nep-ias New Economics Papers
on Insurance Economics
Issue of 2011‒08‒22
eight papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Business Management

  1. Price Analysis, Risk Assessment, and Insurance for Organic Crops By Ariel Singerman; Chad E. Hart; Sergio H. Lence
  2. Estimating the risk-adjusted capital is an affair in the tails By Canestraro, Davide; Dacorogna, Michel
  3. Pro-cyclical Unemployment Benefits? Optimal Policy in an Equilibrium Business Cycle Model By Kurt Mitman; Stanislav Rabinovich
  4. Country Insurance Using Financial Instruments By Marcos Chamon; Yuanyan Sophia Zhang; Luca Antonio Ricci
  5. The mechanics and regulation of variable payout annuities By Vittas, Dimitri
  6. Flood Risks, Climate Change Impacts and Adaptation Benefits in Mumbai: An Initial Assessment of Socio-Economic Consequences of Present and Climate Change Induced Flood Risks and of Possible Adaptation Options By Stéphane Hallegatte; Fanny Henriet; Anand Patwardhan; K. Narayanan; Subimal Ghosh; Subhankar Karmakar; Unmesh Patnaik; Abhijat Abhayankar; Sanjib Pohit; Jan Corfee-Morlot; Celine Herweijer; Nicola Ranger; Sumana Bhattacharya; Murthy Bachu; Satya Priya; K. Dhore; Farhat Rafique; P. Mathur; Nicolas Naville
  7. Is There a Role for Funding in Explaining Recent U.S. Banks’ Failures? By Pierluigi Bologna
  8. The Spirit of Capitalism and Excess Smoothness By Yulei Luo; William T. Smith; Heng-fu Zou

  1. By: Ariel Singerman; Chad E. Hart; Sergio H. Lence
    Abstract: In recent years, the organic sector has grown steadily and significantly. However, little economic research has been performed on risk management in organic agriculture, likely because of the lack of available data. This lack of data may also be why the creation of the current crop insurance policy for organic farmers has been so ad hoc. The Agricultural Risk Protection Act of 2000 recognized organic farming as a “good farming practice,†making federal crop insurance coverage available for organic crops, and taking into account the idiosyncrasies of the organic production system. In addition to the production risks covered for conventional producers, organic farmers who sign up for coverage are compensated for production losses from damage due to insects, disease, and/or weeds. However, the incorporation of organic production into the crop insurance rating structure has been limited. Organic producers are charged an arbitrary 5% premium surcharge over conventional crop insurance. The actuarial fairness of this premium is, at least, questionable. In addition, in the case of crop failure, organic farmers receive compensation based on the prices of conventionally produced crops. Thus, price premiums that organic producers are able to obtain in the market are not compensated for under the current insurance policy structure. The Food, Conservation and Energy Act of 2008, which amends part of the Federal Crop Insurance Act, was written to investigate some of these claims, requiring the U.S. Department of Agriculture to examine the currently offered federal crop insurance coverage for organic crops as described in the organic policy provisions of the Act (Title XII). Such provisions established the need to review, among other things, the underwriting risk and loss experience of organic crops; determine whether significant, consistent, or systematic variations in loss history exist between organic and nonorganic production; and modify the coverage for organic crops in accordance with the results. Here we present the major findings of three analyses we performed on key elements of the insurance of organic crops—prices, yields, and revenue—in an effort to contribute to the design of an organic crop insurance policy that covers organic producers according to their idiosyncratic risks.
    Keywords: crop insurance, organic agriculture.
    Date: 2011–08
  2. By: Canestraro, Davide; Dacorogna, Michel
    Abstract: (Re)insurance companies need to model their liabilities' portfolio to compute the risk-adjusted capital (RAC) needed to support their business. The RAC depends on both the distribution and the dependence functions that are applied among the risks in a portfolio. We investigate the impact of those assumptions on an important concept for (re)insurance industries: the diversification gain. Several copulas are considered in order to focus on the role of dependencies. To be consistent with the frameworks of both Solvency II and the Swiss Solvency Test, we deal with two risk measures: the Value-at-Risk and the expected shortfall. We highlight the behavior of different capital allocation principles according to the dependence assumptions and the choice of the risk measure.
    Keywords: Capital Allocation; Copula; Dependence; Diversification Gain; Model Uncertainty; Monte Carlo Methods; Risk-Adjusted Capital; Risk Measure
    JEL: C10 G11 C15
    Date: 2010–11–05
  3. By: Kurt Mitman (Department of Economics, University of Pennsylvania); Stanislav Rabinovich (Department of Economics, University of Pennsylvania)
    Abstract: We study the optimal provision of unemployment insurance (UI) over the business cycle. We use an equilibrium search and matching model with aggregate shocks to labor productivity, incorporating risk-averse workers, endogenous worker search effort decisions, and unemployment benefit expiration. We characterize the optimal UI policy, allowing both the benefit level and benefit duration to depend on the history of past aggregate shocks. We find that the optimal benefit is decreasing in current productivity and decreasing in current unemployment. Following a drop in productivity, benefits initially rise in order to provide short-run relief to the unemployed and stabilize wages, but then fall significantly below their pre-recession level, in order to speed up the subsequent recovery. Under the optimal policy, the path of benefits is pro-cyclical overall. As compared to the existing US UI system, the optimal history-dependent benefits smooth cyclical fluctuations in unemployment and deliver substantial welfare gains.
    Keywords: Unemployment Insurance, Business Cycles, Optimal Policy, Search and Matching
    JEL: E24 E32 H21 J65
    Date: 2011–08–07
  4. By: Marcos Chamon; Yuanyan Sophia Zhang; Luca Antonio Ricci
    Abstract: The availability of financial instruments related to indices that track global financial conditions and risk appetite can potentially offer countries alternative options to insure against external shocks. This paper shows that while these instruments can explain much of the in-sample variation in borrowing spreads, this fails to materialize in hedging strategies that work well out-of-sample during tranquil times. However, positions on instruments such as those tracking the US High Yield Spread, the VIX, and especially other emerging market CDS spreads can substantially offset adverse movements in own spreads during times of systemic crises. Moreover, high risk countries seem to gain more, as their underlying weaknesses makes them more vulnerable to external shocks. Overall, the limited value in tranquil times, coupled with political economy arguments and innovation costs could justify the limited interest for this type of hedging in practice
    Keywords: Cross country analysis , Economic models , Emerging markets , External shocks , Financial instruments , Insurance , Risk management ,
    Date: 2011–07–15
  5. By: Vittas, Dimitri
    Abstract: This paper discusses the mechanics and regulation of participating and unit-linked variable payout annuities. These annuities offer benefits that are not fixed in either nominal or real terms but depend on the performance of the fund or funds in which the underlying reserve assets are invested, their profit sharing features, and the treatment of longevity risk. The paper focuses on the treatment of investment and longevity risks by different types of these annuities and underscores the challenge of establishing a robust and effective framework of regulation and supervision for these products. The paper also addresses the exposure of annuitants to integrity risk and places special emphasis on the need for a high level of meaningful transparency.
    Keywords: Debt Markets,Insurance&Risk Mitigation,Investment and Investment Climate,Pensions&Retirement Systems,Non Bank Financial Institutions
    Date: 2011–08–01
  6. By: Stéphane Hallegatte; Fanny Henriet; Anand Patwardhan; K. Narayanan; Subimal Ghosh; Subhankar Karmakar; Unmesh Patnaik; Abhijat Abhayankar; Sanjib Pohit; Jan Corfee-Morlot; Celine Herweijer; Nicola Ranger; Sumana Bhattacharya; Murthy Bachu; Satya Priya; K. Dhore; Farhat Rafique; P. Mathur; Nicolas Naville
    Abstract: Managing risks from extreme events will be a crucial component of climate change adaptation. In this study, we demonstrate an approach to assess future risks and quantify the benefits of adaptation options at a city-scale, with application to flood risk in Mumbai. In 2005, Mumbai experienced unprecedented flooding, causing direct economic damages estimated at almost two billion USD and 500 fatalities. Our findings suggest that by the 2080s, in a SRES A2 scenario, an ‘upper bound’ climate scenario could see the likelihood of a 2005-like event more than double. We estimate that total losses (direct plus indirect) associated with a 1-in-100 year event could triple compared with current situation (to $690 – $1890 million USD), due to climate change alone. Continued rapid urbanisation could further increase the risk level. Moreover, a survey on the consequences of the 2005 floods on the marginalized population reveals the special vulnerability of the poorest, which is not apparent when looking only through a window of quantitative analysis and aggregate figures. For instance, the survey suggests that total losses to the marginalized population from the 2005 floods could lie around $250 million, which represents a limited share of total losses but a large shock for poor households. The analysis also demonstrates that adaptation could significantly reduce future losses; for example, estimates suggest that by improving the drainage system in Mumbai, losses associated with a 1-in-100 year flood event today could be reduced by as much as 70%. We show that assessing the indirect costs of extreme events is an important component of an adaptation assessment, both in ensuring the analysis captures the full economic benefits of adaptation and also identifying options that can help to manage indirect risks of disasters. For example, we show that by extending insurance to 100% penetration, the indirect effects of flooding could be almost halved. As shown by the survey, the marginalized population has little access to financial support in disaster aftermaths, and targeting this population could make the benefits of such measures even larger. While this study explores only the upper-bound climate scenario and is insufficient to design an adaptation strategy, it does demonstrate the value of risk-assessment as an important quantitative tool in developing city-scale adaptation strategies. We conclude with a discussion of sources of uncertainty, and of risk-based tools that could be linked with decision-making approaches to inform adaptation plans that are robust to climate change.<BR>hangement climatique. Dans cette étude, nous décrivons une méthode permettant d’évaluer les risques futurs et de quantifier les avantages de solutions d’adaptation à l’échelle urbaine, puis nous l’appliquons à l’estimation des risques d’inondation à Mumbai (Bombay). En 2005, une inondation sans précédent frappait la ville de Mumbai, faisant 500 victimes et occasionnant des dommages économiques directs estimés à près de deux milliards de dollars. Nos résultats suggèrent que, d’ici les années 2080, en appliquant le scénario SRES A2 et en sélectionnant un scénario climatique dans le haut de la fourchette, la probabilité d’un événement tel que celui de 2005 pourrait plus que doubler. Selon nos estimations, les pertes totales (directes et indirectes) causées par une catastrophe centennale pourraient tripler par rapport à leur niveau actuel (pour atteindre 690 à 1890 millions de dollars), du seul fait du changement climatique. L’urbanisation rapide et continue pourrait accroître d’autant plus le niveau de risque. D’autre part, l’étude que nous avons faite des conséquences des inondations de 2005 sur les populations marginalisées met en lumière la vulnérabilité particulière des plus démunis, qui n’est pas apparente lorsqu’on se limite aux analyses quantitatives et aux chiffres globaux. Par exemple, selon notre étude, le total des pertes subies lors des inondations de 2005 par les personnes marginalisées avoisinerait 250 millions de dollars, une faible part du total des dommages, mais un désastre considérable pour les foyers pauvres. Notre analyse montre également que l’adaptation pourrait substantiellement réduire les dommages futurs : nous estimons ainsi que les dommages causés par une inondation centennale pourraient être réduits de 70 % si l’on améliore le réseau d’assainissement de Mumbai. Quand on procède à une évaluation de l’adaptation, il importe d’estimer les coûts indirects des événements extrêmes car on peut ainsi à la fois intégrer à l’analyse l’ensemble des avantages économiques de l’adaptation et identifier des options de gestion des risques indirects liés aux catastrophes. Par exemple, nous montrons que si 100 % des habitants étaient en mesure de souscrire une assurance, les effets indirects des inondations pourraient être réduits de près de la moitié. Comme l’indique notre étude, la population marginalisée a peu accès aux aides financières après les catastrophes : les avantages de telles mesures pourraient donc être encore plus élevés si cette population était ciblée en priorité. Notre étude se limite à un scénario climatique dans le haut de la fourchette et ne suffit pas à élaborer une stratégie d’adaptation à part entière. Néanmoins, elle démontre la valeur des évaluations des risques, outils de mesure importants quand il s’agit de concevoir des stratégies d’adaptation à l’échelle urbaine. Nous concluons par un examen des sources d’incertitude ainsi que des outils fondés sur les risques qui, associés à des processus décisionnels, permettraient de formuler des plans d’adaptation durable au changement climatique.
    Keywords: sustainable development, insurance, government policy, climate change, global warming, natural disasters, flood management, adaptation, urban planning, développement durable, assurance, changement climatique, réchauffement climatique, adaptation, catastrophes naturelles, gestion des inondations, aménagement urbain, action publique
    JEL: E20 O18 Q01 Q54 R11 R52
    Date: 2010–11–22
  7. By: Pierluigi Bologna
    Abstract: This paper tests the role of different banks’ liquidity funding structures in explaining the banks’ failures, which occurred in the United States between 2007 and 2009. The results highlight that funding is indeed a significant factor in explaining banks’ probability of default. By confirming the role of funding as the driver of banking crisis, the paper also recognizes that the new liquidity framework proposed by the Basel Committee on Banking Supervision appears to have the features to strenghten banks’ liquidity conditions and improve financial stability. Its correct implementation together with closer supervision of banks’ liquidity and funding conditions appear, however, the determinant for such improvements to be achieved.
    Keywords: Banking crisis , Bank supervision , Basel Core Principles , Deposit insurance , Liquidity ,
    Date: 2011–07–28
  8. By: Yulei Luo (The University of Hong Kong); William T. Smith (Department of Economics, Fogelman College of Business & Economics, University of Memphis); Heng-fu Zou (CEMA, Central University of Finance and Economics; Shenzhen University; Wuhan University)
    Abstract: In a recent paper [Luo, Smith, and Zou (2009)] we showed that the spirit of capitalism could in theory resolve the two fundamental anomalies of modern consumption theory, excess sensitivity and excess smoothness. However, that basic model could not plausibly explain the empirical magnitude of excess smoothness. In this paper we develop two extensions of the model ¡ª one with transitory and permanent shocks to income, the other with a stochastic interest rate ¡ª that where the spirit of capitalism can explain excess smoothness.
    Keywords: The spirit of capitalism, Consumption smoothing, Interest rate risk
    JEL: C61 E21
    Date: 2011

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