ASME Press Select Proceedings

# Proceedings of the Eighth International Conference on Probabilistic Safety Assessment & Management (PSAM)

Editor
Michael G. Stamatelatos
Michael G. Stamatelatos
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Harold S. Blackman
Harold S. Blackman
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ISBN-10:
0791802442
No. of Pages:
2576
Publisher:
ASME Press
Publication date:
2006

In the last few years, the insurance industry has been exposed, world-wide, to large losses and disruptions, ranging from the payments that had to be made following the attacks of 9/11/01, to the costs of asbestos claims, the collapse of high-tech segments of financial markets, and government investigations of industry practices. Such events, however, do not seem to be the main cause of insurance firms' bankruptcy and at this time, and investments are pouring in that industry in anticipation of high returns of a “hard market” following these events. Yet, the recent failures of Kemper, Reliance and Trenwick, among others, illustrate the reality of the exposure of insurance firms to a spectrum of business failure scenarios.

In this paper, we present a Global Financial Analysis (GFA) framework, i.e., a dynamic stochastic model that goes beyond the scope of the existing Dynamic Financial Analysis model, and is designed to understand better the nature and the relative importance of the different threats in the commercial insurance industry. The approach is to combine the choice of strategies of the firm with a dynamic description of external events in a simplified model and simulation of the balance sheet of an insurance company. The principal output of the quantitative part of the model is the probability distribution of the time to failure of the firm, i.e., the time at which it may become insolvent.

We identify four external factors as key dynamic input to this balance sheet model in the GFA framework:

• the economic variables that affect the return on investment (inflation, stock market, interest rates, etc.)

• the underwriting cycles and their successions of soft and hard markets;

• the occurrences of big losses due to large catastrophes or large long-tail claims;

• emerging social issues and changes in laws, legal interpretations or regulations.

Based on this model, we estimate the probability of insolvency of an insurance firm given a present state and for a specified time horizon, and we determine the effects of external factors on that risk.