Generation of Investable Funds and the Portfolio Behavior of the Non-Life Insurers (original) (raw)

Journal of Risk and Insurance, 1978

Abstract

In this paper, new parameters, representing the funds generated by the insurance. transaction, are introduced into the portfolio model which balances the investment and underwriting activities of an insurer. An insurance activity with a higher funds-generating coefficient may affect both the insurer's expected profit and its risk level. These effects may. operate in opposite directions, and the net result would be that a line with a higher coefficient will be less desirable under certain circumstances. Such a surprising impact of the coefficients could have occurred in practice, but the recent experience of insurers, where large underwriting losses are reported, makes this effect less likely today. The portfolio behavior of financial intermediaries, and especially insurance companies, has been the subject of recent studies in financial literature. These studies present the technique for a simultaneous optimization of the intermediary's assets and liabilities portfolios,' and focus on various implications of the model for ratemaking and regulation. The purpose of this article is to examine some interesting, and relatively surprising, relationships between the composition of the insurer's portfolio and the fundsgenerating process. The ability of insurers to raise funds from their customers is mainly a result of the time lag between the collection of premiums and the payment of claims. Recent articles have. shown that these liabilities often may bear positive yields to borrowers (and not to the lenders). This relationship results from the use of the Standard Ratemaking Formula which allows for a positive underwriting profit in insurance rates, independent of Yehuda Kahane is Academic Director, The Erhard Center for Higher Studies and Research in Insurance, and is a Senior Lecturer in the Faculty of Management, Tel Aviv University, Israel. The paper was written while he was visiting at the Faculty of Management Studies, University of Toronto. The comments of Roger Blair, Myron J. Gordon, Rafael Lusky, David J. Nye and Marshall Sarnat, on earlier drafts are greatly appreciated. Also acknowledged are the helpful comments of the members of the 1975 Risk Theory Seminar of the American Risk and Insurance Assocation. 'The idea was suggested by Michaelsen and Goshay early in 1967, but a detailed formulation of the problem was published later by Krouse (1970) and Parkin (1970). Still later articles offered some extensions to the model. See, for example, Haugen and Kroncke (1971), Hart and Jaffee (1974), Quirin et al. (1974), Kahane and Nye (1975). See references at the end of this paper for citations of the foregoing articles. The same instructions apply to other footnote references.

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