In the face of ever-increasing weather volatility, insurance companies are becoming more adaptive to handle capital challenges and ensuring their solvency. While different divisions within insurance companies would ideally exist within a vacuum, severe price shocks often necessitate that resources flow between them.
In her working paper “How Do Hurricanes Aﬀect Life Insurance Premiums? The Eﬀects of Financial Constraints on Pricing,” Shan Ge, a researcher and PhD candidate at The Ohio State University’s Fisher College of Business and research fellow at The Risk Institute, examines this trend.
According to Ge’s model, a hurricane might result in a severe shock due to a large number of claims to the Property & Casualty (P&C) division while the Life division escapes relatively unscathed. Pricing adjustments can then be made in one division to help transfer needed resources to another division.
“The insurance industry oﬀers a unique setting to study how shocks to ﬁnancial constraints aﬀect ﬁrms’ pricing behavior,” said Ge. “Many insurance companies are organized into groups of commonly owned aﬃliated companies. Some groups contain both life and P&C insurance subsidiaries, which are subject to unrelated shocks. For example, a hurricane can have a large impact on a P&C business but not directly on a life insurance business.”
In the wake of such an event, the Life division of the company will want to stimulate the amount of incoming capital and could lower the premiums of policies whose initial costs would be covered by the purchase price. Conversely, policies resulting in an initial outflow of capital would see their policies increase.
This increase in capital is important for a couple reasons: First, when assets are deemed too low to meet liabilities (say, when P&C claims spike due to a hurricane), regulators can seize control. Transfer of capital from one division to another can help to prevent this. Also, customers prefer to utilize better-capitalized insurers. This free flow of capital is vital to insurers when faced with heavy losses in one division vs. another.
While hurricanes bring a host of literal emergencies, flexibility of resources in their aftermath can help to mitigate some of the potentially devastating effects. Similarly, insurance companies facing financial shortfalls from such disasters can benefit by applying timely pricing strategy to allocate their resources where they’re needed most.
Shan Ge is a research fellow at The Risk Institute. The Risk Institute at The Ohio State University’s Fisher College of Business exists to bridge the gap between academia and corporate America. By combining the latest research with the real-world expertise of America’s most forward-thinking companies, the Risk Institute isn’t just reporting risk management’s current trends — it’s creating tomorrow’s best practices.