Emerald | Journal of Risk Finance, The | Table of Contents

What is the driving force behind consolidations in the insurance market?

literatinetwork@emeraldinsight.com (Mahito Okura, Noriyoshi Yanase) — Fri, 22 Feb 2013 00:00:00 +0000

Abstract

Purpose – The purpose of this paper is to discuss whether insurers could have a strong motivation for M&A in the future because they need to survive within the industry under oversaturated market conditions. Recently, Japanese non-life insurance markets, mainly the automobile insurance market, have reached the point of saturation due to the oversaturated domestic automobile market. At that time, the industry has also experienced successive large-scale M&A transactions. Design/methodology/approach – Using a theoretical model developed by Salent et al., the authors discuss whether an insurer's motivation for M&A could be affected by a saturation of the market. The authors also clarify whether insurance premium deregulation is a necessary condition for merger incentives. Findings – The authors conclude that, first, necessary requirement for insurers' motivation of consolidations is to loosen the rate regulation; and second, the sufficient condition is saturation of market. Research limitations/implications – This result is intuitive to understand recent circumstances surrounding the Japanese non-life insurance industry. Originality/value – This study is believed to be the first to discuss the relationship between a potential market size and M&A transactions.

The relationship between moral hazard and insurance fraud

literatinetwork@emeraldinsight.com (Mahito Okura) — Fri, 22 Feb 2013 00:00:00 +0000

Abstract

Purpose – The purpose of this paper is to investigate the insurance market in which moral hazard and insurance fraud coexist. In this situation, this research examines the relationship between moral hazard and insurance fraud. Also, this research shows how the amount of policyholder's effort to lower accident probability changes when insurance firm increases their investment in preventing insurance fraud. Design/methodology/approach – Using a theoretical model containing five-stages, the author sheds light on how the possibility of insurance fraud affects the amount of policyholder's effort. Findings – The main results of this research are as follows. First, the amount of policyholder's effort is a weakly monotone decreasing function of the insurance firm's investment in preventing insurance fraud. Second, unlike in previous moral hazard models, the policyholder chooses a strictly positive amount of effort even in the full insurance case because the possibility of insurance fraud gives an incentive to realize policyholder's effort. Third, the amount of insurance firm's investment in preventing insurance fraud depends on whether it wants to give an additional incentive to policyholder's effort in exchange for realizing the possibility of insurance fraud. Originality/value – This is the first paper to investigate the relationship between moral hazard and insurance fraud by using the microeconomic theory.

Optimal insurance risk allocation with steepest ascent and genetic algorithms

literatinetwork@emeraldinsight.com (SiewMun Ha) — Fri, 22 Feb 2013 00:00:00 +0000

Abstract

Purpose – Enhanced risk management through the application of mathematical optimization is the next competitive-advantage frontier for the primary-insurance industry. The widespread adoption of catastrophe models for risk management provides the opportunity to exploit mathematical optimization techniques to achieve superior financial results over traditional methods of risk allocation. The purpose of this paper is to conduct a numerical experiment to evaluate the relative performances of the steepest-ascent method and genetic algorithm in the solution of an optimal risk-allocation problem in primary-insurance portfolio management. Design/methodology/approach – The performance of two well-established optimization methods – steepest ascent and genetic algorithm – are evaluated by applying them to solve the problem of minimizing the catastrophe risk of a US book of policies while concurrently maintaining a minimum level of return. Findings – The steepest-ascent method was found to be functionally dependent on, but not overly sensitive to, choice of initial starting policy. The genetic algorithm produced a superior solution to the steepest-ascent method at the cost of increased computation time. Originality/value – The results provide practical guidelines for algorithm selection and implementation for the reader interested in constructing an optimal insurance portfolio from a set of available policies.

Longevity risk and survivor derivative pricing

literatinetwork@emeraldinsight.com (Paul Dawson, Hai Lin, Yangshu Liu) — Fri, 22 Feb 2013 00:00:00 +0000

Abstract

Purpose – Longevity risk, that is, the uncertainty of the demographic survival rate, is an important risk for insurance companies and pension funds, which have large, and long-term, exposures to survivorship. The purpose of this paper is to propose a new model to describe this demographic survival risk. Design/methodology/approach – The model proposed in this paper satisfies all the desired properties of a survival rate and has an explicit distribution for both single years and accumulative years. Findings – The results show that it is important to consider the expected shift and risk premium of life table uncertainty and the stochastic behaviour of survival rates when pricing the survivor derivatives. Originality/value – This model can be applied to the rapidly growing market for survivor derivatives.

Comparison of temperature models using heating and cooling degree days futures

literatinetwork@emeraldinsight.com (Ahmet Göncü) — Fri, 22 Feb 2013 00:00:00 +0000

Abstract

Purpose – The purpose of this paper is to compare the ability of popular temperature models, namely, the models given by Alaton et al., by Benth and Benth, by Campbell and Diebold and by Brody et al., to forecast the prices of heating/cooling degree days (HDD/CDD) futures for New York, Atlanta, and Chicago. Design/methodology/approach – To verify the forecasting power of various temperature models, a statistical backtesting approach is utilised. The backtesting sample consists of the market data of daily settlement futures prices for New York, Atlanta, and Chicago. Settlement prices are separated into two groups, namely, “in-period” and “out-of-period”. Findings – The findings show that the models of Alaton et al. and Benth and Benth forecast the futures prices more accurately. The difference in the forecasting performance of models between “in-period” and “out-of-period” valuation can be attributed to the meteorological temperature forecasts during the contract measurement periods. Research limitations/implications – In future studies, it may be useful to utilize the historical data for meteorological forecasts to assess the forecasting power of the new hybrid model considered. Practical implications – Out-of-period backtesting helps reduce the effect of any meteorological forecast on the formation of futures prices. It is observed that the performance of models for out-of-period improves consistently. This indicates that the effects of available weather forecasts should be incorporated into the considered models. Originality/value – To the best of the author's knowledge this is the first study to compare some of the popular temperature models in forecasting HDD/CDD futures. Furthermore, a new temperature modelling approach is proposed for incorporating available temperature forecasts into the considered dynamic models.

Differences in the risk management practices of Islamic versus conventional financial institutions in Pakistan: An empirical study

Fri, 22 Feb 2013 00:00:00 +0000

Abstract

Purpose – The purpose of this paper is to provide an insight into the differences in the risk management practices of Islamic financial institutions (IFI) and conventional financial institutions (CFI) in Pakistan. Design/methodology/approach – The study makes use of primary data collection method using a questionnaire survey. Findings – Literature review discovered that the types of risks faced by both types of financial institutions can be classified under six categories. The research concludes that credit risk, equity investment risk, market risk, liquidity risk, rate of return risk and operational risk management practices in IFI are not different from the practices in CFI. Whereas the overall risk management practices of IFI and CFI are alike in Pakistan. Research limitations/implications – Further research with a larger sample size is recommended. Practical implications – The paper opens our eyes to the fact that much is unknown about the risk management practices in Pakistani financial system, creating a need for empirical studies for further discoveries to formulate better frameworks and to prevent an impending financial crisis that might be unravelling at the time this paper is being read. Originality/value – This is the first empirical study of its kind that addresses the unmarked topic of RMP in IFI and CFI in Pakistan. The research was conducted because few studies have been executed to understand differences in the risk management practices in Pakistan, exclusively among Islamic financial institutions. This study is expected to expand the existing literature by providing novel empirical evidence.