Anne Kleffner

The Effect of Corporate Governance on the Use of Enterprise Risk Management: Evidence From Canada

This article examines the use of enterprise risk management (ERM) by companies in Canada, the characteristics that are associated with the use of ERM, what obstacles companies face in implementing ERM, and what role, if any, corporate governance guidelines have played in the decision to adopt ERM. We obtained our data from the responses to a mail survey sent to Canadian Risk and Insurance Management Society members as well as telephone interviews with 19 of the respondents. The results indicate that 31 percent of the sample had adopted ERM and that reasons for adopting ERM include the influence of the risk manager (61 percent), encouragement from the board of directors (51 percent), and compliance with Toronto Stock Exchange (TSE) guidelines (37 percent). The major deterrents to ERM were an organizational structure that discourages ERM and an overall resistance to change. Although only about one-third of companies indicated that they had adopted an ERM approach, evidence was clear that a larger portion of the sample was moving in that direction, as indicated by what changes they had observed in their companies in the past three years. These include the development of company-wide guidelines for risk management (45 percent), an increased awareness of nonoperational risks by operational risk management personnel and an increased awareness of operational risks by nonoperational risk management personnel (49 percent), more coordination with different areas responsible for risk management (64 percent), and more involvement and interaction in the decision making of other departments. Contrary to what we expected, there was not a significant difference between firms that are listed on the TSE versus those that are not in terms of the propensity to use ERM. However, the fact that 37 percent of firms indicated that the TSE guidelines were influential in their decision to adopt ERM provides some evidence that the guidelines are influencing companies’ risk management strategies.

Costly Risk Bearing and the Supply of Catastrophic Insurance

Efficient contracts for sharing risk will allocate risk according to comparative advantage. This article considers insurance markets for earthquake risk and how comparative advantage in risk bearing can explain the amount of business individual insurers write. The respective abilities of insurers to write this risk depend on the characteristics of their entire portfolio as well as on financial features that influence the costs of risk bearing. Several recent contributions have shown why risk is costly to corporations such as insurers. The costs of risk arise from tax convexity, principal agent relationships within the firm, and the costs of financial distress. We will show how these types of features jointly determine the capacity of insurers to write earthquake insurance. We derive and estimate a cross-sectional model of earthquake insurance, and the results support the hypothesis that firms with a higher imputed cost of risk bearing assume less earthquake risk.

Optimal Loss Mitigation and Contract Design

This work examines the interaction between the premium rates set by an insurer and the incentives of an individual to purchase market insurance and undertake mitigation to reduce the size of a potential loss. A risk-neutral monopolistic insurer prices insurance according to the price-elasticity of demand for coverage. The elasticity of demand is affected by the presence of both mitigation and government intervention. The availability of loss reduction activities increases the consumers elasticity of demand and lowers the optimal rate charged by the monopolist. Government intervention reduces both expenditures on mitigation and the rate charged by the monopolistic insurer.

The Evolution of the Role of Risk Communication in Effective Risk Management

Risk management has evolved significantly over the past decades causing dramatic changes in the communication channels required to effectively handle the ever-changing risks a firm faces. The first generation of risk management dealt primarily with risks inside a company creating a need for internal risk communication. The second generation, which arose with the growth in third-party liability claims, involved many more stakeholders external to the company and forced the risk management function to deal with communications to these external parties. The third generation, which began as an expansion of the external risks that firms are exposed to, involves the board and senior management in the risk communication function.

Loss Reserves and the Employment Status of the Appointed Actuary

Abstract Property/casualty (P/C) insurers are required to establish loss reserves for unpaid losses at the time that the loss has occurred or is reasonably expected to have occurred. We examine factors that may impact the accurate setting of loss reserves. These include the level of rate regulation faced by the insurer and the incentives to underestimate or overestimate reserves to improve financial ratios or improve solvency scores, to reduce earnings, to defer taxes, or to smooth earnings volatility in order to meet shareholder expectations. The employment status of the Appointed Actuary, that is, whether the Appointed Actuary is an employee of the firm or a consultant, may also impact reserve accuracy. Using a variety of regression models with data from 1995 to 2010, we examine the impact of these factors on the accuracy of reserves posted by Canadian P/C insurers. Our results provide no evidence of systematic differences in the magnitude or direction of loss reserve errors between insurers that use company actuaries versus those that use consultant actuaries. However, we find that for both consultant and company actuaries positive reserve errors are associated with increases in global stock market returns and decreases in unanticipated inflation. The insurance market cycle impacts reserve errors for company actuaries and not consultant actuaries. As well, our results indicate that as the proportion of short-tailed business increases in a company, consultant actuaries are more likely to over-reserve. Similar to many previous studies using U.S. data, we do not find strong evidence regarding insurers’ incentives to deliberately overstate or understate reserves: Loss reserves are relatively unbiased estimates of the true losses paid. Thus these findings should be welcome news to the actuarial profession in Canada and to the prudential regulator: The Appointed Actuary, regardless of employment status, provides objective and unbiased estimates of insurers’ largest liability.

First‐Party Versus Third‐Party Compensation for Automobile Accidents: Evidence from Canada

Insurance regimes for compensating losses arising from automobile accidents vary by jurisdiction, ranging from a pure tort system to a pure no�?fault system, with both systems having well�?documented benefits and costs. The majority of published research focuses on the benefits and costs associated with the compensation for bodily injury. This article extends the existing literature by examining the differences between first�?party and third�?party recovery for both physical damage and bodily injury losses in Canada. Our comparison of auto insurance costs per insured vehicle suggests that government�?run, pure no�?fault provinces have lower average costs than provinces with private tort and modified no�?fault. Lower costs arise from the elimination of tort costs associated with noneconomic damages, lower claims settlement costs due to first�?party compensation, and scales of economy arising from monopoly power. The second goal of the article is to examine the impact of first�? versus third�?party compensation on the settlement of property damage claims. We analyze the claim files of a large insurer that operates within both a traditional tort (third�?party) environment and a first�?party recovery environment for property damage. We find that in a first�?party recovery regime claims are settled sooner, settlement costs are lower, and not�?at�?fault drivers are compensated at a higher rate than in the traditional tort environment.

Barriers to achieving additionality in carbon offsets: a regulatory risk perspective

The Specified Gas Emitters Regulation (SGER) in Alberta, Canada was the first North American regulation to mandate reductions in greenhouse gas emissions. Regulated entities may use carbon offsets to meet their emissions reduction obligations. Although conceptually sound, the offset market has fallen short of its potential to reduce emissions. By analyzing the policies and operations of the Alberta Emissions Offset System (AEOS), enabled by the SGER, we illustrate how participants are impacted by uncertainty in the Alberta carbon offset development process, using ECB Lethbridge Biogas as a case study. Our analysis shows that existing uncertainty from regulation creates risk for projects, which builds barriers that prevent regulated entities, project developers, and the province of Alberta from reaching the full potential of the regulation. We provide recommendations that will help to achieve additionality within the offset system by encouraging increased participation from high-quality projects, ultimately resulting in greater emission reductions.

The Impact of Regulation on the Availability and Profitability of Auto Insurance in Canada

This article investigates the impact of automobile insurance regulation on the size of the involuntary insurance market as well as the level and volatility of auto insurance loss ratios in Canada. We find that rate reduction orders, product reform and a pricing “Grid” that establishes maximum premiums increase the size of the involuntary market, while prior approval does not have any significant effect. In addition, unlike U.S. studies, we find that prior approval does not significantly impact loss ratio volatility. Our models also incorporate the impact of macroeconomic variables that proxy for the underwriting cycle and investment returns. The results suggest that the insurance underwriting cycle and stock market returns appears to be as important in determining insurers’ usage of the involuntary market as regulation. Taken together, our results suggests that regulatory interventions aimed at addressing affordability issues may have the unintended consequence of aggravating availability issues, and underlying market conditions may exacerbate this effect.

The impact of adjuster moral hazard on driving records

Abstract In a first-party recovery scheme for automobile property damage, the first-party insurer compensates not-at-fault vehicular damage. In this scheme, adjusters may not have the incentive to assign liability when the driver is, in fact, at fault for the accident. This is due to adjusters not having to coordinate with a third-party adjuster, and, for insureds that carry collision coverage, the assignment of fault does not appreciably affect the compensation paid out. This in turn reduces the effectiveness of the experience-rating component of the insurance premium. Empirical evidence that supports the presence of incorrect fault assignment is provided. A stochastic model of experience rating analyzing the impact of incorrect fault assignment on driving record classes confirms that low-risk insureds pay more for insurance than if fault was correctly assigned.