Risk-Based Capital and Firm Risk Taking in【推荐论文】 .doc

精品论文Risk-Based Capital and Firm Risk Taking inProperty-Liability InsuranceJIANG CHENG1, Mary A. Weiss25(1. School of Finance, Shanghai University of Finance and Economics, ShangHai 200433;2. Fox School of Business, Temple University, Philadelphia 19025)Abstract: This research investigates the relationship between capital and risk in property-liability insurers from 1993 to 2007.Three-stage-least-squares estimation is used to investigate the relationship between capital and two types of risk: underwriting and asset risk. Overall the results10suggest that risk and capital are positively related, so that capital increases are associated with increases in investment and underwriting risk. This positive relationship was not consistently significant in1993, prior to the implementation of RBC requirements. Both under-capitalized insurers and marginally adequately capitalized insurers adjusted their capital and risk towards firm targets at ahigher speed than well-capitalized insurers in the post RBC period. But underwriting and asset risk15also increased for less well-capitalized insurers.Keywords: Insurance Economics; Risk-Based Capital; Regulatory Effect; Capital; Risk0IntroductionMaintaining insurer solvency has always been a focal point of insurance regulation.U.S.20regulators use various methods to promote insurers financial strength and protect policyholders from losses due to insolvency. One important tool is embodied in Risk Based Capital (RBC) requirements which went into effect in the U.S. property-liability insurance industry in 1994. An important feature of the RBC system is that it mandates intervention by the regulator when risk-based capital levels are deemed deficient. The degree of intervention varies with the degree of25deficiency, and ranges from regulatory approval of an insurer action plan to correct the deficiencyto mandatory take-over of the insurer.Because it contains mandatory requirements, the RBCsystem is at least partly designed to eliminate regulatory forbearance in the industry.Research by Cummins and Nini1 suggests that the imposition of RBC requirements may have been partly responsible for increased capital levels in the property-liability insurance industry30in the 1990s, enhancing solvency. But considerable research criticizes the RBC system.For example, Cummins, Harrington and Niehus2 hypothesize that imperfections in the existing RBC system will likely distort insurers behavior in undesirable and unintended ways so as to avoid being incorrectly identified as needing regulatory attention. Most studies of RBC have focused onthe effectiveness of RBC requirements in predicting property-liability insurer insolvencies.35Research suggests that RBC results are not good predictors of insolvency (e.g., Cummins, Grace and Phillips, 19993; Cummins, Harrington and Klein, 19954). Cheng and Weiss (2012) 5 6 find that the accuracy of the RBC ratio in predicting insolvencies is inconsistent over time. They provide summary statistics for the RBC ratios historically and the RBC classifications. Another possibility that exists is that insurers (especially weak insurers) will exploit anomalies in the RBC40formula so as to make their financial position appear to be more favorable than it really is.To understand the true effect of RBC requirements on insurers behavior, the relationship between capital and risk in insurers must be determined. For example, capital and insurer risk may be positively related so that increasing capital requirements leads to offsetting increases in risk.In this case, increases in risk corresponding to the increased capital requirements associated withFoundations: Specialized Research Fund for the Doctoral Program of Higher Education (New Teachers Grant#Z1025420); Scientific Research Foundation for the Returned Overseas Chinese Scholars (Grant #2012940) Brief author introduction: JIANG CHENG, (1971-), Male, Assistant Professor,Main research areas include Corporate governance and Insurance. E-mail: cheng.jiangmail.shufe.edu.cn- 14 -45RBC may have offset RBCs intended effect of improving solvency.On the other hand, capital and risk may be unrelated or negatively related so that increases in capital requirements are accompanied by no change in insurer risk or decreases in insurer risk.Then, RBC requirements may have led to a net improvement in capital levels and enhanced solvency in the industry.In spite of these possibilities associated with the use of RBC in practice, little research is50aimed at addressing how insurers may have changed their capital decisions and risk taking behavior before and after adoption of RBC. Cummins and Sommer7 determine the empirical relationship between capital and risk in property-liability insurers using a sample period of 1979 to1990. They find the relationship between capital and risk to be positive in property-liability insurers.This result suggests that any increases in capital that may be attributable to RBC55requirements would be offset by increases in risk. However the period preceded implementation ofRBC, and insurer behavior might be different as a result.The purpose of this study is to determine the relation between insurers capital positions and risk-taking behavior in 1993 (prior to the implementation of RBC) and from 1994 to 2007 (after RBC was adopted). The period 1993 in addition to 1994 to 2007 is examined because insurers60may have been readjusting their capital and risk portfolio in anticipation of RBC.Further, this research estimates the impact of RBC requirements on marginally adequately capitalized insurers and under-capitalized insurers in particular.The sample of insurers studied consists of pooled, cross-sectional U.S. property-liability insurers included in the NAICs data base for the period 1992 to 2007. Thus this research also65updates the analysis of Cummins and Sommer7. Following a long line of literature, the modelused allows for capital and risk positions to be determined simultaneously, so that three-stage least squares (3SLS) estimation is used to estimate the capital and risk equations. The 3SLS model incorporates the possibility that insurers may be unable to adjust to their target risk or capital levels over the course of a year.That is, the capital and risk equations estimated allow for partial70adjustment of capital and risk. The capital measures rely on surplus, while measures of insurer risk are based on asset and underwriting risk.To measure the effect of RBC implementation on under- and marginally adequately capitalized insurers, indicator variables that reflect relative capitalization of insurers (using the RBC system) are included in the models.And the inclusion of these variables represents an75innovation from Cummins and Sommer7. The results with respect to these variables can beinterpreted as the impact of regulatory pressure on these insurers from RBC implementation. Ceteris paribus, we posit that weaker insurers may have had a larger response to the imposition of RBC requirements in order to avoid regulatory sanctions.By way of preview, the results overall suggest that risk and capital are positively related, so80that capital increases are associated with increases in asset and underwriting risk.This positive relationship was not consistently significant in 1993, prior to the implementation of RBC requirements.Further, both under-capitalized insurers and marginally adequately capitalized insurers adjusted their capital and risk towards firm targets at a higher speed than well-capitalized insurers in the post RBC period .85The remainder of this research is organized as follows.In the next section the RBCrequirements for insurers are briefly described.Following this, the hypotheses are presented. The next sections focus on the methodology and the data description.The results are contained in the subsequent section, and the last section concludes.90951001Hypotheses DevelopmentCapital adequacy is assessed with the RBC ratio, defined as the ratio of total adjusted capital (TAC) to RBC. TAC is composed primarily of surplus (or equity) of an insurer. RBC itself is determined from a formula that attaches weights (or factors) to detailed, risk-related items in the insurers financial statements.The risks encompassed by RBC requirements are primarily underwriting and asset risk; and these risks account for 87 percent of total risk based capital.Based on their RBC ratios, insurers are classified into one of five ranked categories depending on the degree of any capital deficiency. The RBC categories (and required regulatory/insurer action) are C1 (no action needed), C2 (insurer required to file a plan with commissioner detailing its financial condition and how it proposes to correct deficiency), C3 (regulator examines the insurer and institutes corrective action if necessary), C4 (regulator has legal grounds to rehabilitate the company) and C5 (regulator required to seize the insurer). Table 1 specifies the thresholds corresponding to each of these categories. For example, Table 1 indicates that insurers with an RBC ratio greater than or equal to 2 are associated with no regulatory action.Table 1. “Risk” Categories Based on the NAIC RBC Ratios (TAC/ACL RBC)Insurer "RRBC RatioNAIC Regulatory Action LevelClassifications in this StudyC1RBC ratio >= 2No action needN/AC21.5 <= RBC ratio < 2Company action levelModerately financially distressed/Under-capitalized insurersC3C41 <= RBC ratio < 1.50.7 <= RBC ratio < 1Regulatory action levelAuthorized control levelModerately financially distressed/Under-capitalized insurersModerately financially distressed/Under-capitalized insurersC5RBC ratio < 0.7Mandatory control levelHighly financially distressed/Under-capitalized insurers105110115120Note: TAC is the Total Adjusted Capital, and ACL RBC is the Authorized Control Level RBC.Several reasons exist to suggest that capital and risk are positively related. That is, capital and risk may be considered as substitutes by an insurer. In this case, constraints on capital levels, such as those imposed by RBC, may induce insurers to take on more risk.If insurers are concerned with bankruptcy costs, then increases in risk may lead to higher capital and a positive relationship between risk and capital.Finally, agency costs may lead to a positive relationship between risk and capital if managers, because of their substantial human investment in the insurer, offset increases in insurer risk by holding higher capital amounts. Thus, Hypothesis 1 states,Hypothesis 1:Insurers risk and capital are positively related to each other.However, the positive relationship between risk and capital might be weakened, if not completely reversed to a negative relationship, for insurers close to financial distress. Moral hazard is posited to exist in the insurance industry because of guaranty funds.More specifically, insurers are not charged a risk-based default premium to cover costs in the event of their insolvency.Instead, when an insurer becomes insolvent, solvent insurers are assessed a flat rate to cover insolvency costs. Thus, maximizing shareholders wealth for insurers close to financial distress could entail increasing risk relative to capital to take advantage of the moral hazard posed by the guaranty fund system.However, guaranty fund coverage is much less complete than deposit insurance in the U.S. banking industry, so that the excessive risk-taking incentive is weaker in property-liability insurance.For example, some lines of insurance are excluded from coverage such as commercial insurance, and maximum guaranty fund payment limits exist where coverage does apply. Thus policyholders have an incentive to monitor insurers for excessive risk-taking.125130135140145150155160165Even if incentives were not weaker for excessive risk-taking in property-liability insurance, however, insurers could not increase risk relative to capital in an unchecked fashion.Besides regulatory surveillance (other than RBC), rating agencies provide policyholders with information on the credit-worthiness of the insurer.Following the moral hazard argument, insurers with marginally sufficient capital might havedifferent risk-taking behavior compared to well-capitalized insurers and under-capitalized insurers. The response of insurers capital and risk levels after imposition of RBC may depend on whether insurers were holding an amount of capital above the RBC requirements prior to RBC implementation.Insurers with capital levels significantly above the required level may not have responded to the imposition of RBC at all or may even have increased risk (relatively).Insurers with relatively low capital buffers may have tried to build an appropriate buffer by raising capital and/or lowering risk at a higher speed toward firm targets than well-capitalized insurers. That is, insurers results are exposed to exogenous shocks related to developments in the overall economy or the property-liability insurance industry, hence insurers may wish to insulate their capital from such shocks with a buffer.In addition, reducing risk or raising capital at a higher speed than well-capitalized insurers for these insurers may have served as a signal that they were in regulatory compliance leading to a reduction in regulatory costs. Insurers with RBC deficiencies may have had a stronger response to RBC requirements as these insurers likely experienced regulatory pressure to improve capital positions (or decrease risk) within a relatively shorter time frame.Thus Hypothesis 2 states,Hypothesis 2:Capital and risk were more responsive in weaker insurers with the implementation of RBC.Imposition of RBC requirements may have changed the cost-return tradeoff between risk andcapital in the insurance industry.In this case, one would expect that capital levels for insurers in different RBC categories responded differently prior to the time RBC became effective than afterwards.Hypothesis 3 states,Hypothesis 3:Changes in capital and risk for insurers in varying financial condition were different prior to the imposition of RBC requirements than afterwards.2MethodologyThe models used in Cummins and Sommer7 and Shrieves and Dahl8 with the modification of Aggarwal and Jacques9 and Jacques and Nigro10