Estimating market value of liabilities: The impact of interest sensitivity of loss payments on liabilities of property-liability insurance companies
After the revolution in fixed income valuation technologies that occurred in the mid 1980s, the new technologies have been applied in the insurance area only for life insurance and pensions. Property-liability lines have never been studied. This study has tried to make three contributions. First, a sophisticated, elaborate methodology based on the Modified Taylor's Separation Method (MTSM) was suggested to predict loss payments, considering current economic information. Second, we have looked at actual loss payments versus predicted loss payments and related the variations to changes in interest and inflation rates. Finally, we have used a one-factor interest rate model based on the Black-Derman-Toy algorithm to ascertain the effect of the interest rate sensitivities on the market value and the duration. The regression results found in this study are likely not to support clearly and strongly the positive effect of changes in interest or inflation rates on loss payments, showing that with many property-liability insurance lines there is no statistically significant relationship between unexpected interest or inflation rate changes and claims payments, depending on the methodology used for generating estimated loss payments and the development year. In light of our evidence, and until any additional evidence is generated, it would appear reasonable to continue using the traditional and simpler discounted cash flow models to estimate market values of liabilities for property-liability insurance companies. However, we are still convinced that if a credible correlation of loss payments with interests rates is detected, the property-liability insurer must adopt modern valuation technologies that make explicit allowance for future interest fluctuations. Modern valuation technologies such as a one-factor binomial tree model would provide a sound basis for financial management in a volatile economic environment.
Choi, Jung-Ho, "Estimating market value of liabilities: The impact of interest sensitivity of loss payments on liabilities of property-liability insurance companies" (1991). Dissertations available from ProQuest. AAI9211922.