Table Of ContentFinancial Models of Insurance
Solvency
Huebner International Series on
Risk, Insurance, and Economic
Security
J. David Cummins, Editor
The Wharton School
University of Pennsylvania
Philadelphia, Pennsylvania, USA
Series Advisors:
Dr. Phelim P. Boyle
University of Waterloo, Canada
Dr. Jean Lemaire
University of Pennsylvania, USA
Professor Akihlko Tsuboi
Kagawa University, Japan
Dr. Richard Zeckhauser
Harvard University, USA
Previously published books in the series:
Cummins, J. David; Smith, Barry D.;
Vance, R. Neil; VanDerhel, Jack L.;
Risk Classification in Life Insurance
Mintel, Judith; Insurance Rate Litigation
Cummins, J. David: Strategic Planning and
Modeling in Property-Liability Insurance
Lemaire, Jean: Automobile Insurance:
Actuarial Models
Rushing, William.: Social Functions and
Economic Aspects of Health Insurance
Cummins, J. David and Harrington, Scott E.:
Fair Rate of Return in Property-Liability Insurance
Appel, David and Borba, Philip S.: Workers
Compensation Insurance Pricing
Cummins, J. David and Derrig, Richard A.:
Classical Insurance Solvency Theory
The objective of the series Is to publish original research and advanced
textbooks dealing with all major aspects of risk bearing and economic
security. The emphasis Is on books that will be of Interest to an
International audience. Interdisciplinary topiCS as well as those from
traditional disciplines such as economics, risk and Insurance, and
actuarial science are within the scope of the series. The goal Is to
provide an outlet for imaginative approaches to problems In both the
theory and practice of risk and economic security.
Financial Models of Insurance
Solvency
edited by
J. David Cummins
The Wharton School
University of Pennsylvania
Philadelphia, Pennsylvania
and
Richard A. Derrig
Massachusetts Rating Bureau
Boston, Massachusetts
~
"
Kluwer Academic Publishers
Boston/Dordrecht/London
Distributors
for North America: Kluwer Academic Publishers, 101 Philip Drive,
Asslnlppl Park, Norwell, Massachusetts 02061, USA
for all other countries: Kluwer Academic Publishers Group,
Distribution Centre, Post Office Box 322, 3300 AH Dordrecht,
THE NETHERLANDS
Library of Congress Cataloging· In· Publication Data
Financial models of Insurance solvency I edited by J. David Cummins
and Richard A. Derrig.
p. cm. - (Huebner International series on risk, Insulrance,
and economic security)
Vol. 2 of the proceedings of the 1 st International Conference on
Insurance Solvency held In Philadelphia, 1986 and published under
the tltie Classical Insurance solvency theory.
Includes Index.
ISBN-13: 978-94-010-7631-9 e-ISBN-13: 978-94-009-2506-9
001: 10.1007/978-94-009-2506-9
1. Insurance-Finance-Congresses. I. Cummins, J. David.
II. Derrig, Richard A. III. International Conference on Insurance
Solvency (1st: 1986: Philadelphia, Pa.) IV. Classical Insurance
solvency theory. V. Series.
HG8026.158 1989
368'.01-dc20 89-2725
CIP
Copyright © 1989 by Kluwer Academic Publishers
Softcover reprint of the hardcover 1st edition 1989
All rights reserved. No part of this publication may be reproduc
ed, stored In a retrieval system or transmitted In any form or by
any means, mechanical, photocopying, recording, or otherwise,
without the prior written permission of the publisher, Kluwer
Academic Publishers, 101 Philip Drive, Asslnlppl Park, Norwell,
Massachusetts 02061, USA
Contents
FINANCIAL MODELS OF INSURANCE SOLVENCY
Edited by J.D. Cummins and A.A. Derrig
Volume II of the Proceedings of the First International
Conference on Insurer Solvency
About the Authors vii
Photo xiii
List of Contributors xiv
Contributing Organizations xv
Preface xvii
The Assessment of the Financial Strength of Insurance
Companies by a Generalized Cash Flow Model
by Stewart M. Coutts and Russell Devitt
Cash Flow Simulation Models for Premium and Surplus Analysis
by Albert S. Paulson and R. Dixit 37
Some Aspects of Life Assurance Solvency
by Howard R. Waters 57
The Solvency of a General Insurance Company in Terms of
Emerging Costs
by C.D. Daykin, G.D. Bernstein, S.M. Coutts, E.R.F. Devitt, G.B. Hey,
0.1. W. Reynolds and P.O. Smith (U.K. Solvency Working Party) 87
Some General Approaches to Computing Total Loss Distributions
and the Probability of Ruin
by Albert S. Paulson and R. Dixit 151
Methods for Analyzing the Effects of Underwriting Risk on the
Insurer's Long-Term Solvency
by Jukka Rantala 171
Concepts and Trends in the Study of Insurer's Solvency
by Yehuda Kahane, Charles S. Tapiero, and Laurent Jacques 219
On the Application of Finance Theory to the Insurance Firm
by James R. Garven 243
vi Contents
On the Capital Structure of Insurance Firms
by Neil Doherty 267·
Risk Based Premiums for Insurance Guaranty Funds
by J. David Cummins 283
Solvency Levels and Risk Loadings Appropriate for Fully
Guaranteed Property-Liability Insurance Contracts: A
Financial View
by Richard A. Derrig 303
Index 355
ABOUT THE AUTHORS
Stewart Coutts, International Actuarial Consultants, 8 St. Martins'
-Ie-Grand, London ECIA 4ED, England
Stewart Coutts is a partner with International Actuarial Consultants
in London, England. He holds a Doctorate in Actuarial Mathematics
from the City University in London, and is Fellow of th~ Institute of
Actuaries. He has published a wide range of research papers from
motor-rating to probabilistic models for measuring the Solvency of
Insurance Companies.
J. David Cummins, Department of Insurance, Wharton School,
University of Pennsylvania, 3641 Locust Walk, Philadelphia, PA.
U.S.A. 19104-6218
J. David Cummins is the Harry J. Loman Professor of Insurance and
Executive Director of the S. S. Huebner Foundation for Insurance
Education at the Wharton School. Dr. Cummins has served as Presi
dent of the American Risk and Insurance Association and is a
member of ASTIN, the American Economic Association, and the
American Finance Association. His primary research interests are
the financial pricing of insurance, financial management of in
surance companies, and the economics of property-liability in
surance markets. Dr. Cummins is the author or editor of ten books
on risk and insurance. His numerous articles have appeared in jour
nals such as the ASTIN Bulletin, the Bell Journal, the Journal of
Finance, International Journal of Forecasting, and the Journal of
Risk and Insurance. Dr. Cummins consulting clients have come
from the Insurance industry, business and government.
viii About the Authors
Richard A. Derrig, Massachusetts Rating Bureaus, 40 Broad Street,
Boston, Massachusetts U.S.A. 02109
Dr. Richard A. Derrig is Vice President for Research with the ac
tuarial staff of the Massachusetts Automobile and Workers' Com
pensation Insurance Rating Bureaus. He joined the Bureaus in 1976
after teaching mathematics at the collegiate and graduate levels at
Brown University, Villanova University and Wheaton College in
Massachusetts.
In his current position, Dr. Derrig oversees several on-going ac
tuarial research projects in such diverse area as investment income
and profitability, requirements for solvency, pricing tax-exempt
securities, and claim cost containment. Dr. Derrig has authored
several research papers on ratemaking and has provided expert
testimony in public hearings. He is a member of the American Risk
and Insurance Association, Mathematical Association of America
and the American Statistical Association.
Russell Devitt, NEL Britannia Group of Companies, Nilton Court
Dorking, Surrey, ENGLAND RH4 3LZ
Russell Devitt is Director of Business Development for the NEL
Britannia Group of Companies. He holds a masters degree in finan
cial management from the City University in London, and is a
Fellow of the Chartered Association of Certified Accountants and a
Fellow of the Chartered Insurance Institute.
R. Dixit, School of Management, Rensselaer Polytechnic Institute,
Troy, NY 12180
R. Dixit is systems designer for CAMEX Enterprises of Ballston
Lake, NY. Mr. Dixit holds master degrees in power engineering and
operations research and statistics from Rensselaer Polytechnic In
stitute. He has published several articles in the areas of risk
management and statistics. His current interests are cash flow and
yield curve modeling, and statistical methods for risk management.
Neil A. Doherty, Department of Insurance, Wharton School, Univer
sity of Pennyslvania, 3641 Locust Walk, Philadelphia, Pennyslvania
U.S.A. 19104-6218
About the Authors ix
Neil A. Doherty is Professor of Insurance at the Wharton School of
the University of Pennsylvania. His papers on financial and
economic aspects of insurance markets have appeared in Journals
such as the Journal of Risk and Insurance, The Journal of Finance,
The Journal of Political Economy and The Economic Journal. His
books include Corporate Risk Management: A Financial Exposi
tion, Insurance Pricing and Loss Prevention, and, with S. D' Arcy,
The Financial Theory of Insurance Pricing. He has consulted with
various firms on issues such as insurance rate regulation, the har
monization of insurance services in the European community and
the taxation of captive insurance companies. Dr. Doherty has also
acted as an economic adviser to the U. K. government on social
security and pension issues.
James R. Garven, College of Business Administration, Department
of Finance, The Pennsylvania State University, University Park,
Pennsylvania U.S.A. 16802
James R. Garven, Assistant Professor of Finance at The Penn·
sylvania State University, holds a Ph.D. in Finance from the Univer
sity of Illinois.
His current research interests include the economics of regulation
and the application of contingent claims analysis to insurance and
securities markets. He has published articles in journals such as
the Financial Review, the Journal of Business Finance and
Accounting, the Journal of Finance, and the Journal of Financial
Services Research. He is a member of the American Finance
Association, the Financial Management Association, the American
Risk and Insurance Association, and the Risk Theory Seminar.
Yehuda Kahane, Academic Director, Erhard Insurance Center,
Faculty of Management, Tel·Aviv University, Ramat-Aviv, Israel
69978
Dr. Kahane, who is a member of the International Association of Ac
tuaries, is active in both the academic and business environments.
Since 1967, he has taught at the Hebrew University of Jerusalem,
the University of Florida, the University of Toronto, the Wharton
School, the Instituto of Estudios Superiores De Administracion,
Caracas and has recently served as the Visiting Blades Professor of
x About the Authors
Insurance at the Department of Finance, Insurance and Actuarial
Studies of the University of Texas at Austin. He is currently Pro
fessor of Insurance and Finance and Academic Director of the
Erhard Insurance Center at Tel-Aviv University.
His career includes a period spent in business and in consulting ac
tivities on risk management, insurance and actuarial topics, to
large organizations and major companies in Israel and Europe.
Dr. Kahane is the author of several books and numerous articles.
He is Associate Editor of Insurance Mathematics and Economics,
Insurance Abstracts and Reviews, and the Journal of Finance Serv
ices Research. His studies focus on financial and actuarial aspects
of the insurance business: inflation, portfolio optimization, reserv
ing and ratemaking, pensions, no-fault auto insurance, and natural
catastrophes.
Laurent L. Jacque, Curtis L. Carlson School of Management, Univer
sity of Minnesota, 271 19th Avenue So., Minneapolis, MN 55455
Laurent L. Jacque received his M.A., MBA and PhD from the Whar
ton School where he taught International Management and Interna
tional Finance prior to joining the Carlson School of Management
(University of Minnesota) as an Associate Professor of International
Management. His research centers on risk management in an inter
national setting, and he has published in the Journal of Interna
tional Business Studies, Journal of Operational Research SOCiety,
Journal of Risk and Insurance, the Scandanavian Actuarial Journal
etc. His book Management of Foreign Exchange Risk was first
published in 1978 and is now in its sixth printing.
Albert S. Paulson, School of Management, Rensselear Polytechnic
Institute, Troy, New York, U.S.A. 12181
Albert S. Paulson is Professor of Management, Professor of Opera
tions Research and Statistics and Director of Doctoral Programs in
Management at Rensselaer Polytechnic Institute.
He has published extensively in the areas of risk management,
economics, financial modeling, forecasting and control, engineer
ing management, and statistics. His current interests center on
(1) the use of cash flow simulation models in qu~ntifying premium
