The Geneva Papers

40 Years at the Cutting Edge of Research in Insurance Economics

Christophe Courbage

• Publisher: Palgrave Macmillan
• Year: 2016
• ISBN:
  9781137574794
• Topic: Betriebswirtschaft
• Subtopic: Finanzielles Risikomanagement

In January 1976, Raymond Barre, the first President of The Geneva Association, and Orio Giarini, its first Secretary General, founded The Geneva Papers on Risk and Insurance with the main goal of supporting and encouraging research in the economics of risk and insurance. At that time, research in the field of insurance was still embryonic and insurance was regarded as peripheral social activity. When sustained economic growth gained traction, the function of insurance gradually emerged as a key contributor to economic development. By integrating uncertainty into economic theory and benefiting from the progress of both financial economics and decision theory, research developed further in the field of insurance economics and risk management, and is now prolific. The Geneva Papers on Risk and Insurance undeniably contributed to this evolution and its impact on research in insurance has largely exceeded what its two founding members could have expected. This volume is a special collection of papers celebrating 40 Years of The Geneva Papers on Risk and Insurance. The collection looks back at the storied history of The Geneva Papers on Risk and Insurance and features papers from some of the esteemed authors who have contributed to the journal in its lifetime. This collection of papers highlights just a few of the many themes addressed in the papers published by the journal since it was created. Nevertheless, the selection exemplifies the richness and variety of topics the field of insurance covers.

1

Introduction: The Geneva Papers, 40 Years at the Cutting Edge of Research in Insurance Economics

Christophe Courbage

The Geneva Association, Switzerland

Geneva School of Business Administration – University of Applied Sciences Western Switzerland

The Geneva Papers on Risk and Insurance is celebrating its fortieth birthday this year. In January 1976, Raymond Barre, the first president of The Geneva Association, and Orio Giarini, its first Secretary General, founded The Geneva Papers on Risk and Insurance with the main goal of supporting and encouraging research in the economics of risk and insurance.

At that time, research in the field of insurance was still embryonic. Insurance was regarded as a peripheral social activity and its economic value received very little attention. With the beginning of steady economic growth, the function of insurance gradually emerged as a key contributor to economic development. By integrating uncertainty into economic theory and benefiting from the progress of both financial economics and decision theory, research developed further in the field of insurance economics and risk management and is now prolific. We dare to believe that The Geneva Papers on Risk and Insurance contributed to this evolution and that its impact on research in insurance has largely exceeded what its two founding members could have expected.¹

Looking back at past issues published in The Geneva Papers on Risk and Insurance, it is really astonishing to witness the great number of scholars in the field who contributed to the journal. They include the pioneers of the discipline as well as Nobel Prizes and highly recognised and reputed scholars, and also high-level experts and executives from the insurance industry, making the journal a unique forum to stimulate constructive dialogue between the industry and its economic and social partners.

One activity to celebrate this fortieth anniversary is to issue a special anniversary collection of The Geneva Papers on Risk and Insurance gathering articles published in the last years that echo the diversity of themes addressed in the journal. Of course, this collection deals with just a few of these many themes. Most of these

articles were published during the last five years. We have voluntary selected this set of papers on the grounds that they address themes of high interest both for the insurance industry and academia, ranging from the impact of asymmetric information on insurance market efficiency, the issue of systemic risk in insurance, insurers’ investment in infrastructure, price differentiation in insurance, the effect of climate risks on insurance, microinsurance, and the optimal level of capital for reinsurers and insurance regulation. The papers, now chapters, are presented in reverse chronological order based on their date of publication.

The chapter, by Mark Browne and Tian Zhou-Richter, investigates whether information known to the buyer of insurance but not to the insurer, that is, private information, results in adverse selection or advantageous selection in the German private LTC insurance market. Their analysis reveals sources of both adverse and advantageous selection in the German private LTC insurance market, and that the sources of adverse selection have a dominant impact over those of advantageous selection. These results give support to the conventional claim that asymmetric information distorts market efficiency and results in a lack of insurance demand, at least in the German private LTC insurance market.

The chapter by Andreas Jobst reviews the recent regulatory efforts in defining systemic risk in the insurance sector and the designation of systemically important insurers. Although current evidence suggests that core insurance activities are unlikely to cause or propagate systemic risk, the characteristics and business models of insurance firms vary by country and might require a more nuanced examination, with a particular focus on non-traditional and/or non-insurance activities.

The financial market environment poses serious challenges for insurance companies to provide stable returns on a long-term basis, as particular traditional asset classes are currently characterised by generally low interest rates and high volatility. Against this background, the aim of the chapter by Nadine Gatzert and Thomas Kosub is to study infrastructure investments from an insurer’s perspective. In particular, based on a categorisation of different types of infrastructure investments, it provides an overview of the main characteristics along with risks and chances. In addition, the treatment of different infrastructure investments under Solvency II regulations is studied, which can have a considerable impact on an insurer’s asset management decisions. The study shows that the attractiveness of infrastructure investments strongly depends on the type of investment and its treatment under Solvency II and that considerable risks can be involved.

The chapter by Hato Schmeiser, Tina Störmer and Joël Wagner investigates the 2011 European Court of Justice ruling to ban gender-specific premium differentiation. It discusses the relevance of price differentiation criteria from the point of view of insurers, regulators and ethicists, and reflects on the degree of acceptance of such price differentiation by consumers, which is assessed empirically through an international consumer survey conducted in the United Kingdom, Germany, France, Italy and Switzerland. The perception of risk factors and of effective gender-related

price differences is considered with respect to motor, annuity, term life and health insurance. Finally, possible consequences of the new regulation for the insurance industry are discussed.

As a reaction to the increasing trend of insurers forming and participating in financial conglomerates and insurance groups, supervisory authorities are currently developing group-wide solvency regulations. The chapter by Caroline Siegel provides an overview and comparison of three important approaches to group insurance supervision—the US solo-plus approach of the National Association of Insurance Commissioners, Switzerland’s group structure model and the Solvency II Directive on Group Solvency Assessment. According to the author’s work, the group regulation of the United States reveals various deficits implying the need for future regulatory work. By contrast, the performance of the European frameworks with regard to the recently published International Association of Insurance Supervisors criteria is shown to be good. In particular, the Swiss framework can be seen as a prime example of an innovative and solid group solvency assessment.

In a world of rising natural catastrophe risks, multi-year insurance has been proposed as a tool to incentivise policy-holders to invest in property-level adaptation. The chapter by Trevor Maynard and Nicola Ranger reviews some arguments made in respect of multi-year contracts and provides new analyses on their price implications. They conclude that even under conditions of known and stationary risk, initial capital requirements could be around 50 per cent higher for a 10-year contract than an annual contract and the annual premium around 5.5 per cent higher. They also conclude that multi-year contracts have several additional disadvantages that are likely to limit their demand and availability in the general retail insurance market. For adaptation, they show that other tools, such as risk-based premiums and loans for adaptation tied to the property, have high potential.

The chapter by Christian Biener and Martin Eling provides a comprehensive analysis of the insurability of risks in microinsurance markets. The aim is to enhance the understanding of impediments to and facilitators of microinsurance from an economic perspective and outline potential solutions. The chapter reviews 131 papers and finds that the most severe problems stem from insufficient resources for risk evaluation, small size of insurance groups, information asymmetries and the size of the insurance premium. On the basis of the analysis, it discusses a number of potential solutions such as, for example, a cooperative microinsurance architecture.

The chapter by Jean-Luc Besson et al. presents a consistent way of defining capital for a reinsurance company and of managing it, taking into account the view of all stakeholders of the company involved. They answer the question of how much capital is required by the business, and introduce the notion of buffer capital. This is used to reduce the likelihood of the company having to call too often its shareholders to refurbish its capital. They show how this concept relates to the setting of return on equity objectives for the company. Capital allocation is the driver for measuring the economic performance of a business. The fixing of limits relating to capital consumption is linked to capital allocation because it preserves the diversification of the book. They advocate the use of the internal model to determine all of these parameters, and to set the stage for good enterprise risk management within the company.

This collection of essays deals with just a few of the many themes addressed in the papers published by the journal since it was created. However, it illustrates the richness of topics the field of insurance deals with. It provides important insights on the numerous challenges insurance is confronted with and the helpfulness of research in finding solutions to these challenges. Quoting Raymond Barre in this journal about the celebration of the 25th birthday of The Geneva Association, “The Geneva Association will continue to demonstrate that insurance companies have a great deal to gain from the combination of rigorous economic analysis with inventive research at the service of innovation and progress”. My hope is that The Geneva Papers on Risk and Insurance will continue for many years to come to play its role of improving the scientific knowledge of the insurance industry as a highly esteemed journal among the academic community. Time will tell.

Note

1. In 1990, with the development of more theoretical studies on risk and insurance, The Geneva Papers were split into two publications. The Geneva Papers on Risk and Insurance—Issues and Practice which is more practice oriented as indicated in its name, and the Geneva Papers on Risk and Insurance Theory, renamed in 2005 The Geneva Risk and Insurance Review. Therefore both journals are celebrating their fortieth birthday this year.

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Lemons or Cherries? Asymmetric Information in the German Private Long-term Care Insurance Market

Mark J. Browne^a and Tian Zhou-Richter^b

^aSchool of Risk Management, Tobin College of Business, St. John’s University, 101 Astor Place, NY, New York, 10003 USA.

^bMunich Reinsurance Company, Konigistrasse 107, Munich, 80802 Germany.

This study provides evidence of the presence of asymmetric information in the German long-term care (LTC) insurance market. While certain private information—individuals’ pessimism level and preference for insurance—contributes to advantageous selection, the major source of adverse selection—individuals’ self-assessed high LTC risk—switches the final correlation between insurance and risk to one that is significantly positive. In addition, the study reveals that although individuals’ self-assessment of poor health predicts their future care needs very well, such assessments are not necessarily reflected in insurance demand. The results from this study could assist insurers in better understanding and managing LTC risk.

Introduction

Information on risk is the basis for underwriting and pricing insurance. Asymmetrically distributed information in favour of the buyer of insurance provides the insured the opportunity to act strategically in the transfer of risk through the marketplace. Whether information known to the buyer of insurance but not the insurer, hereafter referred to as private information, results in adverse selection or advantageous selection is the focus of the current study.

There are two predominant theories as to the effects of asymmetric information on the purchase of insurance. One theory, known as the “lemons principle”, concentrates on adverse selection, and suggests that high-risk agents choose to purchase more insurance coverage than do low-risk agents.¹ A testable prediction of adverse selection theory is that risk occurrence is positively correlated with insurance coverage.

The second theory as to the effects of asymmetric information concentrates on advantageous selection. This theory is also called “cherry picking”.² Advantageous selection stresses the role of individuals’ risk aversion and argues that more risk-averse agents are both more willing to purchase insurance and more cautious.³ In the presence of advantageous selection, insurance coverage and risk occurrence are negatively correlated.

This paper aims to answer empirically two research questions. First, do individuals have private information that is associated with either adverse or advantageous selection? Private information is known to the applicant for insurance but not the insurance company. Second, which selection effect (adverse or advantageous) is more pronounced? That is, conditional on the information known by both parties, is the additional information known by insureds associated with insurance purchasing behaviour consistent with adverse selection theory or with advantageous selection theory? The current paper extends our understanding of the association between private information held by individuals and the purchase of insurance. The study considers multiple types of private information, some of which would reasonably be expected to be associated with adverse selection and others that would be expected to be associated with advantageous selection. We consider both types of information simultaneously in our models. While we hypothesise that both types of information will be associated with insurance consumption, a priori we do not have a hypothesis on which will dominate. Our analysis reveals sources of both adverse and advantageous selection in the German private long-term care (LTC) market. We find that the sources of adverse selection have a dominant impact over those of advantageous selection.

Sample data for this study are drawn from the German Socio-Economic Panel Study (SOEP), a representative longitudinal study of private households in Germany. These data, which include both insureds and non-insureds, track their LTC need over 11 years. The SOEP data report on both those who receive LTC care in a nursing home and those who receive care in a non-institutional setting, typically one’s home or that of a family member.

The remainder of the paper is structured as follows. The next section presents the theoretical background of the study. The econometric properties of sources of adverse and advantageous selection are introduced thereafter. The subsequent section describes the data and variable settings applied in this paper. The penultimate ...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of Figures and Tables
• 1 Introduction: The Geneva Papers, 40 Years at the Cutting Edge of Research in Insurance Economics
• 2 Lemons or Cherries? Asymmetric Information in the German Private Long-term Care Insurance Market
• 3 Systemic Risk in the Insurance Sector: A Review of Current Assessment Approaches
• 4 Insurers’ Investment in Infrastructure: Overview and Treatment under Solvency II
• 5 Unisex Insurance Pricing: Consumers’ Perception and Market Implications
• 6 Solvency Assessment for Insurance Groups in the United States and Europe—A Comparison of Regulatory Frameworks
• 7 What Role for “Long-term Insurance“ in Adaptation? An Analysis of the Prospects for and Pricing of Multi-year Insurance Contracts
• 8 Insurability in Microinsurance Markets: An Analysis of Problems and Potential Solutions
• 9 How Much Capital Does a Reinsurance Need?
• Index