative Feedback Loop to Explain It Balzer and Benjamin 1980 – “Dynamic Response of Insurance Systems with Delayed Profit/Loss Sharing Feedback…” Journal of the Institute of Actuaries Zimbidis and Haberman 2001 – “The Combined Effect of Delay and Feedback on the Insurance Pricing Process: a Control Theory Approach” Insurance: Mathematics and Economics

9 Past Research in System Dynamics
The Claims Game and Hanover Insurance “claims management, quality and costs” Quality = Claim Adjustment Quality Daniel H. Kim Learning Laboratories Peter Senge – “The Fifth Discipline” Moissis 1989 Masters Thesis (Sterman) Focuses on Determining Decision Rules Cavaleri and Sterman (1997) “Towards evaluation of systems thinking interventions: a case study” Improved Manager’s Mental Models

10 Past Research in System Dynamics
Insurance Cycle… Are There Really no SD Articles on the Insurance Cycle? Thomas Beck Co-President of Swiss SD Society Works for Large Swiss Reinsurer No Published Articles on Insurance Cycle

11 The Model – Boundary Endogenous Variables Exogenous Variables Premiums
Underwriting Quality (Risk) Claims Employees Administrative Costs Exogenous Variables Desired Profit Margin Size of the Total Market Some Components of Administrative Costs

12 The Model – Boundary Many Feedbacks Excluded
Size of the Insurance Market Investments and Interest Rates Free Capital’s Influence on Underwriting Effect of Time Pressure on Claim Settlement Competitive Effects on Profit Margins Random Claim Incidence Employee Productivity Is this Too Far Towards “Negative Loop w/ Delay”

13 The Model – Casual(ty) Loop Diagram

14 The Model – Structures

15 The Model – Structures

16 The Model – Structures

17 The Model – Structures

18 The Model – Structures

19 The Model – Structures

20 The Model – Structures

21 The Model – PID Control Translating Equations to SD isn’t Always Easy
Proportional Control = Standard Structure Integral Control = No Steady State Error Reasonable that People Use IC Derivative Control = Less Overshoot Less Likely that People Use DC

22 The Model – PID Control

23 The Model – PID Control

24 The Model – PID Control


26 The Model – Behavior Displays Decaying Oscillation to Step Input

27 The Model – Casual(ty) Loop Diagram

28 The Model – Behavior Instability A Function of Largest Source of Costs

29 The Model – Casual(ty) Loop Diagram

30 The Model – Behavior Loop Gain Very Important

31 The Model – Potential Solutions
Derivative Control of Premiums? Careful Tuning Is Necessary Managerial Implementation Industry Wide Application Why Do Quality Standards Change? Can This Loop Be Cut Life Insurance The Kalmanuclear Option? Optimal LINEAR Filter Just Build a Really Good Model Instead

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