The insurance industry is unique in that the cost of its products—insurance policies—is unknown at the time of sale. Insurers calculate the price of their policies with “risk-based rating,” wherein risk factors known to be correlated with the probability of future loss are incorporated into premium calculations. One of these risk factors employed in the rating process for personal automobile and homeowner’s insurance is a credit-based insurance score.
Credit-based insurance scores draw on some elements of the insurance buyer’s credit history. Actuaries have found this score to be strongly correlated with the potential for an insurance claim. The use of credit-based insurance scores by insurers has generated controversy, as some consumer organizations claim incorporating such scores into rating models is inherently discriminatory. R Street’s webinar explores the facts and the history of this issue with two of the most knowledgeable experts on the topic.
[Moderator] Jerry Theodorou, Director, Finance, Insurance & Trade Program, R Street Institute Roosevelt Mosley, Principal and Consulting Actuary, Pinnacle Actuarial Services Mory Katz, Legacy Practice Leader, BMS Group
R Street Institute is a nonprofit, nonpartisan, public policy research organization. Our mission is to engage in policy research and outreach to promote free markets and limited, effective government.
We believe free markets work better than the alternatives. We also recognize that the legislative process calls for practical responses to current problems. To that end, our motto is “Free markets. Real solutions.”
We offer research and analysis that advance the goals of a more market-oriented society and an effective, efficient government, with the full realization that progress on the ground tends to be made one inch at a time. In other words, we look for free-market victories on the margin.
The news immediately following the removal of some Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network has been a moment of victory for the international community in condemning Russia’s invasion of Ukraine. Soon after the sanctions took effect, the ruble sunk 21 percent compared to the U.S. Dollar (USD). Russia’s central bank is in damage control mode, raising interest rates to 20 percent. At a glance it might seem like these punishing sanctions could force Russia to change course, but any optimistic takes should be tempered by a review of the effect of sanctions after Russia’s annexation of Crimea in 2014.
Unlike the United States and other western nations where oil and gas production are controlled by private companies, Russia’s oil and gas production is managed by state-owned enterprises. Oil and gas production in Russia directly finances Russia’s budget, including its military budget, and in 2019 oil and gas exports accounted for 39 percent of Russia’s federal budget revenue. Part of the reason oil and gas is such a lifeline to the Russian budget can be attributed to the effect of the sanctions. In January of 2014, the ruble was $0.03 USD, and by December 2014 it fell to $0.019 USD. In that same year, Russia was the largest producer of crude oil and exported 4.7 million barrels per day. The price of oil in January 2014 was $108/barrel, and by December had fallen to $62/barrel—thanks to high U.S. production. The value of Russian oil exports went from 16.9 billion rubles per day in January to 15.4 billion rubles per day in December, as the sharp decline of oil prices was counteracted by the rising ruble value of oil from the sanctions. If oil prices had remained constant, then the effect of the sanctions would have been to increase Russian export value in the local currency to 26.7 billion rubles per day. In plain English, the harder the sanctions hit, the more valuable Russian energy exports become and the better they are able to sustain the Russian budget.
The war in Ukraine and subsequent international sanctions have triggered a bank run in Russia. But this is no ordinary run—it may become a run on the central bank itself, one that holds important lessons for introducing central bank digital currencies.
Reports show Russians lining up at ATMs to withdraw their cash. For now, the run is largely driven by fears of withdrawal limits and the anticipation that credit cards and electronic means of payments will cease to function. If that happens, cash at hand is the better alternative. For that scenario, central banks know what to do: provide solvent banks with plenty of liquidity against good collateral, as Walter Bagehot recommended.
But will that be all? As Western countries freeze the Russian central bank’s reserves and limit the ability of banks to transact internationally, the exchange rate of the ruble has collapsed, falling by more than 40 percent. Prices for ordinary goods may begin to rise, perhaps dramatically so. If that happens, then rubles would no longer be a good store of value. Russians may seek to convert them into foreign currency, but that’s hard to do with the current sanctions. Consequently, they may start to hoard goods instead, dumping their cash as they go along. The situation would no longer be a run on specific goods, but a run away from fiat money and toward goods—a run, in other words, on the central bank.
Author(s): Linda Schilling, Jesús Fernández-Villaverde, Harald Uhlig
This year we had record participation with over 250 insurance professionals taking part. This is the fifth iteration of this poll and 2022 shows some consistency along with some very new risks. Inflation, Employee retention and Ability to hire new employees are three new risks to the top of this poll, but they should not be surprises.
2. INFLATION Up very sharply – Previously #52 Prices are rising faster than they have since the 1980s in most of the developed world. Insurers will be hit with a double whammy as the real value of invested assets decays and the cost of doing business and claims costs increases at the same time.
EMPLOYEE RETENTION Not on the list previously The Great Resignation makes the headlines. COVID seems to have accelerated the timeline for the inevitable wave of Boomer retirements. Also concerning are the numbers leaving due to health care burnout and caregiver responsibilities. The problem for insurers is figuring out how to respond to the massive loss of experience.
The insurance industry is far from the economy’s most-admired sector. A Forbessurvey found insurance ranking low in popularity in the public eye. Three main reasons are responsible for insurers’ relatively poor rating. First is the intangible nature of the insurance product. Unlike a car one can drive home from the dealership, or a chocolate bar whose taste can be savored, purchase of an insurance policy does not lead to immediate physical gratification. To be sure, if there is no loss, one may never get a flavor of its value. Second, insurance is associated with life’s tragedies, its most physically, emotionally and financially distressing experiences—a home damaged by a storm, a car totaled, being sued, a death or dread disease, or a crippling workplace accident. Insurance payments can take away the sting with financial recovery, but loss remains painful, especially if one discovers the loss is not 100 percent covered. And third, the insurance industry has become an easy target for critics who regularly vilify it.
Why do we maintain that insurance, R Street’s inaugural research program, is fundamentally exciting? Three reasons.
First, insurance is the economy’s financial first responder. When the wind blows, the earth shakes and large-class action lawsuits are decided in plaintiffs’ favor, the insurance industry pays.
Second, insurers are significant investors in the capital markets. They provide much of the financial muscle to power the economy. Property-casualty insurers hold $1.1 trillion in bonds, and life and health insurers hold another $3.6 trillion. Collectively, insurers hold $4.7 trillion in bonds, 10 percent of the U.S. bond market of $47 trillion.
Third, insurance is the grease in the engine of the economy. Without clinical trials insurance, pharmaceutical companies would not take the risk of developing vaccines. Without ocean marine or inland marine insurance, ships would not sail and trucks would not take the risk to carry loads. Airplanes would not fly, people would be afraid to drive, and inventors would not create new products for fear of lawsuits.
Regional conflicts are heating up around the world. Resource needs will accelerate the trend. Fresh water in the Himalayas provide multiple countries who have nuclear arsenals. Oil and rare earth metals could also trigger a war. Climatic events are happening more often, so the cost takes money away from solutions while making the goals seem more obvious.
Resource depletion has no recommended debit treatment from accountants, but attribution analysis is going to do the work after the fact and charge companies for their past practices through the court system. I assume this is how the asbestos risk played out but I will need to learn more about similar historical events as these events play out. How should this enter your thought process as an investor? In 2021 I wrote 4 papers about climate; Climate System, Integrated Assessment Models, Impact of Climate Change on Investors and Municipalities and Climate Change. They are part of the SOA’s Environmental Risk Series. The impact of climate on investors will continue to evolve for many years. One topic of interest to me is how TCFD (disclosures) will play out – we could see “bad” investments like oil companies, gun makers and cigarette companies become privately owned. This would make it harder to apply peer pressure so is an important reminder to be careful what you wish for!
In May of 2020, Hoenig published a paper that spelled out his grim verdict on the age of easy money, from 2010 until now. He compared two periods of economic growth: The period between 1992 and 2000 and the one between 2010 and 2018. These periods were comparable because they were both long periods of economic stability after a recession, he argued. The biggest difference was the Federal Reserve’s extraordinary experiments in money printing during the latter period, during which time productivity, earnings and growth were weak. During the 1990s, labor productivity increased at an annual average rate of 2.3 percent, about twice as much as during the age of easy money. Real median weekly earnings for wage and salary employees rose by 0.7 percent on average annually during the 1990s, compared to only 0.26 percent during the 2010s. Average real gross domestic product growth — a measure of the overall economy — rose an average of 3.8 percent annually during the 1990s, but by only 2.3 percent during the recent decade.
The only part of the economy that seemed to benefit under quantitative easing and zero-percent interest rates was the market for assets. The stock market more than doubled in value during the 2010s. Even after the crash of 2020, the markets continued their stellar growth and returns. Corporate debt was another super-hot market, stoked by the Fed, rising from about $6 trillion in 2010 to a record $10 trillion at the end of 2019.
Epidemiologists report there is no precise definition for what is or is not an epidemic wave. ‘Waves’ are a phenomenon of infections that can develop during a pandemic. A wave implies a rising number of sick patients, a characteristic peak of illness and then a dramatic or sustained decline of infections reaching a baseline.1 Previous experiences with the Spanish influenza pandemic (1918) and seasonal influenza epidemics suggest further waves of COVID-19 are inevitable.2 The UK has endured the first two waves of the COVID-19 pandemic with widespread socioeconomic consequences and mortality.3 The WHO regional office for Europe has recently reported that incidence, hospitalisations and deaths in Central Europe, the Balkans and the Baltic states are among the highest globally suggesting a third wave of COVID-19.4 The reason for this third wave in Europe and anticipated further waves in countries with vaccine roll-out including the UK could be due to the Peltzman effect.
The Peltzman effect is named after Sam Peltzman, professor of economics at the University of Chicago Booth School of Business. It describes the concept of ‘Risk Compensation’.5 In this concept, it is argued that highway safety regulations were not reducing highway deaths. ‘Risk compensation’ is a theory that suggests that people typically adjust their behaviour in response to perceived levels of risk. It postulates that people become more careful where they sense greater risk and lesser careful if they feel more protected. Peltzman theorised that though the introduction of safety devices, like seat belts or air bags, reduced the ratio of fatalities to accidents, the rate of accidents was found to have risen enough to offset the decreased fatality rate. He proposed that though people felt safer driving with a seat belt, it probably led to a phenomenon of driving with less attentiveness or higher speed causing an increased risk of run-off-road crashes or similar accidents.
COVID-19 vaccination triggering Peltzman effect—An analysis of Peltzman effect reveals four main factors contributing to risk compensation, all of which appear to be present in the current COVID-19 pandemic. To initiate an increase in risky behaviour, a measurable benefit must be ‘visible’, a criterion that COVID-19 vaccines meet. This is supported by the decreasing number of infections in vaccinated populations.7 Risk compensation is more likely to occur if people have a ‘motivation’ to take on a risky behaviour and if it is within their ‘control’ to do so. With the COVID-19 pandemic these two factors seem to have manifested as ‘pandemic fatigue’ with decreasing adherence to risk reduction strategies of social distancing, face coverings and hand washing in the population. Such behaviours of risk compensation have raised concerns about threat to global public health efforts to control the pandemic.8 The final factor, the overall effectiveness of the intervention, in this case of the COVID-19 vaccine, is being increasingly recognised worldwide.9 This is highly desirable, increasing the likelihood of vaccine-acquired ‘herd immunity’. However, for the Peltzman effect, this high efficacy is likely to reduce adherence to other safety precautions. Vaccination drives in most European countries started in late December 2020, after which the rise of cases was seen. Thus, people’s complacency and a false sense of increased security after vaccination may have been the possible reasons for people to abandon protective and preventive behavioural strategies.
Research has also found being extroverted or introverted affects how people make decisions about Covid-19 precautions. A recent study of more than 8,500 people in Japan published in the journal PLOS One in October 2020 found that those who scored high on a scale of extraversion were 7% less likely to wear masks in public and avoid large gatherings, among other precautions.
Scientists believe that a person’s propensity to take risks is partly genetic and partly the result of early life experiences. Studies of twins have generally found that about 30% of the difference in individual risk tolerance is genetic. Certain negative childhood experiences including physical, emotional or sexual abuse, parental divorce, or living with someone who was depressed or abused drugs or alcohol are linked to risky behavior in adulthood like smoking and drinking heavily, other research has found.
And scientists have discovered that the brains of people who are more willing to take risks look different than those of people who are more cautious. In a study published in the journal Neuron in 2018 that involved scanning the brains of 108 young adults, scientists at the University of Pennsylvania found that participants who made riskier choices on a gambling task had differences in the structure and function of the amygdala, a part of the brain involved in detecting threats, and the prefrontal cortex, a region involved in executive functioning.
Figure 15 shows that the average risk-based capital ratio for the L&H sector declined slightly in
Specifically, statutory capital and surplus was 4.26 times the level of minimum required regulatory capital on average in 2020 compared to 4.31 times the required level in 2019.
L&H sector net income of $22 billion in 2020 was less than one-half of 2019 levels, affecting the potential for capital generation. The sector reported a nearly 10 percent increase in death and annuity benefit expenses, which contributed to a ratio of total benefit expenses to premiums earned of 50 percent in 2020, rising substantially from 44.4 percent in 2019. According to Fitch Ratings, life insurer operating results in 2020 were largely impacted by higher claims paid, primarily due to increased mortality from COVID-19.24
Certain leverage ratios indicate that L&H insurers faced balance sheet pressures in 2020. The greater financial flexibility afforded by steady leverage ratios has enabled insurers to consistently fulfill policyholder obligations by: (1) returning a profit by investing the premiums received from underwriting activities; and (2) limiting the risk exposure from the policies underwritten. Insurers also employ reinsurance in order to move some of the risks off their own balance sheets and on to those of reinsurers. Figure 16 provides a view of the L&H sector’s general account leverage for the last 10 years.
Insolvency Costs Workbook – This Microsoft Excel workbook contains individual spreadsheets for all insolvency cases along with various summary schedules and assessable premium data.
Insolvency Costs Report – This PDF file contains all commentary and notes for the insolvency cost report. It includes general descriptions of categories, brief comments on individual insolvency cases, assessment and premium tax offset provisions, and premiums by state. Also included are the spreadsheets from the Costs Excel workbook, thus creating one comprehensive report. You will need Acrobat Reader to open and read this file.
Insolvency Costs Report – Comments – This file is no longer provided beginning with 2003 since all information is included in the Report PDF file. This Microsoft Word document contains all commentary and notes for the insolvency cost report. It includes general descriptions of categories, brief comments on individual insolvency cases and premium tax offset provisions.
Date Accessed: 20 Sept 2021
Publication Site: National Organization of Life & Health Insurance Guaranty Associations