1 Math 479/568 Casualty Actuarial Mathematics Fall 2014 University of Illinois at Urbana-Champaign Professor Rick Gorvett Session 3: Economics and Insurance Markets September 2, 2014

2 Last Time Insurance contracts Lines of business Insurability Etc…

3 CAS Exam 5, Spring 2008, #1

4 CAS Exam 5, Spring 2008, #1 Sample Answer

5 CAS Exam 5, Spring 2008, #2

6 CAS Exam 5, Spring 2008, #2 Sample Answer

7 Today ’ s Agenda Underwriting cycle Macroeconomic approach to the cycle Impact of the cycle on insurers and industry behavior

8 The Property / Casualty Insurance Underwriting Cycle

9 P/C Underwriting Cycle Profitability or Written Premium Growth Time Hard Soft

10 Insurance Information Institute Presentation: “Overview and Outlook for the P/C Insurance Industry: Trends, Challenges and Opportunities in 2014 and Beyond” outlook-for-the-p-c-insurance-industry-trends- challenges-and-opportunities-in-2014-and

11 A Macroeconomic Approach to the U/W Cycle (Boor, 1998)

12 Characteristics of the Insurance Market Relatively fixed demand –Buy out of necessity Required by law Required by others Protect against financial ruin –Thus, a relatively flat demand curve –Supply  price

13 Characteristics of the Insurance Market (cont.) Product is largely a “ commodity ” –Policies are similar (for a given line / type) Regulation Policy forms of bureaus –Individual sellers  no control over price –  Seek “ brand names ” Differentiate policies Different values associated with different policies

14 Characteristics of the Insurance Market (cont.) Relatively easy entry and exit of firms –Entry Capitalization and regulatory requirements Not many expensive facilities needed (as compared with, say, manufacturing) –Exit Perhaps regulatory issues Perhaps marketing issues

15 Characteristics of the Insurance Market (cont.) Supply curves –Different between companies Underwriting Expenses Reserve management –Profitability may affect reserve levels –Reserves may be used to manage reported profitability

16 How These Characteristics Affect the Insurance Cycle Commodity  cycle –Suppose low supply (e.g., from low profits) –Raise prices; profits increase; firms enter  excess capacity –Prices lowered; profits fall; firms exit  low supply –Issues affecting length & severity of cycle Accuracy of claim cost estimates Reserving practices Financial conditions

17 Impact of the Insurance Cycle on Insurers (Boor, 2004)

18 Soft Markets Occur when aggregate written premium goal of all insurers is greater than aggregate insurance demanded –To reach volume or growth targets, companies begin dropping their prices –Other companies either follow or fail to meet their premium / growth targets

19 Soft Markets (cont.) Price-reducing mechanisms –Rate filing requirements Theoretically, can slow down falling prices But: political and institutional realities –Company rating plans –Risk classification systems –Affiliated corporate entities

20 Hard Markets Occur when aggregate written premium goal of all insurers is low relative to aggregate insurance demanded –Can result after poor financial condition of insurer(s) –Certain accounts cannot be written at desired terms –Inadequate capacity  prices and profitability rise –Eventually, leads to new entrants

21 Issues Leverage –Ratio of premiums to surplus –Increasing prices can lead to a higher ratio, contrary to regulatory guidelines Degree of reserve adequacy –Can improve during hardening market –Impact on historical loss data used for prospective pricing

22 Issues (cont.) Potential “ cycle-changers ” –Catastrophe loss experience –Financial conditions Underwriting –Commodity market  company cost structure is critical –Losses are the biggest component

23 Insurer Strategies with respect to the Insurance Cycle Maintaining market share –Keep business –Drop / match prices as needed Conserving capital –Insisting on profitable business –Maintaining infrastructure during soft markets

24 CAS Exam 5, Spring 2010, #13

25 CAS Exam 5, Spring 2010, #13 Sample Answer

26 CAS Exam 5, Spring 2010, #14

27 CAS Exam 5, Spring 2010, #14 Sample Answer

28 CAS Exam 5, Spring 2009, #14

29 CAS Exam 5, Spring 2009, #14 Sample Answer

30 CAS Exam 5, Spring 2009, #15

31 CAS Exam 5, Spring 2009, #15 Sample Answer

32 CAS Exam 5, Spring 2008, #42

33 CAS Exam 5, Spring 2008, #42 Sample Answer

34 CAS Exam 5, Spring 2007, #25

35 CAS Exam 5, Spring 2007, #25 Sample Answer

36 CAS Exam 5, Spring 2007, #26

37 CAS Exam 5, Spring 2007, #26 Sample Answer

38 CAS Exam 5, Spring 2005, #11

39 CAS Exam 5, Spring 2005, #11 Answer A. 1 only.

40 Next Time Loss Reserving A fundamental actuarial process Chapter 5 of Foundations of Casualty Actuarial Science