Academic journal article Journal of Risk and Insurance

Economic and Market Predictors of Insolvencies in the Life-Health Insurance Industry

Academic journal article Journal of Risk and Insurance

Economic and Market Predictors of Insolvencies in the Life-Health Insurance Industry

Article excerpt


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.


Life-health insurer insolvency adversely affects various stakeholders (e.g., policyholders, beneficiaries, investors) as well as capital markets, since the insurance industry is a major supplier of funds. While life-health insurers face risks similar to those risks faced by other financial intermediaries (e.g., interest rate, liquidity, and credit), previous research primarily has focused on identifying financial statement variables and insurer-specific ratios to employ as regressors in empirical models to differentiate between low- and high-risk insurers. Although market conditions affect firms to varying degrees, the overall economic environment's impact on the number and size of insolvencies in an industry is potentially significant. Recent experience in the savings and loan industry suggests that exogenous factors have significant implications for the viability of firms in financial services industries.

Early identification of insurers at risk of failure is essential to minimize the burden placed on state insurance guaranty funds and the perceived need to protect the public against the consequences of insolvency. While prior insolvency studies have attempted to identify particular insurers in financial distress, comparatively little research has identified economic and market conditions that increase the probability of insolvency for all insurers.

Figure 1 depicts the life-health insurer insolvency rate in each quarter from 1972 through 1994. The figure shows that during the period 1972 to 1989 the insolvency rate was relatively low, except during 1983, and there was little variation in the rate of insolvencies that occurred between quarters. The insolvency rate began to increase sharply in 1989.

The goal of the study is to identify factors that are exogenous to individual life health insurers that increase their susceptibility to insolvency. Previous studies on life-health insurer insolvency largely have focused on firm-specific factors associated with an increased likelihood of bankruptcy (e.g., see Carson and Hoyt, 1995). However, conditions that are exogenous to the firm may increase the likelihood of financial distress.

The theory of bank and insurer capital structure and default risk posits franchise value (Harrington and Danzon, 1994) as a disincentive for excessive risk taking by firms despite limited liability and guaranty funds. The presence of limited liability creates incentives for insurers to implement riskier underwriting and investment strategies than would otherwise be warranted. Firms with relatively little capital are particularly likely to pursue riskier strategies. If limited liability results in increased risk taking and, thereby, in an increased likelihood of insolvencies, then the probability of insolvency will depend on factors external to the insurer. Factors that affect the success of risky investment strategies and risky underwriting likely will affect the solvency of insurers.

An often-cited function of insurance regulation is to monitor the solvency of insurers. Regulation to prevent insolvencies takes several forms, including minimum capital and surplus requirements, risk-based capital requirements, rate regulation, requirements that annual statements be filed with regulatory authorities, and the periodic examination of the books and records of insurers. …

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