James M. Carson

Life Insurer Financial Distress: Classification Models and Empirical Evidence

This study extends previous research on life insurer insolvency by providing empirical evidence on a large (nonmatched-pair) sample of insurers based on three alternative types of statistical models. The study utilizes 1986 through 1990 data for a sample of insurers that did or did not become financially impaired during 1989 through 1991. Empirical evidence suggests that surplus measures and leverage measures are strong indicators of insurer financial strength; however, no evidence is found for a strong relationship between state minimum capital requirements and insolvency. Classification rates for this studys large sample are generally lower than those found in previous studies examining earlier time periods and using smaller, matched-pair samples.

ECONOMIC AND MARKET PREDICTORS OF INSOLVENCIES IN THE LIFE-HEALTH INSURANCE INDUSTRY

This study identifies factors exogenous to individual insurers that are statistically related to the overall rate of life-health insurer insolvencies. This is a departure from the methodologies of prior studies, which have focused primarily on firm-specific characteristics in assessing insolvency risk. Empirical analysis is based on quarterly data from 1972 through 1994. Results indicate that life-health insurer insolvencies are positively related to increases in long-term interest rates, personal income, unemployment, the stock market, and to the number of insurers, and negatively related to real estate returns. Findings support the hypothesis that economic and market variables are important predictors of life-health insurer failure rates.

Interest Rate Risk and Equity Values of Life Insurance Companies: A GARCH-M Model

The importance of managerial decisions related to interest-sensitive cash flows has received considerable attention in the insurance literature. Consistent with the interest-sensitive nature of insurer assets and liabilities, empirical research has shown that insurer insolvency is significantly related to interest rate volatility. We investigate the interest rate sensitivity of monthly stock returns of life insurers based on a generalized autoregressive conditionally heteroskedastic in the mean (GARCH-M) model. We examine three different portfolios (equally weighted, risk-based, and size-based) with binary variables to explicitly account for varying interest rate strategies adopted by the Federal Reserve System. Results based on data for the period 1975 through 2000 indicate that life insurer equity values are sensitive to long-term interest rates and that interest sensitivity varies across subperiods and across risk-based and size-based portfolios. The results complement insolvency research that links insurer financial performance to changes in interest rates.

A Dynamic Analysis of the Demand for Life Insurance

Prior research suggests that neither the choice to own life insurance nor the amount purchased is consistently related to the presence of children in the household. While these perplexing findings are based on a static framework, we alternatively examine life insurance demand in a dynamic framework as a function of changes in household life cycle and financial condition. Our results indicate both a statistically and economically significant relation between life events, such as new parenthood, and the demand for life insurance. We also provide new evidence in support of the emergency fund hypothesis: households in which either spouse has become unemployed are more likely than other households to surrender their whole life insurance.

Internal Capital Markets and the Partial Adjustment of Leverage

Prior literature provides support both for the existence of target capital structures and internal capital markets (ICM). The issue of whether firms use internal capital markets to reduce deviations from target capital structures, however, has yet to be examined. We provide the first empirical evidence of a link between deviations from target leverage and ICM activity. Based on data that allow us to trace intra-group capital market transactions for property–casualty insurers, our findings provide the first joint evidence that affiliated insurance companies have target leverage ratios and that ICM activity is used to manage deviations from target leverage.

The influence of compensation on product recommendations made by insurance agents

Lawsuits alleging illegal and unethical insurance sales practices have received widespread publicity in recent years. Although many observers have argued that one source of ethical conflicts for insurance agents is the industrys reliance on straight commission compensation, there remains a paucity of empirical data to support the claim. Therefore, we tested whether different forms of compensation influence insurance agent recommendations of products. We obtained survey responses from 336 insurance agents. Respondents were presented with a composite sketch of a hypothetical client. Following this description, they were asked to identify which one of eight specified life insurance products they would recommend to the client. A between-groups design was employed to manipulate differences in compensation associated with the eight products. Results indicated that neither amount of coverage nor type of coverage (term life versus cash value) recommended was associated with compensation. However, an unanticipated finding was that amount of coverage recommended was significantly higher when the insured was male than when the insured was female.

Market Risk, Interest Rate Risk, and Interdependencies in Insurer Stock Returns: A System-GARCH Model

We examine market risk, interest rate risk, and interdependencies in returns and return volatilities across three insurer segments within a System-GARCH framework. Three main results are obtained: market risk is greatest for accident and health (AH interest rate sensitivity is negative and greatest for Life insurers; and interdependencies in returns are significant with the magnitude being strongest between P&C and A&H insurers. The implication is that greatest diversification benefits arise between Life and the other segments of the insurance industry. Market risk and interest rate risk for diversified firms are smaller than those for nondiversified firms for both product and geographic diversification.

Deciding Whether to Invest in Mitigation Measures: Evidence from Florida

Prior research provides theoretical insight on factors likely to impact the decision to mitigate such as the degree of risk aversion, the cost of market insurance, and the cost of self insurance. We provide empirical evidence related to several hypotheses from the self insurance literature on the decision to mitigate.

The Demand for Life Insurance Policy Loans

Previous research has examined the demand for life insurance policy loans using aggregate policy loan data. In contrast, we use a detailed household survey data set containing life insurance and policy loan information to alternatively, and in some cases more directly, examine the four hypotheses traditionally associated with policy loan demand. Our research provides the first U.S. evidence (in the post–World War II period) in support of the policy loan emergency fund hypothesis. In particular, we find that the more detailed emergency fund proxies used here reveal a significantly positive relation between loan demand and recent expense or income shocks.

An Econometric Analysis of the Demand for Life Insurance Policy Loans

Driving Forces of Policy Loan Demand Previous research has found several variables related to the demand for life insurance policy loans, including market interest rates (Schott, 1971; Bykerk and Thompson, 1979; Cummins, 1973), personal income (Wood, 1964; Rejda, 1966), the unemployment rate (Cummins, 1973), and costs of alternative sources of credit (Day and Hendershott, 1977). Policy loans constitute a form of disintermediation for insurers and are important because they disrupt insurer cash flow and impose an opportunity cost if the market interest rate exceeds the policy loan interest rate.(1) This article assesses the impact that redesigned life insurance policy loan provisions and changes in financial markets have had on the demand for policy loans and the risk of disintermediation. The research extends previous work - which has focused exclusively on periods of fixed loan rates - by investigating policy loan demand from 1970 through 1989, a period encompassing both fixed and variable loan rates.(2) Because the structure of policy loan demand may have shifted over the sample period, a test for structural change is performed. While previous econometric analyses of policy loan demand have used quarterly data, this study uses monthly data. Market Conditions On policies issued before 1980, loan rates generally were fixed at between 5 and 6 percent. Thus, for various reasons, when market interest rates were equal to or in excess of policy loan rates, relatively more policyowners exercised their option to access cash values, and insurers lost the use of large amounts of assets. Policy loans outstanding at the end of 1970 equaled