Brehm CH5 Flashcards
Definition of underwriting cycle
the recurring pattern of increases and decreases in insurance prices and profits
Describe the evolution of underwriting cycle
- Emergence (when a new LOB arises, data is thin, demand grows quickly and pricing is erratic. Price wars set in as competitors enter the market. Eventually, a sudden price correction occurs and weak competitions leave the market)
- Control (stabilization of the LOB. Rating bureaus and state DOIs regulate price change)
3.Breakdown (due to technological and societal changes, new types of competitors enter the market and take business away) - Reorganization (return to the condition of “emergence” phase, as a new version of the old LOB emerges)
Driver of each state of the underwriting cycle
- Emergence driven by competition
- Control driven by statistical data lags
- Breakdown driven by competition and data lags
- Reorganization driven by competition
4 recurring themes about underwriting cycle
- Institutional factors (there are time lags between the compilation of the historical data and the implementation of the new rates)
- Competition (Inexperienced firms may have poorer loss forecasts than mature firms. they may drop prices based on poor forecasts, pushes the market toward lower rates)
- Supply and demand, capacity constraints and shocks (When a shock occurs, insurance capital is reduced. With reduced capital, supply is constricted and prices increases. Profits may decline as better performing business leaves the market first)
- Economic linage (economic drivers affect insurance profitability. Insurance profitability is linked to investment income. The cost of capital is linked to the wider economy. Expected losses in some LOBs are effected by inflation, GNP growth or unemployment)
Independent and dependent variables for modeling underwriting cycle
Dependent variables: loss ratio or combined ratio
Independent variables:
1. Historical values of dependent variable and its components
2. Internal financial variables
3. Regulatory/rating variables
4. Reinsurance financials
5. Econometric variables
6. Financial market variables
3 styles of modeling the underwriting cycle
- Soft approach
- Behavioral or econometric modeling
- Technical modeling
Compare the 3 style of modeling the underwriting cycle
For data quality, variety and complexity: Soft > Behavioral > Technical
For recognition of human factors: Soft > Behavioral > Technical
For mathematical formalism and rigor: Technical> behavioral> soft
Describe soft approach to model underwriting cycle
Begin with data gathering and intelligence
Data analysis techniques include scenarios, the Delphi method and competitor analysis
Describe scenarios method
It’s a detailed written statement describing a possible future state of the world.
Firms can think about how they might respond to these scenarios.
Describe Delphi method
It’s a method of obtaining expert consensus on an issue.
Describe competitor analysis
it attempts to discern the states, motives and likely behaviors of individual, competing firms.
Describe behavioral or economic modeling for underwriting cycle
It exists between soft modeling and technical modeling.
The components have meaningful interpretations motivated by economic and behavioral theory.
Most econometric models revolve around supply and demand
