Derivatives and corporate risk management: participation and volume decisions in the insurance industry

In this paper we formulate and test a number of hypotheses regarding insurer participation and volume decisions in derivatives markets. Several specific hypotheses are supported by our analysis. We find evidence consistent with the idea that insurers are motivated to use financial derivatives to hedge the costs of financial distress, interest rate, liquidity, and exchange rate risks. We also find some evidence that insurers use these instruments to hedge embedded options and manage their tax bills. We also find evidence of significant economies of scale in the use of derivatives. Interestingly, we often find that the predetermined variables we employ display opposite signs in the participation and volume regressions. We argue that this result is broadly consistent with the hypothesis that there is also a per unit premium associated with hedging and that, conditional on having risk exposures large enough to warrant participation, firms with a larger appetite for risk will be less willing than average to pay this marginal cost.Corporations - Finance ; Derivative securities ; Financial services industry ; Business enterprises

Derivatives and Corporate Risk Management: Participation and Volume Decisions in the Insurance Industry

The use of derivatives in corporate risk management has grown rapidly in recent years. In this paper, the authors explore the factors that influence the use of financial derivatives in the U.S. insurance industry. Their objective is to investigate the motivations for corporate risk management The authors use regulatory data on individual holdings and transactions in derivative markets. According to modern finance theory, shares of widely held corporations are held by diversified investors who operate in frictionless and complete markets and eliminate non-systematic risk through their portfolio choices. But this theory has been challenged by new hypotheses that take into account market imperfections, information asymmetries and incentive conflicts as motivations for corporate managers to change the risk/return profile of their firm. The authors develop a set of hypotheses regarding the hedging behavior of insurers and perform tests on a sample of life and property-liability insurers to test them. The sample consists of all U.S. life and property-liability insurers reporting to the NAIC. The authors investigate the decision to conduct derivatives transactions and the volume of transactions undertaken. There are two primary theories about the motivations for corporate risk management - maximization of shareholder value and maximization of managerial utility. The authors discuss these theories, the hypotheses they develop from them , and specify variables to test their hypotheses. They posit the following rationales for why corporations may choose to engage in risk management and also specify variables that help them study the use of these rationales by insurance firms: to avoid the costs of financial distress; to hedge part of their investment default/volatility/liquidity risks; to avoid shocks to equity that result in high leverage ratios; to minimize taxes and enhance firm value by reducing the volatility of earnings; to maximize managerial utility. The authors argue that the use of derivatives for speculative purposes in the insurance industry is not common. The authors analyze the decision by insurers to enter the market and their volume of transactions. They use probit analysis to study the participation decision and Tobit analysis along with Cragg's generalization of the Tobit analysis to study volume. The results provide support for the authors' hypothesis that insurers hedge to maximize shareholder value. The analysis provides only weak support for the managerial utility hypothesis. Insurers are motivated to use financial derivatives to reduce the expected costs of financial distress. There is also evidence that insurers use derivatives to hedge asset volatility and exchange rate risks. There is also evidence that there are significant economies of scale in running derivatives operations - only large firms and/or those with higher than average risk exposure find it worthwhile to pay the fixed cost of setting up a derivatives operation. Overall, insurers with higher than average asset risk exposures use derivative securities.

Prophets and Preference: Constructing and Maintaining a Homosexual Identity in the Mormon Church

This thesis is a descriptive ethnography of homosexuals and homosexuality in the Church of Jesus Christ of Latter-day Saints, or Mormon church, The study employs the labeling perspective in sociology and uses gay Mormons to examine how an individual constructs and maintains a homosexual identity in an environment where such an orientation is stigmatized and devalued. Qualitative interviews and documentary analysis are the chief methodological tools for this study. The contradictions between a homosexual lifestyle and Mormon theology are outlined, and a history of Mormon church policy concerning homosexual members from 1959 to the present is presented. The study finds that many homosexual Mormons have great difficulty balancing their religious beliefs and their homosexuality. These difficulties are exacerbated by several unique theological precepts of Mormonism, and by a social climate that is generally hostile or indifferent to gay people and gay rights issues. A great deal of variation between younger informants and older informants to the study was discovered with regard to the depth of these difficulties, with older informants reporting more serious problems managing their sexual preference and Mormon church membership than younger informants. It was found that some gay Mormons choose to live celibate lives, attempt to change their sexual orientation, or marry heterosexually in order to maintain favor with the Mormon church. Others in the study strive to reform the Mormon church and seek to have gay relationships sanctioned within Mormonism. The ramifications of these identity management strategies for the individuals employing them and for the church are analyzed. The consequences of challenging mormon ecclesiastical authority and the impact such a challenge has on the lives of gay Mormons choosing this adaptive strategy is also discussed. The future of gay rights within Mormonism as well as in American society at large is treated

The Basis Risk of Catastrophic-Loss Index Securities

This paper analyzes the basis risk of catastrophic-loss (CAT) index derivatives, which securitize losses from catastrophic events such as hurricanes and earthquakes. We analyze the hedging effectiveness of these instruments for 255 insurers writing 93 percent of the insured residential property values in Florida, the state most severely affected by exposure to hurricanes. County-level losses are simulated for each insurer using a sophisticated model developed by Applied Insurance Research. We analyze basis risk by measuring the effectiveness of hedge portfolios, consisting of a short position each insurer's own catastrophic losses and a long position in CAT-index call spreads, in reducing insurer loss volatility, value-at-risk, and expected losses above specified thresholds. Two types of loss indices are used -- a statewide index based on insurance losses in four quadrants of the state. The principal finding is that firms in the three largest Florida market-share quartiles can hedge almost as effectively using the intra-state index contracts as they can using contracts that settle on their own losses. Hedging with the statewide contracts is effective only for insurers with the largest market shares and for smaller insurers that are highly diversified throughout the state. The results also support the agency-theoretic hypotheses that mutual insurers are more diversified than stocks and that unaffiliated single firms are more diversified than insurers that are members of groups.

The Incentive Effects of No Fault Automobile Insurance

This paper presents a theoretical and empirical analysis of the effects of no fault automobile insurance on accident rates. As a mechanism for compensating the victims of automobile accidents, no fault has several important advantages over the tort system. However, by restricting access to tort, no fault may weaken incentives for careful driving, leading to higher accident rates. We conduct an empirical analysis of automobile accident fatality rates in all U.S. states over the period 1982-1994, controlling for the potential endogeneity of no fault laws. The results support the hypothesis that no fault is significantly associated with higher fatal accident rates than tort.

Pricing Excess-of-loss Reinsurance Contracts Against Catastrophic Loss

This paper develops a pricing methodology and pricing estimates for the proposed Federal excess-of- loss (XOL) catastrophe reinsurance contracts. The contracts, proposed by the Clinton Administration, would provide per-occurrence excess-of-loss reinsurance coverage to private insurers and reinsurers, where both the coverage layer and the fixed payout of the contract are based on insurance industry losses, not company losses. In financial terms, the Federal government would be selling earthquake and hurricane catastrophe call options to the insurance industry to cover catastrophic losses in a loss layer above that currently available in the private reinsurance market. The contracts would be sold annually at auction, with a reservation price designed to avoid a government subsidy and ensure that the program would be self supporting in expected value. If a loss were to occur that resulted in payouts in excess of the premiums collected under the policies, the Federal government would use its ability to borrow at the risk-free rate to fund the losses. During periods when the accumulated premiums paid into the program exceed the losses paid, the buyers of the contracts implicitly would be lending money to the Treasury, reducing the costs of government debt. The expected interest on these "loans" offsets the expected financing (borrowing) costs of the program as long as the contracts are priced appropriately. By accessing the Federal government's superior ability to diversify risk inter-temporally, the contracts could be sold at a rate lower than would be required in conventional reinsurance markets, which would potentially require a high cost of capital due to the possibility that a major catastrophe could bankrupt some reinsurers. By pricing the contacts at least to break even, the program would provide for eventual private-market "crowding out" through catastrophe derivatives and other innovative catastrophic risk financing mechanisms. We develop prices for the contracts using two samples of catastrophe losses: (1) historical catastrophic loss experience over the period 1949-1994 as reported by Property Claim Services; and (2) simulated catastrophe losses based on an engineering simulation analysis conducted by Risk Management Solutions. We used maximum likelihood estimation techniques to fit frequency and severity probability distributions to the catastrophic loss data, and then used the distributions to estimate expected losses under the contracts. The reservation price would be determined by adding an administrative expense charge and a risk premium to the expected losses for the specified layer of coverage. We estimate the expected loss component of the government's reservation price for proposed XOL contracts covering the entire U.S., California, Florida, and the Southeast. We used a loss layer of $25-50 billion for illustrative purposes.

Regulatory solvency prediction in property-liability insurance: risk-based capital, audit ratios, and cash flow simulation

This paper analyzes the accuracy of the principal models used by U.S. insurance regulators to predict insolvencies in the property-liability insurance industry and compares these models with a relatively new solvency testing approach--cash flow simulation. Specifically, we compare the risk-based capital (RBC) system introduced by the National Association of Insurance Commissioners (NAIC) in 1994, the FAST (Financial Analysis and Surveillance Tracking) audit ratio system used by the NAIC, and a cash flow simulation model developed by the authors. Both the RBC and FAST systems are static, ratio-based approaches to solvency testing, whereas the cash flow simulation model implements dynamic financial analysis. Logistic regression analysis is used to test the models for a large sample of solvent and insolvent property-liability insurers, using data from the years 1990-1992 to predict insolvencies over three-year prediction horizons. We find that the FAST system dominates RBC as a static method for predicting insurer insolvencies. Further, we find the cash flow simulation variables add significant explanatory power to the regressions and lead to more accurate solvency prediction than the ratio-based models taken alone.Insurance industry

Using Peplau\u27s Theory to Examine the Psychosocial Factors Associated with HIV-infected Women\u27s Difficulty in Taking Their Medications

Although combination therapies slow progression of HIV disease, HIV-infected women face new challenges that must be overcome to increase their life expectancy. One challenge is adherence to strict, and often unpleasant, drug regimens. Peplau\u27s Theory of Interpersonal Relationships provides a framework for identifying and examining factors that influence medication adherence, in particular difficulties in taking medication. A descriptive, correlational design was used to test associations between difficulty taking HIV medications and a woman\u27s relationship with her primary healthcare provider (PHCP), depression, HIV-specific emotional and tangible support, present life satisfaction, family functioning, HIV-related symptoms, AIDS beliefs and perceptions, medication side-effects, and hope. Relationship with PHCP (F =5.30, p = . 0235) and present life satisfaction (F= 11.32, p = . 0011) explained 22% of the variance in HIV-infected women\u27s difficulty in taking medications. This study supports the importance of a therapeutic relationship between PHCPs and patients in overcoming difficulties associated with taking HIV medications

Flight speed and performance of the wandering albatross with respect to wind

Background Albatrosses and other large seabirds use dynamic soaring to gain sufficient energy from the wind to travel large distances rapidly and with little apparent effort. The recent development of miniature bird-borne tracking devices now makes it possible to explore the physical and biological implications of this means of locomotion in detail. Here we use GPS tracking and concurrent reanalyzed wind speed data to model the flight performance of wandering albatrosses Diomedea exulans soaring over the Southern Ocean. We investigate the extent to which flight speed and performance of albatrosses is facilitated or constrained by wind conditions encountered during foraging trips. Results We derived simple equations to model observed albatross ground speed as a function of wind speed and relative wind direction. Ground speeds of the tracked birds in the along-wind direction varied primarily by wind-induced leeway, which averaged 0.51 (± 0.02) times the wind speed at a reference height of 5 m. By subtracting leeway velocity from ground velocity, we were able to estimate airspeed (the magnitude of the bird’s velocity through the air). As wind speeds increased from 3 to 18 m/s, the airspeed of wandering albatrosses flying in an across-wind direction increased by 0.42 (± 0.04) times the wind speed (i.e. ~ 6 m/s). At low wind speeds, tracked birds increased their airspeed in upwind flight relative to that in downwind flight. At higher wind speeds they apparently limited their airspeeds to a maximum of around 20 m/s, probably to keep the forces on their wings in dynamic soaring well within tolerable limits. Upwind airspeeds were nearly constant and downwind leeway increased with wind speed. Birds therefore achieved their fastest upwind ground speeds (~ 9 m/s) at low wind speeds (~ 3 m/s). Conclusions This study provides insights into which flight strategies are optimal for dynamic soaring. Our results are consistent with the prediction that the optimal range speed of albatrosses is higher in headwind than tailwind flight but only in wind speeds of up to ~ 7 m/s. Our models predict that wandering albatrosses have oval-shaped airspeed polars, with the fastest airspeeds ~ 20 m/s centered in the across-wind direction. This suggests that in upwind flight in high winds, albatrosses can increase their ground speed by tacking like sailboats

Information Effect of Entry Into Credit Ratings Market: The Case of Insurers\u27 Ratings

The paper analyzes the effect of competition between credit rating agencies (CRAs) on the information content of ratings. We show that a monopolistic CRA pools sellers into multiple rating classes and has partial market coverage. This provides an opportunity for market entry. The entrant designs a rating scale distinct from that of the incumbent. It targets higher-than-average companies in each rating grade of the incumbent\u27s rating scale and employs more stringent rating standards. We use Standard and Poor\u27s (S&P) entry into the market for insurance ratings previously covered by a monopolist, A.M. Best, to empirically test the impact of entry on the information content of ratings. The empirical analysis reveals that S&P required higher standards to assign a rating similar to the one assigned by A.M. Best and that higher-than-average quality insurers in each rating category of A.M. Best chose to receive a second rating from S&P